Section 139 to 147 and respective rules under Companies (Audit and Auditors ) Rules 2014 have elaborate provisions for the appointment of auditors and related details. Here we discuss about the disqualifications of Auditor.
Disqualification of Auditors
Sub section (3) of Section 141 lays down the criteria which disqualifies a person from acting as an auditor of a company. It has total 9 clauses as compared to 1956 Act. The disqualifications can be categorized as absolute disqualification of Auditors, disqualification of Auditor pertaining to relationship and disqualification of Auditor pertaining to conflict of interest.
Absolute Disqualification of Auditor
141(3) (a) – An entity other than an LLP under the LLP act, 2008. Hence only an individual, a partnership firm or a limited liability partnership firm can act as an auditor and not a company. In the 1956 act, a body corporate was completely disqualified. Hence, the effect is that now an LLP can act as an auditor which previously could not.
141(3) (g) – A person who is in full time employment elsewhere or a person or a partner of a firm holding employment as its auditor, if such person or partner is at the date of such appointment, holding appointment as auditor of more than 20 companies. This is a new disqualification added in the Companies Act, 2013.
Illustration: Mr. Anmol is appointed as an auditor for 20th firm on 31/3/2019. Hence, he can’t be appointed as an auditor of a new firm on 1/4/2019 unless he ceases to be an auditor of any of the existing firms.
141(3) (h) – A person who has been convicted by the court of an offence involving fraud and a period of 10 years has not elapsed from the date of such conviction. This is a new disqualification added in the Companies Act, 2013.
Illustration: Mr. Anmol, auditor of company “ABC Ltd” is convicted of an offence of fraud on 1/01/2018. He cannot be appointed as an auditor till 1/01/2028.
141(3) (i) – Any person who directly or indirectly renders any service referred to in section 144 to the company or its holding company or its subsidiary company. Section 144 deals with services that auditors are specifically barred from rendering which are in the nature of accounting and book keeping services; actuarial services management services and others. This is an amended clause by the 2017 amendment act. Previously, the position was that any entities related to the potential auditor should not be engaged in rendering services as mentioned above to the concerned company. Now, the potential auditor must not be engaged in rendering services to any related companies of the concerned company.
Illustration: Mr. X provides investment banking services to a company “ABC Ltd” “ABC Ltd” is a holding company of “D Ltd.” Therefore, Mr. A cannot be appointed as an auditor of “D Ltd” The original 2013 act didn’t bar Mr. A from being appointed as an auditor in this case. It only barred Mr. A is any of his related entity is rendering such services to the company, here “D Ltd.”
Disqualification of Auditor pertaining to the relationship
141(3) (b) – An officer or employee of the company. This position remains unchanged in the new act and has been retained as it is. Section 2(59) of the Companies Act defines officer as “officer” includes any director, manager or key managerial personnel or any person in accordance with whose directions or instructions the board of directors or any one or more of the directors is or are accustomed to act. The term ‘employee’ has not been defined under the act. Hence, in the layman sense, the terms ‘officer’ and ‘employee’ collectively bar all persons providing any form of services to the company from being an auditor.
141(3) (c) – A person who is a partner or who is in the employment, of an officer or employee of the company. This position remains unchanged in the new act and has been retained as it is. The previous disqualification barred an officer and an employee and this disqualification bars any person related to the officer or employee as a partner or an employee.
Illustration: Under Section 141 (3) (b), if Mr. A is an employee or officer of company B, then he can’t be an auditor and under Section 141 (3) (c), if Mr. C is either a partner or employee of Mr. A, he is again barred by virtue of indirect connection with the company.
141(3) (f) – A person whose relative is a director or is in the employment of the company as a director or any other key managerial post. This is a new disqualification added in the companies act, 2013.
The term “relative” is defined under section 2(77) of the companies act and it includes
Disqualification of Auditor pertaining to conflict of interest
141 (3) (d) – A person who, or his relative or partner:
A) is holding any security or interest in the company or the subsidiary or the holding or its associate company. But holding of such security or interest is exempted to the extent of Rs. 1 Lakh.
B) is indebted to the company or its subsidiary or its holding or associate Company or subsidiary of such holding company above Rs. 5 Lakh.
C) Has provided the guarantee or any security in the connection with the indebtedness of any third person to the company or its subsidiary or its holding or associate company or subsidiary of such holding company above Rs. 1 Lakh.
The prescribed amounts have been inserted by the Companies (Audit and Auditors) Rules, 2014.
Under the 1956 act, disqualification was with respect to holding security, being indebted or giving guarantee for indebtedness but only with respect to the company. But the 2013 act has brought all the entities namely subsidiary, holding and associate companies under this because dealing with any of the above entities may lead to a conflict of interest with the concerned company also. This is a new disqualification added in the companies act, 2013.
141 (3) (e) – A person or a firm who 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. In the 1956 act, there was no such disqualification regarding having business relationship with the company. But it laid down that if a person is disqualified to be an auditor of either the subsidiary or holding company of the concerned company, then he can’t be the auditor of the concerned company as well. It is worth to be noted that the term “business relationship” is wide in nature and includes ample number of instances in its ambit.
The term “business relationship” has been defined under the Companies (Audit and Auditors) Rules, 2014. It says that a business relationship includes any transaction entered into for a commercial purpose except
1. Transactions at arm’s length price in the ordinary course of business.
2. in the nature of professional services that an auditor is capable of rendering.
Illustration: If a firm “XYZ” shares a commercial relationship with company “ABC ltd.” and buys goods from it at a price of Rs. 1000 which are generally sold in the market at the price of Rs. 2000 then this transaction doesn’t amount to transactions at arm’s length price in ordinary course and hence, the firm “XYZ” cannot be appointed as an auditor for the company “ABC ltd.”
To conclude we can see that the grounds for disqualification of auditors are very elaborate and cover all such instances wherein the duties of the auditor are likely to be compromised owing to the nature of relation he shares with the company or financial interest in the company or possibility of any conflict of interest. This is rightly necessary in the era of corporate governance.