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Introduction

Appointment of statutory auditor has always been an eye-popping issue under the Companies Act, 1956. Lawmakers have always given a great significance to these provisions in order to maintain the integrity, objectivity and unbiasedness of the statutory auditor of the company. Similarly, under new Companies Act, 2013 certain provisions have been introduced so as to eliminate the loopholes present under old Companies Act, 1956 and to increase the reliability of the audit report.

In this article, I will discuss about various provisions with regard to rotation of audits of specified companies.

Important provisions in relation to a statutory auditor.

There is a list of specified companies to whom provisions with regard to statutory auditor’s appointment and functioning and reporting has been notified.

Specified companies

Section 139 of Companies Act, 2013 guides the provision of appointment of the statutory auditors. Section 139(2) of Companies Act, 2013 along with the Rule 5 of Companies (Audit and Auditors) Rules, 2014 stipulates that for the following companies more stringent provisions will be applicable:-

i. Listed Companies;

ii. All unlisted public companies having paid up share capital of Rs 10 lakhs or more;

iii. All private limited companies having paid up share capital of Rs 20 crores or more; and

iv. All companies having paid up share capital of below threshold limit mentioned in (ii) and (iii) above, but having public borrowings from financial institutions, banks or public deposits of Rs 50 crores or more.

How will auditors be appointed?

Important points to be noted in case of appointment of auditor in above specified companies:

a. Auditor shall be appointed either by Audit committee (if required to be formed under section 177) or by the board otherwise.

b. In case Audit Committee is authorized to appoint auditor, such committee shall recommend the name of the individual/firm proposed to be appointed as Auditor to the Board and further if the Board agrees with the same, it will recommend it to the members in annual general meeting.

c. If the Board disagrees with the recommendation made by the committee, it shall remand the matter back to the committee for reconsideration along with the reasons for such disagreement.

d. In case Audit committee is not required to be formed, Board shall directly recommend the name of the individual/firm proposed to be appointed as Auditor to the members in the annual general meeting.

What will be the tenure of an auditor?

a. If an individual as proprietor is appointed as auditor of the company, then tenure of such auditor shall be 5 consecutive years.

b. If the audit firm (ex. partnership firm or LLP) is appointed, then tenure of such audit engagement shall be 10 consecutive years i.e. 2 terms of five consecutive years.

What will be regarded as rotation?

A break in a term for a continuous period of five years shall be regarded as rotation. Thus any auditor, after the completion of its tenure, can be re-appointed only after the gap of five years.

Will rotation of auditors be a tough task?

All the companies falling under the regime of this section are not authorized to 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

c. Companies (audit and auditors) rules, 2014 states:

“The incoming auditor or the audit firm shall not be eligible if such auditor or the audit firm is associated with the outgoing auditor or audit firm under the same network of audit firms”

For the purpose of this rule, “same network” means firms operating or functioning under the same brand name, trade name or common control.

While reading this clause, you may start getting an idea that you and your blood relatives would form same network or you and your friend would form same network. But think from the angle of economy. You are small fish in a big pond. Regulators do not wish to take you in its ambit. It is only certain big firms which do not disclose their identity. Such firms keep on working under single umbrella or brand name of a big organization without any relationship on papers.

There are very few concerns which work like this in our economy, for the reason of privacy and litigation I would not name them. But you all know who these firms are. What these firms do.

Besides this, Companies (Audit and Auditors) Rules, 2014 provides that if a partner who is in charge of an audit firm and also certifies the financial statement of the company, retires from the said firm and joins another firm of chartered accountants such other firm shall also be ineligible to be appointed as auditor for next 5 years.

2.5.1 Is Limited Liability Firm also covered?

As per the explanation to section 139 of the Act, the term ‘firm’ also includes limited liability partnership firm incorporated under the Limited Liability Partnership Act, 2008 for the purpose of applicability of section 139.

How will the new provision affect the currently appointed auditors?

Every company, existing on or before the commencement of this Act, shall comply with the above requirements within 3 years from 01.04.2014.

2.6.1 The following illustration tries to explain the total tenure of appointment in case of Individual Auditor being appointed before the commencement of provisions of Section 139(2) of the Act.

No. of consecutive Years for an individual auditor already served

Maximum number of consecutive years for which he may be an auditor

Aggregate period

Example

(Rules notified w.e.f 1-4-2014)

Date till which he can be an auditor.

 

I

II

III

IV

 

5 years (or more than 5

years)

3 years

8 years or more

He can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

 

4 years

3 years

7 years

He can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

 

3 years

3 years

6 years

He can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

 

2 years

3 years

5 years

He can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

 

1 year

4 years

5 years

He can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

FY 2017-2018

 

2.6.2 The following illustration tries to explain the total tenure of appointment in case of Audit firm being appointed before the commencement of provisions of Section 139(2) of the Act.

No. of consecutive years for an audit firm   already served

Maximum number of consecutive years for which the firm may be appointed in the same company

Aggregate period

Example

(Rules notified w.e.f 1-4-2014)

Date till which such firm can be  auditor.

I

II

III

IV

10 years (or more than 10

years)

3 years

13 years or more

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

9 years

3 years

12 years

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

8 years

3 years

11 years

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

7 years

3 years

10 years

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

6 years

4 years

10 years

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

FY 2017-2018

5 years

5 years

10 years

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

FY 2017-2018

FY 2018-2019

4 years

6 years

10 years

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

FY 2017-2018

FY 2018-2019

FY 2019-2020

3 years

7 years

10 years

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

FY 2017-2018

FY 2018-2019

FY 2019-2020

FY 2020-2021

2 years

8 years

10 years

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

FY 2017-2018

FY 2018-2019

FY 2019-2020

FY 2020-2021

FY 2021-2022

1 year

9 years

10 years

Such firm can be auditor for

FY 2014-2015

FY 2015-2016

FY 2016-2017

FY 2017-2018

FY 2018-2019

FY 2019-2020

FY 2020-2021

FY 2021-2022

FY 2022-2023

Possible getaways for currently appointed auditors

The new provisions have triggered complications for the auditors by reducing their scope. Still there is something to cherish about i.e. around 90% of the companies falls outside the regime of new provisions. Moreover, for the convenience of the auditors of those 10% companies, I, through this article, am disclosing certain loopholes which can be exercised to continue with the audit engagement of the companies and at the same time provisions of rotation can be complied with. Such getaways are as listed below:

Disengage temporarily

Auditor or the audit firm should be disengaged before the completion of their tenure i.e. 5 years or 10 years, as the case may be. So that, they can be re–appointed after the gap of 1 year.

Example: ABC & Co. has been appointed as an auditor of XYZ Ltd in AGM on 25th September, 2014. Such firm can remain the auditor of the XYZ Ltd till FY 2023-24 after there needs to be the gap of five years for the purpose of re-appointment. In this case, XYZ Ltd should disengage ABC & Co. in the AGM of 2022-23 so that they can be re-appointed as an auditor in the FY 2025-26.

Separate firms

Instead of opening a partnership firm, two or more chartered accountants should open separate firms so that they can be appointed as the auditor of the company on alternate basis provided.

Example: A and B are two chartered accountants intending to start a partnership firm AB & Co. Instead of constituting a partnership firm they should open the proprietorship firm say A & Co. and B & Co. So that when their client is required to rotate the auditors, it can appoint them on alternate basis. Suppose PQR Ltd appoints A & Co. as its auditor. After the expiry its term i.e. five years A & Co. will become ineligible for being appointed as an auditor for next five financial years and in that case B & Co. can be appointed as an auditor

Splitting up may or may not benefit you –

2.7.3.1 If a partner who is in charge of an audit firm but does not certify the financial statement of a particular company, retires from the said audit firm and joins another audit firm. Then in such a case according to my personal opinion such other firm shall be eligible to be appointed as auditor however, first mentioned firm will be ineligible to audit such company. However, it has not been mentioned anywhere in the rules.

This view is based on strict reading of Explanation of rule 6 under company (audit & auditors) rules, 2014 which is

“Explanation. II - For the purpose of rotation of auditors,-

(b) if a partner, who is in charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of five years.”

Mr. X is in charge of XYZ & Co. but the financial statements of PQR Ltd are signed by other partner. Then if Mr. X retires from XYZ & Co. and joins ABC & Co. then ABC & Co. would remain eligible for being appointed as an auditor.

2.7.3.2 If a partner who is neither in charge of an audit firm nor certifies the financial statement of the company retires from the said firm and joins another firm of chartered accountants. Then whether such other firm is eligible to be appointed as an auditor or not has not been mentioned anywhere. Then in such a case according to my personal opinion such other firm shall be eligible to be appointed as auditor however first mentioned firm will be ineligible to audit such company. However, it has not been mentioned anywhere in the rules.

This view is based on strict reading of above mentioned rule.

Mr. X is neither in charge of XYZ & Co. nor the partner signing the financial statements of PQR Ltd. Then if Mr. X retires from XYZ & Co. and joins ABC & Co. then ABC & Co. would remain eligible for being appointed as an auditor.

2.7.4  Besides the cases discussed above in detail there could be N number of cases which may be faced by chartered accountant firm. Thereby I have tried to raise all permutations and combination of such events which may happen in the life of a chartered accountant of partnership firm which is summarized below. Please note all these cases may or may not be explicitly covered under gamut of the corporate law. Thereby please read the law yourself for arriving at a decision which could be yours.

Name of the firm

  •  

In charge of the firm

Singing partner of ABC Ltd a listed co.

Retiring partner

New Firm joined by retiring partner

Eligibility status of RM & Co. for auditing ABC Ltd.

Eligibility status of XYZ & Co. for auditing ABC Ltd.

RM & Co.

R & M

  1.  
  1.  
  1.  

XYZ & Co.

Ineligible

[first proviso to section 139(2) of the Act]

Ineligible

[Explanation of rule 6 under company (audit & auditors) rules, 2014]

RM & Co.

R & M

  1.  
  1.  
  1.  

XYZ & Co.

Ineligible

[first proviso to section 139(2) of the Act]

Eligible

[Explanation of rule 6 under company (audit & auditors) rules, 2014][1]

RM & Co.

R & M

  1.  
  1.  
  1.  

XYZ & Co.

Ineligible

[first proviso to section 139(2) of the Act]

Ineligible

[Note 1]

RM & Co.

R & M

  1.  
  1.  
  1.  

XYZ & Co.

Ineligible

[first proviso to section 139(2) of the Act]

Eligible

[Explanation of rule 6 under company (audit & auditors) rules, 2014]Note 2

Note 1

The reason for rendering XYZ & Co. as an ineligible firm for the audit of said company is reason beyond the scope of companies act, 2013. I think partner R as well as newly incorporated firm XYZ & Co. should except the fact that it is not eligible for the audit of the said company in light of the provisions of companies act, 2013 and the chartered accountant act, 1949. Here one more problem will arise when Mr. R will jump from one firm to another as a partner in immediate future, for example if Mr. R joins XYZ & Co. for 10 days and then take admission as a partner in yet another firm DEF &Co. and then to another firm PQR &Co. then in such a case, I feel that such admission even if it is for few number of days would render each firm as ineligible for the audit of said company.

Note 2

I think in this case Mr. M and the new firm XYZ and company should safely assume that they are eligible for audit of the said company as they were not involved in any manner with the audit of said company.

3. Conclusion

This article is one of the articles which is very close to my heart as well as my profession. This new change in company law is there to stay. I do not think that our community of chartered accountants would be able to pressurize government any further to change this law for two reasons:

3.1 Election days are over and we now have a stable government in place. Mr. Modi will be in charge and I do not think that he can be pressurized.

3.2 The new law is just. I also think that for such big organizations (listed company or public company) an auditor does have to concentrate and focus all throughout the year to render a quality opinion.

Having said so we must respect the law and ensure that we do not jump “behind the enemy lines”. One of the benefits of the new law would be higher compliance by qualified chartered accountant in practice towards the law and also a quality of work will be distributed among the deserving and newly qualified chartered accountants in practice.

CA. Rajat Mohan
www.fixet.in

[1] In this point, it must be seen that it is our personal opinion and is not represented by any piece of express legislation. We have reached this conclusion on the basis of strict legal interpretation of Explanation of rule 6 under company (audit & auditors) rules, 2014.However, if we go by the Chartered Accountant Act, 1949 then in order to avoid professional misconduct and assume our professional responsibility, it would be in the best interest of the newly incorporated firm XYZ & Co. not to take such assignment.

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