Business

Companies act 2013 Internal Audit – Auditors and Accounts

Accounts and audit under the New Companies Act 2013 

Accounts

The 2013 Act has introduced certain significant amendments in this chapter. It has also introduced several additional requirements such as preparation of consolidated financial statements, additional reporting requirements for the directors in their report  such as the development and implementation of the risk management policy, disclosures in respect of voting rights not exercised directly by the employees  in respect of shares to which the scheme relates,  etc., in comparison with the requirements of the 1956 Act.

audit 2014 companies act

1. Books of accounts

Every company,  similar to the requirement of the existing 1956 Act, is required to maintain books of accounts  at its registered office. [section  128(1) of the 2013 Act].  ‘Books of accounts’ are required to show (a) all money received and spent and details thereof,  (b) sales and purchases of goods, (c) assets and liabilities and (d) items of cost as may be prescribed. The books of accounts  of a company essentially  provide the complete financial information of a company.

Further, with respect to branches, while the existing 1956 Act provides that where company has a branch office(s) proper summarized returns, made up to date at interval  of not more than three months  was supposed to be sent by branch to the company at its registered office or another place etc.,  such a requirement has now been done away with and only returns are to be periodically sent by the branch to the registered office [section  128(2) of 2013 Act].

Also, in keeping with the times, books of accounts  and relevant papers can now be maintained in electronic mode [section  128(1) of 2013 Act].

2. Cognisance of accounting standards

In several instances across the new companies 2013 Act, there are provisions which are also covered within  the accounting standards currently notified under  section 211(3C) of the 1956 Act and the Companies  (accounting standards) Rules, 2006 there under.

There are certain differences in the manner in which a few terms have been defined under  the 1956 Act. While the differences in some of these terms may not have any adverse impact, in certain cases, these differences may create implementation issues. Differences in definitions exist in the following cases:

•      Associate company

•      Control

•      Subsidiary company

•      Related party

Associate company: The definition  of an associate company poses certain challenges since:

•      It includes joint ventures

•      Significant influence is defined to mean ‘control … of business decisions under  an agreement’

•      It differs from the definition  of an associate as per the Accounting Standard 23: Accounting for Investments in Associates in Consolidated Financial Statements

•      The status of an associate and a joint venture cannot  be equated since, the degree of control that a company can exercise in such entities, varies significantly.  While ‘joint control’ is the driving factor in case of joint ventures, a company can at the most only ‘participate’ in the operating or financing decisions in case of an associate company.

•      With regard  to the explanation to the section in the 2013 Act, which defines the term ‘significant influence, it is to be noted that if a company has ‘control’ [control has been defined in section 2(27) of the 2013 Act] with respect to business decisions of another company,  such other company will in fact be tantamount to a subsidiary  and not an associate company.  Hence, the use of the term ‘control’ within  the definition  of significant influence leads to a conflict between the two definitions (associate company and subsidiary  company).

We believe that the terms which have been defined in the accounting standards, which also form a part of the Companies Act, 1956, must  not been defined again in the case of an associate, control and subsidiary company, in order to eliminate contradictions and ambiguity in compliance requirements. The concept of definitions of the accounting standards having primary significance has already been given cognizance in the Revised Schedule VI to the Companies 1956 Act,1956, as well.

Further, the definitions of the terms ‘associate’ and ‘significant influence’ are also not consistent with the definitions provided  within the Accounting Standard 18: Related Party Transactions, and Accounting Standard 23: Accounting for Investments in Associates in Consolidated Financial Statements (AS 23).

Subsidiaries: The term ‘control’, which is relevant with respect to identifying subsidiaries, has been defined in section 2(27) of the 2013 Act. While this definition  mandates consideration of ‘share holding’ as one of the factors, the corresponding definition  in AS

21: Consolidated Financial Statements (AS 21), refers to ‘voting power’. This issue is an existing one since a similar difference  exists between the definition  of ‘subsidiary’, where the term ‘control’ is relevant under  the existing 1956 Act [section  4(1) of the 1956 Act]. Accordingly, while for consideration of an entity as a subsidiary  for the purpose of consolidated financial statements (CFS), reference is made to AS 21, for the purpose of any compliance with the 1956 Act, reference is made to section 4(1) of 1956 Act.

Now that the requirement of preparing consolidated financial statements has been included within  the 2013 Act itself, a conflict arises as to whether the definition  as per the 2013 Act should be considered for identifying a subsidiary  or the definition  as per the AS 21. In any case, the company will be non-compliant with the requirement of either the 2013 Act or the AS.

With regard  to related party, while there is a substantial difference  between the definition  under  the 2013 Act and AS 18, the difference does not impact the financial statements, since the disclosures in the financial statements will be continued to be made as per AS 18.

3. Consolidated financial statements

The 2013 Act now mandates CFS for any company having a subsidiary, associate  or a  joint venture [section  129(3)]. The manner of consolidation is required to be in line with the requirements of AS 21 as per the draft rules.* Further, the 2013 Act requires  adoption and audit of CFS in the same manner as standalone financial statements of the holding company [section  129(4)].

Apart from CFS, the 2013 Act also requires  a separate statement, containing the salient features of financial statements of its subsidiary (ies) in a form as prescribed in the draft rules* [First proviso to section 129 (3)]. Further, section 137(1), also requires  an entity to file accounts  of subsidiaries outside of India, along with the financial statements (including CFS).

While section 129 of the 2013 Act, requires  all companies to file a statement containing salient features of the subsidiaries financial statements, in addition to the CFS, section 137 of the 2013 Act further requires  entities  with foreign subsidiaries to submit  individual financial statements of such foreign subsidiaries along with its own standalone and consolidated financial statements. There seems to be significant amount of overlap and additional burden on companies with respect to these compliances.

To illustrate this point, in order to comply with these requirements, a company which has a global presence, with subsidiaries both within as well as  outside India will need to comply to the following:

•      Prepare  its standalone financial statements [section  129(1) of the 2013 Act]

•      Prepare  a CFS, including  all subsidiaries, associates  and joint ventures (whether in India or outside) [section  129(3) of the 2013 Act]

•      Prepare  a summary statement for all its subsidiaries, associates  and joint ventures of the salient features of their respective financial statements [Provison to section 129(3) of the 2013 Act]

•      Submit the standalone financial statements of subsidiary(ies) outside India to the Registrar of Companies  (RoC) [section  137(1) of the 2013 Act].

This situation clearly indicates the extent of duplication and additional costs which will be incurred by entities  in order to provide the same information in multiple  forms or  formats.

Differing compliance requirements imposed by multiple regulators will lead to hardship as well increased cost of compliance for companies.

Also, the requirement for unlisted entities to prepare a CFS, would substantially increase the cost of compliance. Further, it does not serve a similar purpose as in the case of a listed entity.

Since there is already a requirement to attach a statement containing salient features of the financial statements of the subsidiary, associate and joint venture,  preparation of a CFS will would lead to duplication of preparing and presenting the same information in different forms.

4. Re-opening of accounts and voluntary revision of financial statements or the board’s report

A company would be able to re-open its books of accounts  and recast its financial statements after making an application in this regard to  the central government, the income tax authorities, the SEBI, or any other statutory regulatory body or authority or any other person concerned, and an order is made by a court of competent jurisdiction or the Tribunal under  the following circumstances (section  130 of the 2013 Act):

•      Relevant earlier accounts  were prepared in a fraudulent manner

•      The affairs of the company were mismanaged during the relevant period, casting a doubt on the reliability of the financial statements

Further, a company would be able to undertake voluntary revision of financial statements or Board’s report  if it appears to the director of a company that the financial statement of the company or the board report  does not comply with the provisions of section 129 (financial statement) and section 134 of the 2013 Act (financial statements and board reports) in respect of any of three preceding financial years, after obtaining approval  from the Tribunal. The Tribunal shall give notice to the central government and the income tax authorities and shall take into consideration the representations, if any, made by the government or the authorities before passing any such order.

To prevent  misuse of these specific provisions,  the section contains  a proviso which states that such a revised financial statement or report  shall not be prepared or filed more than once within  a financial year and the detailed reasons for revision of such financial statement or report  shall also be disclosed in the board’s report  in the relevant financial year in which such a revision is being made (section  131 of 2013 Act).

The provisions envisaged by the 2013 Act in respect of re-opening and voluntary  revision of the financial statements and board report is yet to be acknowledged by SEBI in the equity listing agreement and thus, pending similar amendment in the equity listing agreement,  listed companies may face unnecessary hardships.

5. Financial year

The 2013 Act has introduced a significant difference  in the definition  of the term, ‘financial year’, which has been defined in section

2(41) of the 2013 Act to mean April to March.

There are several reasons for a company to use a year-end which is different from April to March. These include companies which are subsidiaries of foreign companies which follow a different year-end or entities  which have significant subsidiaries outside India which need to follow a different year-end, etc. Accordingly, it would not be appropriate to mandate a single year-end for all companies. Since the 2013 Act does not mandate any specific rules or requirements on the basis of a specific year, as in the case of tax laws, the reason for requiring a uniform year-end under  the 2013 Act, seems to be unclear.

Further, recent notifications or circulars of the Ministry seem to indicate  relaxation in the norms for requiring approvals  from the Tribunal  or the   central government, etc for matters which are administrative or procedural in nature. Accordingly, the option available with  companies to seek an exemption from the Tribunal  will create additional administrative and procedural roadblocks, with no benefits to the companies. Rather, they will need to expend additional costs as well as  time either by way of seeking an exemption or preparing multiple  sets of financial statements.

Audit and auditors

The 2013 Act features extensive changes within  the area of audit and auditors with a view to enhance audit effectiveness  and accountability of the auditors. These changes undoubtedly, have a considerable impact on the audit profession. However, it needs to be noted that these changes will also have a considerable impact on the company in terms of time, efforts and expectations involved. Apart from introducing new concepts such as rotation of audit firms and class action suits, the 2013 Act also increases the auditor’s liability substantially in comparison with the 1956 Act.

1. Appointment of auditors

Unlike the appointment process at each annual general  meeting  under  the 1956 Act, the auditor will now be appointed for a period of five years, with a requirement to ratify such an appointment at each annual general  meeting  [section  139(1) of 2013 Act].

Further, the 2013 Act provides that in respect of appointment of a firm as the  auditor of a company,  the firm shall include a limited liability partnership incorporated under  the Limited Liability Partnership Act, 2008 [Explanation to section 139(4) of 2013 Act].

Also, the 2013 Act specifies that where a firm, including  a limited liability partnership is appointed as an auditor of a company,  only those  partners who are chartered accountants shall be authorised to act and sign on behalf of the firm [section  141 of 2013 Act].

Section 141 of the 2013 Act further prescribes  an additional list of disqualifications, and extends  the disqualification to also include relatives.  The Section of the 2013 Act states that a person who, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary  of such holding company of face value exceeding  one thousand rupees or such sum as may be prescribed; is indebted to the company,  or its subsidiary, or its holding or associate company or a subsidiary  of such holding company,  in excess of Rs.1,00,000* ; or has given a guarantee or provided  any security in connection with the indebtedness of any third person to the company,  or its subsidiary, or its holding or associate company or a subsidiary  of such holding company,  for Rs.1,00,000*, will not be eligible to be appointed as an auditor. Additionally,  a person or a firm who, whether directly or indirectly, has business relationship with the company,  or its subsidiary, or its holding or associate company or subsidiary of such holding company or associate company of such nature as may be prescribed, will be disqualified from being appointed as an auditor.

It would be relevant to note that the draft rules include 15 relationships in the list of relatives including  step son/daughter and step brother/sister.

The ineligibility also extends  to  person or a partner of a firm who holds appointment as an auditor in  more than twenty companies as well as a person who is in full time employment elsewhere. [section  141 (3)(g) of the 2013 Act].

The definition  of a relative does not give cognisance to the Code of Ethics prescribed by the Institute of Chartered Accountants( ICAI) and thus, there  are likely to be interpretational issues. Also, the 2013 Act does not specify as to what would constitute as indirect interest and thus in absence of guidance it would be difficult to assess the extent of implication on the audit profession.

2. Mandatory firm rotation

The 2013 Act has introduced the concept of rotation of auditors as well as  audit firms. It states that in case of listed companies (and other class(es) of companies as may be prescribed) it would be mandatory to rotate  auditors every five years in case of the appointment of an individual as an auditor and every 10 years in case of the appointment of an audit firm with a uniform cooling off period of five years in both  the cases. Further, firms with common  partners in the outgoing audit firm will also be ineligible for appointment as auditor during the cooling off period. The 2013 Act has allowed a transition period of three  years for complying with the requirements of the rotation of auditors [section  139(2) of the 2013 Act]. Further, the 2013 Act also grants an option to

shareholders to further require rotation of the audit partner and staff at such intervals  as they may choose [section  139(3) of the 2013 Act].

Currently, while the 1956 Act does not have any requirements relating to the auditor or audit firm rotation, the Code of Ethics issued by the ICAI has a requirement to rotate  audit partners, in case of listed companies, after every seven  years with a cooling-off period of two years.

3. Non-audit  services to audit clients

The 2013 Act states that any service to be rendered by the auditor needs to be approved by the board of directors or the  audit committee. Additionally,  the auditor is restricted from providing specific services, which include the following:

•      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 service which may be prescribed (no other service has been prescribed*)

Further, the 2013 Act provides that such services cannot  be rendered by the audit firm either directly or indirectly  through itself or any of its partners, its parent or subsidiary  or through any other entity whatsoever, in which the firm or any other  partner from  the firm has significant influence or control or whose name or trademark or brand is being  used by the firm or any of its partners [section  144 of the 2013 Act]. The 1956 Act currently does not specify any requirements relating to non-audit services.

These restrictions are aimed at achieving auditor independence. Auditor independence is fundamental to public confidence  on the reliability of the auditors’ reports. This concept adds credibility to the  published financial information and value to investors,  creditors, companies, employees  as well as  other stakeholders. Independence is the audit profession’s primary means of demonstrating to

the public as well as the  regulators that auditors and audit firms are performing in line with established principles of integrity  and objectivity. To comply with these independence norms,  the 2013 Act provides for a transitional period of one year, that is, an auditor or an audit firm who or which has been performing any non-audit services on or before the commencement of the  1956 Act shall comply with these provisions before closure of the first financial year after the date of commencement.

4. Joint audits

The 2013 Companies Act provides that  members of the company may require the audit process to be  conducted by more than one auditor [section 139(3) of the 2013 Act].

5. Auditors liability

The scope and extent of the auditor’s liability, has been substantially enhanced under  the 2013 Act. Now, the auditor is not only exposed to various new forms of liabilities, however,  these liabilities  prescribed in the existing 1956 Act have been made more stringent. The auditor is now subject to oversight by multiple  regulators apart from the ICAI such as  The National Financial Reporting Authority (NFRA, and the body replacing  the NACAS) is now authorised to investigate matters involving professional or other misconduct of the auditors. The penalty provisions and other repercussions that an auditor may now be subject to as per the 2013 Act includes monetary penalties, imprisonment, debaring of the auditor and the firm, and in case of frauds, can even be subject to class action suits.

6. Additional responsibilities of the auditor

The 2013 Act requires  certain new aspects which need to be covered in an auditors’ report. These include the following:

•    The observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company [section  143(3)(f) of the 2013 Act]

•    Any qualification, reservation or adverse remark  relating to the maintenance of accounts  and other matters connected there with [section  143(3)(h) of the 2013 Act]

•    Whether the company has adequate internal financial controls system in place and the operating effectiveness  of such controls [section  143(3)(i) of the 2013 Act]

There are other reporting requirements specified in the draft rules which include reporting on pending litigations, etc which are already covered either by the accounting standards or guidance from the ICAI, and  thus result in duplication*.

The 2013 Act requires  an auditor to report  to the central government within 30 days in a format prescribed within  the draft rules, if he or she  has any reasons to believe that any offence involving fraud is being committed or has been committed against the company by its officers or employees  * [section  143(12) of the 2013 Act]. Further, where any auditor does not comply with the above requirements, he or she shall be punishable with a fine which shall not be less than 1 lakh INR, but which may extend to 25 lakh  INR [section  143(15) of the 2013 Act]. The above requirements are in addition to the existing requirements under  the 1956 Act.

Disclaimer : This PDF/PPT Research report above is an extract from the full report by prepared by the Price Waters Cooperhouse (PwC). PwC has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. PwC is not responsible for any errors or omissions in analysis / inferences / views or for results obtained from the use of information contained in this report and especially states that PwC (including all divisions) has no financial liability whatsoever to the user of this report.

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