« » Table of Contents………………………………………………………………………………. 1 INTRODUCTION…………………………………………………………………………………………. 3 Importance of Audit…………………………………………………………………………………. 4 Objects of an Audit………………………………………………………………………………….. 4 Auditors Distinguished from Other White-collar Professionals………… 5 Problem Areas in Auditing………………………………………………………………………. 5 Research Methodology:………………………………………………………………….. 7 Appointment, Removal, Resignation and Remuneration of Auditors 8 Appointment of Auditors…………………………………………………………………………. 8 Indian Law………………………………………………………………………………………………. 8 english law…………………………………………………………………………………………….. 12 Removal or Resignation of Auditors…………………………………………………….. 14 Indian Law…………………………………………………………………………………………….. 14 English Law…………………………………………………………………………………………… 14 Qualifications and Disqualifications of Auditors……………………………….. 16 Indian law……………………………………………………………………………………………… 16 English law…………………………………………………………………………………………….. 18 Remuneration of Auditors…………………………………………………………………….. 19 Indian Law…………………………………………………………………………………………….. 19 English Law…………………………………………………………………………………………… 19 Duties and Responsibilities of Auditors…………………………………. 20 Position of the Auditors………………………………………………………………………… 20 Auditor as a Watchdog………………………………………………………………………….. 21 Duties of Auditors…………………………………………………………………………….. 23 GENERAL DUTIES IN CARRYING OUT AUDIT……………………………………. 24 DUTY OF CARE………………………………………………………………………………………… 24 Standard of Care……………………………………………………………………………………. 26 Like Sign Up to see what your friends like. Auditor’s Liability file:///F:/08. Downloads/Documents/auditor-e2-80-99s-liability.html 1 of 55 27-06-2011 04:29 PM
Transcript
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Table of Contents………………………………………………………………………………. 1
INTRODUCTION…………………………………………………………………………………………. 3
Importance of Audit…………………………………………………………………………………. 4
Objects of an Audit………………………………………………………………………………….. 4
Auditors Distinguished from Other White-collar Professionals………… 5
Problem Areas in Auditing………………………………………………………………………. 5
Research Methodology:………………………………………………………………….. 7
Appointment, Removal, Resignation and Remuneration of Auditors 8
Appointment of Auditors…………………………………………………………………………. 8
Indian Law………………………………………………………………………………………………. 8
english law…………………………………………………………………………………………….. 12
Removal or Resignation of Auditors…………………………………………………….. 14
Indian Law…………………………………………………………………………………………….. 14
English Law…………………………………………………………………………………………… 14
Qualifications and Disqualifications of Auditors……………………………….. 16
Indian law……………………………………………………………………………………………… 16
English law…………………………………………………………………………………………….. 18
Remuneration of Auditors…………………………………………………………………….. 19
Indian Law…………………………………………………………………………………………….. 19
English Law…………………………………………………………………………………………… 19
Duties and Responsibilities of Auditors…………………………………. 20
Position of the Auditors………………………………………………………………………… 20
Auditor as a Watchdog………………………………………………………………………….. 21
Duties of Auditors…………………………………………………………………………….. 23
GENERAL DUTIES IN CARRYING OUT AUDIT……………………………………. 24
DUTY OF CARE………………………………………………………………………………………… 24
Standard of Care……………………………………………………………………………………. 26
The Audit operation refers to an examination of auditing records undertaken with a view toestablishing the correctness or otherwise of the transactions reflected therein. It involves an intelligentscrutiny of the books of account of a company, with reference to documents, vouchers and otherrelevant records to ensure that the entries made therein give a true picture of the business conductedduring that period, that every transaction has been properly authorised by the appropriate authorityand that the effect of all the entries in the books of account has been reflected in the final accounts.[1]Thus, the role of audit is to provide a moral check on those who are entrusted with the task of runningthe business and keeping and maintaining books of account of the company. Auditors are alsoregarded as the agents of the members appointed to carry on certain duties as laid down in thestatute and the articles for the purposes of the audit.
Of late, the role of the auditor has gained tremendous importance. The role of regulators andinspectors such as auditors has been brought into prominence with the sweeping changes thatliberalization has brought in, along with recent instances of embezzlement, which have shakeninvestor confidence.
Audit plays a pivotal role in keeping proper legal check on those who carry on the business in afiduciary capacity. Shareholders not being legal experts, the auditor acts as a link between theshareholders and the management.
Statutory auditing, mandatory for all companies, is one of the regulatory mechanism designed tocheck abuses and irregularities in the financial aspects of the companies. There are numerousprovisions incorporated in the Companies Act, 1956 stipulating the norms and rules to be followed inmaintaining the accounts of the company.[2]
All companies are statutorily required to prepare and maintain accounts which are then scrutinised bythe auditor who certify their correctness. For company accounts to be credible they must be true andfair and this is more likely to happen if someone competent and independent of the company hasvetted the accounts.
An auditor has a fiduciary relationship with the company. The statutory auditors are often describedas the watchdogs of the company.[3] They have access to the book of accounts, vouchers anddocuments, which no member of the company has. At the same time a number of duties andresponsibilities are cast upon them.
While describing the position of the auditor Ramaswamy J. has opined:[4]
“An audit is intended for the protection of the shareholders and the auditor is expected to examinethe accounts maintained by the directors with a view to inform the shareholders of the true financialposition of the company. The directors occupy a fiduciary position in relation to the shareholders andin auditing the accounts maintained by the directors the auditor acts in the interest of theshareholders who are in the position of beneficiaries. Thus, the auditor is like a trustee for theshareholders.”
The auditor may be an individual or a firm of many individuals wherein each one is qualified to be an“auditor” individually also.
The Companies Act, 1956 envisages independence in the office of the auditor and therefore,elaborate provisions have been incorporated in the Companies Act to ensure the same. Sections 224to 226 of the Companies Act, 1956 provides for the appointment, qualifications, disqualifications andpayment of remuneration to the statutory auditors.
The present structure of a modern company has the shareholder as the focal point of the legal system
governing them. This is evident in not only the present structures available but also the concerns forthe future. The single largest concern at the moment seems to be corporate governance. The image ofthe Company is of great concern to the company.
Transparency in accounts and an audit that will enforce the financial discipline is the most crucialaspect of maintaining this public image.[5] Audit is the examination of the financial accounts of thecompany. There is a belief that the presence of independent, competent and vigilant authorityexercising strict audit control, ensuring that all the required disclosures have been made by thedirectors from time to time, and the funds of the company have not been siphoned off for extraneouspurposes and so on. The aim is to get the company to present a true and fair view of the financialposition.[6] Thus, the Companies Act, 1956 has provided for appointment, remuneration, removal,etc of the Auditors. Also the listing agreements of various Stock Exchanges have made provisions toensure independent auditing.
The annual audit is one of the cornerstones of corporate governance. Given the separation ofownership from management, the directors are required to report on their stewardship by means ofthe annual report and financial statements sent to the shareholders. The audit provides an externaland objective check on the way in which the financial statements have been prepared and presented,and it is an essential part of the checks and balances required. The question is not whether thereshould be an audit, but how to ensure its objectivity and effectiveness.[7]
Audits are a reassurance to everybody who has a financial interest in companies, quite apart fromtheir value to boards of directors. The most direct method of ensuring that companies areaccountable for their actions is through open disclosure by boards and through audits carried outagainst strict accounting standards.[8]
The main objects of an audit are:
Verification of the book of account and financial statementsDetection of errors and frauds.Prevention of the occurrence of errors and frauds.
The primary object of an audit is to establish by an examination of books, accounts and vouchers thatthe balance sheet at a given point of time is properly drawn up and reflects the true and fair view ofthe financial status of the company.
Another effect of auditing is the moral effect it has on employees, frequently deterring those, soinclined, from committing defalcations or embezzlements. There is distinct possibility that the auditmay uncover a fraud or errors in the records, however that is not the main purpose of the audit.
The audit is also expected to bring to light how effective and efficient the system of accounting beingfollowed by the company is. In the course of audit, the strengths, weaknesses and faults in the systemwill be exposed. Based on this input, the Board can ensure that these weaknesses and faults are takencare of.
The role of the auditor is to report whether the financial statements of the company give a true andfair view. An audit is designed to provide a reasonable assurance that the financial statements are freeof material misstatements. The auditors role is neither (to cite a few of the misunderstandings) toprepare the financial statements, nor to provide absolute assurance that the figures in the financialstatements are correct, nor to provide a guarantee that the company will continue in existence.
It is a common practice of companies to appoint the same entities as the Auditors as well as theaccountants for the company. This causes conflicts of interests and the independent nature of the
The auditor occupies a unique place among white-collar professionals.[10] Although selected andcompensated by client, the duties of an auditor very often extend beyond the client to certain thirdparties and public investors.[11] While attorneys and physicians act as advocates, advisors, andconfidants, an auditor must remain a disinterested and independent party and may be engaged toprotect and promote interests other than those of the client. An understanding of the auditor’s publicresponsibility and the auditor-client relationship is essential to distinguish auditors from other white-collar professionals.
In partial recognition of the auditor’s unique role, courts have struggled with the issue of whether theyshould be treated differently than other professionals when malpractice litigation arises. This is aconsideration which ought to be kept in mind while examining the auditor’s unique position.
The framework within which auditors operate, however, is not well designed in certain respects toprovide the objectivity which shareholders and the public expect of them in carrying out theirfunction. The main reasons for this are as follows:[12]
Accounting standards and practice sometimes allow the boards too much scope for presenting factsand the figures derived from them in a variety of ways. Auditors cannot stand firm against a particularaccounting treatment if it is permitted within the standards.
Although the shareholders formally appoint the auditors, and the audit is carried out in their interests,the shareholders have no effective say in the audit negotiation and have no direct link with theauditors. Auditors do, however, have to work closely with those in management who have preparedthe financial statements which they are auditing in order to carry out their task, and audit firms, likeany other business, will wish to have a constructive relationship with their clients.
Audit firms are in competition with each other for business. They wish to maximise their businesswith companies, of which auditing may only be a part. To the extent that they compete on the basis oftheir professional reputation, this will act as an incentive to maintain high standards. So will theethical guidance of the profession, and the threat of litigation. To the extent however that audit firmscompete on price and on meeting the needs of their clients (the companies they audit), this may be atthe expense of meeting the needs of the shareholders.
Companies too are subject to competitive pressures. They will wish to minimise their audit costs andthey are likely to have a clear view as to the figures they wish to see published, in order to meet theexpectations of their shareholders.
Furthermore, another important problem is with regard to conflict of interest on account of the otherservices that the auditing firm provides to the company. Auditing firms may avoid giving adversereports so as not to lose out on the income from the other services that they provide to the companywhich often exceeds the income they get for the audit services provided. This could result in loss ofauditor independence.
These are some of the issues discussed in detail in this research paper. In this research paper, theresearchers seek to highlight the various issues which arise under company law with regard to the roleand responsibility of the auditors and provide solutions for the same.
This research paper aims to examine the role, responsibilities and liabilities of auditors. Theobjective if this research paper is to examine the position regarding the same in the Indian context indetail taking lessons from the experiences in other jurisdictions. The attempt is to elucidate thereasons for having auditors and to examine the protection they afford to the various stakeholders in aCompany. This research paper seeks to also examine the recommendations of the variousCommittees with regard to the role and responsibilities of auditors in the context of corporategovernance. This project-report also aims to scrutinise the role, responsibility and liabilities of theauditors in the context of Enron.
The research questions addressed in this project report include:
The chapterisation of this research paper is as follows: This research paper is divided into fourparts. The first part deals with the appointment, re-appointment, remuneration, resignation andremoval of auditors under both Indian and English law. The second part of the research paper dealswith rights, duties, responsibilities and liabilities of auditors not only in the Indian context but also inother jurisdictions. Further, this part also deals with the importance of auditor independence. Thethird part of the research paper deals with role of the audit committee in the context of corporategovernance. The fourth part of this research paper deals with a case study of Arthur Anderson in thecontext of the Enron debacle.
The sources of data relied on include both primary and secondary sources. The materials used forthis research paper include articles, case law and books. The research-methodology adopted ismainly analytical and descriptive.
The mode of citation adopted is uniform throughout this project-report. This is as follows:
Books
Author’s surname, First Name, Name of the Book, Vol., edn., Publishers, Place of Publication, Year.
Articles
Author’s surname, First Name, “Name of the Article”, Journal, Vol., No., Year.
Websites
Author’s surname, First name, “Name of Article”, Web Site Address, Date on which visited.
The Companies Act, 1956 makes provision for the appointment, removal, resignation andremuneration of auditors. Similarly, the English Companies Act also has provisions for the same.
General Rule of AppointmentTo ensure compliance with the statutory requirements and accountability to the shareholders, Section224 of the Companies Act, 1956 makes the appointment of an auditor or auditors by the company ingeneral meeting, before which accounts are laid, mandatory. An auditor thus appointed at a generalmeeting holds office from the conclusion of that meeting until the conclusion of the next such annualgeneral meeting.[13] The appointment of auditors at the AGM ensures that they are appointed by theshareholders.
The exception to this rule of appointment at the annual general meeting is the appointment of thefirst auditor/auditors by the board of directors of a company. the Board of Directors of the companyhave to appoint the first auditor within one month from the date of its registration. Such auditors holdoffice until the conclusion of the first annual general meeting. If the Board fails to appoint the firstauditor, the company may do so at the first annual general meeting. The remuneration of the firstauditor is fixed by the Board or the general meeting as the case may be. The company may, at ageneral meeting, remove the first auditor appointed by the Board and appoint in its place anotherauditor, of whose nomination a special notice has been given. [14]
An auditor appointed in the above manner should be informed of his appointment within seven daysand he is required to inform the Registrar within thirty days whether or not he has accepted theappointment.[15] The obligation to give notice to the Registrar is cast only on auditors appointedunder sub-section (1) of Section 224. Persons appointed as auditors under other sub-sections neednot inform the Registrar. Hence, the first auditors who are appointed by the Board of Directors areunder no obligation to inform the Registrar.
Casual VacancyA casual vacancy is a vacancy of temporary nature that may occur during the currency of the year afteran appointment is made by the company at its general meeting. Thus, a casual vacancy is not onecreated by a deliberate omission on the part of the company to appoint an auditor at its generalmeeting.[16] It denotes a vacancy caused by a validly appointed auditor ceasing to act as such, due todeath, disqualifications, etc. The auditor appointed in a casual vacancy shall hold office till theconclusion of the next annual general meeting.
Ceiling on Number of Company AuditsBefore an appointment or re-appointment of auditors is made, a certificate in writing is required bythe company from the auditor regarding compliance of ceiling limit on total number of audits.[17]
Sub-section (1B) places a ceiling on the number of company-audits which a Chartered Accountant infull time employment, or a firm of Chartered Accountants, can conduct. The limitation on number ofcompany audits vide Explanation I and II is applicable to
i) a member of the Institute of Chartered Accountants of India who, while being in whole-timeemployment elsewhere, also holds operating agency certificate of practice from the Institute, and
ii) a practicing firm of Chartered Accountants.
In other words, the section does not cover (a) a Chartered Accountant, who, while in part-timeemployment elsewhere, holds a certificate of practice from the Institute, and (be) a CharteredAccountant who is practicing in his sole capacity (that is, as a proprietor) and not as a partner of afirm of Chartered Accountants.[18]
As per the Companies Act, the ‘specified number’ of company audits which a auditor is allowed tohandle, that is, the overall ceiling limit on company audits is twenty. Of these twenty companies, not
more than ten should be companies should have a paid up capital of Rs. Twenty-five lakhs or more.In the case of a firm, the specified number is to be calculated with reference to each partner in thefirm, who is not in full time employment elsewhere. For the purpose of ceiling on number of companyaudits in the case of a partner of a firm who is also a partner in another firm, the total number ofaudits held by him individually or by different firms on his account should be taken intoconsideration.
In computing the number of audits for the above purpose, joint audits are to be taken into account,that is, each of the firms appointed as joint auditors of a company shall count the audit assignment asone company audit.
An important question which has arisen is with regard to whether the audit of the branches of Indiancompanies and the audits of the Indian business of foreign companies which have established placesof business in India and are doing business in India are to be taken into account while calculating thespecified number of company audits a company can take up.
The Department of Company Affairs has clarified that the branch audits are not to be included whilecalculating the specified number. The Branch auditor of an Indian company appointed under section28 audits the accounts of the specific branch only for which he is appointed and forwards his report tothe auditor appointed under section 224 of the Act. Hence the branch auditor cannot be equated withthe company auditor appointed under section 224 of the Act who has to report to the annual generalmeeting on the accounts of the company as a whole including the accounts audited by the branchauditor.
With regard to the auditing of the accounts of foreign companies, the Department has clarified thatsince the definition of companies under section 3 of the Act does not include foreign companies, theyare outside the scope of Section 224 of the Companies Act. Therefore, the accounts of foreigncompanies are also not to be included within the specified number of twenty.[19]
Also, since there is no legal requirement under the Companies Act to prepare consolidated accountsor group accounts and a subsidiary is considered to be a separate legal entity, no responsibility is castupon the auditors of the holding company in respect of the work of the auditors of the subsidiarycompany.
Appointment/Re-appointment of Auditor by Special ResolutionSection 224-A was introduced by the Companies Amendment Act, 1974 enumerating the cases inwhich an auditor can be appointed only by a special resolution. Where twenty-five per cent or more ofthe subscribed share capital of a company is held jointly or singly by a public financial institution, aGovernment company, Central Government, any State Government, any institution established by aState Act in which the State Government holds not less than 51% of the subscribed capital, anationalised bank or an insurance company carrying on general insurance business, the appointmentor re-appointment of an auditor can be made only be made by a special resolution. Thus, thisprovision implies that a company in which 25% or more of the subscribed share capital is held by anyof the aforesaid institutions can appoint or re-appoint auditors only with the concurrence of suchinstitutions.[20]
If a company in which 25% or more of the subscribed share capital is held by any of the institutionslisted in this Section omits or fails to pass at its annual general meeting a special resolutionappointing or re-appointing an auditor, it shall be deemed that no auditor has been appointed by thecompany. Even if an ordinary resolution is passed unanimously, the auditors cannot be deemed tohave been validly appointed.
In such an event, the company is required to give notice of that fact within seven days to the CentralGovernment as required by Section 224(3) and the Central Government may appoint a person to fill
Tenure of Office of AuditorsAn auditor appointed in the annual general meeting holds the office from the conclusion of the annualgeneral meeting at which he is appointed until the conclusion of the next annual general meeting. Inany case where an annual general meeting is not held within the period prescribed by the CompaniesAct,[21] unlike in the case of directors retiring by rotation who will be deemed to have ceased to holdoffice on the last day of the period within which the annual general meeting should have been held, inthe case of an auditor inasmuch as he is appointed to hold office up to the conclusion of the nextannual general meeting, he will continue until the next annual general meeting is held and concluded.The auditor cannot be deemed to have retired on the date when the meeting ought to have beenheld.[22]
Reappointment of Retiring AuditorAt any annual general meeting a retiring auditor is re-appointed, except in the following foursituations[23]:–
(1) when he is not qualified for re-appointment;
(2) when he has given to the company notice in writing of his unwillingness to be re-appointed;
(3) a resolution has been passed at that meeting appointing somebody instead of him or providingexpressly that he shall not be re-appointed; or
(4) where notice has been given of an intended resolution to appoint some person or persons in theplace of a retiring auditor , and by reason of the death, incapacity or disqualification of that person orof all those persons, as the case maybe, the resolution cannot be proceeded with.
This provision on re-appointment is a step in the direction of ensuring auditor independence as theauditor cannot be replaced except in the specific circumstances enumerated in the Act.
However, the retiring auditor cannot be deemed to be re-appointed or automatically re-appointed atthe annual general meeting. The expression “shall be re-appointed” used in the provision in theCompanies Act postulates some action on the part of the company resulting in the re-appointment ofthe retiring auditor. Thus, the passing of the resolution for this purpose at the annual general meetingis essential for the re-appointment of the retiring auditor if he is still qualified and willing to act.[24]
For appointing a person other than the retiring auditor or to provide that the retiring auditor shall notbe re-appointed, a special notice has to be given proposing that such a resolution would be moved atthe next annual general meeting.[25] On receipt of the special notice, the company should send acopy thereof to the retiring auditor.
The form, procedure vis a vis special notice has been laid down in section 190 which mandates thatthe special notice be given to the company at least fourteen clear days before the meeting is to beheld. The day on which the notice is served and the day of the meeting itself are to be excluded incomputing the period of fourteen days. The object of giving a special notice is to invite the special orpointed attention of the members to the particular resolution.
In the absence of such a special notice being given, the resolution would be rendered illegal andineffective.[26] And the appointment of a new auditor without complying with the provisions ofSection 225 (that is, without special notice required for a resolution appointing as an auditor a personother than the retiring auditor), then the resolution passed for appointing the new auditor would beillegal and ineffective.
Where at any such meeting no auditor is appointed or re-appointed, the Central Government mayappoint a person to fill the vacancy. Notice of the fact that the powers of the Central Government have
become exercisable has to be given by the company to the Central Government within seven daysthereof. Any delay in giving such notice does not affect the jurisdiction or the capacity of the CentralGovernment to appoint the auditor. The auditor so appointed by the Central Government holds officetill the next annual general meeting of the company. The Central Government is also authorised to fixthe remuneration of the auditors so appointed by it. Also, in cases where the appointment of theauditor is void ab initio, the Central Government may fill the vacancy. Similarly where the personappointed at the annual general meeting is unwilling to accept the appointment, the CentralGovernment would be eligible to appoint the auditor.
Under English law, the regulations dealing with the appointment, rights and duties of auditors arecontained in Sections 384-394.
General Rule of AppointmentUnder English law also, the general rule is that a company shall at every general meeting before whichaccounts for an accounting reference period are laid in accordance with Section 241 of the CompaniesAct appoint an auditor or auditors who shall hold office from the conclusion of that meeting until theconclusion of the next such general meeting.[27] Table A, unlike its predecessor in the 1948 Act, nolonger requires the company to appoint auditors, as this is now a statutory requirement.
The provision for automatic “re-appointment”, without a resolution, of an existing auditor who iswilling to continue in office has been repealed. Thus, if the company does not pass a resolution forthe appointing or re-appointing an auditor, the office of auditor will be vacant. A resolutionconcerning the appointment or reappointment of auditors should therefore be put before eachmeeting held to consider the accounts.
Where at the appropriate general meeting held to consider the accounts no resolution is passed forthe appointment re-appointment of auditors, the Secretary of State may appoint a person to fill thevacancy. The company must notify the Secretary of State within one week of the company’s failure toappoint or re-appoint the auditors. The company and every officer in default are liable to a fine forfailure to give this required notice.[28]
The directors or the company in general meeting may fill any casual vacancy in the office of auditor.But, while the vacancy continues, the surviving or continuing auditor or auditors may act.[29]
Resolution for Appointment or Removal of AuditorsSpecial notice[30] is required of a resolution:
(1) to fill a casual vacancy in the office of auditor;
(2) to appoint as auditor a retiring auditor who has been appointed by the directors to fill a casualvacancy;
(3) to appoint as auditor a person other than the retiring auditor, unless the resolution is for thecontinuation of the appointment of auditors whose appointment was approved at the previous generalmeeting held to consider the accounts;[31] and
(4) to remove an auditor before the expiration of his term of office.[32]
The company is required to send forthwith a copy of the notice to the person proposed to beappointed or removed, and, where applicable, to any person who by his resignation caused the casualvacancy in either of the first two situations above, or to the retiring director in the third situationabove.[33]
The first auditors of the company may be appointed by the directors at any time before the firstgeneral meeting held for the consideration of the accounts, to hold office until the conclusion of thatmeeting. If the directors fail to do so, the company in general meeting may appoint them.[34]
Auditors in Private CompanyA private company which has elected to dispense with the laying of accounts before the company ingeneral meeting must appoint auditors in the general meeting held at least twenty-eight days beforecopies of the company’s annual accounts are sent to the members. It may, however, elect to dispensewith the annual appointment of auditors, in which case the auditors are deemed to be re-appointed ineach succeeding year unless a resolution is passed ending their appointment.[35]
Within the accountancy profession, it is a requirement of professional ethics, for the person who isapproached on behalf of the company to take the place of retiring auditor, prior to giving assent so toact, to ascertain from the retiring director whether there are any reasons why it might not be proper ordesirable to accept the appointment.[36]
ExceptionsThe first exception to the abovementioned general rule is that a dormant company that is not requiredto prepare group accounts may by special resolution exclude the obligation to appoint auditors. Sucha resolution may be passed at any general meeting of the company at any time after copies of theaccounts, prepared under Section 226 of the Companies Act, 1985, have been sent out in accordancewith Section 238 (1), provided that it has been dormant since the end of that financial year.
Where the resolution is passed at a general meeting that is not the first such meeting, the companymust in addition, be entitled to the benefit of accounting exemptions available to small companies, ormust be ineligible for those exemptions only on account of the fact that it is a member of an ineligiblegroup.[37]
Alternatively, such a resolution may be passed at any time, provided that the company has beendormant from the time of its formation, and provided that it is not a public company, a banking orinsurance company, or an authorised person under the Financial Services Act, 1986.
The other exception is with regard to private companies which are exempt from the auditrequirement, in which case they are also exempt from the obligation to appoint an auditor.[38]
General Rule of Resignation of AuditorAn auditor may resign before his term of office expires by depositing a notice in writing to that effectat the company’s registered office. His resignation becomes effective on the date he lodges suchnotice or on such later date as may be specified in the notice. The auditor’s notice of resignation isnot effective unless it is accompanied either by a statement to the effect that there are nocircumstances connected with his resignation which the auditor considers should be brought to thenotice of members or creditors of the company, or a statement of any such circumstances. Thevacancy caused by the resignation of auditors is to be filled by the company in general meeting.
Removal of AuditorsAny auditor appointed under Section 224 except the auditors appointed by the Board of Directors inpursuance of the proviso to Section 224(5) can be removed before the expiry of his term only by thecompany in the general meeting.[39] Additionally, a prior approval from the Central government is
A company may remove an auditor by ordinary resolution before the expiration of his term of office,notwithstanding any previous agreement to the contrary. The registrar of Companies must beinformed by the company on the prescribed form within 14 days of any such resolution having beenpassed.[40]
Removal of AuditorsAn auditor who has been removed is entitled to be notified of, to attend and to be heard at thegeneral meeting at which his term of office would otherwise have ended and any general meeting atwhich it is proposed to fill the vacancy caused by his removal.[41]
If a company receives special notice of a resolution proposing the removal of an auditor before theexpiration of his term of office or proposing a change of office when the present auditor’s term ofoffice expires, it must forward a copy of that notice to the retiring auditor or to the auditor who is tobe removed. The auditor may make representations in writing to the company and, if he so requestsand the representations are not received too late, the company must, in any notice of the resolutiongiven to members of the company, state that representations have been received and send a copy toeach member to whom notice of the meeting is sent.
If a copy of the representation is not sent, the auditor who has made them may require that they beread out at the meeting. The Court has power to waive these requirements for notifyingrepresentations if it is satisfied that the rights conferred have been abused to secure needlesspublicity for defamatory matter.[42]
Resignation of AuditorsThe 1976 Companies Act introduced regulations governing the resignation of auditors which preventsan auditor from resigning without reporting to the members on a problem situation of which he isaware. To be effective, an auditor’s notice of resignation must be sent in writing to the registeredoffice of the company and must either state that there are no circumstances connected with hisresignation which he considers should be brought to the notice members or creditors or include astatement of any such circumstances.[43]
The company must send a copy of notice of resignation to the registrar of companies within fourteendays. If the notice includes a “statement of circumstances connected with the auditors’ resignation” thecompany must also send a copy of the notice of resignation to all persons entitled to receive copies ofaccounts under the Companies Act.[44] The auditor must send a copy of the any statement thatcontains details of such circumstances to the Registrar of Companies unless the company has madean application to the Court.
The Court may, on application, direct that copies of the notice should not be sent out if it is satisfiedthat the auditor is using the notice to secure needless publicity for defamatory matter; in this case thecompany must send out a statement setting out the effect of the order.[45]
If the company does not, within fourteen days, circulate an auditor’s statement of circumstances, ordoes not, within twenty-one days, convene an extraordinary general meeting which has beenrequisitioned by the auditor for a day not more than twenty-eight days after the date0 on which noticeconvening the meeting is given then, unless the company has obtained a Court order excusing it fromso doing, the company and every officer who is in default will be liable to fine.[46]
In addition to his duties to report the circumstances of his resignation, the auditor is given the rightunder Section 391 to make further statements to the members. If the notice of resignation alsoincludes a statement of circumstances to be brought to the notice of the members or creditors, it may
also be accompanied by a requisition signed by the auditor requiring the auditors to convene anextraordinary general meeting for the purpose of considering such explanation of the circumstancesconcerned with his resignation as he may wish to place before the meeting. He may also attend andbe heard at the general meeting of the company at which his term of office would have expired if hehad not expired or at any general meeting convened at his requisition or at which it is proposed to fillthe casual vacancy caused by his resignation.
The auditor who has resigned has the same rights to have statements circulated to members beforesuch meetings as an auditor who is proposed to be removed and subject to the proviso about“needless publicity for defamatory matter.”[47]
The qualifications and disqualifications of auditors are provided in Section 226 of the Companies Act.The main purpose of this Section is to ensure that only qualified person possessing the requisiteknowledge and technical skill acts as the auditor of the company so that he may discharge his dutieseffectively. This is to ensure that the auditor is independent in carrying out his work so that he be ableto give an unbiased opinion based on the objective assessment of the facts.
Auditor’s QualificationsSub-sections (1) and (2) of Section 226 enumerate the qualifications required to be an auditor.
A person who is a Chartered Accountant within the meaning of the Chartered Accountants Act, 1949and holds a certificate of practice, or a partnership firm whereof all the partners are CharteredAccountants holding certificates of practice may be appointed as auditor, of a company. In the lattercase, the appointment of an auditor may be made in the firm name and any of its partners may act inthe name of the firm.
Sub-section (2) provides for recognition of certain persons though not Chartered Accountants orpossessed of similar qualifications, for appointment as auditors, if they have been functioning as suchin the erstwhile Part ‘B’ States, or in Jammu and Kashmir, subject to the Rules framed in this behalf.
Disqualification of AuditorsSub-section (3) of Section 226 enumerates the categories of persons who are disqualified forappointment as auditors. The object of these disqualifications is to make the position of auditors asindependent as possible from the affairs if the companies whose affairs they handle. Also, if under theChartered Accountants Act any other disqualifications are added, they shall also apply.
None of the following persons are qualified for appointment as auditor of a company:
(1) a body corporate;
(2) an officer or employee of the company;
(3) a person who is a partner, or who is in employment of an officer or employee of the company;
(4) a person indebted to the company for an amount exceeding one thousand rupees, or who hasgiven any guarantee or provided any security in connection with indebtedness of any third person tothe company for an amount exceeding one thousand rupees;
(5) a person who is director or member of a private company, or a partner of a firm, which is themanaging agent or the secretaries and treasurers of the company;
(6) a person holding any security of that company after a period of one year from the date of
commencement of the Companies (Amendment) Act, 2000.
(7) further, a person disqualified for appointment as auditor under the above disqualifications of anyother body corporate which is that company’s subsidiary or holding company or a subsidiary of thatcompany’s holding company, or would be disqualified if that body corporate were a company
Section 226(5) further provides that “if an auditor becomes subject, after his appointment, to any ofthe disqualifications, he shall be deemed to have vacated his office”.
Apart from the disqualifications laid down in Section 226, the Institute of Chartered Accountants ofIndia has prepared its own code of ethics which is mandatory for its members.
In order to ensure independence of the auditors and also to prevent conflict of interest and duty, theCouncil has decided not to permit a Chartered Accountant in employment to certify the financialstatements of the concern in which he is employed, or of a concern under the same management asthe concern in which he is employed, even though he is holding a certificate of practice and eventhough such certification can be done by any chartered accountant in practice. This restriction doesnot apply where the certification is permitted by any law. Further, it has also been decided that achartered accountant should not by himself or in his firm name:–
(1) accept the auditorship of a collage, if he is working as a part-time lecturer in the college.
(2) Accept the auditorship of a trust where his partner is either an employee or a trustee of the trust.
Qualifications of AuditorsThe Companies Act1989 implemented the Eight EC Company Law Directive on the qualifications andtraining of auditors. The stated purpose of the Act is ‘to secure that only persons who are properlysupervised and appropriately qualified are appointed as company auditors and that audits by personsso appointed are carried out properly and with integrity and with a proper degree ofindependence’.[48]
To qualify for appointment as a company auditor, a person, either an individual or a firm, must be:
(1) a member of a recognised supervisory body; and
(2) eligible for appointment under the rules of that body.
To be eligible, the auditor must hold an appropriate qualification. This may be:
(1) by virtue of membership immediately before 1 January 1990 of a body recognised for thepurposes of Section 389(1) (a) of the Companies Act, 1985;[49] or
(2) a recognised professional qualification obtained in the United Kingdom from a qualifying body;or
(3) an overseas qualification approved by the Secretary of State, provided that the person alsosatisfies any traditional educational qualifications that the Secretary of State may require.
Regulations relating to recognised supervisory bodies, qualifying bodies and recognised professionalqualifications are set out in the Companies Act 1989, Schedules 11, 12, 13, and 14 and Sections 30to 42. From 1 October 1991 all those accepting appointments as company auditors must beregistered with a recognised supervisory body.
Certain classes of persons are disqualified from appointment as auditors. They include:
(1) an officer or servant of the company (Section 389(6)(a));
(2) a person who is a partner or employee of an officer or servant of the company (Section389(6)(b));
(3) a body corporate (Section 389(6)(c));
(4) a person disqualified for appointment as auditor of a subsidiary or holding company or a fellowsubsidiary (Section 389(7)).
An officer of the company for this purpose includes a director, manager or secretary (Section 744),but not an auditor (Section 389(6)).
Any person who acts as auditor of a company when he knows he is disqualified, or who fails to vacatehis office and to give notice of that fact to the company when to his knowledge he becomesdisqualified, is liable to a fine. Section 28 (5) of the Companies Act 1989 provides that it is defencefor a person to show that he did not know and had no reason to believe that he was, or had become,ineligible for appointment.
Section 224(8) of the Companies act provides that the remuneration of the auditor of a company maybe fixed by the Board of directors, if the appointment has been made by the Board or by the CentralGovernment, if the appointment was made by the Government. Subject to this, the remuneration hasto be fixed by the company in general meeting.
The company at the annual general meeting, however, need not fix the remuneration. It may be fixedin any manner as determined by the general meeting. The remuneration fixed for an auditor isinclusive of all expenses allowed to him so that he cannot claim any amount additional to theremuneration fixed either as expenses or otherwise.
Where the auditor seeks expert advice in respect of any legal or technical matter for the properdischarge of his duties the cost of such advice is permissible extra expenditure which can properly beclaimed from the company. Besides remuneration for audit work, the auditor may also be paidremuneration for services rendered in any other capacity.[50]
The remuneration of the auditor of a company is to be fixed by the company in general meeting or insuch manner as the company in general meeting may determine in the case of an auditor appointedby the directors or by the Secretary of State, it may be fixed by the directors or the Secretary of State,as the case may be (Section 385).
The Companies Act requires that in the profit and loss account of the company the auditor’sremuneration be shown separately.[51] A consolidated profit and loss account must show theremuneration of the auditors of all the companies included in the consolidated accounts. Any sumpaid by the company in respect of auditors’ expenses is deemed to be included in the expression“remuneration”.[52] This provision applies only to audit fees and expenses, and not to remunerationfor accounting work. Disclosure of remuneration including expenses paid to auditors or theirassociates in respect of services other than audit must also be made.[53]
The duties and responsibilities of the auditor are laid down in Section 227 of the Companies Act,1956.
While examining the duties of the auditor, it is important to keep in mind the position of the auditor’swithin the framework of company law. The role and responsibilities of the auditor’s cannot be isolatedfrom the position that the auditor has been assigned by the law and judiciary. Over the years, theposition ascribed to the auditor’s has changed with the judiciary playing an important role inexpanding their role and responsibilities.
“The audit is intended for the protection of the shareholders and the auditor is expected to examinethe true financial position of the company. The directors occupy a fiduciary position in relation to theshareholders and in auditing the accounts maintained by the directors the auditor acts in the interestof the shareholders who are in the position of beneficiaries. The auditor is like a trustee forshareholders.” [54]
Thus, auditors have a fiduciary relationship vis-a-vis the shareholders as a body.[55] The statutoryauditors are the watchdogs of the company and they have access to the books of accounts, vouchersand documents which no member of the company has. These powers are given to the auditors tofacilitate discharge of their functions and responsibilities.
The reason for the fiduciary relationship of the auditors with the company has been explained by theCalcutta High Court in the case of Deputy Secretary v. S.N. Das Gupta: [56]
“A joint stock company carries on business with capital furnished by persons who buy its shares. Theowners of the capital are, however, not in direct control of its application, which is left to the executiveof the company. In those circumstances, some arrangement is obviously called for by which those whoprovide the capital know periodically what is being done with their money, how the affairs of thecompany stand and what the present value of their investment is. The Companies Act, therefore,provides for the employment of an auditor who is the servant of the shareholder and whose duty is toexamine the affairs of the company on their behalf at the end of a year and to report to them what hehas found. That examination by an independent agency such as the auditors is practically the onlysafeguard which the shareholders have against the enterprise being carried on in an unbusiness likeway or their money being misapplied or misappropriated without their knowing anything about it. TheAct provides the safeguard in two forms. It makes the duty of the auditor to give an expression ofopinion on certain specified matters of a vital character and it makes him liable, along with thedirectors, for misfeasance, if he fails to perform his duties as required by law and the approved auditprocedure.”
The auditor, being an appointee of the shareholders has a duty to take care of their interests and thusany failure to report any major flaws and deficiencies may result in the non-fulfillment of the duties ofthe Auditors.[57]
“The auditor is a watchdog and not a bloodhound.”
Beginning with In Re Kingston Cotton Mills Case,[58] the Courts have held that while it is true that theauditors primary function is to look into the account books of the company, it is also the law of theland that where there is adequate material before the auditor to arouse suspicion, he should probeinto the matter in detail and attempt to get under the skin of the problem and thus help resolve theissue.[59]
The Court held in this case that “an auditor is not bound to be a detective or … to approach his work
with suspicion. He is a watchdog and not a bloodhound. He is justified in believing the tried servantsof the company in whom confidence is placed by the company. He is entitled to assume that they arehonest and rely on their representations, provided he takes reasonable care. If there is anythingcalculated to excite suspicion, he should probe it to the bottom, but in the absence of anything of thatkind he is only bound to be reasonably cautious and careful. His duty is verification and not detection.If in the course of his sniffing around he detects something suspicious he must track it down to verifyit.”
In the recent past, a higher standard has been applied to the auditor’s requiring them to apply an“enquiring mind” to their task. This higher standard been discussed in research paper while dealingwith the standard of care expected of an auditor.
The auditor is an officer of the company only for limited purposes as given in Section 2(30) of theCompanies Act, 1956.[60] As far as maintenance of the books of account, preparation of financialstatements and their audit is concerned, the auditor is not an officer of the company and therefore cannot be prosecuted for contravention of the provisions of the Company Act, 1956 which are required tobe complied with by the management of the Company.
Numerous duties are owed by the auditors to the company and its shareholders. The foremost ofthese duties is to check the accuracy of accounts. But this duty is “not confined merely to the task ofverifying the arithmetical accuracy of the balance sheet, but also to inquire into its substantialaccuracy, and to ascertain that it was properly drawn up, so as to contain a true and correctrepresentation of the state of the company’s affairs”.[61]
The duties of the auditor do not include the giving of advise to the company on the prudence orotherwise of giving loans. Whether or not the business of the company is being conducted prudently isnot a concern of the auditor. The sole duty of the auditors is to ascertain the true financial position ofthe company at the time of the audit.[62]
Thus, the auditor is not an adviser to the Company or to the shareholders of the company. Neitherdoes the auditor sit in judgment on the management decisions and policies or the commercialprudence of transactions. His primary function is to carry out what is termed a “verificatory audit”[63]This position has been slightly modified by the introduction of the Section 227(1A) and the issuanceof the Order under Section 227(4A). The duty has been now extended to include making a statementon various matters involving management functions like inventory control, adequacy of internal auditprocedures, etc.[64]
The auditor of a company is not the insurer and does not guarantee that the books of account of thecompany show the true position of its affairs or that its balance sheet is accurate according to itsbooks. It is, however, the duty of the auditors to ascertain and certify to the shareholders the truefinancial position of the company at the time of the audit.[65]
In carrying out certain functions of which company audit is a prime example, the auditor is subject tocertain duties. The duties of an auditor may be effectively divided into three categories, viz., statutoryduties; contractual duties; and duties owed to third parties.
Statutory duties:
The Companies Act, 1956 requires the appointment by a company of an auditor and performance ofcertain duties by him. Section 227 of the Companies Act specifies the powers and duties of the
auditor. Section 209(1) requires every company to maintain ‘proper’ books of account with respect tomatters stated therein. Section 209(3) provides that books of account, to be proper, must provide atrue and fair view of the state of the company or its branches, as the case may be, and explain itstransactions.
To establish if the books of accounts have been maintained as required, and whether the provisions ofthe Act have been complied with, the auditor is appointed, and is required, inter alia, to report onthese aspects. The examination by an independent agency such as the auditor is practically the onlysafeguard which shareholders have against the enterprise being carried on in an unbusiness-like wayor their money being misapplied or misappropriated.[66]
The purpose of statutory audit is to provide such a mechanism to enable those who have a proprietaryinterest in the company or are concerned with its management and control, to have access to accuratefinancial information about the company. When those persons have such information, the statutorypurpose is satisfied.[67]
It is the duty of the auditor to protect the shareholders by examining the accounts maintained by thedirectors with a view to informing the shareholders of the true financial position of the company.[68]While the directors occupy a fiduciary position in relation to the shareholders, in auditing the accountsmaintained by them, the auditor acts in the interest of the shareholders who are in the position ofbeneficiaries.
The duties cast upon the auditor are accompanied by certain powers; for example, access to thebooks of account of the company, to enable him to discharge these functions effectively. Anyregulations which preclude the auditors from availing themselves of all the information to which theyare entitled are inconsistent with the Act.
Contractual duties:
The contractual duties of the auditors depend upon the contract between the auditor and the client.The contract will regulate the nature and extent of the task and the standard of the performance. Evenwhen the nature of the engagement is established as audit, questions may arise as to whether theaudit contract requires the taking of certain steps. Where the extent of the audit is described in somedetail, whether expressly in the contract of engagement or in the case of statutory audit, in the statuteconcerned, these questions are less likely to arise.
Duties owed to third parties:
Another important duty of the auditors is with regard to third parties. An issue that has beenaddressed by the Courts in numerous cases is whether the auditors owe any duty and are liable tothird parties in the absence of any contractual relationship. This issue has been examined in detailwhile discussing the liability of the auditors.
The prevailing view is that even in the absence of contractual relationship, in certain circumstances theauditor’s could be held to be liable. The parameters of such responsibility are limited by the“neighborhood principle laid down by Lord Atkin in Donaghue v. Stevenson.[69]
The three broad aspects that the duties of the auditor’s cover are (a) the duty to make certainenquiries; (b) the duty to make a report to the members of the company on the accounts examined byhim, and on every balance sheet and profit and loss account including on all documents annexedthereto; and (c) the duty to make statements in terms of the provisions of MAOCARO, 1988.[70]
The duties of the auditor can be broadly classified as:
These duties are discussed in detail in the following chapters of this research paper.
An auditor of a company has, equally, rights and duties, which have to be performed, in order tosatisfy the position he is holding in the company. The duties of the auditors has been discussed andelucidated by the Courts in numerous cases.
While describing the general duties of an auditor the Courts have opined:[71]
“An auditor is not to be confined to the mechanics of checking vouchers and making arithmeticalcomputations. He is not to be written off as a professional adder-upper or a subtractor. His vital taskis to take care to see that errors are not made, be the errors of computation or errors of omission orcommission or downright untruths. To perform this task, he must come to it with an inquiring mind —not suspicious of dishonesty — but suspecting that someone may have made a mistake somewhereand that a check must be made to ensure that there has been none.”
In exercise of his duty, an auditor must use reasonable care and skill, and must certify to theshareholders only what he believes to be true. Essentially, an auditor should give a true and fair viewof the company’s annual financial statement. One of the earliest cases establishing this principle is InRe London and General Bank,[72] where the Court held:
The duty of the auditor “is to ascertain and state the true financial position of the company at the timeof the audit, and his duty is confined to that. He discharges his duty by examining the books thecompany. But he does not discharge his duty by doing this without inquiry and without taking anytrouble to see that the books themselves show the company’s true position.”
True and Fair viewThe phrase “true and fair” was inserted in the Companies Act, 1956 in place of the phrase “true andcorrect” in the earlier Companies Act. This amendment was introduced since the term “true andcorrect” could be interpreted as implying that the auditor had to merely examine whether the financialstatements were arithmetically correct and corresponded to the figures in the books of account andwas not required to examine whether these books reflected a fair view of the affairs of thecompanies.[73] With this amendment, the burden cast on the auditor is much higher. The Auditor, inhis report, has to show whether the accounts reflect a fair view of the company’s financial position.
The true and fair view may be taken to represent and signify that the auditor gives an opinion as towhether the financial statements represent the actual financial position. Thus, what constitutes a trueand fair view is a matter of opinion of the auditor in the circumstances of the case. There are certainbroad indicators which the auditors are required to take into consideration while determining whetherthe book of accounts represent a true and fair view of the company’s financial position. These include:
The balance sheet and profit and loss account should be drawn up in conformity with theprovisions of Schedule VI of the Companies Act and/or as per requirements of the specialprovisions governing special categories of companies.The balance sheet and profit and loss account should be drawn up in keeping with the generallyaccepted principles of accounting which should be applied consistently. In the event of any
deviation from these principles, the reason and effect should be suitably disclosed.The information should be so disclosed in the balance sheet and the profit and loss account thatthere is neither an overstatement nor an understatement with regard to the financial position andworking results.The Auditor should see the situation as it exists at the end of the accounting period. The auditormust also take into account post accounting period events, if material in making a betterassessment of the position as at the date of the balance sheet.The financial statements should convey the requisite information clearly. In this context, itshould be understood by the auditor that information and means of information are not thesame term.[74]
Thus, the duty of the auditor to ascertain and state the true financial position of the company at thetime of the audit will be fulfilled if the above considerations are kept in mind while preparing theaudit report.
“An auditor is not bound to do more than exercise reasonable care and skill in making inquiries andinvestigations. He is not an insurer; he does not guarantee that the books do correctly show the trueposition of the company’s affairs, he does not even guarantee that the balance sheet is accurateaccording to the books of the company…he must be honest, that is, he must not certify what he doesnot believe to be true, and he must take reasonable care and skill before he believes that what hecertifies is true…Where there is nothing to excite suspicion very little inquiry will be reasonablysufficient…Where suspicion is aroused more care is obviously necessary; but still an auditor is notbound to exercise more than reasonable care and skill even in case of suspicion, and he is perfectlyjustified in acting on the opinion of an expert where special knowledge is required.”
Thus, it is not the auditor’s duty to give advice to members or directors about giving loans or aboutthe business prudence of the company but the true financial position of the company must be statedat the time of the audit. The auditor has the duty to take reasonable care to ascertain that accountsbooks show the true position. The auditor is not a insurer and does not guarantee that the booksshow the company’s position directly.[75]
This point was further reiterated in Trisure India v. A.F.Fergueson & Co. where it was held that theauditor must be honest and should have reasonable skill and care in ascertaining the accuracy of thecompany’s books of account, balance sheet and profit and loss account.
Reasonable care and skill is not exercised when in spite of the presence of unusual features in theaccounts which prima facie, give reason for believing that the accounts of the company are not inorder, the examination is not detailed.
Neither legislation nor the normal contract of engagement indicates the standard of care required ofthe auditor. However, this issue has been subject to detailed consideration by the Courts. It has beenthe law that the auditor must exercise reasonable skill and care in the discharge of his duties.
This has been best described in the following words of Romer J. in City Equitable Fire Ins. Co., Re:[76]
“He must be honest, that is, he must not certify what he does not believe to n true and he must takereasonable care and skill before he believes that what he certifies is true. What is reasonable care inany particular case must depend upon the circumstances of that case. Where there is nothing to excitesuspicion very little inquiry will be reasonably sufficient. Where suspicion is aroused more care isobviously necessary; but, still an auditor is not bound to exercise more than reasonable care and skilleven in case of suspicion and he is perfectly justified in acting on the opinion of an expert wherespecial knowledge is required.”
The early cases suggested a standard of care based on the concept of the auditor as a watchdog. In ReKingston Cotton Mills Case,[77] the Court while holding the auditors liable for not personallyinspecting the securities, it was opined that while it may be easy to charge the auditors withnegligence after the event, the auditor did not have advantage of hindsight.
More recent authorities, however, have higher standard of care based on the auditor’s applying an‘inquiring mind’ to his task. In Fomento Sterling Area Limited Selsdson Fountain Pen Co.,[78] LordDenning observed that “to perform his tasks properly, he (the auditor) must come to it with aninquiring mind — not suspicious of dishonesty, but suspecting that somebody may have made amistake somewhere, and a check must be made to ensure that there has been none”.
This point was further reiterated in Re Thomas Gerrad & Sons Ltd.,[79] where the auditors failed todetect fraudulent accounting principles although they discovered altered invoices. They were heldliable as “suspicion ought to automatically have been aroused by the discovery”. Commonwealth caseshave also emphasised that the auditor can no longer limit their investigation to a “watch-dog-role”and a more active inquiring role is required.[80]
Thus, it is the duty of an auditor to bring to bear on the work he has to perform that skill, care andcaution which a reasonable competent, careful and cautious auditor would use. The particularcircumstances of each case determine whether reasonable skill, care, and caution have beenexercised.
The trend of the Courts seems to be in the direction of enforcing liability on the auditors if they fail totake a degree of care which would be required to ensure that there is no fraud or irregularity. Once thesuspicion is raised they must investigate thoroughly and ensure that any discrepancy in the accountsis brought to light.
One of the most important duties of the auditor is with regard to the report on the accounts of thecompany which the auditor has to submit to the members of the company. “The scheme of the Act…isthat the directors must prepare the accounts; the auditor must make a report tot he members on theaccounts; and this report must contain statements on certain specified matters.”[81] This reportshould state whether the accounts are kept in accordance with the provisions of the Act and whetherthey give a true and fair view of the state of affairs of the company.[82]
Sub section (2) of Section 227 requires the Auditor to make a report to the members on the findingsof the Audit done by him. This Report is based on the accounts examined by them and on everybalance sheet and the profit and loss account and all group accounts, a copy of which is laid beforethe company in general meeting during their tenure of office. In this report, the auditors are requiredto state whether the accounts give the information required by the Companies Act in the manner sorequired. Thus the duty cast on the auditors is not merely to report on the balance-sheet but on theaccounts which they are required to examine; and they are also required to state whether in theiropinion proper books of accounts as required by law have been kept by the company.[83]
The requirement of law includes the requirement of Section 209 (3), i. e., that the books should be sokept as to give a “true and fair view”[84] of the state of affairs of the company and explain itstransactions. Furthermore, the law does not mandate that this Report be sent to each and everyshareholder.[85]
The Companies (Amendment) Act, 2000 have brought in some amendments affecting the
responsibilities of the auditors. Sub-section (3) of section 227 describes the scope of an audit report,and lays down the matters to be stated therein. Clauses (e) and (f) have been inserted in thissub-section which provides that observation or comments of auditors, which may have an adverseeffect on the functioning of the company, are required to be stated in thick type or italics in theauditor’s report. With this amendment, the responsibilities of the auditor have been widenedsubstantially, it is now not confined only to the accounts but extends to the total functioning of thecompany. Further, as per this amendment the Report should also state whether any director isdisqualified from being appointed as director under Section 274 of the Companies Act. For this, theauditor has to confirm and verify the details of other directorships in public companies of all thedirectors of the company.
Though under Section 227(1A) of the Companies Act the Auditor is not required to make report onthe results of his inquiry, he will certainly have to mention in his report anything serious, which theinquiry may have revealed, or give a warning. In his Report, the auditor is required to state the reasonsand the justifications if the report is in the negative or is qualified.
This report is distinct from a mere certificate. The distinction is that a certificate has no expression ofopinion. The report is a formal statement made after inquiry and examination of the records andincludes the opinion of the Auditor.[86]
In view of the above it is not enough for the report of the auditor merely to repeat the language of thesection and barely state that in his opinion and to the best of his information and according to theexplanations given to him the accounts of the company give the information required by the Act in themanner so required.
Under the Indian Companies Act, 1913, the report made by the auditor was in most cases a mereformality. The requirement in the present Act that the report of the auditor shall state whether in hisopinion the accounts give the information required by the Act in the manner required and whether inhis opinion proper books of account as required by law have been kept by the company so far asappears from his examination of those books would seem now to require from the auditor a moreexacting duty as regards verification than under the previous Act.
In this connection, the Ninth Annual Report submitted to the Parliament in pursuance of Section 638is relevant. In this Report it was explained that “the Company Law Board has been of the view that it isnecessary to ensure a high standard of audit of companies because it is only by doing so that a highstandard of integrity in company affairs could be maintained. In order to attain this required standardit is necessary for auditors to be fully alert and to satisfy themselves by examining such basicmaterials and documents as they consider necessary, that the accounts which they certify really reflecta true and fair view of the state of affairs of the company concerned”.[87]
Language of the ReportThe auditor should be careful about the use of language in the report, which should be clear andunambiguous. The Auditor while drafting the report must keep in mind that the shareholders, whoseagent he is and to whom he is submitting the report, and with whom he shares a fiduciary relationshipare ordinary persons who do not possess technical knowledge and skill of accountancy or auditing.His opinions and observations should, therefore, be communicated in no uncertain terms so that thereader of the report is able to know what they are.
In London and General Bank Ltd.[88] the Court held that a person whose duty it is to conveyinformation to others, does not discharge that duty by simply giving them, so much information as iscalculated to induce them, or some of them, to ask for more. Information and means of informationare by no means equivalent terms. An auditor who gives shareholders means of information instead ofinformation in respect of a company’s financial position does so at his peril, and runs the very seriousrisk of being held, judicially, to have failed to discharge his duty.
The duty of an auditor is to convey information, not to arouse inquiry, and although an auditor mightinfer from an unusual statement that something was seriously wrong, it by no means follows thatordinary people would have their suspicions aroused by a similar statement if, as in this case, itslanguage expresses no more than any ordinary person would infer without it.
Report should be completeThe auditor should give a complete report. If he gives his report, subject to separate notes, thosenotes also should be given simultaneously. In Hitkarini Mahavidyalaya, Jabalpur v. P.C. Madan[89]where the auditor made his report on the accounts of an institution subject to separate notes whichwere not submitted within a reasonable time, the Court held him guilty of gross negligence. Thereasoning for this was that any one going through the report would assume that those notes wereprepared and were ready at the time when the report was signed by him. It could not be supposedthat those notes were not in existence at that time and were written at some later date on some facts,which were still to be verified or ascertained. Though this was not a case of bad or vicious intention, itwas still held to be an act of gross negligence.
Qualified opinionWhere an auditor gives a qualified opinion, that is, he expresses an opinion subject to certainreservations, he should express clearly the nature of the qualification in the report. The reasons forthe qualification should also be stated. In the case of companies, this is a legal requirement underSection 227(4) of the Companies Act, which requires that where the auditor answers any of thestatutory affirmations in the negative or with a qualification, his report should state the reasons forsuch answers.
Qualified audit reports may be classified into four categories:
Disclaimer: In a disclaimer of opinion the auditor states that he is unable to form an opinion as towhether the financial statements give a true and fair view.
Adverse: In an adverse opinion the auditor states that in his opinion the financial statements do notgive a true and fair view.
‘Subject to’: In a ‘subject to’ opinion the auditor effectively disclaims an opinion on a particularmatter which is not considered fundamental.
Exception: In an ‘except for’ opinion the auditor expresses an adverse opinion on a particular matterwhich is not considered fundamental.
Auditors who wrongfully fail to qualify company accounts are not liable to the company forsubsequent loss if the company did not actually rely upon them and was not misled by theinformation contained in the accounts. Certification of accounts by auditors does not on the basis ofthe Caparo principle[90] expose them to the risk of being sued by lenders who may rely on thoseaccounts when considering whether to make finance available to the company.[91]
Adverse or negative opinion: If, based on his examination, the auditor does not agree with theaffirmations to be made, the auditor may give an adverse opinion. For example, the opinion given bythe auditor is adverse or negative when he states that the financial statements do not represent a trueand fair view of the state of affairs and the working results of an undertaking.
An adverse opinion is appropriate where the reservations or the objections of the auditor are somaterial that he feels that the overall view of the accounts is materially distorted. Where the auditorgives an adverse opinion, he should disclose all material reasons therefor. For example, in case thecompany is engaged in hire purchase and finance business where provision for doubtful debts wasnot made in spite of the fact that a sizeable proportions of sundry debtors were not recoverable, theauditor is expected to state that the said accounts do not give a true and fair view of the state of
affairs of the company in as much as no provision for bad and doubtful debts has been made.
Disclaimer of opinionIf an auditor fails to obtain sufficient information which results in his inability to express an opinion,he makes a disclaimer of opinion. The auditor may state that he is unable to express an opinionbecause he has not been able to obtain sufficient evidence to form an opinion. The necessity ofdisclaiming an opinion may arise due to many reasons. For example, the auditor may not get accessto all the books of account for any reason; there may exist material items, the value of which may betotally uncertain, or, certain material information may not be forthcoming. Whenever an auditordisclaims an opinion, he should give reasons for the same. For example, the auditor could say that“we have not been unable to verify the existence and value of the fixed assets of the company and,therefore, we are unable to state whether the balance sheet shows a true and fair-view”.
The right of a statutory auditor to give a qualified report is a great deterrent and prevents themanagement of a company from resorting to accounting practices and methods of disclosure whichare not in accordance with the law. A qualified report is normally not necessary, unless the issuesinvolved are material. However, items requiring disclosure under the law such as directorsremuneration, whether material or not, have to be specifically disclosed. If this is not done, it is theduty of the auditor to qualify his report.[92]
An auditor of a company is appointed by shareholders to perform certain statutory functions andduties and it is expected of him that he will in fact perform these functions and duties. The failure toperform a statutory duty in the manner required is not excused merely by giving a qualification orreservation in auditor’s report. In such circumstances, the auditor should, while giving a qualificationor reservation indicate clearly the reasons why he was unable to perform the audit in accordance withgenerally accepted procedures and standards. [93]
In a majority of cases, items which are the subject matter of qualification are not so material as toaffect the truth and fairness of the accounts, taken as a whole, but merely create uncertainty about aparticular item. In such cases, the auditor may report that in his opinion, but subject to specificqualifications mentioned, the accounts present a true and fair view.
On the other hand there may be cases where the reservations may be so material that it would bemeaningless to state that subject to the qualifications, the accounts disclose a true and fair view. Theauditor then should make a disclaimer of opinion or give an adverse/negative opinion, asappropriate. In this context, the nature of the facts, their materiality and their bearing upon the truthand fairness of the accounts should be taken into consideration.[94]
The auditors must give full information about the subject matter of their qualification and not merelycreate grounds for suspicion or inquiry and leave it to the shareholders to ascertain the facts bymaking diligent inquiry. The distinction between “information” and “means of information” made inthe London and General Bank’s case[95] is still valid. A qualification should be clear and precise andthe manner in which qualifications are made in the auditor’s report should be such as not to leave anyroom for doubt in the minds of the public.
The company’s auditor should mention clearly whether in his opinion a particular matter stated in hisreport is in the nature of a qualification or is merely an explanation. A factual reference in the reportdoes not automatically become a qualification. The use of the expression ‘read with the notesthereon’ does not qualify the contents of the auditor’s report. In any case, the notes are necessarily apart of the accounts and even if the auditor does not make a specific reference thereto, his reportautomatically covers them.
The report prepared by the auditor’s should be comprehensive and brief and specify the matters inrespect of which the auditors have reservations or qualifications, and the amounts involved in clearand unambiguous manner, leaving no scope for misinterpretation. Full information and if that is notavailable as much information as is available should be given in the report. Vague statements, theeffect of which is not ascertainable on the accounts should be avoided. The auditor should avoidmaking qualifications in his report, which do not contain any real objection on his report. Further, it isnot a good practice to qualify the present Report by reference to a report made in an earlier yearbecause the shareholders may not have access to such reports. Each year’s accounts beingindependent, the essential facts relating to a qualification made in an earlier year must be repeatedwhere appropriate.
All qualifications should be contained in the auditor’s report itself and should appear at one place inorder to give the reader a clear view thereof.
Notes in the ReportNotes appended at the foot of the financial statements normally represent the explanations given bythe directors elucidating or clarifying various items of accounts. The notes may include those givingspecific information required by Schedule VI to the Companies Act, for example, arrears of dividendson preference shares’, computation of managerial Remuneration, etc. If the auditor qualifies his reportby making reference to the notes or if the qualifications made by the auditor are also included inthese notes, the shareholders may be unable to appreciate the significance of such qualifications. Itis, therefore, necessary that the notes to accounts should not contain the opinion of the auditor. Further, the auditor should only reproduce notes of a qualificatory nature in his report to enable thereader to know the importance of the qualifications. The word ‘reproduce’ does not imply a verbatimreproduction of the qualificatory notes. Where notes of a qualificatory nature appear in the accounts,the auditor should state all qualifications independently of his report in an adequate manner so as toenable a reader to assess the significance of these qualifications. However, where a note has alreadybeen given in detail by the management, it is not necessary to reproduce it verbatim in the auditreport and a brief self-explanatory statement may be sufficient.[96]
The auditor should quantify, wherever possible, the effect of the qualifications on the financialstatements, if the same is material. Where it is not possible to precisely quantify the effect of thequalifications, the auditor may do so on the basis of estimates made by the management aftercarrying out such tests as is possible and he may then indicate that the figures are based on themanagement’s estimates.
An auditor should not be satisfied merely by vouchers, apparently formal and regular but should byfair and reasonable examination of them, see that they are not for payments in any way unauthorizedor illegal or improper.
Report on annexed documentsThe report has to deal not only with the accounts and balance sheet and profit and loss accounts, butalso every other document declared to be part of or annexed to the balance sheet and profit and lossaccount. Among the documents required to be annexed is also included a list relating to investments,if any, specified in Section 372(9) of the Companies Act with all the particulars required to be statedtherein.
A statement in the auditor’s report that he has dealt with the branch auditor’s report in such manneras he considers necessary is not a sufficient compliance of these Provisions. The company’s auditorhas to make disclosure of anything in regard to the branch which he thinks is not in order and whichhas come to his notice.[97]
The company’s auditor need refer in his report to the branch audit when a person other than himselfaudits the branch accounts.[98]
Conversion of a deemed public company to a Private LimitedCompany-clarification regarding Auditor’s Report.The Auditor’s Report is issued to the members of the company on a particular date. The report shouldbe addressed to the members of that company, which is in existence at the time the report, is issued. Accordingly, if the status of the company changes from that of a deemed public company to privatecompany changes after the close of its financial year but before the Auditor’s Report is issued, itshould be addressed to the members of the “deemed public company”. If the Auditor’s Report isissued after the change, in status, as aforesaid, the report should be addressed to the members of theprivate company. However, the Auditor’s Report relates to period during which the company was adeemed public company. In view of this, the fact that the Auditor’s Report relates to the periodduring which the company was a deemed public company should be disclosed in the beginningthereof .[99]
The liability of Auditors is unique from that of other white collar professionals in so much as they areliable not only to the who has appointed them. Another noteworthy fact is that there have been farlesser cases against accountants than any other professionals.[100]
The liability of Auditors may be classified under the following heads:
(1) Negligence;
(2) Misfeasance; and
(3) Criminal liability.
The first and foremost issue which arises as far as the liability of the auditors are concerned is withregard to the nature of their liability. They may arise from either:
(1) Negligent Acts, that is, where the acts of the auditors lead to the damage being suffered by theplaintiffs, or
(2) Negligent Statements, that is, the incorrectness of a statement given to the client causing loss ordamage to the clients interests.
There have been cases which have followed different principles at different points of time as per thecircumstances of the case. The case of Hedley Byrne v. Heller[101] is a case where the liability hadarisen from negligent misrepresentation. The essence of the liability arises from the fact that theparties have a special/contractual relationship and the negligent behaviour results in the breach of thecontract.
There has been a great discussion on this aspect for a number of years and the legal position seemsto have settled that if the misrepresentation was of a very general nature and had not been specific innature as pursuant to a contract then the tort action would be a better option for the client. Thus, nowthe narrow scope, which would have been the result of negligence based on contractual relationship
has been expanded a great deal.[102] Negligence is a tort in which a breach of duty of care results indamage to person to whom such duty is owed. We now seek to examine the scope and extent of suchtortuous liability of the auditor.
Liability to the Company.To hold the Auditors liable for negligence at common law it is necessary for the company to show thatloss has been caused to the company through the failure of the Auditors to perform their duty withreasonable care and skill. This was held in Leeds Estate Building and Investment Co. v.Shepherd[103] and London Oil Storage Co. v. Seear Hasluck & Co.[104] amongst other cases.
Where an individual is appointed as an auditor and that individual is a partner in a firm ofprofessional accountants, that firm may be held liable for his negligence in performing his duties, atleast where the audit fee is paid directly to the firm.
The duty of auditors in case of private companies was considered in Pendleburys Ltd. v.Ellis Greenand Co.[105] The courts held that where interests of the Companies are limited to a very smallnumber of people and there are no outsiders because all interests are held by the Directorsthemselves, if the auditor has reported to the directors, then there is not much else which he can do.This decision underlines the fact that the negligence of Auditors arises when the issues of public,shareholder interests are paramount.
Another factor which is a crucial element in negligence is that of the standards by which the work ofthe auditors are measured. It has been submitted that standards of skill and care change over time.The standards have become stricter over time and the explanations of directors are no longeraccepted without making probes and inquiries into the matter in great detail. The report must reflectthe fact that they were suspicious of the functioning of the company and were given explanationswhich were either satisfactory or not for them.
The Cannons of Foreseeability and ProximityThe law in relation to the auditors duty of care and the liability for negligent misstatement by auditorshas been subject of comprehensive analysis in England, in the case Caparo Industries Plc v.Dickman[106]. The court held that the auditors owe a duty of care to the members but not topotential investors in the company. They owe a duty of care to the members because they are under astatutory obligation to report to them and because the members have a corresponding statutoryentitlement to receive such a report. The Auditors have no duty of care to the lenders and creditors ofthe company. This is an extension of the same logic which makes them liable to members.
The case has laid down the following propositions as regards the auditor’s duty of care andliability:[107]
In cases of negligent misstatement, foreseeability that the plaintiff or someone in a similarposition will rely upon the statement is a necessary but not sufficient condition for liability.In addition, it is necessary to establish a nexus or relationship between the parties sufficient tocreate a duty of care. That relationship can only be determined by a close analysis in each case.The label applied to such a relationship is ‘proximity’, but there is no single definitive test. Insome cases, it may be useful to consider whether there has been a voluntary assumption ofresponsibility in the others, whether the relationship is ‘equivalent to contract’.The necessary relationship exists between the auditors and the members because there is astatutory duty to send reports to the later by the former and a corresponding entitlement of themembers to receive such a report.The relationship may also exist if the circumstances are such that the auditors can be takenimplied to have represented the accuracy of the accounts to the plaintiff, and perhaps wheneverthey provide the accounts to the company with the intention, or in knowledge that it is the
company’s intention, that they are to be supplied to the plaintiff or to persons in a class of whichthe plaintiff is one.It is not necessary that the auditors should have any particular transaction in contemplation, orshould intend the recipient of their report to rely upon it in any such transaction. If the necessaryrelationship exists, it is enough if it is foreseeable that the recipient of the report may rely uponit in some future transaction, whether contemplated by the auditors or not, and whether withreference to his existing shareholding or not.
The necessary relationship does not exist between a companies auditors and potential investors whoare not existing shareholders in the company. The fact that it is foreseeable that their report maycome into their hands and be relied upon by them is not sufficient in itself to create a relationship.
Hence, in order to establish the existence of duty of care owed to the plaintiff, who claims damages,by auditor who is alleged to have made a negligent misstatement, three requirements must besatisfied. These are:
i) It must be reasonably foreseeable by the defendant that the statement will be relied on by theplaintiff;
ii) There must exist the relevant degree of proximity between the parties; and
iii) It must be just and reasonable in all circumstances to impose a duty of care on part of thedefendant to the plaintiff.
This however, leads us into the issue of liability to third parties.
Liability to Third PartiesThere was formerly the prevailing view that there is no liability for negligent misrepresentation madeby one person to another who had relied upon it to his detriment, in the absence of any contractual orfiduciary relationship between the parties or the fraud.[108]
This position was overruled in Hedley Byrne & Co. v. Heller & Partners[109] where it was held that incertain circumstances contractual liability could be incurred for a negligent misstatement made byone person to another, even in the absence of any contractual or fiduciary relationship.
The parameters of such responsibility were limited by the “neighbourhood principle” laid down byLord Atkin in Donaghue v. Stevenson.[110] In Jeb Fastners v. Marks Bloom & Co.,[111] theappropriate test for establishing whether a degree of care exists was laid down to be whether thedefendant knew or reasonably should have foreseen at the time the accounts were audited that aperson might rely upon those accounts for the purpose of deciding whether or not to take over thecompany and, therefore could suffer a loss if the accounts were inaccurate. Firstly, they must haverelied upon the accounts and secondly, they must have done so in circumstances where either theauditor’s knew they would, or ought to have known, that they might.
The decision in Hedley Byrne v. Heller[112] held that liability for negligent statements resulting in thefinancial loss is not limited only to cases where there is an existing contractual or fiduciaryrelationship. This raised the question of the limits of such liability. The test of a reasonable manwould not make the auditors liable. The rule thus was that the auditors would not be liable to thirdparties unless the facts of the case showed otherwise.
Thus, in Candler v. Crane, Christmas and Co[113], where the accounts were prepared specifically forthe purpose of inducing the plaintiff to invest in the company, to the knowledge of the auditors, therewas a duty of care even though the plaintiffs were not members or shareholders of the Company. Thiscan however, be negated by a clear clause expressly disclaiming liability.[114] There are recent caseswhich state that the auditors should have foreseen that the accounts may be relied on by future
investors for the purpose of making decisions regarding their investments..[115]
In order to carry out the duties as laid down with regard to the accounts presented to the members,the Companies Act has also given the auditors certain rights. These rights, enshrined in Sub-section(1) of Section 227 of the Companies Act, 1956, are primarily:
1.The right to call for information and explanations;
2.The right to have access to the books of accounts; and
3.The right to notices and to attend meetings.
The scope and ambit of these rights of the auditor are studied in detail in this part of the researchpaper.
An auditor has the right to require from the officers of the company such information, as the auditorsmay think necessary for the performance of their duties. The auditor can call for any explanations orinformation that he considers necessary. It is obligatory on the part of the officers of the Company tofurnish the relevant information to the auditor. In the event of the information not being furnished orexplanation given, the auditor is required to report the same in his report. This is to ensure that theshareholders are made aware of the fact and such awareness may give critical clues to them andindicate that all is not well with the Company.[116]
The power to ask for information includes the exercise of such powers over the officers of thecompany and includes the Directors and Managing Directors. This power is not extinguished by thewinding up of the Company.[117]
Where a Company is under Liquidation, the courts can call upon the directors to appear before theAuditors to submit explanations to the questions raised by them. This is based on the logic that whiledirectors may cease to enjoy powers, the obligations and liabilities incurred by them in the time whenthey were directors are not extinguished with the passing of the order of winding up. This was held inBhawnagar Vegetable Products Ltd., In Re.[118]
Under English law, an officer of the company who makes to an auditor (orally or in writing) amisleading statement which conveys, or purports to convey, any information or explanation which theauditor requires, or is entitled to in his capacity as auditor is guilty of a statutory offence and may beliable to fine or imprisonment or both.[119] For the officer to be guilty of an offence, the statementmust be misleading, false or deceptive in a material particular and made knowingly or recklessly.
Section 227 confers on the auditors the right of access to the books of accounts of the company at alltimes for the performance of his duties. The auditor’s powers cannot be limited or abridged in anyway.
A Company Articles may not limit the auditor’s statutory right to information. In Newton v.Birmingham Small Arms[120] the Court held that
“The auditor has the right to access to books of accounts of a company. Any provision in thecompany’s articles precluding auditors from obtaining or availing themselves of the information they
are entitled to by statute is void. They must have free access to all the material necessary for theirreport. A resolution limiting the powers of the auditor or a provision to this effect in the effect in thearticles will be void.”
The auditor is also entitled to request access to other documents necessary for audit. The books ofaccounts of the company may be kept in the headquarters of the Company or elsewhere. The right ofaccess to the books can be enforced by mandatory injunction but not where litigation is pendingbetween the company and the auditors.
This right is inclusive of the right to see vouchers also. The term Vouchers includes all documents,correspondence, agreements and evidence which support any transaction or data disclosed in thefinancial statements whether directly or indirectly. The term book also includes the financial, statutoryand statistical books including cost records. The auditor can also examine the books which recordquantities of production, stock, sales, etc.
The inspection is inclusive of the minutes of the general meetings and the Directors meetings. It hasbeen held as early as 1906, in England that any regulation precluding the Auditors from availing allthe information required by them is invalid.[121] Such a rule is also valid in India and is essential toprotect the sanctity of the Auditors Report.
The term “at all times” enables the auditor to check the records without waiting for financial year toend, but it means the examination only during office business hours.[122]
The auditor can visit any branch office at any time for his purposes. There is a limitation to this powerand that is with regard to the foreign branches of a Banking Company, under section 228(2) of theCompanies Act, 1956.
The auditors of a company are entitled to attend any general meeting of the company and to receivenotice of, and communications relating to, any general meeting which any member of the company isentitled to receive.
Thus, the Auditor has the right to receive notices and other communications relating to the generalmeetings. The auditors also have the right to attend the meeting and speak on any part of thebusiness of such meetings which concerns them as auditors. Where a company is proposing aresolution as a written resolution, they are entitled to receive copies of all communications supplied tomembers.
However, the mere fact that the Auditor has said something in the meeting does not mean that he isabsolved of all responsibilities to say material facts in the Report.
In Woolworth v. Conroy, [123] the Court of Appeal held that ‘accountants in the course of doing theirordinary professional work of producing and auditing accounts, advising on financial problems andcarrying on negotiations in relation to taxation have at least a particular lien over any books ofaccounts, files and papers which their clients have delivered to them, and also over documents whichhave come into their possession in the course of acting as their clients’ agents in the course of theirordinary professional work.’
When an auditor conducts the audit of accounts of a business entity such as a company there are threefundamental accounting assumptions that he must keep in mind. These are laid down by theAccounting Standard (AS-I) prescribed by the Institute of Chartered Accountants of India.[124] Thesefundamental accounting assumptions are as follows:
(1) Going Concern,
(2) Consistency;
(3) Accrual.
The above mentioned accounting assumptions underlie the preparation and presentation of financialstatements. Each one of these accounting assumptions has been dealt with in detail in this researchpaper.
Going Concern as per AS-IThe definition of a going concern as given in AS-I states that “the continuance of an entity is assumedfor a foreseeable future and that there is neither an intention nor necessity of liquidation or ofcurtailing materially the scale of operations”.[125]
Thus, if an entity is in a position to normally produce and sell its goods and perform its obligationstowards various bodies, whether governmental or otherwise, then it could be called a ‘going concern’.
SAP 16 has now specified that the “foreseeable period” should be a period not exceeding one yearafter the balance sheet date. There may be situations within the fundamental accounting assumptionsof going concern, consistency and accrual, when an entity may not satisfy any one of them and as aconsequence shows results which may not affect its liquidity, though theoretically there may be apossibility of technical insolvency. The standard is not clear as to the manner of consideration of thesame.[126]
For example, if a company with a small capital base has been showing marginal profits afterdepreciation but without accounting for gratuity. Gratuity is paid as and when liability arises on cashbasis. If the gratuity is provided, the company will come under the purview of potential sickness underSICA. Such a policy is violative of the accrual concept. The company’s activities may not be affectedbecause gratuity is only a contingent liability and the liability to pay arises only when all workersdecide to retire on the same day.[127]
Hence, the auditor need not doubt the condition of the company, as days to day activities are notaffected.
IndicatorsThere are a number of indicators which can help the Auditor in determining whether the status of acompany as a going concern is affected. These indicators can be categorized into three sets. Theseare:
1.Financial Indicators;
2.Operation Indicators;
3.Other indicators.
The financial indicators that indicate whether the company is a ‘going concern’ are as follows:
Negative net worth or negative working capital;Fixed term borrowings approaching maturity without realistic prospects of renewal or repayment
or excessive reliance on short term borrowings to finance long term assets;Adverse key financial ratios;Substantial operating losses;Substantial negative cash flows from operations;Arrears or discontinuance of dividends;Inability to pay creditors on due dates;Difficulty in complying with terms of loan agreements;Change from credit to cash on delivery transactions with suppliers;Inability to obtain finance for essential new product development or other essential investments;Entering into a scheme of arrangement with creditors for reduction of liability.
The operating indicators showing that the company is a ‘going concern’ are as follows:
Loss of key management without replacement;Loss of major market, franchise, license or principal supplier;Labour difficulties or shortage of important supplies.
The other indicators of the same are:
Non Compliance with capital or other statutory requirements;Pending legal proceedings against the entity that may, if successful result in judgments thatcould not be met;Changes in Legislation or Governmental policySickness of the company under any statutory definition.
Thus, it can be stated that the role of the Auditor has been made more proactive than ever before asfar as the ‘going concern’ is concerned. Any of the above factors if present or apprehended will entaila detailed enquiry by the Auditors.
While looking at the above mentioned criteria the AS- 3 which is regarding cash flow has to be kept inmind. The moment a cash flow statement is prepared, normally it would show the true colours of thecompany. However, a fund flow statement would also be of great value as then the various sources offunds would also have been revealed and also indicate how the same have been utilised. If short-termfunds have been used for long term purposes, then that would amount to diversion of funds. Theimpact of such diversion would then have to be studied in terms of SAP -16 to ascertain whether suchdiversion would affect the liquidity of the company on a long-term basis.
As far as negative working capital is concerned, there are a few issues which a re rather complicated.The fact that there is negative working capital may not always be an indication of sickness. Manybusinesses today work on trust. There are units which have been technically sick nut have the backingand confidence of creditors, workers, bankers, etc. They continue to get credit and bankers havereposed their faith on the units due to either the ingenuity of the promoters, honesty, work ethics, etc.Any adverse report by the Auditor under SAP -16 would have a negative impact on the units such asthese. The role of the Auditor in such a situation becomes very tricky as the aim is not to threaten thevery existence of the company.
As far as Non financial indicators are concerned, they are to be looked into with great care as anymistaken reading of the same may result in the devastation of the business of the company. It is thus,critical that the Auditor after having applied his mind to the indicators has a discussion with themanagement and seeks explanations from them and to see what measures are being taken to reverseany adverse situation which may have arisen.
The validity of the going concern status may be judged on the following scale:
Going concern status being appropriate;Going concern status being questionable and resolved by management explanations;Going concern status being questionable and managements explanations being inadequate;Going concern status being inappropriate.
This being a basic accounting assumption, if in the opinion of the Auditor, an entity is found to beinga ‘going concern’ then the Auditor need not qualify so in the Report.
The Auditor has to exercise his judgment as to the factors, which point to the entity’s stature as anon-going concern. If he thinks that the company may have a chance to recover and will not becomeinsolvent then he may not have it in the report.
In case the explanations given by the management are not found to be adequate by the Auditor, heshould consider whether the financial statements:
Adequately describe the principal condition that raises substantial doubt about the company’sability to continue in operation for the foreseeable future;State that there is significant uncertainty that the entity will be able to continue as a goingconcern and therefore, may be unable to realize its assets and discharge its liabilities in thenormal course of its business.State that the financial statements do not include any adjustments relating to recoverability andclassification of recorded assets and classification of liabilities that may be necessary if the entityis unable to continue as a ‘going concern’.
SAP 16 states that if adequate disclosure of the above facts is made in the financial statements, theauditor need not qualify his report. However, he is required to highlight the problem by drawingattention to the note in the financial statement which discloses the matter as set out above.
The Auditor can also issue a disclaimer of opinion for going concern uncertainty. Adverse opinion orqualified opinion should be expressed where the Auditor feels that the disclosure is not adequate.
If the Auditor feels that the company will not be able to maintain its status as a going concern heshould state that the assumption of the company being a going concern is not applicable in theparticular case.
SAP 16 has become operational for all Audits relating to accounting periods beginning April 1999.There may be a few problems in the areas where the judgment of auditor is sought regardingnon-financial matters. The high responsibility given to the auditor has also meant that the liabilitiesfor failure to deliver are also enhanced. There are doubts as to whether the profession is ready todeliver such high levels of expectations.
The emergence of corporate governance, which refers to the establishment of a structural frameworkor reforming the existing framework to ensure the governing of the company to best serve interests ofall stakeholders, as an important concept and indispensable to resilient and vibrant capital marketsand is an important instrument of investor protection has resulted in efforts to find ways of ensuringstrong corporate governance. The spate of Committees and recommendations on the code ofcorporate governance starting for the Cadbury Committee for Corporate governance constituted in theUnited Kingdom to the Committee on Corporate governance constituted by the Securities ExchangeBoard of India under the Chairmanship of Kumaramangalam Birla have all recommended the settingup of an Audit Committee in companies to ensure the ‘enhancement of shareholder value, keeping inview the interests of other stakeholders’.
‘A system of good corporate governance promotes relationships of accountability between theprincipal actors of sound financial reporting – the Board, the management and the auditor.’ To thisend the setting up of Audit Committee by the Board of the company will ensure proper accountabilityto the stakeholders especially the shareholders and other investors. The Board of a company isresponsible and accountable for sound financial reporting.
The Board of a company is responsible and accountable for sound financial reporting. The AuditCommittee being a sub-group of the full board is charged with the responsibility of monitoring theprocess supporting responsible financial disclosure and active and participatory supervision. It is notthe role of the audit committee to prepare financial statements or engage in the myriad of decisionsrelating to the preparation of these statements. The Committee’s function is clearly one of overseeingand monitoring, and in carrying out this function it relies on the senior financial management of thecompany and the outside auditors. Thus, the role of the Audit Committee is to act as a catalyst foreffective financial reporting.
Historical evolution:
In the United States, the New York Stock Exchange has required all listed Companies to have auditcommittees composed solely of independent directors. The 1987 report of the American TreadwayCommission concluded that audit committees had a critical role to play in ensuring the integrity of UScompany financial reports. Experience in the United States has shown that even where auditcommittees might have been set up mainly to meet listing requirements, they have developed into anessential and important committee of the Board.
Similarly in the United Kingdom, the results of a published research shows that companies with auditcommittees offer added assurance to the shareholders that the auditors, who act on their behalf, arein a position to safeguard their interests.
The Cadbury Committee which was set up in 1991 by the Financial Reporting Council, UK, the LondonStock Exchange and the accountancy profession in UK to address the financial aspects of corporategovernance, after reviewing the relevant issues, recommended that all listed companies shouldestablish an audit committee.
The following further recommendations of the Cadbury Committee spell out in detail the role,functions, and duties of the audit committee:
1)Audit committees should be formally constituted to ensure that the have a clear relationship withthe Boards to whom they are answerable and to whom they should report regularly. They should begiven written terms of reference which deal adequately with their membership, authority and duties,and they should normally meet at least twice a year.
2)There should be a minimum of three members. Membership should be confined to non-executive
directors of the company and a majority of the non-executives serving on the committee should beindependent. Membership of the committee should be disclosed in the annual report.
3)The external auditor should normally attend audit committee meetings, as should the financedirector. As the Board as a whole is responsible for the financial statements, other board membersshould also have the right to attend. The company should have a discussion with the externalauditors, at least once a year, without executive Board members present, to ensure that there are nounresolved issues of concern.
4)The audit committees should have explicit authority to investigate any matter within its terms ofreference, the resources which it needs for this purpose, and full access to information. Thecommittee should be able to achieve external professional advice and to invite outsiders with relevantexperience to attend, if necessary.
5)The audit committee’s duties should be determined in the light of the company’s needs but shouldnormally include:
ØMaking recommendations to the Board on the appointment of the external auditor, the auditfee, and any questions of resignations or dismissal;ØReview of the half-year and annual financial statements before submission of the Board;ØDiscussion with the external auditor about the nature and scope of the audit, co-ordinationwhere more than one audit firm is involved, any problems or reservations arising from the audit,and any matters which the external auditor wishes to discuss, without executive Board memberspresent;ØReview of the external auditor’s management letter;ØReview of the company’s statement on internal control systems prior to endorsement by theBoard; andØReview of any significant findings of internal investigations.
6.Where an internal audit function exists, the audit committee should ensure that it is adequatelyresourced and has appropriate standing within the company. The audit committee should review theinternal audit programme, and the head of internal audit should normally attend its meetings.
7.The chairman of the audit committee should be available to answer questions bout its work at theannual general meeting.
The Cadbury Committee has expressed its belief that Boards should appoint audit committees, ratherthan aiming to carry out this function themselves. A separate audit committee enables a Board todelegate to the subordinate-committee a thorough and detailed review of audit matters, it enablesthe non-executive directors to contribute an independent judgement and play a positive role in anarea for which they are particularly fitted, and it offers the auditor a direct link with the non-executivedirectors. The ultimate responsibility of the Board for reviewing and approving the annual report andaccounts and the quarterly or half-yearly reports remain undiminished by the appointment of an auditcommittee, but it provides an important assurance that a key area of the Board’s duties will bedischarged.
The appointment of the audit committee is considered to be an important step in raising standards ofcorporate governance. The effectiveness of such a committee would depend largely on the strength ofthe Chairman, who has the confidence of the Board and auditors, and on the quality of thenon-executive directors.
The Greenbury and the Hampel Committee established in the United Kingdom in 1993 and 1995respectively have reiterated the need to establish an audit committee of at least three non-executivedirectors, at least two of whom are independent.
In India, the origin of audit committee lies in the conditions laid down by financial institutions whilesanctioning term-loans and/or subscribing to shares and/or debentures. It is at the instance of thefinancial institutions that the companies assisted by them constituted audit sub-committees with thenominee director(s) being made a compulsory member(s) thereof. The meetings of the auditsub-committee were held prior to the meetings of the Board of Directors. Their decisions werereferred to the directors of their meetings. However, the desired results did not flow from the settingup such audit sub-committees and an increasing number of companies, which were assisted byfinancial institutions, became sick companies.[128]
The Reserve bank of India, in its guidelines and regulations to Non-Banking Financial Companies alsorequires NBFC’s having assets of Rs. 50 crore or more as per their last audited balance sheet toappoint audit committees on the lines of the scheduled Banks, as per directions dated January 13,2000 of the Reserve Bank of India. The audit committee constituted under these directions shall havea minimum of three directors of the Board of directors.
The concept of audit committee gained further ground during the economic recession when about2200 companies disappeared after raising funds from the public. At around the same time, the largerconcept of corporate governance gained currency and the top industrialists and chambers of tradeand commerce in the country initiated steps towards better corporate governance. The key role of theaudit committee in corporate governance was recognised and the Confederation of Indian Industries(CII) set up a committee in 1996 to report on the subject.
The CII Report on corporate governance also emphasises the need and importance of the auditcommittee. The Confederation of Indian Industries report on corporate governance also emphasisedthe need and importance of the audit committees. This report provided that:
“There should be an audit committee in every organisation. The terms of reference of the auditcommittee should, inter alia, include the following:
ØReview the draft annual accounts prior to their approval by the Board focusing in particular on(1) significant changes in accounting policies and practices; (2) major judgmental areas; and (3)significant audit adjustments;ØReview the compliance with statutory and stock exchange requirements for financial reporting;ØDiscuss the scope of the audit with external auditors;ØDiscuss the matters arising from the audit with the external auditors;ØReview the preliminary announcements of results prior to publication;ØReview the annual reports taken as a whole;ØEnsure that the Board receives reliable and timely management information;ØMake recommendations on the appointment and remuneration of external auditors;ØStatutory auditors and the finance directors of the companies should attend audit committeemeetings as invitees;ØThe audit committee needs to identify the areas of non-compliance draw attention to it in theirreport on the financial health of the company; andØThe audit committee needs to ensure that an objective and professional relationship ismaintained with the auditors.
The Securities and Exchange Board of India also set up a committee which went into the question ofcorporate governance. The initiative of SEBI was with the twin objective of enhancing shareholders’wealth, and protecting the interest of other stakeholders in the company. The Shri KumaramangalamBirla Committee on Corporate Governance came out with numerous recommendations which wereaccepted by SEBI and came to be inserted in the listing agreement.
The Kumaramangalam Committee Report has recommended that a qualified and independent AuditCommittee be set up by the Board of the company, thus enhancing the credibility of the financial
disclosures of the company and promoting transparency. It provides, inter alia, for constitution of anaudit committee to achieve the aforesaid objectives and it is applicable to all listed companies.
Further, the Companies Act has also incorporated Section 292A in the Companies Act providing forthe constitution of an Audit Committee in every public company having a paid up capital of not lessfive crore rupees.
Thus, there are three different regulations in respect of incorporated companies providing for theconstitution audit committees to achieve the common object of better corporate governance.
Meaning and Purpose of Audit Committee:
The audit committee plays an important role in the corporate governance of the company as it relatesto the overseeing of financial reporting. The three main groups responsible for financial reporting —the Board, the internal auditors, and the external auditors form the three legged stand that supportsresponsible financial disclosure and active and participatory supervision. The Audit Committee has animportant role to play in this process, as it is a sub-group of the full Board and hence the monitor ofthe process.
The Audit Committee is a committee of the Board of Directors with no management responsibility forthe company’s financial operations, which reports directly to the main Board and has no executivepowers of its own. Its job is clearly one of overseeing and monitoring, and to perform this function itdepend on senior financial management and the outside auditors.
The principle purpose of the audit committee is to assist the Board of directors in discharging theirindividual and collective legal responsibilities for ensuring the following things:
1)the company’s financial and accounting systems are providing accurate and up-to-date informationon its current financial position;
2)the company’s published financial statements represent a true and fair reflection of this position;
3)the external audit, which the law requires to provide independent confirmation that these legalresponsibilities are being met, is conducted in a thorough, efficient and effective manner.
The task of the company directors and external auditors in fulfilling their separate duties has grownas the commercial operations of companies and the financial systems needed to support them havebecome more complex. The audit committee can serve as a useful Board of Directors to provide amechanism whereby this task is given additional attention by those who are not themselves involvedin the day-to-day management of the company.
The Kumaramangalam Birla Committee Report on Corporate Governance has made numerousrecommendations with regard to the composition of the Audit Committee and other aspects which areas mentioned below:
Composition:
While recommending the composition of the Audit Committee the factor that was considered was theindependence of the Committee.
ØThe Audit Committee should have a minimum of three members all being non-executivedirectors, with the majority being independent and with atleast one director having financial andaccounting knowledge;ØThe Chairman of the Committee should be an independent director;ØThe Chairman should be present at the annual general meeting to answer shareholder queries;ØThe Audit Committee should invite such of the executives, as it considers appropriate to bepresent at the meetings of the Committee,
ØThe Company Secretary should act as the Secretary of the Committee.
Frequency of Meetings and quorum:
As per the recommendations, the Audit Committee should meet at least thrice a year. One of thesemeetings should be held before finalisation of the annual accounts and one necessarily every sixthmonth.
The quorum of these meetings should be either two members or one-third of the members of theCommittee, whichever is higher and there should be a minimum of two independent directors.
Powers of the Audit Committee:
Being a Sub-committee of the Board, the Audit Committee derives its powers from the authorisationof the Board. Hence its powers should include:
ØTo investigate any activity within its terms of reference;ØTo seek information from any employee;ØTo seek outside legal or other professional advice;ØTo secure attendance of outsiders with relevant expertise, if it considers necessary.
Functions of the Audit Committee:
As the Audit Committee acts as a bridge between the Board, the statutory auditors and internalauditors, the following role has been recommended for it:
ØOverseeing the company’s financial reporting process and the disclosure of its financialinformation to ensure that the financial statements are correct, sufficient and credible.ØRecommending the appointment and removal of external auditors, fixation of audit fee, andalso approval for payment for any others services.ØReviewing with management the annual financial statements before submission to the Board,focusing primarily on:·Any changes in accounting policies and practices;·Major accounting entries based on exercise of judgement by management;·Qualification in draft audit reports;·Significant adjustments arising out of audit;·The going concern assumptions;·Compliance with accounting standards;·Any related party transaction;·Reviewing with the management and external and internal auditors, the adequacy of internalcontrol systems, etc.
Thus, the Committee is expected to play an important role in corporate governance. Therecommendations provide scope for the Audit Committee to evolve its own guidelines for its day today functioning.
Amendments to the Listing Agreement:
The Securities Exchange Board of India has decided to make amendments to the listing agreementand incorporation of Clause 49 to incorporate the Kumarangalam Committee recommendations.
Part II of Clause 49 relates to the Audit Committee. Almost all the recommendations of theKumaramangalam Committee relating to Audit Committees are incorporated in this part. The Clausefurther stipulates that if the company has set up an audit committee pursuant to provisions of theCompanies act, the company shall agree that the said Audit Committee shall have such otherfunctions/features as are contained in the Listing agreement. Thus, the Committees recommendations
concerning Audit Committee have come into force through the Stock Exchange Listing Agreement.
Requirements of the Companies (Amendment) Act, 2000:
A new Section 292A has been inserted in the Companies Act to the effect that every public company(listed or unlisted) having a paid-up capital (equity and preference) of not less than five crores ofrupees should constitute a committee of the Board of directors to be known as the “Audit Committee”which shall consist of not less than three directors and such other number of directors as the Boardmay determine. Two-thirds of such directors should be directors other than managing or whole-timedirectors.
The audit committee should act in accordance with terms of reference specified in writing by theboard. The Committee should elect a chairman from amongst themselves. The annual report of thecompany should disclose the composition of the Audit Committee. It should discuss with the auditorsthe scope of the audit and internal control systems. The Audit Committee shall have the authority toinvestigate into an matter in relation to the items specified in the provisions of Section 292A orreferred to it by the Board and for this purpose shall have full access to information contained in therecords of the company and external professional advice, if necessary.
The auditor, the internal auditor, and the director of finance shall attend and participate at meetingsof the Audit Committee but they shall not have the right to vote. Recommendations of the AuditCommittee on any matter relating to financial management including the audit report shall be bindingon the board. If the board does not accept the recommendations of the Committee, the reason fordisagreement shall be recorded and shall be intimated to the shareholders to be discussed in theannual general meeting and the view of the shareholders shall be final. The chairman of the AuditCommittee shall attend the annual general meeting to provide clarifications on accounts and mattersrelating to audits.
Subordinate-section (1) to Section 292A provides that penalty for default in complying with theprovisions of this section would be imprisonment for a term upto one year or a fine upto Rs. 50,000or both.
The provisions relating to the periodical discussions with the auditors, internal as well as external,about internal control systems and the scope of audit including the observations of the auditors,which are intended to make the functioning of the corporate sector more transparent are quitewelcome.
The reach and the range of provisions of the Companies Act are much wider than those of the KumaraMangalam Birla Committee Code as the provisions of the Act are applicable to both listed andunlisted companies. Also, unlike the Birla Committee Code, there is no phased schedule ofimplementation.
There are certain variations between the Kumara Mangalam Committee Code and the Companies Actregarding the constitution and the function of the Audit Committee. Such variations are as follows:
(1)Chairpersons of the Committee: there is no provision in the Companies Act regardingindependence of the chairperson.
(2)Composition of the committee: although both the Companies Act and the K.M. Birla CommitteeCode stipulate that the committees should consist of at least 3 members, there is no stipulationregarding qualification of members in the Companies Act. on the other hand the Birla CommitteeCode stipulates that one member of the Committee should have financial and accounting knowledge.Moreover, the Companies Act allows induction of executive directors in the committee. Also, noprovision is there in the Companies Act to ensure independence of the Committee. The BirlaCommittee report also requires that the majority of the members should be independent.
(3)Functions of the Audit Committee: the Kumaramangalam Committee report is more explicitregarding the role of the audit committee. However, the Companies (Amendment) Act, 2000 hasgiven much wider powers to the Audit Committee by providing that the recommendations of the auditcommittee on any matter relating to financial management, including the audit report, shall bebinding on the Board.
The basic objective sought to be achieved through the instrumentality of the Audit Committee is toensure smooth, transparent and efficient management of the corporate sector, inter alia, from thepoint of view of the stakeholders in the company in particular shareholders and investors.
The concept of corporate governance and audit committee is an evolving concept in India, thoughaudit committees were formed in the past by many companies on account of the stipulation by thefinancial institutions. However, it is important to understand the effectiveness of such a committee inother parts of the However, there are other provisions such as the one providing that therecommendations of the Audit Committee in relation to financial management, including the auditreport, shall be binding on the Board. This provision may result in obliteration of the lines ofdemarcation between the domains of the auditors, directors, and the audit committee. Further, theauditor’s independence may get affected if the Audit Committee is to sit in judgement over the auditreport. Legally the audit report is submitted after the board of directors adopts the accounts. If theAudit Committee is to make recommendations on the auditors’ report, thereafter to the Board, itwould amount to sitting in judgement of its won actions or revising the accounts adopted earlier bythe Board. There are other such provisions in the Companies Act which require clarifications.
While elaborating on the role of audit committee, the Kumarmangalam Birla Committee on CorporateGovernance, in India, has stated that it is not the role of the audit committee to prepare financialstatements or engage in the myriad of decisions relating to the preparation of those statements. Theaudit committee is required to overview and monitor and in performing this function it relies onsenior financial management and the outside auditors. However it is important to ensure that theboards function efficiently for if the boards are dysfunctional, the audit committees will do nobetter.[129]
“Independence, adequate competence and due professional care in conducting an audit are the threeessential attributes of an auditor.”
Audit has been universally recognised and accepted as a corner stone of corporate governance. Giventhe separation of ownership from management, the directors are required to report on theirstewardship by means of the annual report and their financial statements sent to the shareholders.The audit provides an external, impartial and objective check on the preparation of the financialstatements of a company and their presentation to the shareholders and the public at large, and it isan essential part of the checks and balances required. Shareholders and others rely upon the auditor’sreport on company accounts as reassurance of the accuracy or otherwise of reports and accountspublished by the company. In this context, company auditors have a fiduciary obligation towards theusers of the audited financial statements.
The auditors’ position is akin to that of company directors who are accountable to shareholders of thecompany in the discharge of their stewardship obligations. Auditors thus become virtual trustees ofthe shareholders ensuring that disclosures by the company are a true and fair reflection of reality.Thus, to fulfil its primary function of giving a true and fair view of the financial affairs of the company,it has necessarily to be independent of the management.
From the investors’ point of view, if it is not believed that the auditor is truly independent from theissuer, they will derive little confidence from the auditor’s opinion and will be far less likely to investin the issuer’s securities. Fostering auditor confidence, therefore, requires not only that reasonableinvestors perceive them to be independent.
An auditor is expected to apply generally accepted auditing standards in the course of auditexamination and preparation of financial statements. However, a lack of independence could lead to alower application of accounting standards.
It is often argued that auditors are trained by their professional discipline to shoulder the onerousresponsibilities placed on them. However, from time to time, issues of bias and lack of independenceon their part comes up for discussion. Though theoretically it is the shareholders who approveauditors’ appointment, it is the management that proposes their appointment in the first place.Therefore, it is believed, a sense of obligation towards the management is unavoidable.
Another reason why the issue of auditor independence is often questioned is the increasing trend ofother services which auditors are called upon to provide to their audit companies.
As in the case of directors, establishing independence of auditors may not be easy. But, auditors morethan directors, must be above suspicion and seem to be independent for the abovementionedreasons. Thus, the interests of the shareholders demand the independence of the statutory auditorfrom the influence of the management itself is not involved in its own audit.
Companies Act provisions on Auditor Independence:
The Companies act ensures in many ways that the power to appoint auditors is not in the hands of themanagement and that it vests in the general body of shareholders. Where the shareholders fail toexercise this power, the Central Government appoints the auditor. However, the directors of thecompany can appoint the first auditors and can also fill a casual vacancy. To prevent the power ofcasual vacancy from being abused by the Board, it is enacted that a vacancy caused by resignationshall only be filled by the company in general meeting.
The Act also gives shareholders the opportunity to repeatedly exercise their power of appointment byproviding that the appointment would have to be renewed every year and that the shareholders mayeven replace the various appointees. Special notice of every such move of replacement has to be givenso that the auditor sought to be replaced may have an opportunity of explaining matters to the bodyof shareholders. Important information may be revealed in this process.
Section 276(3) of the Companies Act bars the following persons from being appointed as auditors ofthe company:
1.A body corporate;
2.An officer or employee of the company;
3.A person who is a partner, or who is in the employment, of an officer or employee of the company;and
4.A person who is indebted to the company for an amount exceeding one thousand rupees, or whohas given any guarantee or provided any security in connection with the indebtedness of any thirdperson to the company for an amount exceeding one thousand rupees.
Further, a person attracting any of the abovementioned disqualifications is also disqualified frombeing appointed as an auditor in any of the group body corporates. Section 226(5) is the logicalextension of the rule mentioned above, and is applicable to a person even after his appointment as anauditor. Thus, a person attracting any of the disqualifications mentioned in section 226(3) and (4) canneither be appointed nor continue in office as auditor.
The restrictions mentioned in the Companies act, however, are not exhaustive. They aresupplemented by the Chartered Accountants Act, 1949 and the Chartered Accountants’ Regulations,1988.
§Clause 10 of Part I of the First Schedule to the Act deems as professional misconduct thecharging or offering to change in respect of any professional employment fees which are basedon a percentage of profits which are contingent upon the findings or results of suchemployment.[130]§Clause 4 of Part I of the Second Schedule provides that a chartered accountant in practice shallbe deemed to be guilty of professional misconduct if he expresses his opinion on financialstatements of any business or enterprise in which he, his firm, or a partner in his firm has‘substantial interest’ unless he discloses his interest in the report. The expression ‘substantialinterest’ has the same meaning as in Appendix 10 to the Chartered Accountants’ Regulations,1988. Thus, a member shall be deemed to have a ‘substantial interest’ in a concern –
(1)In a case where a concern is a company, if its shares (not being shares entitled to a fixed rate ofdividend whether with or without a further right to participate in profits) carrying not less than 20 percent of the voting power at any time, during the ‘relevant years are owned beneficially by suchmember or by anyone or more of the following persons: (a) one or more relatives of the member; (b)any concern in which any of the persons referred to above has a substantial interest;
(2)In the case of any other concern, if such member is entitled or the other persons referred to aboveor such member and one or more of the other persons referred to above are entitled in the aggregate,at any time during the relevant years to not less than 20 per cent of the profits of such concern.
Though theoretically it is the shareholders who approve auditors’ appointment, it is the managementwhich proposes their appointment in the first place, and, therefore, a sense of obligation towardsmanagement is unavoidable. This is further compounded by the inevitably close working relationshipthat develops between auditors and management during the audit.
The other issue bearing upon auditor independence is the increasing trend of other services whichauditors are called upon to provide. The trend of providing such non-audit services has beendescribed as a “worrisome trend as growing reliance on non-audit services has the potential tocompromise the objectivity or independence of the auditor by diverting firm leadership away from thepublic responsibility associated with the independent audit function…” According to an estimate,non-audit revenues of firms in the US in recent years were four times their audit fee income.
Under Indian law, Section 2(2)(iv) of the Chartered Accountants Act allows a chartered accountant torender such other services as, in the opinion of the Council, are or may be rendered by a charteredaccountant in practice. However, Clause 11 of Part I of the First Schedule bars a chartered accountantin practice from engaging in any business or occupation other than profession of charteredaccountants unless permitted by the Council. Subject to the prohibition in Section 226(3)(b) and (c), achartered accountant in practice can be the director of a company. Under the Chartered AccountantsAct, the chartered accountants in service can offer services that cannot be strictly classified as thosearising from their competence as accountants. Consequently, the Council of the Institute of CharteredAccountants of India has often opined in favour of a number of other services which can be offered bya chartered accountant in practice, such as:
§Taxation representation before the tax authorities and tax planning and advisory services;§Management services: inclusive of financial planning and financial policy determination, capitalstructure planning and advice regarding raising of finance, preparing project reports andfeasibility reports, preparing case budgets, etc.§Company law advisory services in relation to compliance with the various provisions andprocedures under the Companies Act;
§Investigation of accounts for various purposes;§Valuation of shares of limited companies for various purposes;§Issue of certificates as required by the Government and other authorities for various purposes;§Special assignments required by the company for its own benefit, for example, a surpriseverification of cash or inventories or surprise visits to branches under special circumstances;§Review of systems and procedures;§Audit of ancillary institutions of the company like the Employees Provident Fund in respect ofwhich the fees are paid by the company itself.
The Council justifies these ‘opinions’ with the observation that these services are to some extent‘complementary’ in character to the main function of the auditor.[131] Further, Clause 4b, Part II ofSchedule VI to the Companies Act requires disclosure in the profit and loss account of amounts paidto the auditors as advisors, or in any other capacity, or in any other manner.
However, the ‘complementarity’ between auditor and management services leads to concerns withregard to corporate governance. This could result in enormous pressure on auditors to give way to themanagement on audit matters in order not to jeopardise their other business services.
This issue was addressed by the Cadbury Committee on corporate governance which opined that‘such a prohibition would limit the freedom of companies to choose their sources of advice and couldincrease their costs’.
In the United States, the Securities and Exchange Commission and the American Institute of CertifiedPublic Accountants (AICPA) established a separate Independence Standards Board in March, 1997,with the principal objective of setting out well-conceived and debated guidelines for establishingauditor independence. The SEC believes that an accountant is not independent when the accountant(1) has a mutual or conflicting interest with the audit client; (2) audits his or her own work; (3)functions as management or an employee of the audit client; (4) acts as an advocate for the auditclient. These principles are rooted in the philosophy of the profession that auditors must beindependent in fact and in appearance.
One of the biggest stories to have hit the market in the last one year is the fall of the energy monolith,Enron Corp. There are a number of issues, of great interest to financial analysts related to Enron. Oneof the major issues is that of the role and responsibilities of the auditors and whether in the presentcase it was their failure to identify the rot in the company which further magnified the problem andresulted in such huge losses for the stakeholders.
Before we examine that issues and causes of the fall of Enron, we seek to briefly summarise the riseand fall of Enron.
In the past, Enron was greatly admired for its innovative business strategies and superiormanagement skills. The rise of Enron demonstrated that the Internet could be used to enhancebusiness performance. The stocks of Enron were skyrocketing, the juggernaut was unstoppable andthe executives were eager to take the company to the uncharted markets of energy trading, water,optical fiber, etc. there was diversification into areas with which the original business had no link.
The fact that the stock markets and the value of the stock was critical to the company meant thatthese risks had to be hedged in a manner that any loss or risk of losses were not to be reflected in thebalance sheets of the company. Thus, the Company was in a catch 22 situation, where on the onehand they had to keep their balance sheets free of losses in order to maintain the stock prices and onthe other hand they had very little real assets to fall back on in the event of the stock prices crashing.
The rising stock prices gave the executives the hot currency to lure private equity investors intoinvesting in Enron’s new ventures. Further, Enron’s assets and debts were kept off the balance sheets,and investment grade credit ratings were maintained.
Hence, accounting jugglery was the reason for the growth rate shown to the investors. A complex webof partnerships was created. These partnerships helped the company keep the debts off its balancesheets all through these years, though the money itself has been going into the coffers of the companywithout the market noticing it. There is a strong possibility that the jugglery with accounts was done toensure that the markets were bullish about the company’s growth prospects. Hence, there wasunbridled pouring of money into its businesses and yet there was reluctance to show these debts inthe balance sheets. The method used to circumvent was that of using partnerships and showing thedebts in the accounts of partners.
No one, including the auditors, Arthur Andersen, took the pain to look into the murky waters of thesepartnership dealings. The bubble was first pierced in October 2000, when the company announcedthat it had to restate its profits of the last four years, from 1997 and had to take a hit of around $600million. This put the auditors on a very sticky wicket as it plainly showed them to have been negligent.The stock of the company crashed by 50% by April 2001. The market capitalization, which at one timewas at $200 billion had crashed to less than 50% of that sum.
All this took the market by surprise. The company revealed that several of its off balance sheet,Special Purpose Entities, partnerships made for special businesses were now being consolidated intothe accounts of the company. One of the best examples of such financial jugglery is provided bySterling Marlin. Enron took water assets, primarily based in the United Kingdom, off its balance sheetsand the Marlin II trust took a stake in them. Meanwhile Marlin II issued senior debt to investors, theproceeds of which went to Enron. The company did not recognise these notes as debts on its balancesheets, due to the structure of the trust. Marlin II replaced a similar trust called Marlin I. Ideally theaim was to maximise the value of the assets of these trusts and then sell them off and cover the trusts.To cover the risks that such sale would not be able to raise enough money, Enron also pledged toissue as much new stock as may be needed to pay off the notes. The assets did not perform well. Infact, the Merlin II trust was set up so that Enron did not have to issue fresh stock to cover the losses asit had promised to do. Hence, suddenly there was apprehension that the company would not bewilling to abide by its commitments. Thus, the faith of investors was shaken and the downfall became
As a result a loss of $560 million has occurred. The effect was to reduce earnings dramatically.[132]The company further announced a $1.2 billion in shareholders equity and a $1.01 billion charge onaccount of some investments that went awry. The bottom line was that Enron appears to have thoughtthat it could defy market scrutiny by nifty accounting but its luck ran out.
There are several issues arising out of the Enron fiasco related to Auditing. One of the main onesbeing that of independence of auditors.
The first issue which arises relates to the duty of care owed by the auditors to not only theshareholders of the company but also to the future investors in the company. There is a view that theauditors have to present a true and fair view of the accounts of the company for the benefit of theshareholders only. It is unfortunate that the position has not yet been cleared up in India either by thelegislature or by the department through a clarificatory note.
The role of the auditors of Enron Corp., Arthur Anderson, has been under fire arising out of a conflictof interest situation. The question that has been raised time and again has been whether the auditorsin this case did a bad job in not spotting the bad accounting practices and the company’soverstatement of profits, or whether it was complicit in the accounting gimmickry. Though it hasbecome common for accountancy firms to provide non-audit services, concerns arise as regardsindependence of the auditors. The issue that arises in the context of an accountancy firm providing avast gamut of services, including audit, would be that of conflict of interest. This results in thequestion: how can one be sure that a firm has been unprejudiced in an audit of a company that couldbe a client for its consultancy services. In the United States, the SEC Rules prohibit an independentaccountant from providing any service that wold involve stepping into the shoes of the management ofthe company and that involves any kind of decision making on behalf of the management.
Non-audit services have been listed, though this is not an exhaustive list, and include servicesinvolving book-keeping, design and implementation of financial information systems, appraisal andvaluation and fairness opinions, legal services, broker/dealer services et al. Internal audit servicescannot exceed 40 per cent of the total hours spent an internal audit activities of the client. Thisapplies to firms with over $200m in assets.
Arthur Anderson derived $25 million towards audit fees and $27 million towards consultingcontracts. There is a clear conflict of interest since an auditor is supposed to provide an independentview of the company’s accounts. Unlike in many countries in Europe, auditors in the US even representthe company in tax matters to the Internal Revenue Services. If they are truly independent of thecompany, they should not be doing this. Moreover, the almost automatic renewal of auditing contractsis another important factor to be considered.
Andersen the company’s auditors have admitted to an error of judgment in its treatment of the debtof one of Enron’s off balance sheet partnerships. Such ventures in which the former chief financialofficer of the company is alleged to have reaped over $30 million as profits are stated to have led toan overstatement of profits by almost $600 million over the years 1997-2000, as has been statedbefore. The failure of the auditors to point these out has led to the accusations of failure to presentfair and true view of the financial status of the company. The auditors have failed to blow the whistleand the Audit Report can only be taken to have presented a view aimed at hoodwinking theshareholders and the investing public at large.
This raises the question of the independence, integrity and the neutrality of auditors. In the USA as in
India, auditors are also allowed to be the accountants of the company. There are provisions relating todisclosure of fees, etc, yet incidents like Enron are a proof of the fact that the systemic safeguards, ifany, are inadequate.
Andersen has derived more money out of Enron as their accountants than as their auditors. They haveearned around $27 million as fees for non-auditing services and only $25 million as auditors. Suchhuge payments raise issues of conflict of interests. The firm has in the past vehemently opposed anyattempts to bar the usage of the auditors as accountants of the same company stating that there is noevidence that this is required. Now, there may be just that evidence.
Proposed amendments to the Section 224 of the Companies Act, 1956 seeks to exclude the statutoryauditor from having any other role in the Company. This amendment should have language such thatthe indirect and disguised consideration should also be taken care of. It is admittedly difficult to havea fool proof solution to the problem as there may be a firm which is not related on the face of it buthas deeper organic connections with the auditing firm. One example could be a partner breaking offand becoming the accountant while the firm is the auditor. These are issues which will have to be seenin the light of the facts of the case. The language will have to be such that there is enough flexibility toaccommodate the various manipulations by the accounting firms.
Accounting standards are the minimum requirements that need to be adhered to while maintainingthe accounts of a company. But by no means can they assure and guarantee the detection ofillegal/extralegal activity by the companies.
With the collapse of the energy giant, Enron Corp. concerns regarding the effectiveness of theGenerally Accepted Accounting Principles (GAAPs) in presenting a true and fair view of theperformance and statement of affairs of a company have been raised.
One of the issues that needs to be addressed is with regard to revenue recognition. Enron’s revenuegrowth from 1996 to 2000 was 50 per cent per annum.
However, the profits remained the same over the same period. This was possible on account of aloophole in Statement 133 on accounting of derivative transactions that allowed the company to bookrevenue from energy-derivative contracts at their gross value instead of their net value.
The major part of Enron’s revenue came from “wholesale business”, which had all the unconsolidatedentities in its fold. This gave rise to the issue of accounting of transactions between Enron and itsunconsolidated entities and the lacunae in the statement of consolidation. According to theconsolidation norms laid down by the Financial Accounting Standards Board, a Special PurposeVehicle (SPE) need not be merged with the company, if the company owns 97 per cent or less in theSPE. Hence, the SPEs were created by Enron to acquire assets and keep it off the books. Even DabholPower Corporation was an unconsolidated Special Purpose Vehicle in which Enron held a 50 per centshare. Thus, the company was able to create and trade in assets having high risk and negative returns
without bringing it in the books. Further, these Special Purpose Vehicles enabled the company to enterinto multiple transactions and thus boost its toplines.[133]
This is very normal practice in India, where the listed companies enters into dealings with unlistedgroup companies and thus are able to hike or deflate sales according to the needs of moment. TheChartered Accountants who participated in the Companies Act, 1956 survey conducted by the ETIntelligence Group, stated that the companies could tamper with sales and profit figures both ways,through dealing with the group companies.
Enron case has illustrated that the companies can easily circumvent the standards and still not be inviolation of any laws. There is enough scope for manipulation and the integrity of the people involvedis what is the most important thing in the final analysis.
The fact that standards can be manipulated around is not a case to not have them at all. They havetheir useful purpose as well and at least form the bench mark which can be used to detectnon-compliance or circumvention.
Though there can be no standard which can be fool proof, the standards can be in a perpetual state ofevolution so that they are able to keep pace with the manipulations of the companies.
There have been proposals to have an independent body which could have a control over the auditingundertaken by the various firms. These proposals have gained ground in the light of the fact that theEnron papers were shredded by Andersen. This destruction of documentary evidence has raisedserious questions over the feasibility and trustworthiness of the self-regulatory model of supervisionof the auditors.
Thus, in the Indian context also a question needs to be asked as to the integrity of accounting firms.The SEBI could be a body which could act as a body to supervise the accounting firms. The Institute ofChartered Accountants does not have a great record as far as disciplinary actions are concerned. TheICAI, after all is fiercely protective of the chartered accountants.
Even in the case of Enron the self regulation process has been discredited and there have been callsfor the Securities Exchange Commission to probe into the affairs of Andersen.
Enron’s collapse has also exposed the limitations of Audit Committees. It shows that independentdirectors are not really independent. The chairman of Enron’s Audit Committee is a Stanfordprofessor with 30 years experience of auditing and accounts. There is no ban on the members of theAudit Committee from holding stock in the company. This may seriously question their status asindependent directors forming part of the audit committee. Apart from that the fact that the membersof the Audit Committee, with all the experience they have were just not competent enough tounderstand the complexities of the transactions being undertaken by the company is a serious andgrave reflection on the reliability of the Audit Committee.
There have been large donations to the institutions were members of the Audit Committee areemployed by Enron. It is therefore not an exaggeration to state that the Audit Committee has lost anysemblance of independence.
Another issue that arises in this context relates to transactions with related parties. The Institute ofChartered Accountants of India issued an accounting standard (AS 18) which requires companies todisclose details of its transactions with related parties. Here again, the auditor is required to mentionin the Manufacturing and Other Companies Auditor’s Report Order, whether the transaction entered
into by the company with related companies are at arm’s length or not. However, if such companies,SPVs and partnerships are formed by creating a layer, such as another company, between thedirectors and the company itself, then it may be difficult to lift the corporate veil, according toexperts.
Hence, such structures can be efficiently used to transfer funds and assets of the company and alsohelp the company to trade with its group company, without attracting disclosure requirements.
Another issue that is raised is about the accounting of value investments in subsidiaries, associatecompanies and joint ventures. The Institute of Chartered Accountants, India has taken measures,making companies consolidate their interest in such entities. However, if the company holds less than20 per cent in a company, then the requirement of consolidation of interest in the associate companyis not required. Thus, a company can flout with this provision by making an investment of an amountless than 20 per cent and having provisions which do not dilute the management control overt heother company.
Independence of Auditors:
The role of Auditors in the open market economy is critical. An audit is an examination on a test basisof numerical data and explanations of such data presented in a companies financial statement. AnAudit includes an assessment of the principles and methods used in the preparation of those financialstatements. An audit, however, does not represent a review of each transaction or a qualitativeassessment of the companies performance. The role of an independent Audit is to provide anindependent opinion on the fairness of the companies financial statements. As required by law, it isthe responsibility of auditors to give their opinion as to whether these financial statements are fairlypresented and comply with the rules on book keeping.
Audit is a key component of good Corporate Governance. As a result of their audit work, the auditorsoften make recommendations to the board of directors and to management on ways to improvecorporate governance, internal controls and financial reporting. However, it is the responsibility of theclient to decide on whether and to what extent the auditors’ recommendations are to be implemented.
Independence is a fundamental feature of the audit profession and, along with objectivity andunquestioned technical expertise. From the business perspective it is more than reasonable to avoidsituations which may compromise the reputation which generations of professionals have beendeveloping for decades. Yet there have been a number of incidents which have raised questions overthe integrity of auditors and auditing firms.
One may then ask: why are auditors so protective with respect to attempts of third parites to discusstheir work? The answer to this is simple: client confidentiality, which is a contractual, professional andregulatory requirement. However, as has been proved by the Enron case, such an argument can not beused to avoid inspection any more as now the larger interests of shareholders and other investors arethe primary concern. As a result there is no avoiding scrutiny by third party regulators.
Enron has presented before us the perfect example of what can go wrong if the Auditors do notperform their duties in accordance with accepted legal principles and accounting practices. TheIndependent nature of Auditing is severely questioned in such a scenario. The nature of liabilities ofauditors is also brought into focus. The integrity of auditors and the mixing of audit and non-auditfunctions also raise questions regarding their independence.
[2] See: Sections 209-223 and Schedules V & VI of the Companies Act, 1956.
[3] Infra.
[4] Institute of Chartered Accountants v. P.K. Mukherjee, AIR 1968 SC 1104.
[5]K. Srinivasan, “Corporate Governance- Audit as a key factor”, [2001] CLA (Mag.) 25.
[6] Ibid,
[7] Cadbury Commission,Report of the Committee on the Financial Aspects of Corporate Governance(December 1992). at www.worldbank.org/html/fpd/privatesector/cg/docs/cadbury.pdf.
[8] Ibid.
[9] R.K. Aggarwal, COMPANY AUDIT REPORTS, 1996.
[10] Travis Morgan Dodd, “Accounting Malpractice and Contributory Negligence: Justifying DisparateTreatment Based Upon the Auditor’s Unique Role”, 80 Geo. L.J. 909.
[11] Ibid.,
[12] Supra note 3.
[13] Section 224(1) of the Companies Act provides that “every company shall at each annual generalmeeting appoint an auditor or auditors to hold office from the conclusion of that, until the conclusionof the next, annual general meeting.”
[14] ICAI, Compendium of Opinions, Vol. VII, 1st edn., 1990 Reprint, p. 81.
[15] Section 224 (1-A), Companies Act, 1956, this rule is applicable to auditors who are not retiringauditors.
[16] Institute of Chartered Accountants v. Jnanendranath Saikia, (1955) 25 Com Cases 53, 56(Assam).
[17] Section 224 (1-B), Companies Act, 1956.
[18] Exclusion of these two categories of auditors from the ceiling on company audits was, perhaps,not intended by the legislature. This could be a drafting error or omission. The desirable legalposition would be that no Chartered Accountant in practice (whether individually or as a partner in afirm of Chartered Accountants. Ramaiya, p. 1745.
[19] Departmental Clarification, Circular Number 21 of 75; F. No. 35/3/75-CL-III, dated 24-9-1975.
[20] Ramaiya, p. 1755.
[21] Section 166 lays down the period within which the annual general meeting is to be held.
[22] “The tenure of an auditor is laid down in section 224(1); it is from the conclusion of the annualgeneral meeting to the conclusion of the next annual general meeting and cannot therefore be for anyparticular year or financial year. The duty of the auditor is laid down in Section 227(2), whereunderthe auditor in office has to audit ‘every balance sheet and profit and loss account’ and every otherdocument in it or annexed to it which are laid before the general meeting held during his tenure ofoffice of any particular auditor. That also shows that the office of any auditor is not related to anyparticular balance sheet or profit or loss account or to any particular financial year.” ICAI,Compendium of Opinions, Vol. I, 3rd edn., 1986, p. 206.
[26] Department Clarification, Circular No. 2/72, dated 21-2-1972.
[27] Section 384(1), English Companies Act.
[28] Section 387, English Companies Act. The fines to be imposed are specified in Schedule 24.
[29] Section 384 (4), English Companies Act.
[30] Section 379 provides that at least twenty-eight days’ notice of the intention to move such aresolution must be given to the company and that the company must give at least twenty-one days’notice to its members.
[31] Sections 388 (1) and 391A, English Companies Act.
[32] Section 388 (1), English Companies Act.
[33] section 388 (2), English Companies Act.
[34] Section 385 (3) (4), English Companies Act.
[35] Sections 385A and 386, English Companies Act.
[36] In relation to the Institute of Chartered Accountants in England and Wales, Sections 1.2 and1.309 respectively, Statement 8 of the “Guide to Professional Ethics” and the Council Statement“Changes in Professional Appointment”, Member’s Handbook.
[37] Section 250 as amended by the Companies Amendment of Section 250 and 251) Regulations1992 (SI 1992 No. 3003), Regulation 2.
[38] Section 388A, English Companies Act.
[39] Section 224(7), Companies Act, 1956.
[40] Section 391 (1), (2), English Companies Act, as amended by the Companies Act 1989, Section122.
[41] Section 387 (2), English Companies Act.
[42] Section 388 (3), (4), (5), English Companies Act.
[43] Section 390 (2), English Companies Act.
[44] Refer to Section 240, English Companies Act.
[45] Section 390(4), (5), (6), English Companies act.
[46] Section 392(3) & 392A(5), as amended by English Companies Act 1989, Section 122 andSchedule X.
[47] Section 391 (2)-(7), English Companies Act, 1985.
[48] Section 24, English Companies Act 1989.
[49] The Institute of Chartered Accountants in England and Wales, the Institute of the CharteredAccountants of Scotland, the Chartered Association of Certified Accountants, the Institute of CharteredAccountants in Ireland and the Association of Authorised Public Accountants.
[50] Ramaiya, p. 1751.
[51] Schedule 4, Para. 53(7); Schedule 9, Para 16, English Companies act.
[52] Section 390A, as inserted by the Companies Act, 1989, Section 121.
[53] SI 1991/2128.
[54] Institute of Chartered Accountants v. P.K. Mukherjee, AIR 1968 SC 1104.
[55] Ramaiya, 14th ed, p. 1781
[56] Deputy Secretary v. S.N. Das Gupta, (1955) 25 Com Cas 413.
[57]CIT v. Dandekar, (1952) 22 Com Cases 1153 ( Mad).
[58] In Re Kingston Mill Company, [1896] 2 Ch. 279. See also: In Re City Equitable Fire InsuranceCompany, [1924] All ER Rep 485.
[59]Institute of Chartered Accountants v. P.K. Mukherjee, AIR 1968 SC 1104.
[60] Section 2(30) states that the auditor is an officer of the Company as far as winding up isconcerned and gives a list of provisions under which the auditor is considered to be an officer of thecompany. These provisions are section 477, section 478, section 539, section 543, section 545,section 625, and section 633.
[61] Leeds Estate Co. v. Shepherd, (1887) 36 Ch D 787 at 802. See also: London & General Bank, Re,[1895-9] All ER 953.
[62]Re London & General Bank , (1895-9) All ER 953 (CA).
[63]Ramaiya, 14th ed, p. 1782.
[64] Ibid.
[65] City Equitable Fire Insurance Co. Re., [1924] All E R Ref 485 (CA).
[66] Deputy Secretary to Government of India, Ministry of Finance v. S.N. Das Gupta, AIR 1955 Cal414.
[67] Berg Sons & Co. v. Meruyn Flampton Adams, 1993 BCLC 1045 QBD.
[68] I.C.A.I. v. P.K. Mukherjee, AIR 1968 SC 1104.
[69] Donoghue v. Stevenson, [1932] AC 562.
[70]Manufacturing And Other Companies ( Auditors Report) Order, 1988. Notification no G.S.R. 909 (E), dated 7th September, 1988.
[71]
[72] In Re London and General Bank, [1895-96] All ER Rep 953.
[73]Ramaiya, 14th ed.,p.1786.
[74]Ibid.,
[75] In Re London and General Bank, [1895-96] All ER Rep 953.
[76] City Equitable Fire Ins. Co., Re, [1924] All ER Rep 485.
[81] Thomas Gerrard Son Ltd., Re, [1967] 2 All ER 525 Ch D.
[82] Section 227(3) also requires that the auditor’s report state whether he has obtained all theinformation and explanations which to the best of his knowledge and belief were necessary for thepurpose of the audit; whether the company’s final accounts are in agreement with the books ofaccounts and returns; whether he has received report on the accounts of any branch office.
[83] Section 227 (3)(b), Companies Act, 1956.
[84]We shall examine the concept of ‘true and fair view’ in detail in a subsequent part of this paper.
[85] Allen Craig & Co, Re, (1934) All ER Rep 301.
[86]Ramaiya, 14th ed, p. 1786.
[87] Ninth Annual Report, dated 5th August, 1965 on the Working and Administration of theCompanies Act, 1956, page 23.
[88](1895) 2 Ch 166.
[89] ICAI Disciplinary cases, Vol. IV, Judgment of the High Court delivered on 11th April 1963.
[90] Infra.
[91]Berg Sons & Co. Ltd. v. Adams, 1993 BCLC 1045 (QBD).
[92] ICAI’s Statement on Qualification in Auditor’s Report, Paragraphs 3.1 and 3.2.
[93] ICAI’s, Statement on Qualification in Auditor’s Report, Paragraph 3.5.
[94]ICAI’s, Statement on Qualification in Auditors Report, Paragraph 3.7.
[95] London and General Bank’s case, (1895) 2 Ch 166.
[96] ICAI’s, Statement on Qualifications in Auditor’s Reports, Paras 3.10, 3.12.
[97]Research Committee of the Institute of Chartered Accountants of India, Opinion Regarding CertainProvisions of the Companies Act, 1969, p. 17.
[98]Department’s File No. 8/16(1)/61 -PR.
[99]ICAI’s Comm of pendium of opinions, Vol. X, Pp. 177-178.
[100] Jon H. Holyoak, “Accountancy and Negligence”, Journal of Business Laws, 1986, p. 120.
[101] (1964) A.C. 465.
[102] Jon H. Holyoak, “Accountancy and Negligence”, Journal of Business Laws, 1986, p. 121.
[103] (1887) 36 Ch. D. 787.
[104] (1904) 30 Acct. L.R 93, cited from, P.A. Bird, et al, “Annual Accounts and Returns”, Ed., Clive M.Schmitthoff, Palmer’s Company Law at 1091 (Vol. 1, 24th ed., 1987).
[105] (1936) 80 Acct. L. R. 39.
[106] [1990] BCC 164.
[107] K.R. Chandratre, “Auditors duty of care and liability for negligence: Recent Judicial Exposition”,[2002] 35 SCL ( Mag) 109 at 112.
[108] In Candler v. Crane, Christmas & Co., [1951] 2 KB 164, a majority of the Court of appealdismissed the claim of the plaintiff who had invested money a company, in reliance upon the accounts
[130] Exceptions can be made, however, under the Regulations.
[131] Code of Conduct, Institute of Chartered Accountants of India, 1980, p. 47.
[132]In 1997, the earning were reduced from $105million to 9 million; In 1998 the change was from$703 to $590 million; In 1999 it was $893 to $643 million; In 2000 $979 to $847 Million.
[133] Mehta, Sumeet, Kalloor, Roshni, “Bridging the GAAPs”, The Economic Times, Bangalore, 13 April2002.
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