Accounts, Audit and Auditors

Introduction

• Shareholders provide capital to the company for running the business. They are in

a way, the owners of the company.

• They cannot take part in managing the affairs of the company as their number is

usually much more.

• They have a right to know as to how their money has been dealt with by the

directors in a particular period.

• This is why perhaps compulsory disclosure through annual information to the

shareholders by the directors about the working and financial position of the

company enables them to exercise a more intelligent and purposeful control over

the affairs of the company.

• For preparation of annual accounts the maintenance of proper books of account

is a must.

• Section 128 of the Companies Act, 2013 contains the provisions for books of

account etc. to be kept by company

Major Sections

• Section 128- Books of account, etc., to be kept by company.

• Section 129- Financial statement.

• Section 133- Central Government to prescribe accounting standards.

• Section 134- Financial Statement, Boards report, etc.

• Section 135- Corporate Social Responsibility.

• Section 136- Right of member to copies of audited financial

statement.

• Section 137- Copy of financial statement to be filed with Registrar.

• Section 138- Internal Audit.

• 139 -Appointment of Auditors

• 140 - Removal, resignation of auditor and giving of special notice

• 141- Eligibility, qualifications and disqualifications of auditors

• 142 - Remuneration of auditors

• 143 - Powers and duties of auditors and auditing standards

•144 - Auditor not to render certain services

• 146 - Auditors to attend general meeting

• 147 - Punishment for contravention

• 148 - Central Government to specify audit of items of cost in respect of Certain companies

Section 128 – Books of Account (Companies Act, 2013)

1. Requirement to Maintain Books of Account

• Every company must maintain proper books of account.

• These records help track all financial activities of the company.

2. Contents of Books of Account

As per Section 2(13), books must contain:

• All money received and spent (cash inflows and outflows).

• Details of sales and purchases of goods/services.

• Records of assets and liabilities of the company.

• Proper accounting of branch offices, if any.

3. Method of Maintaining Accounts

• Must be maintained on the accrual basis of accounting:

o Record income and expenses when they occur, not when cash is received or paid.

• Must follow the double entry system:

o Every transaction has two entries: one debit and one credit.

4. Objective/Purpose

• To present a true and fair view of:

o The financial condition of the company.

o The state of affairs of branch offices (if applicable).

• Ensures transparency and accountability in financial reporting.

Books of Account – Section 2(13) of the Companies Act, 2013

This section defines what is included in the term "books of account" for a company.

1. Record of Receipts and Payments

• All money received and spent by the company.

• Also includes information about the purpose of those receipts and expenditures.

2. Record of Sales and Purchases

• Complete record of all sales and purchases of goods and services made by the company.

3. Record of Assets and Liabilities

• Details of everything the company owns (assets) and owes (liabilities).

4. Cost Records (Specific Companies)

• For certain specified companies (as per Section 148), the books must also include:

o Items of cost (like production cost, material cost, labor cost, etc.)

o These are maintained as cost records, as prescribed by rules under Section 148.

Section 128(1) – Place of Keeping Books of Account

1. Location for Keeping Books

• Every company must prepare and maintain:

o Books of account

o Relevant books and papers

o Financial statements

• These must be kept at the company’s registered office.

2. Option to Keep Books at Another Place

• The company may keep all or some of its books of account at another place in India, if:

o The Board of Directors passes a resolution to that effect.

3. Intimation to Registrar

• If books are kept at another place:

o The company must inform the Registrar of Companies (RoC).

o This must be done within 7 days of the Board’s decision.

4. Form for Intimation

• The notice to the Registrar must be given in Form AOC-5.

• It should contain the complete address of the new location.

 Maintenance of Books of Account in Electronic Form

(As per Rule 3 of the Companies (Accounts) Rules, 2014)

1. Permission and Choice

• Companies are allowed to maintain their books of account and other papers in electronic
mode.

• This is optional, not mandatory.

2. Accessibility

• Electronic records must be accessible in India.

• They should be usable for future reference or use.

3. Format and Integrity of Records (Rule 3(2))

• Information must be:

o Retained completely in the original format in which it was generated, sent, or

received; or

o In a format that accurately presents the original information.

• The electronic records must be:

o Complete

o Unaltered

o Reliable for inspection and use

Maintenance of Books in Electronic Form – The Rules

Rule 3(3): Data from Branch Offices

• Information received from branch offices:

o Must not be altered.

o Should be stored exactly as originally received.

o Must clearly show the original data sent by the branch.

Rule 3(4): Legibility

• Electronic records must be legible.

• They should be capable of being displayed in a readable format.

Rule 3(5): System and Backup Requirements

• There must be a proper system in place for:

o Storage
 o Retrieval

o Display or printout of electronic records

• This system should be approved by the Audit Committee or Board, as applicable.

• Records must not be destroyed or made unusable, unless permitted by law.

Backup Rule – Very Important

• Backups of electronic books and records (even if stored abroad) must:

o Be kept on servers physically located in India.

o Be maintained periodically.

Inspection by Directors – Section 128(3) & Rules

1. Right to Inspect

• Any director of the company has the right to inspect the books of account and other books
and papers.

• Inspection can be done during business hours.

2. Meaning of "Books and Papers"

• Defined under Section 2(12).

• Includes:

o Accounts

o Deeds

o Vouchers

o Writings

o Documents

3. Who Can Inspect?

• All types of directors can inspect:

o Nominee Directors

o Independent Directors

o Promoter Directors

o Whole-Time Directors

4. Inspection of Subsidiary’s Books

• A director can inspect subsidiary company’s books of account only if:

o Authorized by a Board resolution of the holding company.

Rules for Information Maintained Outside India

Rule 4(2): Request for Foreign Financial Information

• If a director needs financial information maintained outside India:

o They must submit a written request to the company.

o The request should include:

▪ Details of the information required

▪ The specific time period for which information is needed

Rule 4(3): Time Limit

• The company must provide the requested information within 15 days from the date of
receiving the request.

Rule 4(4): No Delegation

• The director must inspect or request information personally.

• Cannot authorize anyone else (e.g., attorney, agent, representative) to inspect on their
behalf.

Important Note

• This inspection right is exclusive to directors.

• No one else (even shareholders) has this right under Section 128.

Preservation of Books of Account – Section 128(5)

1. Minimum Preservation Period

• A company must keep and preserve its:

o Books of account, and

o Relevant vouchers

• For a minimum of 8 years immediately preceding the current financial year.

2. For Newly Incorporated Companies

• If the company is less than 8 years old, then:

o It must preserve books and vouchers for the entire period since incorporation up to
the current financial year.

3. Compliance with Income Tax Act

• In addition to the Companies Act:

o The company must also follow the record-keeping requirements under the Income
Tax Act.
 4. Extension in Case of Investigation

• If an investigation is ordered under Chapter XIV (Inspection, Inquiry & Investigation):

o The Central Government can direct the company to keep the books for a longer
period than 8 years.

o Such a direction is given through an official order.

Persons Responsible for Maintaining Books – Section 128(6)

Who is Responsible?

The following persons must take all reasonable steps to ensure the company complies with the
requirements of Section 128 (i.e., maintenance of books of account):

1. Managing Director (MD)

2. Whole-Time Director (WTD) in charge of finance

3. Chief Financial Officer (CFO)

4. Any other person specifically authorized by the Board of Directors for this duty

Key Responsibility

• These persons must ensure that the books of account and relevant papers are:

o Properly maintained

o Accurate

o In compliance with the Act and rules

Penalty for Failure to Comply – Section 128(6)

Who is Liable?

• The persons responsible under Section 128(6):

o Managing Director (MD)

o Whole-Time Director (Finance)

o Chief Financial Officer (CFO)

o Any other person designated by the Board

When Are They Liable?

• If they fail to take reasonable steps to ensure compliance with Section 128 (i.e.,
maintenance of proper books of account),

• And contravene the provisions, they will face penalty.

 Nature of Penalty

• Imprisonment:

o Up to 1 year (Note: This has been omitted w.e.f. 21.12.2020)

• Fine:

o Minimum: ₹50,000

o Maximum: ₹5,00,000

• Or both (prior to omission of imprisonment clause)

Current Status (Post-Amendment)

• As of now, only monetary fine is applicable — no imprisonment.

Cloud Storage Compliance for Financial Records

Importance

• Critical for companies storing financial records outside India.

• Ensures records are secure, accessible, and compliant with legal requirements.

Key Points

• Records must be available for inspections and audits whenever required.

• Must be retained for the prescribed period (usually 8 years or as directed by authorities).

• Cloud storage solutions must:

o Protect records from loss or alteration.

o Allow easy retrieval and viewing.

o Comply with Indian laws and regulations.

Security Measures and Backup Requirements

Record Type Retention Period Storage Requirements

Financial Records 8 financial years Cloud storage with daily backups

Audit Trails Permanently Secure electronic storage

Backup Records Daily Backup servers physically located in India

Important Points on Section 128 – Companies Act, 2013

Mandatory Maintenance (Section 128(1))

• Companies must prepare and maintain books of account and other relevant papers every
financial year.

• These records must give a true and fair view of the company’s financial position.

Investigation and Extended Retention

• If an investigation is initiated under Sections 206–229 (by Regional Director or SFIO),

• The Central Government may direct the company to keep books for more than 8 years, as
deemed necessary.

Persons Responsible (Section 128(6))

• Responsible persons include:

o Managing Director (MD)

o Whole-Time Director (Finance)

o Chief Financial Officer (CFO)

o Any other person authorized by the Board

• They must ensure compliance with Section 128 requirements.

Case Laws

• Prithavi Tea Co. Ltd. v. Regional Director, Eastern Region, Registrar of Companies (2019 SCC
Online NCLAT 1363)

o Reinforces the importance of proper maintenance of books.

• Dr. Rajesh Kumar Yaduvanshi vs Serious Fraud Investigation Office (2020 SCC Online Del
1222)

o Highlights liability for contravention of Section 128.

Tax Laws and Audit – Record Keeping Requirements (Expanded)

Rule 6F(5) of Income Tax Rules, 1962

• According to this rule, an assessee (a person or company paying taxes) is required to keep
the books of account and other related documents for a minimum period of 6 years from
the end of the relevant assessment year.

• The assessment year is the year following the financial year in which income is assessed for
tax purposes.

• This rule ensures that records are available for review or audit by tax authorities during this
period.
Reopening of Assessments under Section 147 of the Income Tax Act

• Sometimes, if the tax authorities believe that income has been underreported or escaped
assessment, they can reopen the assessment of an earlier year.

• When such reopening happens, the assessee must keep their books and records until the
reassessment or reopened assessment is completed, even if that extends beyond the
standard 6 years.

Recent Amendments to Time Limits for Reopening Assessments (Finance Act, 2021)

• The law was amended to specify different time limits for reopening assessments based on
the amount of income escaped:

o The assessment can be reopened within 3 years for most cases of income
escapement.

o If the escaped income is more than ₹50 lakhs, the reopening can happen up to 10
years from the end of the relevant assessment year.

• This change aims to give tax authorities a longer window for serious cases of tax evasion.

Discrepancy with Rule 6F

• Although the Income Tax Act was amended, Rule 6F has not yet been updated to reflect this
change.

• So, officially, Rule 6F still states the record-keeping period as 6 years, which creates some
practical confusion.

Section 142(1) – Requirement to Produce Accounts

• When an assessment or reassessment is underway, the Assessing Officer may ask the
assessee to produce accounts and documents for up to 3 years prior to the financial year
under assessment.

• This means that, during an audit or inquiry, the tax officer can ask for records beyond just the
immediate assessment year.

Practical Implication

• Combining all these rules:

o 10 years for reopening cases involving large escapement of income,

o Plus 3 years look-back during assessment/reassessment,

• The practical implication is that assessee should maintain records for up to 14 years to be
fully compliant and prepared for any tax scrutiny.
GST Law and Audit – Record Keeping

Legal Provisions

• Section 35 of the CGST Act, 2017, along with Rule 56 of the CGST Rules, 2017, requires
every registered person (business/entity registered under GST) to maintain accurate and
true accounts at their principal place of business.

Details to be Maintained

• Accounts must include correct and complete records of:

o Production or manufacture of goods

o Inward and outward supplies of goods or services (both taxable and non-taxable)

o Stock of goods held

o Input Tax Credit (ITC) availed by the taxpayer

o Output tax payable and paid

o Details of goods or services imported or exported

o Supplies involving reverse charge tax payments (where recipient pays tax)

o Details of suppliers, customers, and premises where goods are stored

o Detailed stock maintenance records

Consequences of Non-Maintenance

• Failure to maintain these records properly results in the goods being deemed as ‘supplied’
by the registered person.

• Under Sections 73 and 74 of the CGST Act, the person will be liable to pay tax on these
deemed supplies along with interest and penalties.

Retention Period

• Records must be kept for 72 months (6 years) from the due date of filing the annual return
for the relevant financial year.

• If there are ongoing proceedings (such as appeals, revisions, investigations, or offenses), the
records must be retained until:

o One year after disposal of the proceedings, or

o The 72 months period, whichever is later.

Criminal Law and Audit – Limitation and Record Keeping

Limitation Period in Criminal Cases

• Unlike civil matters, limitation periods generally do NOT apply to criminal cases.

• A criminal case can be initiated at any time, even after 50 years or more.

• This creates practical difficulties for parties, especially if relevant documents or records have
been lost over time.

Case Law

• Ravindra Singh v. The State of Chhattisgarh (Criminal Revision No. 527 of 2011)

o Affirmed that criminal proceedings can be initiated even after a long lapse of time
due to no prescribed limitation.

Exceptions for Minor Offences (Section 468, CrPC, 1973)

• Section 468 of the Code of Criminal Procedure lays down limitation periods for less serious
offences:

o Applies to offences punishable by fine only or imprisonment up to 3 years.

• Similar provisions exist under Section 514 of BNSS (presumably replicating CrPC Section 468).

Economic Offences and Serious Crimes

• Economic offences and serious crimes punishable with imprisonment of more than 3 years
are excluded from limitation under:

o Economic Offences (Inapplicability of Limitation) Act, 1974.

• This means no time limit applies for initiating criminal prosecution in such cases.

Practical Implication

• For companies and individuals, this means records should be retained for long periods, as
criminal investigations can be initiated long after the alleged offence.

• It is often assumed that no limitation applies to criminal procedural law in economic and
serious offences, increasing the importance of maintaining thorough records.

Indian Evidence Act and Audit – Lost Documents & Secondary Evidence

Issue of Lost Documents

• In legal proceedings, if original documents required as evidence are lost, it poses a serious
problem for parties relying on such documents.

• The law does not allow secondary evidence (like photocopies or reproductions) to be
admitted easily.

Requirement to Prove Loss

• Before secondary evidence can be accepted, the party relying on it must prove the original
document is lost or destroyed.

• This proof of loss must be established satisfactorily in court.

Relevant Provisions

• Sections 65 and 66 of the Indian Evidence Act, 1872 deal with the admissibility of secondary
evidence when original documents are unavailable.

o Section 65 outlines types of secondary evidence admissible.

o Section 66 requires proof of loss, destruction, or inability to produce the original.

Case Law

• Benga Behera v. Braja Kishore Nanda (2007) 9 SCC 728

o The Supreme Court emphasized that secondary evidence taken from an original
document, such as a photocopy of a will, can only be admitted if the loss of the
original is properly proven in court as per Sections 65 and 66.

Audit Implications

• Maintaining original financial and legal documents is critical.

• Loss of original records can weaken legal or audit defenses.

• Proper documentation and backup (physical or electronic) ensure smooth evidence

production if required.

Reasonable Period of Maintenance of Records – Judicial Perspective

Context

• While criminal cases generally have no limitation period, courts recognize that it is
unreasonable to expect individuals or companies to face proceedings indefinitely for very
old allegations.

• There is a balance between legal rights to prosecute and practical fairness to the
accused/respondent.

Judicial Stance

• Courts have held that parties should not be made to face legal proceedings for irregularities
or allegations that are extremely old.

• This principle supports the idea of a ‘reasonable period’ within which records should be
maintained and cases initiated.

Key Case Laws

1. State of Madhya Pradesh v. Bani Singh, 1990 Supp SCC 738

o Courts recognized the impracticality of indefinitely old claims.

2. Mohamad Kavi Mohamad Amin v. Fatmabai Ibrahim, (1997) 6 SCC 71

o Affirmed that delay beyond a reasonable period can bar proceedings.

3. Government of India v. Citedal Fine Pharmaceuticals, Madras, (1989) 3 SCC 483

o Highlighted the need for a fair time frame for initiating actions and maintaining
records.

Practical Implication

• Though law may not always prescribe a fixed limitation for criminal or audit-related
proceedings, the principle of reasonableness guides courts and regulatory authorities.

• Maintaining records for a reasonable period (like 6-10 years) is advisable for balancing
compliance and practicality.

• This principle also encourages timely investigation and prosecution by authorities.

Reasonable Time and Statutory Limitation for Record Maintenance

Supreme Court View on Unreasonable Proceedings

• The Supreme Court ruled that initiating proceedings beyond the statutory limitation period
is unfair and unreasonable.

• Example: In the context of Foreign Exchange Regulation Act (FERA), 1973, proceedings
initiated much before the 8-year limitation period were held invalid.

• Case: Union of India v. Citi India (2022 SCC Online SC 1073)

Significance of Statutory Limitation Periods

• Statutory limitation periods prescribed by various laws are significant.

• Once all statutory limitation periods (e.g., under Income Tax law, which has one of the
longest periods) have expired, a person may choose not to maintain records beyond that.

When No Statutory Period Exists

• If the statute does not specify any time limit for record retention or prosecution:

o The Supreme Court in State of Gujarat v. Patil Raghav Natha (1969) 2 SCC 187 held
that a reasonable time period will apply.

o This reasonable time is decided based on the facts and circumstances of each case.

Section 129 – Financial Statements

Definition of Financial Statement (Section 2(40))

• Financial Statement includes:

o Balance Sheet
 o Profit & Loss Account / Income & Expenditure Account

o Cash Flow Statement

o Statement of Changes in Equity

o Any explanatory notes annexed to these statements

• This definition came into effect from 12th September 2013.

Correspondence with Previous Law

• Section 129 replaces the earlier Section 210 of the Companies Act.

Key Requirements under Section 129

• Financial statements must present a true and fair view of the company’s state of affairs.

• Must comply with accounting standards notified under Section 133.

• Should be prepared in the format specified by Schedule III of the Companies Act.

Sections 130 and 131 – Reopen and Recast Financial Statements

New Provision in Company Law

• For the first time, the Companies Act introduces a provision for reopening or recasting
accounts after they have been adopted by members at the AGM.

• Earlier, the government’s stance was that once accounts were adopted, they could not be
reopened or altered.

When Can Accounts be Reopened? (Section 130)

• Accounts can be reopened or recast if:

(i) The accounts for a specific financial year were prepared fraudulently; or
(ii) The company’s affairs were mismanaged, raising doubts about the reliability of the
financial statements for that period.

Who Can Apply?

• An application can be made by:

o Central Government

o Income Tax Authorities

o SEBI (Securities and Exchange Board of India)

o Other statutory regulatory bodies or authorities

o Any concerned party

Procedure

• The application is made to a competent Court or Tribunal.

• Upon the Court/Tribunal’s order, the company must reopen or recast its accounts as per the
directions.

• The revised/recast accounts shall be considered final and binding.

Section 131 – Revision of Financial Statements and Directors’ Report

When Can Revision Happen?

• If directors believe that either:

(i) The financial statement, or
(ii) The Board of Directors’ report
for any financial year does not comply with Section 129 or Section 134, they may revise
these documents.

Scope of Revision

• Revision can be made for any of the three preceding financial years.

Procedure to Revise

• Directors must apply to the Tribunal in the prescribed manner and obtain its order before
revising.

• The Tribunal must give notice of hearing to the Central Government and Income Tax
Authorities before passing any order.

Limitations on Revision

• Such revision can be made only once in any financial year.

• The directors must disclose detailed reasons for revision in their report to the members
during the financial year when the revision is made.

Section 132 – Constitution of National Financial Reporting Authority (NFRA)

Constitution of NFRA

• The Central Government will establish the NFRA (National Financial Reporting Authority).

• NFRA will consist of:

o A Chairperson: a person of eminence with expertise in accounting, auditing, finance,

or law.

o Up to 15 full-time or part-time members (as prescribed).

Appointment and Terms

• The terms and conditions and the manner of appointment of the Chairperson and members
will be prescribed by the government.

• Other related procedural matters will also be specified.

 Role of NFRA in Accounting Standards (Section 133)

• Section 133 mandates the Central Government to prescribe Accounting Standards or any
addendum based on recommendations by:

o The Institute of Chartered Accountants of India (ICAI), and

o After consultation and examination of recommendations from NFRA.

• These Accounting Standards will be binding on companies and their auditors.

Role in Auditing Standards (Section 143(10))

• The Central Government will also prescribe Auditing Standards or addendums similarly.

• Until new auditing standards are notified, the existing ICAI auditing standards remain
binding on auditors.

Current Status

• Section 133 (Accounting Standards) has been in force since 12/09/2013.

• Section 132 (Constitution of NFRA) has not yet come into force.

• This creates a practical challenge on how the government exercises powers under Section
133 without NFRA being constituted.

Appointment of the First Auditor [Sec. 139(6)]

• The Board of Directors (BOD) must appoint the first auditor within 30 days of the company’s
registration (incorporation).

• Applies to all companies except Government companies.

 • If the BOD fails to appoint within 30 days, it must inform the members.

• The members then appoint the auditor within 90 days at an Extraordinary General Meeting
(EGM).

• The first auditor holds office from the appointment date until the conclusion of the first
Annual General Meeting (AGM).

Here’s a simple note on the Appointment of the First Auditor of a Government Company [Sec.
139(7)]:

Appointment of the First Auditor of Government Company [Sec. 139(7)]

• The first auditor of a Government company is appointed by the CAG (Comptroller and
Auditor-General of India).

• The appointment must be made within 180 days from the date of the company’s registration
(incorporation).

• If the CAG fails to appoint within this period, the Board of Directors of the company must
appoint the auditor within the next 30 days.

Disqualification of Auditors [Section 141(3) of the Companies Act, 2013]

• Even if a person or firm is otherwise qualified to be appointed as an auditor, they cannot be

appointed if they fall under the disqualifications listed in Section 141(3).

• These disqualifications are intended to maintain the independence, integrity, and credibility
of the auditor.

• Section 141(3) is read along with Rule 10 of the Companies (Audit and Auditors) Rules,
2014, which provides further clarification.

Overview

• Disqualification means a person or firm is prohibited from being appointed or re-appointed

as an auditor of a company.

• Disqualifications can be based on conflict of interest, relationship with the company, past
conduct, employment status, etc.

• Disqualifications are absolute (no exceptions) in certain cases.

Absolute Disqualification (No Exceptions Allowed)

A person or firm is absolutely disqualified to be appointed or re-appointed as auditor in the

following cases:

1. Firm where majority of partners are not practicing in India

 o Example: If a firm has 3 partners and 2 of them practice outside India, the firm
cannot be appointed as auditor of any company.

o This ensures auditors practicing in India are under the jurisdiction of Indian laws and
standards.

o Reference: Proviso to Section 141(1).

2. Body Corporate (other than LLP)

o A body corporate (company, corporation) cannot be appointed as an auditor, except

for Limited Liability Partnerships (LLPs), which are allowed since they are considered
a type of body corporate.

o Reference: Section 141(3)(a).

3. Employee or Officer of the Company

o An auditor cannot be an employee or officer of the company they audit.

o This includes any person who is a:

▪ Director

▪ Manager

▪ Key Managerial Personnel (KMP) — as defined under Section 2(51) of the

Act.

o This avoids conflict of interest and preserves auditor independence.

o Reference: Section 141(3)(b) and Section 2(59).

4. Person in Full-Time Employment Elsewhere

o A person who is engaged in full-time employment with any other entity cannot be
appointed as auditor.

o This prevents divided loyalties and ensures auditors devote adequate time and
attention to their audit duties.

o Reference: Section 141(3)(g).

o Interpretation is further guided by Clause (11) of Part I of the First Schedule of the
Chartered Accountants Act, 1949.

5. Person Convicted of Fraud

o Any person convicted by a court for an offence involving fraud is disqualified for 10
years from the date of conviction.

o This protects the audit process from dishonest individuals.

o Reference: Section 141(3)(h).

6. Debarred by NFRA
 o Even if not disqualified under Section 141(3), a Chartered Accountant or firm
debarred by the National Financial Reporting Authority (NFRA) under Section
132(3)(c)(B) cannot be appointed as auditor for the period of debarment.

o NFRA is an authority empowered to regulate auditors and enforce standards of

quality and independence.

Importance of Disqualification

• These provisions ensure auditor independence and professionalism.

• They help avoid conflicts of interest and maintain the credibility of financial reporting.

• They align with international best practices on audit quality and ethics.

Additional Notes

• The disqualification rules also help in preventing corporate frauds and malpractice by
ensuring only fit and proper persons are auditors.

• The Board and members of companies must carefully verify these disqualification criteria
before appointing auditors.

• Non-compliance may lead to penalties under the Companies Act.

Disqualification Based on Relationship [Section 141(3)]

A person cannot be appointed as an auditor if they have certain relationships with the company’s
officers or employees that could impair their independence.

Specific Disqualifications Based on Relationship

1. Partner of an officer of the company

o If the person is a partner in a firm with any officer of the company, they are
disqualified.

o Reference: Section 141(3)(c).

2. Partner of an employee of the company

o If the person is a partner in a firm with any employee of the company,

disqualification applies.

o Reference: Section 141(3)(c).

3. Employment relationship with an officer of the company

o If the person is employed by any officer of the company, they are disqualified.

o Reference: Section 141(3)(c).

 4. Employment relationship with an employee of the company

o If the person is employed by any employee of the company, disqualification applies.

o Reference: Section 141(3)(c).

5. Relative of certain persons connected with the company

A person is disqualified if their relative is:

o A director of the company, or

o In the employment of the company as a:

▪ Director, or

▪ Key Managerial Personnel (KMP).

o Reference: Section 141(3)(f).

Definition of Relative

• The term relative is defined under Section 2(77) of the Companies Act, 2013.

• It includes close family members such as spouse, parents, siblings, children, and their
spouses, etc.

Why These Disqualifications?

• These provisions aim to avoid conflicts of interest and maintain the independence and
objectivity of the auditor.

• Personal or professional ties with company management may compromise audit quality or
lead to bias.

Disqualification Based on Conflict of Interest [Section 141(3)(d)]

An auditor or related persons having financial interests in the company or related entities may be
disqualified to ensure auditor independence.

Specific Conflict of Interest Disqualifications

1. Holding of Securities or Interest by Auditor or Partner

An auditor or any of their partners cannot hold securities or any interest (no minimum limit)
in:

o The company, or

o Its subsidiary company, or

o Its holding company, or

 o Its associate company, or

o Its joint venture company (as defined under Section 2(6)), or

o Subsidiary of such holding company.

o Reference: Section 141(3)(d)(i).

2. Holding of Securities or Interest by Auditor’s Relative

o If an auditor’s relative holds securities or interest in the company exceeding Rs. 1

lakh in face value, the auditor is disqualified.

o Reference: Proviso to Section 141(3)(d)(i) read with Rule 10(1).

3. Holding of Securities or Interest by Auditor’s Relative in Related Companies

o If the auditor’s relative holds securities or interest (no minimum limit) in the
company’s:

▪ Subsidiary, or

▪ Holding company, or

▪ Associate company, or

▪ Joint venture company, or

▪ Subsidiary of such holding company,

the auditor is disqualified.

o Reference: Section 141(3)(d)(i).

4. Indebtedness in Excess of Rs. 5 Lakhs

o If the auditor, their relative, or partner is indebted to the company or any related
entity (subsidiary, holding company, associate, joint venture, or subsidiary of holding
company) for more than Rs. 5 lakhs, disqualification applies.

o Reference: Section 141(3)(d)(ii) read with Rule 10(2).

5. Guarantees or Security Provided for Third-Party Indebtedness Exceeding Rs. 1 Lakh

o If the auditor, their relative, or partner has given a guarantee or security for a third
party’s indebtedness exceeding Rs. 1 lakh to the company or any related entity as
above, they are disqualified.

o Reference: Section 141(3)(d)(iii) read with Rule 10(3).

Purpose of These Provisions

• To avoid financial conflicts of interest which could impair the auditor’s objectivity.

• To ensure auditors are independent and unbiased when examining company records and
financial statements.
 • Prevents auditors from having material financial stakes or liabilities connected to the
company or its group.

Disqualification Based on Nature of Services Rendered [Section 141(3)(i)]

An auditor or firm cannot be appointed if they directly or indirectly provide certain prohibited
services to the company or its related entities, to ensure independence and avoid conflict of interest.

When is a Person Disqualified?

• A person (or firm) is disqualified if they render any of the services listed under Section 144
to:

o The company itself, or

o Its holding company, or

o Its subsidiary company, or

o Its joint venture company (as defined in Section 2(6)).

• Reference: Section 141(3)(i).

Services Prohibited under Section 144

The following services, if rendered by the auditor or their firm, result in disqualification:

1. Accounting and Book-Keeping Services

o Maintaining the company’s accounting records or books of account.

2. Internal Audit Services

o Conducting the internal audit function.

3. Design and Implementation of Financial Information Systems

o Designing or implementing any financial IT system for the company.

4. Actuarial Services

o Providing actuarial valuations or related services.

5. Investment Advisory Services

o Advising the company on investments.

6. Investment Banking Services

o Providing services related to investment banking.

7. Rendering of Outsourced Financial Services

o Providing outsourced financial functions.

 8. Management Services

o Offering management consultancy or similar services.

Purpose of this Disqualification

• To maintain auditor independence by preventing auditors from auditing their own work or
being involved in management functions.

• Ensures the auditor’s objectivity is not compromised by any operational or advisory roles.

RBI Regulated Entities and Audit (Notes)

• Applies to banks, NBFCs, and other RBI-regulated entities.

• Must comply with RBI circulars alongside Companies Act.

• Before appointing audit firm as statutory auditor:

o Minimum 1-year gap after completion of any non-audit work by the same firm for
that entity.

o Also, 1-year gap after audit/non-audit work for other group entities of the RBI
regulated company.

• Purpose: Ensure auditor independence.

• Effective from FY 2022-23.

Removal of Auditor [Section 140]

• A company may remove an auditor before the expiry of their term only by:

o Passing a special resolution in a general meeting, and

o Obtaining prior approval from the Central Government.

• Process:

1. Board Resolution to approve removal.

2. File an application to Central Government (Form ADT-2) within 30 days with required
details.

3. Provide the auditor the right to be heard before removal.

4. Conduct General Meeting and pass a special resolution for removal.

5. File Form MGT-14 with Registrar of Companies (RoC) within 30 days of passing the special
resolution.

6. Intimate the auditor about the removal.