'Quarantining’ audit from other serivces

Quarantining’ audit from other services - Services which auditor should not provide to the auditee-company-Section 144 of the Companies Act,2013

Section 144 stipulates what the Cadbury Report termed as ‘quarantining audit from other services’ but recommended against the same. Section 144 of the Act provides that an auditor appointed under this Act shall not directly or indirectly  provide any of the following “other services” (i.e. services other than statutory audit under the 2013 Act) to auditee-company or its holding company or subsidiary company :

• accounting and book-keeping 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 kind of services as may be prescribed.

Services other than the above may be provided by the auditor to the company only if the services are approved by the Board of directors or the audit committee, as the case may be.

Transitional provisions

An auditor or audit firm who or which has been performing any non-audit services on or before the commencement of this section shall comply with this section before the closure of the first financial year after the date of such commencement.

“Directly or indirectly”

The Explanation to section 144 defines the expression “directly or indirectly” as under :

(A) In case auditor being an individual

(B) In case of auditor being a firm (including LLP incorporated under the LLP Act)

The term “directly or indirectly” shall include rendering of services : either by himself or  through his relative  or  through any other person connected or associated with himself  through any other entity, whatsoever, in which such individual has significant influence or  through any other entity, whatsoever, in which such individual has control or  through any other entity whose name or trade mark or brand is used by such individual.

The term “directly or indirectly” shall include rendering of services: either by itself or  through any of its partners or  through its parent or  through its subsidiary or  through its associate entity or  through any other entity in which the firm has significant influence or  through any other entity in which the firm has control or  through any other entity whose name or trade mark or brand is used by the firm  through any other entity in which any partner of the firm has significant influence  through any other entity in which any partner of the firm has control  through any other entity whose name or trade mark or brand is used by any of its partners.

It may be noted that the expressions, ‘associate entity’, ‘associated person’, ‘connected person’ are used in the Explanation to section 144 but are not defined in the Act.

Mandatory internal audit for certain companies

Backdrop

• The Companies Act,1956 did not  cast a legal obligation on any company to have an internal audit.
• The MAOCARO,1988 and CARO,2003 orders issued by the Central Government under section 227(4A) of the said Act merely required statutory auditors of specified companies to comment in audit report whether company had an internal audit commensurate with the size and nature of its business. 
• The obligation was on the statutory auditor to report. If any specified company did not have an internal audit, it was not a violation of any statutory provision.
• The Companies Act,2013 brings a sea change in the position. Section 138 of the Companies Act,2013 titled 'Internal Audit' provides that such class or description of companies as may be prescribed  shall be required to appoint an internal auditor to conduct internal audit of the functions and activities of the company.

Companies or classes of companies which are required to appoint internal auditor

Rule 13(1) of the Companies (Accounts)Rules,2014 provides that  the following class of companies shall be required to appoint an internal auditor or a firm of internal auditors, namely:—
(a) every listed company;

(b) every unlisted public company having—

• (i) paid up share capital of fifty crore rupees or more during the preceding financial year; or
• (ii) turnover of two hundred crore rupees or more during the preceding financial year; or
• (iii) outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year; or
• (iv) outstanding deposits of twenty five crore rupees or more at any point of time during the preceding financial year; and

(c) every private company having—

• (i) turnover of two hundred crore rupees or more during the preceding financial year; or
• (ii) outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year:

An existing company covered under any of the above criteria shall comply with the requirements of section 138 and this rule within six months of commencement of such section.

Qualifications of internal auditor

 Internal auditor shall be

• a Chartered Accountant or 
• a Cost Accountant or 
• such other professional as may be decided by the Board.

 Explanation  to Rule 13(1) clarifies that —

• the internal auditor may or may not be an employee of the company;
• the term “Chartered Accountant” shall mean a Chartered Accountant whether engaged in practice or not.

Appointment of internal auditor shall be by Board resolution at a Board meeting
In view of section 179(3) of the Companies Act,2013 and Rule 8(4) of the Companies (Meetings of Board
and its Powers) Rules, 2014, the power of appointment of internal auditor shall be exercised by the Board of Directors by means of a resolution passed at a Board meeting . Appointment of internal auditor cannot be
made by means of a circular resolution. However, there is no bar in making the appointment at a Board meeting held through video conferencing or audio visual means

Scope, functioning, periodicity and methodology of internal audit
Rule 13(2) of the Companies (Accounts) Rules, 2014 provide that the Audit Committee of the company or the Board shall, in consultation with the Internal Auditor, formulate :
(i) the scope,
(ii) functioning,
(iii) periodicity, and
(iv) methodology
for conducting the internal audit.

Statutory auditor cant be internal auditor
A statutory auditor of a company cannot also be its internal auditor. Nor can he be the internal auditor of the company’s holding company or subsidiary company. [Section 144 of the 2013 Act].