Soon the financial statements and watchdog’s (read as auditor’s) report will be read with greater reliance and trust --- thanks to the far-reaching changes proposed by the new Companies Bill with respect to auditors and the manner in which the audits will be conducted. The Bill was passed by the Lok Sabha in the recently concluded winter session.

The deficiencies and ambiguities in the existing Companies Act, 1956, with respect to audits were felt after a spate of scams that shocked India Inc. A need was felt to upgrade the audit standards to bring them in line with globally-accepted practices.

It was also felt to make auditors more accountable to the various stakeholders who rely heavily on their assessments. Realising this need, there were recommendations that ranged from ensuring more independence to auditors, providing for rotation of auditors, punishing those guilty of fraud or abetting or colluding in any fraud, prohibiting them from providing non-audit services, and so on. The Companies Bill has incorporated these recommendations.

APPOINTMENT OF AUDITORS

The auditors can now be appointed for five years, with yearly ratification by the shareholders in the annual general meeting. Under the Companies Act, 1956, an auditor’s term is from one annual general meeting to the next one — usually for a year at a time. An auditor cannot audit more than 20 companies.

Listed companies have been put on a more stringent footing. This is rightly so, since public stake is involved in them. Listed companies and such other classes of companies as may be prescribed by the Centre will not be permitted to appoint an ‘individual’ as auditor for more than one term of five consecutive years, and the ‘audit firm’ cannot be appointed for more than two terms of five consecutive years.

However, they can be appointed again after a cooling-off period of five years from their last term of appointment. This will ensure that a company will not have the same auditor for very long. To avoid longevity for any auditor, the Companies Bill also permits members of a company to rotate an auditor partner and his team at such intervals as the shareholders want.

The Companies Act, 1956, does not provide for any period within which the casual vacancy in the office of auditor has to be filled. The Companies Bill, however, provides that casual vacancy has to be filled by the board of directors within 30 days. In the case of a casual vacancy arising because of ‘resignation’ of an auditor, it will need to be filled by the shareholders of the company within three months from the date of recommendation of the board of directors. This is a welcome step.

Although the Companies Bill attempts to reform the audit system, it misses some crucial reforms, such as the role of audit committee in the appointment of auditors. In some of the most developed economies, the appointment of auditors requires approval of an independent audit committee. The Companies Bill, however, only provides for seeking the recommendation of the audit committee in matters of appointment and filing casual vacancy of an auditor. But audit committee can only recommend. The final say for the choice of auditor rests with shareholders, which means a large controlling shareholders’ decision can influence the choice of auditor.

A welcome change which will make the auditors more accountable to punish the auditor, if found guilty of abetting or colluding in any fraud. Such an auditor will be removed and debarred to act as auditor of any company for a period of five years. In such cases, both the firm and the partner concerned will be jointly and severally liable.

Therefore, now, audit firms will not be able to wash their hands of corporate scams perpetrated in connivance with their audit partners. Further, for certain violations of duties and obligations, an auditor can be imprisoned and made liable to pay damages to the company, statutory bodies or authorities, for loss arising out of incorrect or misleading statements in the audit report.

In order to ensure independence, an auditor is prohibited from holding any interest in the company or its subsidiaries, be indebted to it, have business interest with the company or a relative who is a director of that company.

Further, no auditor will be allowed to provide non-audit services such as accounting and book keeping, internal audit, actuarial services, and so on. These steps will help ensure independence of auditors.

REPORTING OF FRAUD

The Companies Bill casts an obligation on the auditors to report to the Central Government offence involving fraud, if the auditor has reason to believe that such an offence has been committed against the company by its officers or employees. This will ensure vigilance by the auditors in the performance of his duties.

(The author is a partner with J. Sagar Associates. The views are personal.)

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