UNIT 2 AUDIT OF COMPANIES

1. Explain the qualification and disqualification of an auditor?

A person in order to be appointed as the auditor should meet the following qualifications-
1. A person shall be a Chartered Accountant.
2. A firm where majority of the partners practicing in India are qualified for appointment may be
appointed by its firm name to be the auditor of the company.
3. In case of an LLP, only those partners who are Chartered Accountants shall be authorized to
act and sign on behalf of the firm.
The following persons are not eligible to be appointed as the auditor-
1. A body corporate except an LLP registered under Limited Liability Act,2008.
2. An employee or officer 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 who or his relative or partner is having interest or holding security in a company.
However, a relative can hold security or interest in a company not exceeding the face value of Rs.
1,000 or Rs. 1,00,000 as prescribed by the rules. In case the amount of security or interest held by a
relative exceeds the threshold limits, a corrective action shall be taken by the auditor to maintain the
limits, within 60 days from the date of such acquisition or interest.
5. A person who or his relative or partner has indebted to a company or its holding or its subsidiary
or an associate company or a subsidiary of such holding company for an amount exceeding Rs.
5,00,000.
6. A person who or his relative or partner has given guarantee to the indebtedness of any third party
to the company or its holding or its subsidiary or an associate company or a subsidiary of such
holding company for an amount exceeding Rs. 1,00,000.
7. A person or a firm who, whether directly or indirectly has any business relationship with the
company or its holding or its subsidiary or an associate company or a subsidiary of such holding
company.
However, the commercial transactions in the nature of professional services permitted to be rendered
an auditor or an audit firm under Chartered Accountants Act, 1949 and the rules and regulations
made thereunder and the commercial transactions which are made in the ordinary course of
business of the company at an arm’s length price shall not be considered as business relationship.
8. A person whose Relative is a director or is in employment of the company as director or Key
Managerial Personnel of the company.
9. A person who is full-time employed elsewhere.
10. A person who is convicted of an offence involving fraud and a period of ten years has not elapsed
from the date of such conviction.
11. A person who directly or indirectly renders any service referred to in section 144 of the
Companies Act, 2013 to the company or its holding company or its subsidiary Company.
The following services are covered under section 144 of the Companies Act, 2013
• Accounting and Bookkeeping Services
• Internal audit
• Design and Implementation of any financial information system
• Actuarial Services
• Investment Advisory services
• Investment Banking Services
• Rendering of Outsourced Financial Services
• Management Services and
• Any other services as may be prescribed
If a person attains any of the above-discussed disqualifications after being appointed as an auditor
of the company, then, such person shall vacate his office as an auditor immediately.
The vacancy arising due to such vacation shall be considered a casual vacancy.
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2. Explain the modes of appointment of an auditor?

Appointment of Auditor in Government Company
CompaniesAct,2013 defines a Government Company [Section 2 (45)], "as a company in which not less
than 51% of the paid up share capital is held by the Central or State Government or Governments or
partly by the Central government and partly by one or more State governments."
1. Appointment of First Auditor [Section 139 (7)]
· The first auditor of Government company shall be appointed by the Comptroller and Auditor
General of India within 60 days from the date of registration of the company.
· In case the Comptroller and Auditor General of India does not appoint such auditor within 60
days, the Board of Directors of the company shall appoint first auditor within next 30 days.
· In case of failure of the Board to appoint the first auditor, it shall inform Members of the
company who shall appoint first auditor within 60 days at an Extraordinary General Meeting.
· First Auditor shall hold office till the conclusion of the first Annual General Meeting.
2. Appointment of Subsequent Auditor [Section 139 (5)]
The Comptroller and Auditor General of India shall appoint subsequent auditor of Government
companies within 180 days from the commencement of the financial year and who shall hold office
till the conclusion of the Annual General Meeting.
3. Appointment in case of Casual Vacancy [Section 139 (8)]
Appointment of auditor due to casual vacancy in Government Company is filled by the Comptroller
and Auditor General of India within 30 days. If he fails to do so, the Board of Directors shall fill within
next 30 days.
Appointment of Auditor in Non-Government Company
1. Appointment of First Auditor [Section 139 (6)]
The first auditor of a company other than a Government company, shall be appointed by the Board of
Directors within 30 days from the Date of Registration of the company.
In case of failure of the Board to appoint the auditor, it shall inform the members of the company.
The Members shall appoint the auditor within 90 days at an Extraordinary General Meeting
Appointed First Auditor shall hold office till the conclusion of the first Annual General Meeting.
2. Appointment of Subsequent Auditor's [Section 139 (1)]
Every company shall appoint an individual or a firm as auditor of the company at the first Annual
General Meeting.
The appointed auditor shall hold the office till the conclusion of sixth Annual General Meeting and
thereafter till the conclusion of every sixth meeting.
The Company shall place the matter relating to such appointment of ratification by member at every
Annual General Meeting.
Before such appointment is made, the written consent of the auditor to such appointment and also a
certificate from the auditor that he is eligible for appointment shall be obtained from the auditor.
The company shall inform the appointed auditor and also file a notice of such appointment with the
Registrar within 15 days of the meeting in which the auditor is appointed.
3. Appointment in case of Casual Vacancy [Section 139 (8)]
Causal vacancy arise due to death or insanity or insolvency of an auditor. If an auditor is disqualified
after his appointment, he shall vacate his office as auditor. Such vacation shall be deemed to be a
casual vacancy in the office of the auditor.
Appointment of auditor's in case of casual vacancy shall be done by the Board of Directors within a
period of 30 days.
If vacancy is due to resignation of an auditor, such appointment shall also be approved by the
company at a General Meeting convened within 3 months of the recommendation of the Board.
The auditor shall hold office till the conclusion of the next Annual General Meeting.
3. What are the rights and duties of an auditor?
 UNIT 2 AUDIT OF COMPANIES

Powers (or) Rights of an Auditor [Sec.143]

The Companies Act has conferred certain rights on auditor's so as to enable them to discharge their
duties smoothly.
1. Right to Access Books and Vouchers: Every auditor of a company has a right to access book of
accounts and vouchers of the company at all times. Vouchers include all documents,
correspondence, agreements, etc.
Books include financial, accounting, statutory and statistical books of the company. The term all
times means only during the normal business hours.
2. Right to Obtain Information and Explanation:
An auditor has the right to seek information and explanation from the directors and officers of the
company. That will enable him to perform his duties successfully. Every officer of the company must
furnish the necessary information to the auditor. If the officer refuses to do so, the auditor may report
to the members of the company.
3. Right to Sign Audit Report [Sec.145]:
The auditor has the right to sign the auditor’s report. The auditor can also sign or authenticate any
document which the law requires to furnish.
4. Right to receive Notices and attend General Meeting [Sec.146]:
The company must send all notices and communications to the auditor relating to any general
meeting. The auditor shall attend the meeting either through himself or through his representative,
who shall be an auditor. The auditor in general meeting must be given reasonable opportunity to
speak on any part of the business, which concerns him as the auditor.
5. Right to visit Branches:
The auditor has the right to access all books and vouchers kept at the head office or at any branches
of the company. In case the accounts of branches are audited by a person other than the company’s
auditor, he shall be entitled to visit the branch office. The company auditor can get copies of accounts
certified by the branch auditor.
6. Right to get Remuneration:
The remuneration of the auditor of a company shall be fixed in its general meeting for auditing the
books of accounts of the company. The auditor can claim remuneration from the appointing
authority. At the time of winding up of the company, he can claim remuneration as creditor of the
company.
7. Right to Report to Members:
The auditor has the right and duty to report to the members of the company regarding the accounts
examined by him. He is also required to give his opinion about whether the financial statements give
a true and fair picture of the state of affairs of the company.
8. Right to seek Legal and Technical Advice:
The auditor has the right to seek expert advice in respect of legal or technical matters at the expense
of the company.
9. Right to give Suggestions to the Board: The auditor has the right to suggest some modifications
in the books of accounts to the Board. The Board should comply with the suggestions made by the
company auditor. If not, the auditor should report the same to the members. But the auditor cannot
make changes in the books of accounts of his own.
10. Right to Correct Wrong Statements: The auditor has the right to correct wrong statements
made by the directors relating to the accounts. But it should be remembered that any statement by
him to this effect will not relieve himself for any omission or incompleteness in his report.
11. Right to be Indemnified:
The auditor has the right to be indemnified out of the assets of the company against any liability
incurred by him in defending himself against the civil or criminal proceedings by the company if it is
proved that the auditor has acted honestly.
1. Duty to report to the Members [Sec.143 (3)]:
 UNIT 2 AUDIT OF COMPANIES

The auditor shall make a report to the members of the company on accounts and financial
statements examined by him.
The report shall state:
a. Whether he has sought and obtained all necessary information and explanations.
b. Whether proper books of accounts has been kept.
c. Whether company’s Balance Sheet and Profit and Loss account are in agreement with books of
accounts and returns.
2. Duty to Enquire [Sec.143 (1)]:
It is the duty to inquire into the following matters:
· Whether loans and advances made by the company based on security have been properly
secured and whether the terms on which they have been made are prejudicial to the interests of the
company or its members.
· Whether transactions of the company, which are represented merely by book entries, are
prejudicial to the interests of the company.
· Whether loans and advances made by the company have been shown as deposits.
· Whether personal expenses have been charged to revenue account.
· Whether it is stated in the books and documents of the company that any shares have been
allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash
has actually been so received, whether the position as stated in the account books and the balance
sheet is correct, regular and not misleading.
3. Duty to comply with Auditing Standards [Sec.143 (9)]:
· Every auditor shall comply with the auditing standards.
· The Central Government shall notify standards in consultation with National Financial
Reporting Authority, (NFRA).
· The government shall also notify that auditor’s report shall include a statement on such
matters as notified.
4. Duty to report on Frauds [Sec. 143 (12)]:
When an auditor suspects an offence involving fraud is being committed by officers or employees of
the company, he shall immediately report the matter to the Central Government in such manner as
may be prescribed.
5. Duty to state the reasons for qualified or negative report [Sec.143 (4)]:
In case of negative or qualified report, the reasons must be stated in the report.
6. Duty to assist investigation:
It is the important duty of the auditor to assist the investigator to investigate the affairs of the
company. Further, it is the duty of the auditor,
· To provide and preserve the necessary documents which are in his custody to the
investigator, and
· To assist the investigator by providing all assistance in connection with the investigation.
7. Duty to certify Statutory Report: The auditor has to certify statutory report as correct to the
extent of –
· Shares allotted by the company,
· Cash received in respect of such shares, and
· An abstract of receipts and payments of the company.
8. Duty to certify Prospectus:
It is the duty of auditor to certify a report showing statement of profits or losses and assets and
liabilities of the company and its subsidiaries. The report shall also include rates of dividend paid by
the company for each of five financial years preceding the issue of prospectus.
9. Duty to report under Voluntary winding up:
When the company proposes for voluntary winding up, directors of the company have to make a
declaration of solvency. The auditor has to certify a report upon the solvency based on the Profit and
 UNIT 2 AUDIT OF COMPANIES

Loss Account and Balance Sheet.

10. Duty to preserve Working Papers: It is the duty of an auditor to preserve and produce all books
and papers relating to the company which are in his custody and to assist the inspector appointed by
the government for investigation.
4. Explain the liability of an auditor?
1. Liability for Negligence:
Negligence means breach of duty. An auditor is an agent of the shareholders. He has to perform his
professional duties. He should take reasonable care and skill in the performance of his duties. If he
fails to do so, liability for negligence arises. An auditor will be held liable if the client has suffered loss
due to his negligence. It should be noted that an auditor will not be liable to compensate the loss or
damage if his negligence is not proved.
2. Liability for Misfeasance:
Misfeasance means breach of trust. If an auditor does something wrongfully in the performance of his
duties resulting in a financial loss to the company, he is guilty of misfeasance. In such a case, the
company can recover damages from the auditor or from any officer for breach of trust or misfeasance
of the company. Misfeasance proceedings can be initiated against the auditor for any untrue
statement in the prospectus or in the event of winding up of the company.
3. Untrue statement in Prospectus [Sec.34]
The auditor is liable when he authorizes a false or untrue prospectus. When a prospectus includes
any untrue statement, every person who authorizes the issue of prospectus shall be imprisoned for a
period of six months to ten years or with a fine, which may be three times the amount involved in the
fraud or with both.
4. Non compliance by auditor [Sec. 143 and 145]:
If the auditor does not comply regarding making his report or signing or authorization of any
document and makes willful neglect on his part he shall be punishable with imprisonment upto one
year or with fine not less than ₹. 25,000 extendable to ₹. 5,00,000.
5. Failure to assist investigation [Sec.217 (6)]:
WhenCentral Government appoints an Inspector to investigate the affairs of the company, it is the
duty of the auditor to produce all books, documents and to provide assistance to the inspectors. If the
auditor fails to do so he shall be punishable with imprisonment upto one year and with fine up to
₹.1,00,000.
6. Failure to assist prosecution of guilty officers [Sec.224]:
An auditor is required to assist prosecution when Central Government takes any action against the
report submitted by the Inspector. If he fails to do so, he is found guilty and is punishable.
7. Failure to return property, books or papers [Sec.299]:
When a company is wound up the auditor is supposed to be present and subject himself to a private
examination by the court and is also liable to return to the court any property, books or papers
relating to the company. If the auditor does not comply, he may be imprisoned.
8. Penalty for falsification of books [Sec.336]:
An auditor when destroys, mutilates, alters or falsifies or secrets any books of account or document
belonging to the company. He shall be punishable with imprisonment and also be liable to fine.
9. Prosecution of auditor [Sec.342]:
In the course of winding up of a company by the Tribunal, if it appears to the Tribunal that an
auditor of the company has been guilty of an offence, it shall be the duty of the auditor to give all
assistance in connection with the prosecution. If he fails to give assistance he shall be liable to fine
not less than ₹ 25,000 extendable upto ₹.1,00,000.
10. Penalty for deliberate act of commission or omission [Sec.448]: If an auditor deliberately
make a statement in any report, certificate, balance sheet, prospectus, etc which is false or which
contains omission of material facts, he shall be punishable with imprisonment for a period of six
 UNIT 2 AUDIT OF COMPANIES

months to ten years and fine not less than amount involved in fraud extendable to three times of
such amount.
11. Liability under Income Tax Act [Sec.278]
 For tax evasion exceeds ₹.1,00,000, rigorous imprisonment of six months to seven years.
 A person who induces another person to make and deliver to the Income Tax authorities a
false account, statement or declaration relating to any income chargeable to tax which he
knows to be false, he shall be liable to fine and imprisonment of three months to three years.
An auditor may also be charged in case of wrong certification of account.
 A Chartered Accountant can represent his clients before the Income Tax Authorities. However,
if he is guilty of misconduct he can be disqualified from practicing.
 An auditor can face imprisonment upto two years for furnishing false information.
5. What do you mean by audit report? Explain the contents of an audit report? Explain the
types of audit report? Explain the essentials of an audit report?
Audit Report is the formal written opinion about the entity’s financial statements. The auditor
conveys the report to the management at the end of the audit. Apart from the opinion on the
statements, it also includes factual information.
It is a medium of communication of the views of the auditor to the company’s management. Hence,
he submits the report created to the client. The report explains the information contained in it with
clarity and brevity.
The audit report is the final product of the audit work performed by the auditor and his staff.
Lancaster has defined a report as “a report is a statement of collected and considered facts, so drawn
up as to give clear and concise information to persons who are not already in possession of the full
facts of subject matter of the report.”
According to Cambridge Business English Dictionary, Audit report is defined as a formal document
that states an auditor’s judgment of a company’s accounts.
Under Sec. 143(3), auditor of a company must report to its members.
(a) The accounts examined by him;
(b) Balance Sheet, Profit and Loss Account, and Cash Flow statement, which are laid in general
meeting of a company during his tenure of office; and
(c) The document declared to be attached to the Balance Sheet and Profit and Loss Account.
Contents of Audit Report
1. Title: An appropriate title facilitates the reader to identify the report. It also differentiates this
report from others.
2. Address: It has to be properly addressed. For instance, in a statutory audit, the audit report is
addressed to the shareholders. Whereas the same is addressed to the government in case of
special audit.
3. Identification of financial statements: It should display the name and address of the
enterprise.
4. Reference to auditing standards and practices: It ensures conformity of the resolution of
ICAI. Plus, it guarantees that the accounting and auditing standards are duly complied with.
5. Opinion on the financial statements: It expresses the auditor’s opinion on the company’s
financial position.
6. Signature: The auditor should sign the audit report. Further, in case the audit firm is an
auditor, then the representative can sign the report on behalf of the firm.
7. Date: The report must display the date of audit.
Types of Audit Report
There are four major types of audit report:
Unqualified Report:
The clean report is an alternative term for the unqualified report. It shows that the company’s
 UNIT 2 AUDIT OF COMPANIES

financial statements present a true and fair view. It does not contain any reservations.
Qualified Report:
Here, the auditor doesn’t give a clean report. Rather, he expresses his opinion on the truth and
fairness, with some reservations.
Adverse Report:
In this, the auditor generates a report based on an examination conducted. He/She is not in
agreement with the affirmations given on the financial statements.
Disclaimer Opinion:
Here, the auditor is unable to give any opinion on the financial statement. He/She denies passing any
statement, after the audit.
Essential of an Ideal Audit Report
 Simplicity: A good audit report has to be simple and clear as understandable. It should be
free from any ambiguous terms and facts.
 Clarity: Clarity is about cleanness in the audit report. It should contain all the relevant
information. The information is necessary for evaluating and appraising the performance of the
business.
 Brevity: Brevity implies the conciseness of the audit report. The auditor must avoid repetitive
use of facts and figures. This will result in keeping the length of the report in control.
 Firmness: The audit report must demonstrate the scope of work performed. Along with that, it
shows whether the company’s account books show a true and fair view.
 Objectivity: Objective evidence should form the basis of the audit report. He should give his
opinion based on obtained information and evidence. But it must contain monetary
information only.
 Consistency: A good report must be consistent in the presentation of accounting details. It
should take into account the consistency in the method of inventory valuation. The auditor
should also check invariability in the method of depreciation.
 Accepted Principles: Fact and figures in the report have to be in accordance with GAAPs.
These facts and figures often form the basis of an audit report.
 Disclosure Principles: The audit report must be unbiased. It should contain all the relevant
facts and truth.
6. Explain the mode of removal, rotation of an auditor?
Once an auditor has been appointed by a company, they can be removed only when:
• He is removed by company suo-moto before his term.
 The auditor himself resigns.
 There is a casual vacancy other than by resignation.
 The term of the auditor is completed and another auditor is to be appointed in place of the retiring
auditor.
• Removal by Tribunal.
A Company may Suo-moto remove its auditor from office before the expiry of his term as per the
provisions of section 140 of the Companies Act 2013 read with Rule 7 of Companies (Auditor and
Auditors) Rules 2014. As per section 140(1), only by a special resolution of company can an auditor
appointed u/s 139 be removed after obtaining previous approval from CG in form ADT-2 along with
fees where:
• The application made in form ADT-2 shall be made to CG within 30 days of resolution passed by the
board
• The company shall hold GM within 60 days of approval of CG for passing SR.
The procedure in brief for the removal is as under:
• Company to pass a Board Resolution for removal and the Auditor concerned needs to be given a
reasonable opportunity of being heard
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• Within 30 days of the above resolution, the company would apply for the approval of the Regional
Director (RD) in Form ADT-2 which is to be filed with prescribed fee.
• After due procedure RD may pass an order for removal of auditor.
 After obtaining the approval, company shall hold an EGM within 60 days of receipt of approval and
then pass a Special Resolution for removal of the Auditor therein.
• Company to file MGT-14 within 30 days of passing of the said special resolution.
Rotation of auditors is a new topic introduced in the Companies Act, 2013. As per the section, a
company should rotate auditors after specified time. It means, the same auditor cannot continue
forever.
Rotation is applicable only to
(1) Listed companies;
(2) Other prescribed class of companies (except One person & small companies)
(a) all unlisted public companies having paid up share capital ≥ ` 10 crore;
(b) all private limited companies having paid up share capital ≥ ` 50 crore; or
(c) all companies having public borrowings from financial institutions, banks or public deposits ≥
` 50 crores.
The above companies shall not appoint or re-appoint:
(a) an individual as auditor for more than ONE term of five consecutive years; and
(b) an audit firm as auditor for more than TWO terms of five consecutive years