AUDITING

By-Asst.Prof. Utkarsh Singh Parihar

UNIT -3

Audit of Limited Companies

Auditing plays a crucial role in ensuring that limited companies operate transparently and comply with
financial regulations. This document provides a detailed evaluation of the key aspects of auditing limited
companies, including the appointment, powers, duties, and liabilities of a company auditor, along with
the auditor’s report and audit certificate.

1. Company Auditor
A company auditor is an independent professional (Chartered Accountant) responsible for examining and
verifying the financial records of a company. The primary role of an auditor is to ensure the accuracy,
fairness, and compliance of financial statements with legal and regulatory frameworks such as the
Companies Act, 2013, and the Generally Accepted Accounting Principles (GAAP) or Indian
Accounting Standards (Ind AS).
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1.1 Appointment of Auditor

The appointment of an auditor depends on the type of company and the stage of its operations.

(A) Appointment of First Auditor

1. For Companies (Other than Government Companies)

o The Board of Directors (BOD) appoints the first auditor within 30 days of incorporation.
o If the Board fails to do so, the members appoint the auditor within 90 days at an
Extraordinary General Meeting (EGM).
o The first auditor remains in office until the conclusion of the first Annual General Meeting
(AGM).
2. For Government Companies
o The Comptroller and Auditor General (CAG) of India appoints the first auditor within 60
days of incorporation.
o If CAG fails to do so, the Board appoints the auditor within next 30 days.
o If the Board also fails, the members appoint within next 60 days.

(B) Subsequent Appointment of Auditor

• For Public and Listed Companies:

o The auditor is appointed at the first AGM and holds office till the conclusion of the sixth
AGM.
o No requirement for ratification at every AGM (as per the Companies (Amendment) Act,
2017).
• For Private Companies:
o Appointed at each AGM and remains in office till the next AGM.

(C) Appointment in Case of Casual Vacancy

• If the vacancy is due to resignation, the Board appoints a new auditor within 30 days, and
shareholders approve within three months.
• If the vacancy is due to any other reason, the Board can directly appoint a new auditor.

(D) Removal and Resignation of Auditor

• Removal before tenure completion requires:

o Special Resolution in General Meeting
o Approval from the Central Government
• Resignation by Auditor:
o The auditor must submit a resignation letter stating reasons to the Registrar of Companies
(ROC) within 30 days.

Example:
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ABC Ltd., incorporated in April 2024, failed to appoint an auditor within 30 days. As per legal
requirements, shareholders appointed an auditor at an EGM in July 2024.

1.2 Powers of an Auditor

Under the Companies Act, 2013, an auditor has several powers:

1. Right to Access Books and Accounts

o The auditor can inspect all financial records, books, and documents to ensure accuracy.
2. Right to Seek Information and Explanations
o The auditor can demand clarifications from company officers regarding transactions and
records.
3. Right to Visit Branches
o The auditor can visit and inspect branch offices if necessary.
4. Right to Report to Shareholders
o The auditor submits reports directly to shareholders, ensuring transparency.
5. Right to Receive Notices and Attend General Meetings
o Auditors have the right to attend AGMs and present their findings.

Example:

XYZ Ltd. refused to provide sales records to its auditor. The auditor exercised their legal power and gained
access, ensuring a transparent audit.

1.3 Duties of an Auditor

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1. Duty to Ensure True and Fair Financial Statements
o Auditors must verify that financial statements accurately represent the company's financial
position.
2. Duty to Detect Fraud and Errors
o Auditors must identify and report fraudulent activities and material misstatements.
3. Duty to Maintain Confidentiality
o Auditors must not disclose sensitive information unless legally required.
4. Duty to Report Irregularities
o If fraud is detected, the auditor must report it to the Board or government authorities.
5. Duty to Comply with Legal Standards
o Auditors must follow auditing standards set by ICAI and SEBI regulations.

Example:

An auditor found that PQR Ltd. overstated its profits. They reported the fraud in their audit report, leading to
legal action against the company.

1.4 Liabilities of an Auditor

1. Civil Liability
o If an auditor is negligent, resulting in financial loss, they can be sued for damages.
2. Criminal Liability
o If an auditor knowingly signs false financial statements, they face imprisonment and fines
under Section 447 of the Companies Act.
3. Professional Misconduct
o If an auditor violates professional ethics, ICAI can take disciplinary action.

Example:
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An auditor of LMN Ltd. signed off on false financial statements. Investors sued the auditor for negligence,
leading to penalties and cancellation of their license.

2. Auditor’s Report
The auditor’s report is a formal statement expressing the auditor’s opinion on the company’s financial
statements.

1. Types of Auditor’s Opinions

The auditor can issue different types of opinions based on the audit findings:

A. Unqualified Opinion (Clean Report)

This is the best type of audit opinion, indicating that the financial statements are free from material
misstatements and comply with Generally Accepted Accounting Principles (GAAP) or Ind AS (Indian
Accounting Standards).

Key Features:

3. No material misstatements
4. Financial statements comply with relevant standards
5. No significant accounting errors
6. Audit evidence is sufficient and appropriate
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Example:
Tata Motors Ltd. underwent an audit, and the auditor found that the financial statements were
properly prepared as per Ind AS and provided a true and fair view of the company’s financial position.
The auditor issued an Unqualified Opinion, meaning investors and stakeholders can rely on the
financial statements without concerns.

Sample Audit Opinion Statement:

"In our opinion, the accompanying financial statements present fairly, in all material respects, the
financial position of XYZ Ltd. as of March 31, 2024, in accordance with the applicable financial
reporting framework."

B. Qualified Opinion
A qualified opinion is issued when there are certain misstatements or non-compliance with
accounting standards, but they are not pervasive (do not affect the entire financial statement).

Key Features:

• Financial statements are mostly correct but contain some material misstatements
• The issue is limited to a particular aspect of financial reporting
• The rest of the financial statements are reliable

Example:
A pharmaceutical company in India, Sun Pharma Ltd., was audited, and the auditor found that some
inventory records were not maintained properly. However, the rest of the financial statements were
accurate. In this case, the auditor may issue a Qualified Opinion, stating that except for the
inventory issue, the financial statements are fairly presented.

Sample Audit Opinion Statement:

"In our opinion, except for the matter described in the Basis for Qualified Opinion section, the
financial statements present fairly, in all material respects, the financial position of XYZ Ltd. as of
March 31, 2024."

C. Adverse Opinion
An adverse opinion is issued when the financial statements contain material and pervasive
misstatements that do not give a true and fair view of the company's financial position. This is the
worst type of audit opinion, as it signals serious financial mismanagement.

Key Features:

• Material misstatements that significantly impact financial statements

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• Non-compliance with accounting standards
• High risk for investors and stakeholders

Example:
Imagine a real estate company in India, ABC Builders Ltd., falsely inflates its revenue by including fake
sales transactions. If the auditor finds that the financial statements are misleading and do not reflect
the company’s actual financial position, they will issue an Adverse Opinion, warning stakeholders
not to rely on the financial statements.

Sample Audit Opinion Statement:

"In our opinion, because of the significance of the matters discussed in the Basis for Adverse Opinion
section, the financial statements do not present fairly the financial position of XYZ Ltd. as of March 31,
2024, in accordance with the applicable financial reporting framework."

D. Disclaimer of Opinion
A disclaimer of opinion is issued when the auditor is unable to obtain sufficient appropriate audit
evidence and, as a result, cannot form an opinion on the financial statements.

Key Features:

• Auditor lacks sufficient evidence

• Significant uncertainties in financial statements
• High risk due to lack of reliable financial data

Example:
Suppose Reliance Infrastructure Ltd. undergoes an audit, but the company does not provide
important financial records and supporting documents due to a fire destroying records. The auditor
may issue a Disclaimer of Opinion, stating they could not verify the accuracy of financial
statements.
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Sample Audit Opinion Statement:
"We were unable to obtain sufficient appropriate audit evidence to provide a basis for an audit
opinion. Accordingly, we do not express an opinion on the financial statements of XYZ Ltd. as of March
31, 2024."

2. Factors Affecting Auditor’s Opinion

Several factors influence the type of opinion an auditor issues:

6. Compliance with Accounting Standards – If a company follows GAAP/Ind AS properly, it

is more likely to receive an Unqualified Opinion.
7. Material Misstatements – If errors are found in financial reporting, the auditor may issue a
Qualified or Adverse Opinion.
8. Scope Limitation – If the auditor cannot access necessary records, they may issue a
Disclaimer of Opinion.
9. Fraud or Manipulation – If financial fraud is detected, an Adverse Opinion may be issued.
10. Sufficiency of Audit Evidence – The quality and availability of audit evidence affect the
opinion.

3. Impact of Auditor’s Opinion on Businesses

The type of audit opinion has a significant impact on the company’s reputation, stock price, and
investor confidence.
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Audit Opinion Impact on Business

Unqualified Opinion Positive impact; boosts investor confidence

Qualified Opinion Moderate impact; minor concerns for stakeholders

Adverse Opinion Negative impact; major concerns about financial health

Disclaimer of Opinion Serious concern; loss of credibility

Example Impact:

6. If Infosys Ltd. receives an Unqualified Opinion, its stock price may remain stable, as
investors trust the financial statements.
7. If YES Bank receives an Adverse Opinion, investors may lose confidence, leading to a stock
price drop and regulatory investigations.

4. Auditor’s Opinion in India: Legal and Regulatory Framework

In India, auditors follow the Companies Act, 2013, Ind AS, and SA (Standards on Auditing)
issued by ICAI (Institute of Chartered Accountants of India).

Legal Provisions Related to Auditor’s Opinion:

4. Section 143(2) of the Companies Act, 2013 – The auditor must report whether the
financial statements present a true and fair view.
5. SA 700 – Provides guidance on forming an Unqualified Opinion.
6. SA 705 – Deals with Modified Opinions (Qualified, Adverse, Disclaimer).
7. SA 706 – Covers Emphasis of Matter Paragraphs for special cases.

Conclusion
The auditor’s opinion is a vital indicator of a company’s financial health and transparency. It helps
investors, creditors, and regulators assess the reliability of financial statements.

1. Unqualified Opinion → Good, clean report

2. Qualified Opinion → Minor issues, but still reliable
3. Adverse Opinion → Major misstatements, unreliable
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4. Disclaimer of Opinion → Insufficient evidence, high risk

3. Audit Certificate
An audit certificate is a formal document confirming that the company's financial statements comply with
auditing standards.

Key Features:

• Certifies the accuracy and integrity of financial reports.

• Signed by a qualified auditor.
• Used for government compliance, bank loans, and investor confidence.

Example:

DEF Ltd. needed a bank loan. The bank required an audit certificate, ensuring that DEF Ltd.’s financial
records were accurate.

Conclusion
The audit of a limited company ensures financial transparency, investor confidence, and regulatory
compliance. Auditors play a critical role in verifying financial accuracy, detecting fraud, and providing
valuable insights to stakeholders. The auditor’s report and audit certificate help build trust and maintain
ethical business practices.

Auditor Rotation under the Indian Companies Act, 2013

1. Introduction to Auditor Rotation
Auditor rotation is a regulatory requirement that mandates a company to change its auditors
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periodically. The concept aims to enhance audit independence, prevent long-term association risks,
and improve audit quality. The Companies Act, 2013, introduced mandatory auditor rotation to
reduce familiarity threats and ensure objectivity in financial reporting.

2. Legal Provisions under the Companies Act, 2013

The Companies Act, 2013, under Section 139, provides for mandatory rotation of auditors for
certain classes of companies.

a) Applicability of Auditor Rotation

According to Section 139(2) of the Companies Act, 2013, the mandatory rotation of auditors applies
to:

7. Listed Companies
8. Unlisted Public Companies with a paid-up share capital of ₹10 crore or more
9. Private Companies with a paid-up share capital of ₹50 crore or more
10. Companies with public borrowings from banks or financial institutions exceeding
₹50 crore

b) Rotation Requirements
• Individual Auditor:
o An individual auditor can hold office for a maximum of one term of 5 consecutive
years.
o After completion of this term, the individual auditor must take a cooling-off period
of 5 years before being reappointed.
• Audit Firm:
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o An audit firm can serve for two consecutive terms of 5 years each (i.e., a total of
10 years).
o After completing these two terms, the audit firm must take a cooling-off period of 5
years before being reappointed.
• Partner Rotation within an Audit Firm:
o If an audit firm is conducting an audit, the engagement partner and key audit
personnel must be rotated at regular intervals to ensure independence.

c) Manner of Rotation (Rule 6 of the Companies (Audit and Auditors) Rules, 2014)

• The incoming auditor or audit firm cannot have any common partners with the outgoing
audit firm during the preceding financial year.
• The company has the right to remove an auditor before the completion of the term,
but this requires the approval of a special resolution in a general meeting and prior
approval from the Central Government (Section 140 of the Companies Act, 2013).
• The new auditor must submit a certificate confirming their eligibility, qualifications,
and compliance with rotation requirements.

3. Rationale for Auditor Rotation

The introduction of auditor rotation is based on the following key objectives:

• Independence and Objectivity: Long-term relationships between auditors and companies

can lead to compromised audit quality. Rotation ensures independence.
• Prevention of Conflict of Interest: Rotation prevents undue influence by company
management over auditors.
• Fresh Perspective: New auditors bring a fresh viewpoint, reducing the risk of oversight or
fraud.
• Global Best Practices: Many countries, including the USA and EU nations, have similar
rotation policies.
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• Fraud Detection: Regular rotation prevents collusion between auditors and management,
enhancing fraud detection.

4. Challenges and Disadvantages of Auditor Rotation

While the concept of auditor rotation has clear advantages, it also comes with some practical
challenges:

11. Loss of Institutional Knowledge: Frequent auditor changes can lead to a loss of
understanding of the company’s business and financials.
12. Higher Costs: Transitioning to a new auditor involves additional costs and time for both the
company and auditors.
13. Limited Auditor Availability: For specialized industries, finding experienced auditors who
comply with rotation rules can be difficult.
14. Short-Term Disruptions: The initial transition period may cause delays in financial
reporting.
15. Risk of Audit Quality Issues: New auditors may face a learning curve, which could impact
audit quality initially.

5. Case Example in India

Case: Tata Motors Auditor Rotation
Tata Motors Limited, a listed company in India, followed the mandatory auditor rotation rule and
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changed its audit firm from Deloitte Haskins & Sells to BSR & Co. LLP (a KPMG affiliate) after
completing the maximum tenure. This was done in compliance with Section 139 of the Companies
Act, 2013.