Article by Anant Pratap Singh Chauhan, Edited by Chinmay Jain.
Private Company is a type of company, wherein the company does not float shares in public for the purpose of amassing capital.
A private company has been defined under Section 2(68) of the Companies Act, 2013 as –
“private company means a company having a minimum paid-up share capital as may be prescribed, and which by its articles, —
- restricts the right to transfer its shares;
- except in case of One Person Company, limits the number of its members to two hundred:
Provided that where two or more persons hold one or more shares in a company jointly, they shall, for the purposes of this clause, be treated as a single member:
Provided further that—
- persons who are in the employment of the company; and
- persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased, shall not be included in the number of members; and
- prohibits any invitation to the public to subscribe for any securities of the company;”
A private company, just like any other business organisation, has to fulfill certain compliances set forth by law.
To do regular audits of the company’s financial position is one such compliance which the company has to fulfill. This article focuses primarily on the law relating to audits of private limited companies in India.
Meaning of Auditing
An Audit can be defined as the examination or review of various books of accounts by an independent authority, known as the auditor, followed by checking of stock and other assets, to make sure that all sections of the organisation are following standard system of recording transactions.
It is done for the purpose of ascertaining the correct financial position of the organisation.
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According to the Institute of Chartered Accountants of India:
Auditing is defined as a systematic and independent examination of data, statements, records, operations, and performance (financial or otherwise) of an enterprise for a stated purpose.
In any auditing situation, the auditor perceives and recognizes the proposition before him for examination, collects evidence, evaluates the same, and on this basis formulates a judgment which is communicated through an audit report.
An audit is an independent examination of financial information of an entity, irrespective of its size and form when such examination is conducted with a view of expressing an opinion thereon.
Objectives of Auditing
The objectives of auditing, as has been defined under Standards of Auding 200 are as follows –
- To obtain reasonable assurance about whether the financial statements as a whole, free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.
- To report on the financial statements, and communicate as required by the Standards of Auditing, in accordance with the auditor’s findings.
Further, as under Section 143 of the Companies Act, 2013, the primary objective of the auditor is to report to the owners that the accounts, financial statements give a true and fair view of the state of the company’s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed.
Sections 139 to 147 of Chapter X of the Companies Act, 2013, contain the provisions in relation to statutory audit and auditors. Following are the step by step procedure of conducting a statutory audit.
#1. Appointment of Auditors
As it has been provided under Section 139 of the Companies Act, 2013, every company, whether public or private, at its first annual general meeting (AGM), has to appoint an individual or a firm as an auditor.
For the purpose of appointing, the appointee’s name has to be placed before the members of the company in the AGM. It is essential that the written consent of the prospective auditor is available.
Following the decision of the AGM, the auditor has to be informed about his/her appointment and the notice of such appointment is to be sent to the Registrar of the Companies within 15 days of the AGM.
Such an auditor shall hold office from the conclusion of the first AGM till the conclusion of the sixth AGM.
An individual auditor may hold office for not more than five consecutive years, and one is not eligible for reappointment in the same company for the next five years after completion of one’s term.
In case there exists a casual vacancy in the office of an auditor, the same is to be filled by the Board of Directors of the company within 30 days of the occurrence of such vacancy.
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In case, such casual vacancy is the result of the resignation of the auditor, the appointee has to be approved by the company in the general meeting within three months of the recommendation of the Board. Such appointed auditor would hold office until the next AGM.
#2. Powers of the Auditor
The Auditor of a company has the following powers –
- Right to Access – As provided under Section 143(1) of the Companies Act, 2013, every auditor of a company shall have a right of access at all times to the books of account and vouchers of the company, whether kept at the registered office of the company or any other place and shall be entitled to require from the officers of the company such information and explanation as he may consider necessary for the performance of his duties as auditor.
- Right to Inquire – As provided under Section 143(1) of the Companies Act, 2013, the auditor would have the right to inquire in matters relating to loans and advances, transactions, assets and liabilities, receipts and payments, revenue and expenditure, etc.
#3. Duties of the Auditor
The following are the duties which are to be fulfilled by the auditor appointed under Section 139 of the Companies Act, 2013.
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Duty to report to the members of the company on financial matters
As provided under Section 143(2) of the Companies Act, 2013 –
The auditor shall make a report to the members of the company on the accounts examined by him and on every financial statements which are required by or under this Act to be laid before the company in the general meeting and the report shall after taking into account the provisions of this Act, the accounting and auditing standards and matters which are required to be included in the audit report under the provisions of this Act or any rules made thereunder or under any order made under sub-section (11) and to the best of his information and knowledge, the said accounts, financial statements give a true and fair view of the state of the company‘s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed.
Apart from the matter as provided under Section 143(2) of the Companies Act, 2013, the auditor’s report shall also state the following as provided under Section 143(3) of the Companies Act, 2013 –
(a) whether he has sought and obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his audit and if not, the details thereof and the effect of such information on the financial statements;
(b) whether, in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books and proper returns adequate for the purposes of his audit have been received from branches not visited by him;
(c) whether the report on the accounts of any branch office of the company audited under sub-section (8) by a person other than the company‘s auditor has been sent to him under the proviso to that sub-section and the manner in which he has dealt with it in preparing his report;
(d) whether the company‘s balance sheet and profit and loss account dealt with in the report are in agreement with the books of account and returns;
(e) whether, in his opinion, the financial statements comply with the accounting standards;
(f) the observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company;
(g) whether any director is disqualified from being appointed as a director under sub-section (2) of section 164;
(h) any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith;
(i) whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls;
(j) such other matters as may be prescribed.
Duty to comply with the auditing standards
As it has been provided under Section 143(9) of the Companies Act, 2013, the auditor shall comply with the auditing standards. The auditing standards shall be those recommended by the Institute of Chartered Accountants, constituted under Section 3 of the Chartered Accountants Act, 1949.
The auditor has the duty to disclose to the Central Government, if he has reason to believe that the officers or employees of the company are committing or have committed an offense involving fraud against the company, as has been provided under Section 143(12) of the Companies Act, 2013.
Further, the disclosure of fraud shall not be considered to have contravened any of the duties, an auditor has in respect of the company.
Duty to sign audit reports, etc.
Section 145 of the Companies Act, 2013 provides the duty of the auditor to sign audit reports and other documents in relation to the company. The Section reads as –
The person appointed as an auditor of the company shall sign the auditor‘s report or sign or certify any other document of the company in accordance with the provisions of sub-section (2) of section 141, and the qualifications, observations or comments on financial transactions or matters, which have any adverse effect on the functioning of the company mentioned in the auditor‘s report shall be read before the company in general meeting and shall be open to inspection by any member of the company.
Thus, the amalgamation of the rights and duties of the auditor as has been described above is known as a statutory audit.
Another kind of audit which a private company may have to undergo is the internal audit.
Internal Audit is an evaluative activity within a company, for the appraisal of accounting, financial, and related business activities, for the purpose of providing the management with useful insights in relation to the business.
The purpose of internal audit in an organisation is to provide an independent assurance that various sectors of business organisation are performing well and in case this isn’t the case; to provide the management with necessary insights and advice for the purpose of fixing any difficulties which may exist.
Classes of Companies which may undergo an internal audit
The class of companies which have to undergo internal audit has been defined under Rule 13 of The Companies (Accounts) Rules, 2014.
The concerned provision states as follows –
“(1) The following class of companies shall be required to appoint an internal auditor which may be either an individual or a partnership firm or a body corporate, namely: –
- every listed company;
- every unlisted public company having-
- paid up share capital of fifty crore rupees or more during the preceding financial year; or
- turnover of two hundred crore rupees or more during the preceding financial year; or
- outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year; or
- outstanding deposits of twenty five crore rupees or more at any point of time during the preceding financial year; and
- every private company having-
- turnover of two hundred crore rupees or more during the preceding financial year; or
- outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year:
Provided that an existing company covered under any of the above criteria shall comply with the requirements of section 138 and this rule within six months of commencement of such section.
Explanation. – For the purposes of this rule –
- the internal auditor may or may not be an employee of the company;
- the term ‘Chartered Accountant’ or ‘Cost Accountant’ shall mean a ‘Chartered Accountant’ or a ‘Cost Accountant’, as the case may be, whether engaged in practice or not.
(2) The Audit Committee of the company or the Board shall, in consultation with the Internal Auditor, formulate the scope, functioning, periodicity and methodology for conducting the internal audit.”
Thus, a private company having a turnover of Rs. 200 crore or more during the preceding financial year, or outstanding loans and borrowings from banks or public financial institutions exceeding Rs. 100 crore or more at any point of time during the preceding financial year, shall undergo an internal audit.
Appointment of Internal Auditor
Section 138 of the Companies Act, 2013 is the provision concerned with the appointment of an internal auditor. The Section reads as –
(1) Such class or classes of companies as may be prescribed shall be required to appoint an internal auditor, who shall either be a chartered accountant or a cost accountant, or such other professional as may be decided by the Board to conduct an internal audit of the functions and activities of the company.
(2) The Central Government may, by rules, prescribe the manner and the intervals in which the internal audit shall be conducted and reported to the Board.
Thus, any chartered accountant or cost accountant or any other professional as deemed fit by the Board of Directors may be appointed as an internal auditor for the company.
In January 2020, Secretarial Audit was made compulsory for private companies which have high borrowings.
Secretarial Audit is a process to check the compliance of the company’s activities with the provisions of laws, rules, regulations, procedures, records, etc.
Since there are frequent amendments in the law, it is essential that the practice of secretarial audit is followed periodically and steps should be taken if there exist any deviations from the laws.
The audit is conducted by an independent professional who shall be a Company Secretary in Practice, as has been defined under Section 2(2)(c)(v) of the Company Secretaries Act, 1980.
Section 204 of the Companies Act, 2013 talks about Secretarial Audit. The Section reads as follows –
“(1) Every listed company and a company belonging to other class of companies as may be prescribed shall annex with its Board‘s report made in terms of sub-section (3) of section 134, a secretarial audit report, given by a company secretary in practice, in such form as may be prescribed.
(2) It shall be the duty of the company to give all assistance and facilities to the company secretary in practice, for auditing the secretarial and related records of the company.
(3) The Board of Directors, in their report made in terms of sub-section (3) of section 134, shall explain in full any qualification or observation or other remarks made by the company secretary in practice in his report under sub-section (1).
(4) If a company or any officer of the company or the company secretary in practice, contravenes the provisions of this section, the company, every officer of the company or the company secretary in practice, who is in default, shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.”
Thus, the Section mandates that a “secretarial audit report is to be attached with the Board’s report made under Section 134(3) of the Companies Act, 2013, in case of “listed companies and other classes of companies as may be prescribed”.
Rule 9 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, lists the classes of companies which are prescribed to conduct a secretarial audit The Rule reads as follows –
“(1) For the purposes of sub-section (1) of section 204, the other class of companies shall be as under-
(a) every public company having a paid-up share capital of fifty crore rupees or more; or
(b) every public company having a turnover of two hundred fifty crore rupees or more. or
(c) every company having outstanding loans or borrowings from banks or public financial institutions of one hundred crore rupees or more.
Explanation – For the purposes of this sub-rule, it is hereby clarified that the paid-up share capital, turnover, or outstanding loans or borrowings as the case may be, existing on the last date of latest audited financial statement shall be taken into account.
(2) The format of the Secretarial Audit Report shall be in Form No.MR.3.”
Clause (1)(c) of the rule mandates every company, whether public or private, to conduct a secretarial audit if it has outstanding loans or borrowings from banks or financial institutions of one hundred crore rupees or more.
The clause was inserted through the Companies (Appointment and Remuneration of Managerial Personnel) Amendment Rules, 2020 dated 03.01.2020 w.e.f., 01.04.2020.
The functions of a company secretary are defined under Section 205 of the Companies Act, 2013. The Section reads as –
“(1) The functions of the company secretary shall include,—
(a) to report to the Board about compliance with the provisions of this Act, the rules made thereunder and other laws applicable to the company;
(b) to ensure that the company complies with the applicable secretarial standards;
(c) to discharge such other duties as may be prescribed.
Explanation. —For the purpose of this section, the expression ―secretarial standards means secretarial standards issued by the Institute of Company Secretaries of India constituted under section 3 of the Company Secretaries Act, 1980 (56 of 1980) and approved by the Central Government.
(2) The provisions contained in section 204 and section 205 shall not affect the duties and functions of the Board of Directors, chairperson of the company, managing director or whole-time director under this Act, or any other law for the time being in force.”
Further, as has been provided under Section 143(14) of the Companies Act, 2013, all the provisions in relation to rights and duties of statutory auditors which have been discussed previously in the article, would apply to Company Secretary in Practice as well.
The Section reads as –
The provisions of this section shall mutatis mutandis apply to—
(a) the cost accountant in practice conducting cost audit under section 148; or
(b) the company secretary in practice conducting secretarial audit under section 204.
Wrapping it Up
A private company has become an attractive form of business organisation because of the benefits involved.
Despite the easiness of carrying on business through a private company, there are certain mandatory compliances which a company has to fulfil.
One of such compliances is having routine audits.
The Companies Act, 2013 provides with the various kinds of audits which a private company has to undergo. These are Statutory Audit, Internal Audit, and Secretarial Audit.
Professionals like Chartered Accountants, Company Secretaries, and Cost Accountants perform these audits for companies and thus help in the maintenance of a clear financial record and a clean legal status.
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Author Bio: Anant Pratap Singh Chauhan is a BA,LLB(H) student from Aligarh Muslim University and an intern at WinSavvy. Connect with him on LinkedIn.
Editor Bio: Chinmay Jain is a BA.LLB(H) student from Institute of Law, Nirma University, and an intern at WinSavvy. Connect with him on LinkedIn.