The Hindu Business Line : Are auditors the most-wanted?

THE statutory auditors' job seems far from enviable. This is the conclusion one would draw looking at the responsibilities cast on them by law, by fiction and by self-regulation. And as if these were not enough, the Joshi Committee, appointed by the Department of Company Affairs to amend the Companies Act, has made certain observations that would make their life even more difficult.

The committee refers to the problem of the so-called "expectation gap" — the difference between what audits do achieve and what they ought to achieve. The report says that in order to narrow the expectation gap there is need for clarity about the respective responsibilities of directors and auditors for preparing and reporting on the financial statements of companies. The committee observes thus: "The auditor's responsibility is to plan, perform and evaluate his audit work so as to have a reasonable expectation of detecting material misstatements in the financial statements. The frauds may involve forgery, collusion or management override of control system. Sometimes the auditor may suspect the top management itself of being a party to the fraud, but he may lack the necessary evidence to back up his suspicion. In such a situation he may not be in a strong position to confront the management but he may have a case which he can report to the appropriate authority for action.

The question is whether he should report. One view is that the auditor should have a duty to report a fraud to the appropriate authority.

The other view is that this is not a part of his statutory duty as per the provisions of the existing law. There is yet another scenario wherein it is feasible that the auditors, even if they detect a misappropriation or misstatement in accounts by management, look the other way and do not record such lapses in the statutory report. Such misappropriations, which are intentional, make the auditor a party to the conspiracy to defraud the investors by misrepresenting the financial position of the company. It also makes them equally guilty in the fraud with the management of the company."

Since the Companies Act, 1956, at present, does not have a provision to deal with such a situation, which leads to falsification of accounts, the committee has recommended, inter alia, that the auditor should be brought within the ambit of Section 5 of the Act which defines the "Officer who is in default".

Rotation: The committee feels that the present dispensation of reappointing the retiring auditor year after year leads to establishing a nexus between the management and the auditor. According to the committee, there have been cases where auditors collude with the management by misreporting facts to the shareholders. Therefore, it has recommended that no company shall reappoint the same auditor for more than five consecutive years. However, such an auditor may be considered for reappointment after five years from the last term of appointment.

Falsification of accounts: The committee has proposed that a provision be inserted in the Act providing for imprisonment of not less than one year and up to 10 years for the management and statutory auditors if they are found to be involved in fraudulent practices.

Diversion of funds: The report observes that "companies have been raising funds from various sources for their business needs, including for certain identifiable plans or projects. The funds can be raised through public issues, financial institutions or banks or by inviting deposits from the public etc. It is, however, noticed that sometimes companies deploy such funds for the purpose other than for which these were raised." The committee has, therefore, recommended that responsibility be cast on the auditor to check and report diversion, misutilisation and misappropriation of funds by companies, by including it in MAOCARO.

These responsibilities are in addition to the ones under Section 227 of the Act and the professional guidelines of the ICAI and other statutes. Is the auditor a watchdog, bloodhound or the hunted?

Other recommendations

Consolidated accounts: To give legal effect to the regulations under the listing agreement, the committee proposes to make a provision in the Act obligating preparation of consolidated accounts by a holding company as and when notified by the Government. It is also proposed that a holding company along with its annual reports need not attach annual reports of its subsidiary companies where such holding company prepares group accounts for itself and its subsidiaries as required by law.

Chief accounts officer: The committee feels that the time is ripe now to develop a system wherein companies have a officer whose services should be specifically used for the preparation and maintenance of proper books of account and the management of the company's finances. The incumbent should either be an ICAI or ICWA member. Such appointments are to be mandated only for companies having a paid-up capital of Rs 5 core or more.

Inspection: Section 209A of the Act provides that the books of account and other books and papers of every company shall be open for inspection by i) the Registrar; ii) such officer of the government as authorised by the Central Government; and iii) such officer of SEBI as may be authorised by it.

The committee observes that the big increase in complexities of law, procedures and practices of corporate bodies have made it imperative for an inspector to have expertise and specialised knowledge in varied fields, including law, accountancy, finance, trade, marketing, and so on. The committee has, therefore, proposed that the Central Government be empowered to notify professionals, such as company secretaries, chartered accountants and cost accountants, whose services can be utilised for conducting inspection of books and records of companies under Section 209A.

Defunct companies: The present procedure to strike off the name of the company from the register, besides being time consuming, is cumbersome and lengthy. To provide a simplified exit route to companies which are not carrying on any business or have no future plans for continuing the business, it is proposed to change the requirement of publishing the notice in the Official Gazette and, instead, publishing the same in one English newspaper and one vernacular newspaper circulating in the area in which the registered office of the company is situated. The requirement of publishing the notice twice is also proposed to be dispensed with.

Practising company secretary: While the removal and appointment of statutory auditors are usually by members at a general meeting, no such protection is available to company secretaries in practice. The committee feels that it is desirable to bring company secretaries and auditors on a par with a view to ensure independence to the secretary in whole-time practice for issuing compliance certificate under Section 383A.

The committee has, in addition, suggested: a) prohibition of distribution of gifts at general meetings; b) restricting the number of directors to 15; c) service of notice by courier or electronic media; d) deletion of Sections 108A to 108H dealing with restrictions on transfer of shares; e) fixing responsibility on auditors to report on diversion of funds or, in other words, the end use of the funds mobilised either by way of accessing the public, or accepting public deposit or by means of any other financial instruments; and f) all special notices or notices served on the company by the members proposing resolutions for consideration should be accompanied by a deposit of Rs 10,000, which is refundable only if the proposal is carried.

This will discourage shareholders from resorting to pressure tactics. But it would have been better if a qualifying quantum of shareholding were prescribed so that those holding, say, one share do not abuse this provision.

There are quite a few other provisions, such as issuance of memorandum and articles of association on payment of Re 1 (Section 39), extracts of permitted records being provided at nominal cost, and so on, which are dated and need to be looked at afresh. There are inconsistencies between the provisions relating to voting by ballot and the rules made thereunder and these also need to be reconsidered.

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