ACCOUNTS AND AUDIT UNDER THE NEW COMPANIES ACT 2013
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.
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 the company has a branch office(s) proper summarized returns, made up to date at an interval of not more than three months was supposed to be sent by the 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 that are also covered within the accounting standards currently notified under section 211(3C) of the 1956 Act and the Companies (accounting standards) Rules, 2006 thereunder.
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:
1. Associate company
3. Subsidiary company
4. Related party
Associate company: The definition of an associate company poses certain challenges since:
1. It includes joint ventures
2. Significant influence is defined to mean ‘control … of business decisions under an agreement’
3. It differs from the definition of an associate as per the Accounting Standard 23: Accounting for Investments in Associates in Consolidated Financial Statements
4. 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 the case of joint ventures, a company can at the most only ‘participate’ in the operating or financing decisions in case of an associate company.
5. 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 be 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 ‘shareholding’ 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 like 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 a related parties, 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 a 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 with the following:
1. Prepare its standalone financial statements [section 129(1) of the 2013 Act]
2. Prepare a CFS, including all subsidiaries, associates and joint ventures (whether in India or outside) [section 129(3) of the 2013 Act]
3. 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]
4. 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 that 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 as the 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 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):
1. Relevant earlier accounts were prepared in a fraudulent manner
2. The affairs of the company were mismanaged during the relevant period, casting doubt on the reliability of the financial statements
Further, a company would be able to undertake a voluntary revision of financial statements or the 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 that 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 enhancing 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 authorized 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 a 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 stepbrother/sister.
The ineligibility also extends to a person or a partner of a firm who holds an 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 cognizance 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 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 the 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 an 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:
1. Accounting and bookkeeping services
2. Internal audit
3. Design and implementation of any financial information system
4. Actuarial services
5. Investment advisory services
6. Investment banking services
7. Rendering of outsourced financial services
8. 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 the 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 have been substantially enhanced under the 2013 Act. Now, the auditor is not only exposed to various new forms of liabilities, however, but these liabilities prescribed in the existing 1956 Act have also 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 authorized 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 include monetary penalties, imprisonment, debarring of the auditor and the firm, and in case of fraud, can even be subject to class action suits.
6. Additional responsibilities of the auditor
The 2013 Act requires certain new aspects that need to be covered in an auditors’ report. These include the following:
1. 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]
2. Any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith [section 143(3)(h) of the 2013 Act]
3. 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 offense 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.