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Role of the Auditors to Protect the Audit Interest

Audit is a formal examination and verification of financial accounts and records of any organisation. It has become an essential requirement for good corporate governance as it plays a major role in ensuring transparency and accountability in the corporate financial administration, thus auditors are often referred to as gatekeepers. A company carries on business with capital provided by persons who are not in control of the use of the money supplied by them.

They would, therefore, like to see their investments are safe, being used for intended purposes and the annual accounts of the company present a true and fair view of the state of affairs of the company. For this purpose, the accounts of the company must be checked and audited by a duly qualified and independent person who is neither employed in the company nor are in any way indebted or otherwise obliged to the company.[1]

The contract under which the work of a company's auditor is with the company should be as a separate person. Like anyone who renders professional services for reward, a company's auditor owes the company an implied contractual duty of care in and about the manner in which the audit is performed.[2] The nature of an auditor's duty of care in the performance of an audit was considered by Lopes LJ in Re Kingston Cotton Mill Co (No-2)[3] which is relevant even today also-
It is the duty of an auditor to bring to bear on the work he has to perform that skill, care and caution which a reasonably competent, careful and cautious would use. What is reasonable skill, care and caution must depend on the particular circumstances of each case.

An auditor is not bound to be a detective, or as was said, to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is a watchdog, but not a bloodhound.....an auditor does not guarantee the discovery of all fraud.[4]

According to Lord Denning,

An auditor is not bound to be confined to the mechanics of checking vouchers and making arithmetical computations. He is not to be written off as a professional adder-upper and subtractor. His vital task is to take care to see that errors are not made, be they errors of computation, or errors of omission or commission, or downright untruths. To perform this task properly he must come to it with an inquiring mind- not suspicious of dishonesty, I agree- but suspecting that someone may have made a mistake somewhere and that a check must be made to ensure that there has been none[5].

As stated above, Audit is a formal examination and verification of financial accounts and records of any organisation. It is defined as a systematic and independent examination of data, statements, records, operations and performances (financial or otherwise) of an enterprise for a stated purpose. In any auditing, the auditor perceives and recognizes the propositions before him for examination, collects evidence, evaluates the same and on this basis formulates his judgment which is communicated through his audit report. Whether detecting fraud or errors is a primary function of an auditor?

Research Question:

  1. What are the Power, Duties and Liabilities of Auditor?
  2. What is the role of an auditor in case of detection of fraud?
  3. What are the other provisions under the Companies Act 2013 which protect the investors?


Sections 138 to 148 of the Companies Act, 2013 deal with audit and auditors. An internal audit by qualified auditors as decided by the board in the manner prescribed by the Central Government has been made mandatory as per section 138 of the Act. Every company will appoint an individual or firm as an auditor in the Annual General Meeting (AGM) who shall hold office for five years and he shall also be present in every AGM. Section 144 of Companies Act 2013, now, provides for the services which the auditor cannot perform directly or indirectly to the company or its holding company, subsidiary company or associate company.

Now there are civil and criminal liabilities, through section 147, have been imposed on the auditor and on the partner(s) of an auditor firm who has audited in contravention of provisions of the Companies Act, 2013. In the present article meaning of audit, auditor, qualification of auditors, other essentials for their appointment, their powers and duties, civil and criminal liabilities have been discussed in the light of the Companies Act, 2013 and endeavour has been made to prove that audit is an important means to protect the investor's interests.

I- Meaning of Audit and Auditor
As stated above, Audit is a formal examination and verification of financial accounts and records of any organisation. It is defined as a systematic and independent examination of data, statements, records, operations and performances (financial or otherwise) of an enterprise for a stated purpose. In any auditing the auditor perceives and recognizes the propositions before him for examination, collects evidence, evaluates the same and on this basis formulates his judgment which is communicated through his audit report.

The purpose is then to give an opinion on the Adequacy of controls (financial and otherwise) within an environment they audit, to evaluate and improve the effectiveness of risk management, control, and governance processes[6]. When there is inequality of information between parties, it is desirable, not only between parties concerned, but also from a wider social perspective that the accounts should be attested by an independent third party. A prospective purchaser of a company's share will require this information before he commits himself to investing in the company.

The established convention is to have an independent third party, an auditor, to validate this information[7]. An audit must adhere to generally accepted standards established by governing bodies. These standards assure third parties or external users that they can rely upon the auditor's opinion on the fairness of financial statements, or other subjects on which the auditor expresses an opinion. The audit has revealed many corporate frauds in the past and it is an important means to protect the interests of investors. It plays a major role in ensuring transparency and accountability in the corporate world, thus they are often called as gatekeepers.

Auditing is the central to the public confidence in financial disclosures especially as an auditor is considered to be an intermediary between firms and investors in respect of corporate financial statements. Auditors act as eyes and ears of the shareholders and prospective investors, thus to instil confidence in the market and to provide a true and fair account of the company the role of an unbiased objective auditor is an undeniable necessity.

II- Objective and Scope of Audit
Originally, the audit function was primarily a public function[8]. Dicksee in his textbook on auditing[9] has outlined the objectives of an audit as-

  1. The detection of fraud
  2. The detection of technical errors
  3. The detection of errors of principle


The means for achievement of such an objective was a detailed analysis of transactions. He has mentioned the concept of internal check and pointed out that when a good system of internal check exists, a detailed audit is frequently not necessary in its entirety.

With the passage of time and the growth of enterprises to the size that made significantly improved internal system of control economical, a detailed audit of transactions became impractical and the objectives of the audit function changed significantly. The auditor's report on financial statements became an end product rather than merely an evidence of absence of fraud. The Institute of Chartered Accountants of India has enumerated the following as the objective of auditing the financial statements[10]:

  1. The objective of auditing the financial statements prepared within a framework of recognized accounting policies and practices and relevant statutory requirement, if any, is to enable an auditor to express an opinion on such financial statements.
  2. The auditor's opinion helps in the determination of the true and a fair view of the financial position and operating results of an enterprise. The user, however, should not assume that the auditor's opinion is an assurance as to the future viability of the enterprise or the efficiency or effectiveness with which management has conducted the affairs of the enterprise.

Therefore, the main objective of auditing today is the evaluation of a financial statement to see whether they truly and fairly represent the actual financial status of the organization. Detection of frauds and errors is only an incidental objective. An auditor is often in a position to discover frauds. If after the auditor has completed his audit, a fraud is discovered pertaining in that period, it does not necessarily mean that the auditor has been negligent or that he has not performed his duties completely.

The auditor does not guarantee that once he has signed the report on the accounts, no fraud exists. If he has conducted his audit by applying due care and skill in consonance with the professional standards expected, the auditor would not be held responsible for not having discovered that fraud[11].

III- Eligibility, Qualifications and disqualifications of Auditor
In India, an auditor is a chartered accountant[12] under the Chartered Accountants Act, 1949 who is appointed to examine the books of account and the accounts of a company registered under the Companies Act, and to report upon them to the company's shareholders.

A firm may be appointed in its name provided the majority of partners practising in India is qualified for appointment as auditor[13]. Where a firm including a limited liability partnership is appointed as an auditor of a company, only the partners who are chartered accountants are authorised to act and sign on behalf of the firm14.

An auditor is an officer of the company for the purpose of a misfeasance a summons under s.212 of the U.K's Insolvency Act 1986 and for the purposes of offences under ss.206-211 and s.218 of that Act in the United Kingdom[14]. Where an Auditor is retained to conduct and carry out the audit function without an appointment as an Auditor, he may not be treated as an officer of the company[15]. The following persons are not eligible for appointment as an auditor of a company[16], namely:

  1. a body corporate other than a limited liability partnership registered under the Limited Liability Partnership Act, 2008;
  2. an officer or employee of the company;
  3. a person who is a partner, or who is in the employment, of an officer or employee of the company;
  4. 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: or
    • is indebted to the company, or its subsidiary, 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
  5. 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
  6. a person whose relative is a director or is in the employment of the company as a director or key managerial personnel;
  7. a person who is in full-time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such persons or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies;
  8. a person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction;
  9. any person whose subsidiary or associate company or any other form of entity is engaged as on the date of appointment in consulting and specialized services as provided in section 144.
     

End-Notes:

  1. Majumdar A.K and Kapoor, Company Law and Practice, 15th ed, Taxmann, Page No. 819.
  2. Equitable Life Assurance Society v. Ernst and Young (2003) EWCA Civ 1114 (2003)
  3. 1896) 2 Ch 279 at pp 28-89
  4. As quoted by Mayson, French and Ryan in their book Company Law 26th edition 2009-10, Oxford at p.528
  5. Fomento (Sterling Area) Ltd v. Selsdon Fountain Pen Co Ltd (1958) 1 WLR 45
  6. Audit and Assurance Standard (AAS-1), ICIA.
  7. Charlesworth's Company Law, 18th edn.( London Sweat and Maxwell, 2011) at page No. 481
  8. Majumdar A.K and Kapoor, Company Law and Practice, 15th edn, Taxmann, p. 819.
  9. I. R Dicksee, Auditing- A Practical manual for Auditors, p.7
  10. See Statement on objective and scope of audit of financial statement, ICAI.
  11. Majumdar A.K and Kapoor, Company Law and Practice, 15th edn, Taxmann, p. 821
  12. Ibid
  13. Section 141 of the Companies Act, 2013.
  14. Id. Section 141 (2)
  15. Charlesworth's Company Law, 18th edn.( London Sweat and Maxwell, 2011) at page No. 487 and in Re London and General Bank (1895) 2 Ch. 166 CA.
  16. Dutta C.R. on the Company Law, 6th edn. (Lexis Nexis, Wadhawa and Co. Nagpur, 2008) at page No. 3733.

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