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Company Audit-l: Statutory Requirements Governing

Company Auditors

Qualifications of a Company Auditor

To be appointed as a company auditor, a person must meet the prescribed
qualifications and be free from disqualifications as outlined by the Companies Act,
1956, under Section 226. Below are the key qualifications required for the
appointment:

1. Chartered Accountant Requirement

A person shall not be qualified for appointment as an auditor of a company (whether
public or private) unless:
• Chartered Accountant: The person must be a chartered accountant under
the Chartered Accountants Act, 1949 and hold a certificate of practice.
• Firm of Chartered Accountants: A firm where all partners are practising
chartered accountants may be appointed as the auditor of a company. In such
cases, any partner can act in the firm's name (Section 226(1)).
• Sole Proprietor: If the chartered accountant is practising as a sole
proprietor, they can only be appointed as an auditor in their individual
capacity and not under the firm's name.

2. Disqualification for Appointment

A person shall also not be qualified for appointment as an auditor if, by virtue of
subsection (3), they are disqualified from being appointed as an auditor of another
body corporate related to the company, such as:
• The company’s subsidiary or holding company,
• A subsidiary of the company’s holding company.
Additionally, they would be disqualified if the body corporate were a company itself
(Section 226(4)).

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3. Certified Auditors
• Certified Auditors: In addition to practising chartered accountants, a person
holding a certificate under the Registered Auditors Certificate (Part B States)
Rules, 1956 is also eligible to be appointed as an auditor of a company. These
persons are known as Certified Auditors.
• Government Regulation: The central government may issue notifications
concerning the grant, renewal, suspension, or cancellation of such
certificates. Certified auditors are subject to government rules in this regard
(Section 226(2)).

Disqualifications for Appointment as Auditor

Section 226(3) of the Companies Act, 1956 outlines specific disqualifications for
individuals who wish to be appointed as independent auditors of a company. The
disqualified persons include:
1. Body Corporate
• A body corporate is disqualified from being appointed as an auditor.
2. Officer or Employee of the Company
• An officer or employee of the company is not eligible for appointment as an
auditor.
3. Partners or Employees of Officers or Employees
• A person who is a partner or employed by an officer or employee of the
company is disqualified from being appointed as an auditor.
4. Indebtedness to the Company
• A person who is indebted to the company for an amount exceeding Rs. 1,000
or who has provided a guarantee or security for the indebtedness of any third
person to the company for an amount exceeding Rs. 1,000.
5. Ownership of Securities with Voting Rights
• A person holding securities of the company carrying voting rights for a
period of more than one year from December 13, 2000, (the date of
commencement of the Companies (Amendment) Act, 2000).

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o The purpose of this provision is to prevent possible insider trading by

auditors.
6. Relatives of Directors
• A chartered accountant who is a relative of a director is disqualified from
being appointed as the auditor unless the appointment is approved by the
company through a special resolution in its general meeting.
7. Applicability to Subsidiary and Holding Companies
• The above disqualifications extend to the subsidiary or holding company,
or a subsidiary of the holding company.
Independence of the Auditor
The provisions of Section 226 aim to ensure that auditors maintain their
independence while auditing the companies, preventing conflicts of interest or
undue influence. If, after appointment, an auditor becomes subject to any of the listed
disqualifications, they shall be deemed to have vacated their office immediately.

Act vs Order

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APPOINTMENT OF AUDITORS [SECTION 224]

1. Appointment of First Auditor(s) [Section 224(5)]
• The first auditor(s) of a company shall be appointed by the Board of
Directors.
• The appointment must be made within one month from the date of
registration of the company.
• The auditor(s) appointed shall hold office until the conclusion of the first
annual general meeting (AGM) of the shareholders.
o A company may, at a general meeting, remove any such auditor(s) and
appoint others in their place.
o The new auditor(s) must be nominated by any member of the
company and notice of the nomination should be given to members at
least 14 days before the meeting date.
• If the board fails to appoint the first auditor within one month, the company
in general meeting may appoint the first auditor(s).
2. Appointment of Subsequent Auditor(s) [Section 224(1)]
• Empowerment of Shareholders: The Companies Act, 1956 empowers the
shareholders to appoint auditors of the company, except in certain cases such
as the first auditor or an auditor appointed to fill a casual vacancy (except
when caused by the resignation of the auditor).
• Appointment Process: According to Section 224(1), every company must,
at each Annual General Meeting (AGM), appoint an auditor(s) to hold
office from the conclusion of that meeting until the conclusion of the next
AGM.
• Intimation: The company must, within 7 days of the appointment, notify
every auditor(s) who has been appointed.
• Acceptance or Refusal of Appointment: As per Section 224(1A), the
auditor, upon receiving intimation of their appointment, must, within 30 days,
inform the Registrar in writing whether they have accepted or refused the
appointment.

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• Independence of Auditor: The authority of shareholders to appoint auditors

stems from the fact that auditors hold a position of trust with the shareholders.
Therefore, auditors must be independent of the management.
3. Re-appointment of Auditor(s) [Section 224(2)]
• Nature of Auditor's Appointment: A statutory auditor is not appointed on a
permanent basis; it is typically a contractual assignment. The auditor usually
holds office from the conclusion of the AGM in which they were appointed
until the conclusion of the next AGM.
• Re-appointment of Retiring Auditors: While an auditor’s appointment is
not automatically renewed at every AGM, retiring auditors are often re-
appointed. However, a resolution must be passed to re-appoint them.
Retiring auditors cannot be deemed to be re-appointed automatically.
• Conditions for Re-appointment: According to Section 224(2), a retiring
auditor shall be re-appointed unless:
1. (a) The auditor is not qualified for re-appointment.
2. (b) The auditor has given the company a notice in writing of their
unwillingness to be re-appointed.
3. (c) A resolution has been passed at the AGM appointing someone else
instead or expressly stating that the retiring auditor shall not be re-
appointed.
4. (d) A notice has been given for an intended resolution to appoint
another person(s), but due to the death, incapacity, or disqualification
of that person(s), the resolution cannot proceed.
4. Appointment by the Central Government [Section 224(3)]
• (a) Appointment of Auditor by the Central Government: If no auditor is
appointed or re-appointed at an Annual General Meeting (AGM), the
Central Government has the authority to appoint an auditor to fill the
vacancy.
• (b) Notice to the Central Government: It is the company’s duty to inform
the Central Government about the appointment or re-appointment of the
auditor within 7 days of the AGM.

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• (c) Penalty for Non-Compliance: If the company fails to give the required
notice, both the company and every officer in default may be penalized with
a fine of up to Rs. 5,000.
5. Appointment in a Casual Vacancy [Section 224(6)]
• Definition of Casual Vacancy: The term "casual vacancy" is not defined in
the Act. It generally refers to a vacancy in the office of the auditor resulting
from accidental or unexpected circumstances, such as death, resignation,
or disqualification of the existing auditor.
• Filling the Casual Vacancy:
o (a) If the casual vacancy is not caused by resignation, it shall be filled
by the Board of Directors.
o If the vacancy is caused by the resignation of the auditor, it can only
be filled by the company in a general meeting.
• Tenure of Auditor Appointed to Fill Casual Vacancy:
o The auditor appointed to fill a casual vacancy will hold office until the
conclusion of the next Annual General Meeting (AGM).
6. Appointment by Special Resolution [Section 224(A)]
• Appointment or Re-appointment by Special Resolution: Section 224(A)
requires the appointment or re-appointment of auditors to be made at the
Annual General Meeting (AGM) by special resolution in the following
cases:
1. Public Financial Institution, Government Company, or
Central/State Government: If at least 25% of the subscribed capital
is held by:
▪ A public financial institution, government company, Central
Government, or any State Government.
2. Financial Institutions with Majority State Ownership:
If at least 51% of the subscribed capital is held by any financial or
other institution established by a provincial or state act, where the state
government holds not less than 51% of the subscribed share capital.

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3. Nationalized Banks or Insurance Companies: If the company is

owned by a nationalized bank or an insurance company carrying on
general insurance business.
4. Combination of the Above Categories: If a combination of any of the
above categories holds the required share capital.
• Failure to Pass Special Resolution: If the company fails to pass the special
resolution for appointment or re-appointment of auditors at the AGM, it will
be considered as if no auditor has been appointed. In such cases, the Central
Government may appoint an auditor for the company.
7. Appointment of Auditor of Government Companies [Section 619]
• Definition of Government Company: A Government Company is defined
as a company in which not less than 51% of the paid-up share capital is
held by:
o The Central Government, or
o Any State Government(s), or
o A combination of the Central and State Governments.
This also includes a company that is a subsidiary of such a government company
(as per Section 617).
• Appointment of Auditor: The auditor of a Government Company is
appointed or re-appointed by the Central Government based on the advice
of the Comptroller and Auditor General (CAG) of India.

AUDITOR'S REMUNERATION

The remuneration of an auditor is determined by the appointing authority as per

Section 224(8) of the Companies Act, 1956. The key provisions are as follows:
1. Appointment by Board of Directors:
o If the auditor is appointed by the Board of Directors (either as the first
auditor or to fill a casual vacancy, except due to resignation), the
Board will determine the remuneration.

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2. Appointment by Central Government:

o If the auditor is appointed by the Central Government, the Central
Government will fix the remuneration.
3. Appointment by Shareholders:
o If the auditor is appointed by the shareholders at the annual general
meeting (AGM), the company will fix the remuneration.
4. Re-appointment of Auditor:
o In the case of the re-appointment of an auditor in a general meeting,
the remuneration fixed in the previous year may be considered as the
remuneration for the current year unless a resolution is passed to re-fix
it.
5. Remuneration of Auditor Appointed by CAG:
o For an auditor appointed under Section 619 by the Comptroller and
Auditor General (CAG) of India, the company in general meeting
will fix the remuneration, or the company may delegate this power to
the Board of Directors.
6. General Principles:
o The authority that appoints the auditor also determines the
remuneration.
o The remuneration does not have to be fixed in the same meeting where
the appointment is made and may be decided in a subsequent meeting.
7. Additional Services:
o If the auditor performs additional services beyond the normal audit
work (e.g., tax, company law matters, or management services), he
will be entitled to extra remuneration.
o The approval of such additional remuneration need not be obtained in
the general meeting.
o However, such payments should be disclosed in the profit and loss
account as per Clause (4B) of Part II of Schedule VI.

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8. Categories of Additional Services: The remuneration for services other than

audit work should fall under the following categories:
o Taxation matters
o Company law matters
o Management services
o Internal auditing
o Other services
9. Out-of-Pocket Expenses:
o Any sum paid by the company for the auditor's out-of-pocket expenses
(while carrying out his duties) will be considered as part of the
remuneration.

RIGHTS OR POWERS OF AUDITORS

The rights of an auditor are essential for performing duties independently and
effectively. Below are the key rights conferred upon auditors under the Companies
Act, 1956:
Right of Access to the Books, Accounts, and Vouchers
o The auditor has unrestricted access to the company's books, accounts,
and vouchers (including correspondence and agreements) maintained
at the company's head office or other locations.
o Section 227(1) grants this right, which is absolute and cannot be limited
by any provision in the Articles of Association.
Right to Obtain Information and Explanations
o The auditor has the right to obtain necessary information and
explanations from the company's officers for performing his duties.
o If denied, the auditor may report this to the members.
Right to Receive Notices and Attend General Meetings
o Section 231 grants the auditor the right to receive notices and attend
general meetings, and to be heard on matters concerning him as an
auditor.

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Right to Make Corrections in Financial Statements

o If the auditor identifies errors in the financial statements, he can suggest
corrections. If not implemented, the auditor can report the issue in his
audit report.
Right to Report to the Members
o Section 227(2) mandates the auditor to report to the members on the
financial statements, confirming if they present a true and fair view.
Right to Visit Branches and Access Branch Accounts
o Section 228 gives the auditor the right to visit the company’s branch
offices and access branch accounts and vouchers.
Right to Sign Audit Report
o Section 229 states that only the appointed auditor(s) can sign the audit
report or authenticate any documents required by law.
Right to Take Expert’s Opinion
o The auditor may consult experts on technical or legal matters. However,
the final report is the auditor’s opinion, not the expert's.
Right of Indemnity
o Clause 99 of Table A provides indemnity for the auditor against any
liability incurred in defending legal proceedings, provided the auditor
is acquitted or judgment is in his favor.
Right to Receive Remuneration
• The auditor is entitled to receive remuneration for his services upon
completion of his audit work and submission of the audit report.
• Section 224(8) ensures this right.
Right of Lien on Working Papers
• The auditor has the right to retain his working papers (gathered during the
audit) as they are considered his property.
• Sockokinsky vs. Bright, Graham and Co. (1938) established that working
papers are the property of the auditor.

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Right of Lien on Books of Account and Other Documents

• If the auditor’s fees are unpaid, he can retain the company’s books and related
documents until his remuneration is paid.

Duties of a company auditor

The duties of a company auditor, as outlined in the Companies Act, 1956, are crucial
to ensuring transparency, accuracy, and fairness in a company’s financial reporting.
These duties can be classified into four categories:
Statutory Duties:
o Certify Statutory Report (Section 165): Auditors must certify the
accuracy of a public company's statutory report, including subscription
to share capital and cash received for shares.
o Report to Members (Section 227): Auditors must report on the
financial statements and whether they present a true and fair view of
the company’s financial status.
o Enquire into Specific Matters (Section 227(1A)): The auditor must
examine specific issues, such as the security of loans, accuracy of
transactions, and correct reporting of share allotments.
o Certify Director’s Declaration of Solvency (Section 488): In case of
voluntary winding up, auditors must certify the solvency of the
company.
o Report for Prospectus (Section 56(1)): Auditors must certify the
accuracy of financial information presented in a company’s prospectus.
o Assist Inspectors (Section 245(1)(6)): Auditors must assist
government-appointed inspectors investigating the company’s affairs.
o Assist Public Prosecutor (Section 242(1)): Auditors must assist the
Central Government in prosecuting the company’s officers in case of
misconduct.

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Duties Arising Out of Common Law:

o Guidance on Taxation and Company Law: Auditors may provide
advice on taxation and company law matters.
o Internal and Non-Statutory Audits: Auditors may be asked to
conduct internal audits or perform other non-statutory audits.
o Managerial Tasks: They may also be assigned to perform managerial
tasks such as inventory assessments.
Duties Arising Out of Professional Ethics:
o Responsibility and Integrity: Auditors must demonstrate high levels
of professional integrity, objectivity, and independence, adhering to
ethical standards set by the Institute of Chartered Accountants of India
(ICAI).
o Public Interest: They should act in the public interest, maintaining
trust and professionalism.
o Due Care: Auditors should continually improve their competence and
provide services to the highest standard.
General Duties of the Auditor:
o Skill and Care: Auditors are required to exercise skill, care, and
caution in performing their duties. They should verify the accuracy of
the balance sheet and financial statements beyond mere arithmetical
checks.
o Independence: As per various case laws (e.g., Leeds Estate Building,
Re Kingston Cotton Mills), the auditor must maintain an independent
professional opinion, free from undue influence, and ensure that the
company’s financial statements are accurate and fair.
o Watchdog Role: While auditors are not expected to detect fraud, they
must approach their work with due diligence, considering the
possibility of errors or fraud, even without suspicion of dishonesty.

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Status of the company auditor

The status of the company auditor is critical in understanding their role and
responsibilities. The auditor holds a statutory position by being appointed under
the provisions of the Companies Act. This position is legally recognized, and the
auditor functions in several key capacities, which can be classified as follows:
1. As an Agent of the Members
The auditor is appointed by the shareholders and represents them. Their duty is to
safeguard the interests of the shareholders and act as an agent for them. The auditor
addresses their report to the shareholders and follows the statutory duties outlined in
the Companies Act, Articles of Association, and the audit agreement.
• Key point: The auditor’s relationship with shareholders is that of an agent-
principal. This means that auditors act on behalf of the shareholders to ensure
the financial reporting is accurate and fair.
2. As an Officer of the Company
An auditor is considered an officer of the company under certain circumstances,
especially for specific statutory purposes. Some sections of the Companies Act treat
auditors as officers, such as those concerning the winding-up of a company or the
prosecution of delinquent officers. However, this status is limited to certain legal
functions and does not imply full officer responsibilities.
• Key point: While the auditor may have limited rights and duties under the
Companies Act, they are not fully regarded as officers in the broader sense of
corporate management.
3. Auditor is Not an Advisor
An auditor does not provide advice on the company’s management, policies, or
business decisions. Their role is purely to verify the accuracy and fairness of the
financial statements. Auditors do not assess whether the company's business is being
conducted prudently or profitably.
• Key point: Auditors are not involved in advising on the business operations
but focus on ensuring that financial reports reflect the true and fair view of the
company’s financial status.

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4. Auditor is Not an Insurer or Guarantor

Auditors do not guarantee the accuracy of the company’s financial statements or
ensure the company’s books are free from errors. Their responsibility is to examine
the financial statements and provide an opinion on whether they present a true and
fair view.
• Key point: Auditors are not responsible for ensuring accuracy in the books
beyond their verification process. They are not insurers of the financial health
of the company.
5. Auditor is Not a Critic of Management Decisions
An auditor is not tasked with evaluating the prudence of management decisions or
the policies of the company. Their role is to audit the financial statements and ensure
they comply with accounting standards, not to critique management decisions.
• Key point: The auditor does not judge the management’s business decisions
but verifies the financial outcomes.
6. Auditor is Not a Detective
An auditor is not required to act as a detective. While they do check for errors and
fraud, they are not tasked with uncovering fraud unless there are indicators that
would lead to suspicion. Auditors rely on the integrity of the company’s management
and employees.
• Key point: Auditors are not responsible for detecting sophisticated fraud
unless it raises suspicion during their audit.
7. Auditor is Not to Unearth Frauds
While the detection of fraud is part of the audit process, auditors are not liable for
uncovering frauds that are carried out in a concealed or sophisticated manner. They
are not expected to uncover frauds unless there are red flags or clear signs of
wrongdoing.
• Key point: Auditors should not be held accountable for fraud that is carefully
concealed without arousing suspicion.

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Removal of auditors
The removal of auditors under the Companies Act, 1956 follows a structured
procedure that ensures fairness and transparency. The provisions regarding removal
are detailed in Sections 224 and 225.
Removal Before Expiry of Tenure (Section 224)
1. First Auditor(s): The first auditor(s) is appointed by the board of directors
before the first annual general meeting. They can be removed before the
expiry of their tenure by a general meeting of the company via ordinary
resolution. A special notice must be given to the members at least 14 days
before the meeting. Approval from the Regional Director is not required
for removal under Section 224(5).
2. Other Auditors: For auditors other than the first auditor, removal before the
expiry of their tenure can occur only after obtaining previous approval of the
Central Government. The auditor being removed has the right to:
o Make written representations.
o Have their representation circulated to the shareholders.
o Be heard orally at the general meeting.
Removal After Expiry of Tenure (Section 225)
1. Special Provisions for Retiring Auditor:
o A special notice must be given 14 days before the annual general
meeting if a resolution to remove the retiring auditor is proposed, or to
appoint someone else in their place.
o The company must immediately send a copy of this notice to the
retiring auditor.
2. Right to Representations:
o If the retiring auditor wishes to make written representations, they must
do so within a reasonable time.
o The company is required to notify the members about the
representations and circulate them.

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o If the company fails to send these representations to the members, the

auditor can demand that the representations be read aloud at the
meeting.
3. Retiring Auditor’s Right to Attend and Address the Meeting:
o The retiring auditor has the right to attend the annual general meeting
and speak on the proposed removal.

Unjustified Removal of Auditors

In 1980, the Institute of Chartered Accountants of India (ICAI) established a
committee to address cases of unjustified removal of auditors, ensuring their
independence. The procedure is as follows:
1. Auditor’s Resignation or Non-Reappointment:
o If an auditor resigns or does not offer themselves for reappointment due
to professional reasons, they must communicate this to the board and
send a copy to the ICAI. The incoming auditor must consider this
communication before accepting the appointment.
2. Failure to Reappoint Willing Auditor:
o If an auditor is willing to be reappointed but is not reappointed, they
can file a statement with the ICAI for circulation among shareholders.
3. Review by the ICAI Committee:
o The committee may review the reasons for the resignation or non-
reappointment and may request further information from the outgoing
auditor, incoming auditor, and the company.

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