AUDITOR'S REPORT- By- Law Padho

 This article is written by Kunal Yogesh Nadkarni, a student at Symbiosis Law School, Hyderabad, where he discusses about the  "AUDITORS REPORT"

TOPIC: AUDITOR'S REPORT

CHAPTER I: INTRODUCTION

“The Auditor is a Watchdog and not a Bloodhound” – Lord Justice Topes

 

An audit report can be defined as a structured and self-sustaining form of examination of the relevant financial statements, data, records, day-to-day operations of an undertaking in consonance with the purpose sought to be achieved. Fundamentally, the auditor perceives and examines the relevant evidence and conveys his judgment in form of an audit report with the purpose of enhancing the productivity of control, risk management and administration.[1] The auditor is entrusted to review whether the said financial statements are in adherence to the “International Financial Reporting Standards” (IFRS) and the “Generally Accepted Accounting Principles” (GAAP).

Furthermore, a detailed audit report is primitive for quality corporate governance as it ensures transparency and accountability in the corporate financial administration. Also, taking into consideration the mere fact that those persons who invest in the capital of the company do not have control over the use of such money, it is elementary that the audit report portrays an accurate and equitable outlook of the financial affairs of the company.[2] Thus, in the case of “re Kingston Cotton Mills Company”[3], the House of Lords laid emphasis on the notion that the Auditor must exercise reasonable diligence and caution while also implement substantive measures to protect and promote the interests of the investors as well as inspire public confidence. [4]

Predominantly, “Section 143 of the Companies Act, 2013”, lays emphasis on the powers and duties of the auditor as well as the right to conduct inquiry into a wide array of matters in adherence to the financial statements of the company. Furthermore, the above-mentioned section lays down the requisites which need to be adhered while drafting an audit report.

The Auditor’s Opinion acts as a certification of the financial statements which is presented in the second section of the Auditor’s report.[5] Furthermore, the diverse kinds of audit reports namely, (i) Unqualified Audit Report, (ii) Qualified Audit Report, (iii) Adverse Audit Report, (iv) Disclaimer Audit Report as well as the advantages and limitations of the above-mentioned report shall be comprehensively analysed in the paper.

 

The research paper fundamentally focuses on the concept of Auditor’s report as enshrined under the provisions of the “Companies Act, 2013”. In view of the modern-day competitive business environment, an audit report is primitive to ensure transparency between an enterprise and its investors as well as inspire confidence among the public. Emphasis will be laid on the fundamental objectives of the report in conjunction with financial statements of the company. The paper will also pertinently explore the powers and duties of auditors in relation to audit report in adherence to “Sec 143 of the Companies Act, 2013”. Furthermore, the paper will shed light on the diverse types of audit report as well as the advantages and limitations of such reports. Also, the requisites which need to be adhered by the auditor will be briefly analysed. Lastly, emphasis will be laid on the significance of the Auditor’s opinion in relation to the state of affairs of an enterprise as enumerated under the audit report. Thus, the significance of study is fundamentally focused on drawing a comprehensive analysis of the diverse rights and duties of the auditor as well as enumerate the substantial significance of the audit report in the modern contemporary business environment.

CHAPTER II: Qualifications and Dis- Qualifications of an Auditor in adherence to the Companies Act, 2013.

“Section 141(1) of the Companies Act, 2013” prescribes the qualifications and Dis- Qualifications of a company auditor. Taking into consideration the above-mentioned provision, an auditor retaining the prescribed qualifications is pertinently termed as a “Statutory Auditor” in view of the pre-dominant fact that he procures his authority, duties and powers from the parent statute, namely, “The Companies Act, 2013”.

2.1 The following is an overview of the qualifications prescribed under the above-mentioned provision:[6]

·         Firstly, in adherence to the above-mentioned provision, a personal will be considered for appointment as an auditor provided, he is a chartered accountant possessing a certification of practise within the meaning of “Section 2(17) of the Charted Accountants Act, 1949”.

·         Secondly, in adherence to “Section 141(2) of the Companies Act, 2013”, wherein a firm is assigned as the auditor, only those personal who are “chartered accountant” possessing a certification of practise shall be permitted to sign in representation of the firm.

2.2 The following is an overview of the dis-qualifications prescribed under “Section 141(3) of the Companies Act, 2013” [7]

The fundamental purpose of the dis-qualifications prescribed under “Section 141(3) of the Companies Act, 2013” is to protect and promote the independence of the functioning as well as counter potential hostile conflicts arising due to pecuniary interest. Furthermore, in the case of “Dharangdhara Chemical Works v. State of Saurashtra” [8], the court laid substantial emphasis on the notion that a chartered accountant who is employed in a said company on a whole-time or permanent basis cannot perform the duties of an auditor. The following are entities or personal disqualified in adherence to “Section 141(3) of the Companies Act, 2013”: [9]

·         A personal who has been convicted for an offence with imprisonment in relation to fraudulent activities for a period of ten years.

·         A personal who is prominently involved in rendering diverse kinds of services in relation to “Section 144 of the Companies Act, 2013”.

·         A body corporation other than a “Limited Liability Partnership” (LLP) within the purview of the “Limited Liability Partnership Act, 2008”.

2.3 Tenure of an Auditor [10]

“Section 139 of the Companies Act, 2013” lays fundamental emphasis on the mandate that the tenure of the auditor is for a stipulated time period ranging from the completion of the primary “Annual general meeting” to the completion of the sixth “Annual general meeting”. If deferred, his tenure will prolong till the completion of the postponed meeting. In case of no fresh appointment, the current auditor shall continue executing his duties.

2.4 Stature of an Auditor: Judicial interpretation

The stature of the auditor has been subjected to a series of diverse Judicial Interpretations as prescribed below: 

·         In the case of “Spackman v. Evans”[11], an auditor was termed as an agent of the stakeholders while also laying fundamental emphasis on the phraseology “the knowledge of the agent is the knowledge of the principal”.

·         In the case “London and General Bank” [12], an audit was termed as an officer of the company taking into consideration the mere fact that he/she is appointed by the “Board of Directors” (BOD) in perusal of the provisions of the “The Companies Act, 2013”. The same was reiterated in the case of “re Kingston Cotton Mills Company” [13] and Connell v. Himalaya Bank Ltd[14]

·         Thus, in consonance with the “Companies (Amendment) Act, 2000” and “The Companies Act, 2013”, the term “officer” wasn’t included within the purview of the definition of an auditor. Thus, it can be presumed that the primary interpretation of an auditor being “an agent of the shareholders” is in adherence with the current prevailing law of the land. [15]

CHAPTER III : Fundamental objectives of the audit report in conjunction with financial statements of the company in the contemporary business environment.

Audit can be described as a conventional and elaborate scrutiny and corroboration of financial accounts and records of a said enterprise with the fundamental purpose of enhancing corporate governance[16], ensuring healthy investor relationships as well as dispensing a true and fair[17] outlook of the state of affairs of the company.[18] Coherence, impartiality and independence of an auditor is substantially fundamental for the utility of the financial statements and records.[19] Furthermore, it is primitive that the investments are secure and prudent and are being adopted for the intended and conscious purpose.[20] Thus, in order to effectively expedite the above-mentioned process, the accounts of the company must be periodically scrutinised and due-diligence must be initiated by an independent personal namely the “auditor”.[21]  Furthermore, non-compliance with the “International Financial Reporting Standards” (IFRS) and the “Generally Accepted Accounting Principles” (GAAP) as well as infectiveness of the internal control system must also be duly reviewed by the auditor. To summarise, the audit report contributes substantially to the process of apprehension and disclosure of fraud and malpractices, technical lapses and non-adherence to statutory principles.[22]

CHAPTER IV: Comprehensive analysis on the different types of audit reports prescribed under the “Companies Act, 2013” as well as the advantages and limitations of such reports.

4.1 Diverse Types of Audit Report [23]

·         Unqualified Opinion (Clean Audit report)

The concerned report illustrates that the financial statements and the records of the company are presented in a just and equitable manner in respect of the financial position, fundamental purpose and outcome of operations and cashflows in conformance with the “Generally Accepted Accounting Principles” (GAAP).  Firstly, it is the statutory responsibility of the auditor to manifest an opinion in relation to the financial statements on the basis of the report. Secondly, it is the statutory responsibility of the auditor to maintain the desired standard level of audit quality. Lastly, the auditor is also empowered to manifest an additional explanatory opinion in relation to a material uncertainty.

·         Qualified Opinion

The concerned report illustrates that the financial statements contain a series of discrepancies and material misstatements which are not of pervasive and extensive nature. For instance, the primary balance which contain a sizeable number of inventories cannot be verified.

·         Adverse Opinion

The concerned report illustrates that the financial statements and the records of the company do not provide a just and equitable financial position, true and fair outlook of the state of affairs, fundamental purpose and outcome of operations and cashflows in conformance with the “Generally Accepted Accounting Principles” (GAAP). Herein, the discrepancies and material misstatements are of pervasive and extensive nature. Thus, the following report enumerates that the financial statements as a whole cannot be relied upon by the shareholders and the investors.

·         Disclaimer of opinion

The concerned report does not expressly provide an opinion on the financial statements of the company but rather enumerates matters in relation to the breach of the auditor’s statutory independence, wherein due to the lack of adequate audit scope an opinion could not be formed. For instance, the above-mentioned audit report includes matters wherein the auditor is subject to restrictions and prohibited access to certain critical information.

4.2 The following are a series of incentives of the duly and periodically scrutinised audit report [24]:

·         Incorporates immense value to a business in form of enhancing business relationships as well as effectively discharging commercial and internal affairs.

·         Taking into consideration the mere fact that the auditor is an entity independent from the management, the audit report enumerates an honest and assured overview in relation to the management of the company.

·         Taking into consideration Professionalism as prescribed under “Section 141(1) of the Companies Act, 2013”, an unbiased opinion in relation to the state of affairs and the financial statements of the company is duly sought. 

·         Enumerates the shareholders of the company with accurate cognition of the operational and financial scenario as well as prospective future prospects and predicaments of the company.

4.3 The following are a series of limitations of an Audit Report[25]:

·         The purview of audit might be restricted by the management: It is a well-established notion that auditors have complete right to access any kind of information in relation to the preparation of audit report. However, in certain cases the management withholds sensitive and confidential information prominently due to the lack of trust.

·         Auditor’s competency: In adherence to “Section 141 of the Companies Act 2013”, an auditor must hold a CPA qualification and thus, taking into consideration the sizeable amount of workload and the time restrains, the quality of the audit report can be substantially affected.

·         Standard audit practice necessitates adequate planning and risk management. Certain class of risks such as inherent risk and fraud risk might not be detected by the auditor.

 

CHAPTER V: The rights, powers and duties of auditors in relation to audit report in adherence to “Section 143 of the Companies Act, 2013”.

5.1 Duties of an Auditor[26]

The fundamental purpose of an Audit report is enhancing corporate governance, ensuring healthy investor relationships as well as dispensing a true and fair outlook of the state of affairs of the company.[27] In the case of “London and General Bank” [28], it was held that the auditor is duty-prudent to undertake reasonable caution in exercise of his duty. Furthermore, in the case of “re Kingston Cotton Mills Company”[29], the House of Lords laid substantial emphasis on the notion that the Auditor must exercise reasonable diligence and caution while also implement substantive measures to protect and promote the interests of the investors as well as inspire public confidence.

Thus, it is the imperative duty of the auditor to effectively and efficiently perform the following duties in perusal of the above-mentioned purpose:

1.      Duty to prepare the Audit Report on the examination of the financial statements: It is the statutory duty of the auditor to prudently examine each and every financial transaction and express his opinion to the best of his knowledge, in the General meeting.

2.      Duty to in relation to Annual General Meeting: It is the predominant duty of the auditor to participate in the “General Meeting” either in person or through an authorised agent or representative.

3.      Duty to issue statement in Prospectus: Taking into consideration the mere fact that a prospectus is substantially important in relation to prospective investors and financial growth of the company, the auditor is duty bound to prepare a report which provides a comprehensive overview of the profit and loss statements of five financial years as well as the prospective list of assets and liabilities.

4.      Duty to generate documents and evidence: It is the imperative duty of the auditor to produce all relevant documents and books of accounts of the company to the concerned inspector during inspection as well as facilitate in the process of investigation.

5.2 Rights of an Auditor[30]

Predominantly to facilitate and enhance effective and efficient discharge of duties, the Companies Act 2013 renders a broad and extensive series of rights to the auditor which are statutory in nature and cannot be curtailed or overruled either by the articles of association or resolution by the concerned members. The same was reiterated in the case of “Newton v. Birmingham Small Arms Co.”[31] , wherein it was held that any provision which is contrary to the above-mentioned ideology is ultra vires. The following are the broad and extensive series of rights of the auditor:

1. Right to access books and accounts: Taking into consideration the mere fact that the fundamental purpose of an audit report is to dispense a true and fair outlook of the state of affairs of the company, it is primitive that the auditor is permitted access to all relevant financial documents which also include correspondence and agreements. Furthermore, in relation to a “holding company”, the auditor has statutory right to access financial statements of all its “subsidiaries”.

2. Right to procure relevant information: The auditor has the statutory right to procure relevant information and justifications from the officials of the company in adherence to pertinent performance of his duties.

·         Firstly, information in relation to outstanding loans and advances, their secure status and their terms and conditions.

·         Secondly, information in relation to transaction of the company which are merely constituted in form of book entries.

·         Thirdly, information in relation to purchase and sale of assets, shares, debentures and other prominent securities.

·         Fourthly, information in relation to personal and private expenses added to the revenue account.

·         Lastly, information in relation to outstanding loans and advances merely being constituted as deposits

3. Rights in relation to Branch Accounts: The financial statements of the branch office of the concerned company are mandated to be audited by either the “company auditor” or “any other auditor”. However, wherein the audit report has been prepared by an auditor other than the company auditor, such “branch auditor” must submit a report to the “company auditor”.

4. Right to initialise Audit report: The signature of the auditor on the audit report acts as a mark of certification and authenticity.

5. Right to receive remuneration: The auditor has a statutory entitlement to his remuneration post consummation of his duties.

6. Right in relation to Annual General Meeting: An auditor has a statutory right to attend as well as be heard at the “Annual General Meeting” in perusal of his statutory duties as prescribed under “Section 143 of the Companies Act 2013”. Furthermore, it is primitive that any pronouncement or scrutiny in relation to the financial statements, which can potentially have a hostile effect on the effective and efficient functioning of the company, must be stated and open for discussion.

CHAPTER VI: CONCLUSION

Laying fundamental emphasis on the quote, “The Auditor is a Watchdog and not a Bloodhound” by Lord Justice Topes, the auditor report plays a crucial and prominent role in fulfilling the fundamental purpose of enhancing corporate governance ensuring healthy investor relationships as well as dispensing a true and fair outlook of the state of affairs of the company. To facilitate the above-mentioned process, it is primitive that the auditor has complete discretion, consistency, impartially and independence in order to enhance the efficient and effective functioning of a company.  Furthermore, On the basis of the judicial precedents cited, it can be inferred that the Auditor is duty-prudent to exercise reasonable diligence and caution while exercising its duties prescribed under “Section 143 of the Companies Act, 2013”, taking into consideration the mere fact that he is an agent of the shareholders and must undertake substantial measures to protect and promote the interests of the investors as well as inspire public confidence at large. Also, the diverse kinds of audit reports cover a wide range of areas which fundamentally focus on identification and termination of malpractices. Thus, in the modern-contemporary competitive business environment, it is primitive and fundamental for the auditor to express his opinion in form of the audit report taking into consideration the massive financial transactions, complexities as well as malpractices in the company.

 

Author- Kunal Yogesh Nadkarni,

Symbiosis Law School, Hyderabad.

END NOTE

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[1] Radheshyam Prasad, Role of Audit to protect the investors interest under Companies Act, 2013, January, 2014. 

[2] Ruchika Jha, Auditor and its position under Company Law, Lawtimesjournal, ed. March 3, 2020.

[3] re Kingston Cotton Mills Company, 1986.

[4] Kumkum Sen, Accounting and accountability, Financial Express, ed. January 29, 2002.

[5] Alicia Tuovilla, Auditors Opinion, Investopedia, ed. October 24, 2020.

[6] G.P. Whittred, Audit Qualifications and the Timelines of Corporate Annual Reports, The Accounting Review, Vol. 55 Issue 4, JSTOR, October 1980, pp. 563-577.

[7] Gokberk Can, The Impact of Auditor Qualificiation on Earnings Management of Companies. Business and Economic Research Journal, Vol. 10 Issue 2, January 24, 2019, pp. 373-390.

[8] Dharangdhara Chemical Works v. State of Saurashtra, 1957 A.I.R. SC 264.

[9] G.P. Whittred, Audit Qualifications and the Timelines of Corporate Annual Reports, The Accounting Review, Vol. 55 Issue 4, JSTOR, October 1980, pp. 563-577.

[10]Augustine Okolie, Auditor Tenure, Auditor Independence and Accrual, Euproean Journal of Accounting, Auditing and Finance Research, Vol. 2 Issue 2, April 2014, pp. 63-90.

[11] Spackman v. Evans, 3 H.L. 236.

[12] London and General Bank, 1895 2 Ch. 682.

[13] re Kingston Cotton Mills Company, 1986.

[14] Connell v. Himalaya Bank Ltd, 1895.

[15] B. McGladrey, The Audit Report, The Accounting Review Journal, Vol. 26, No. 2, pp. 197-208, April 1951.

[16]Naveen Srivastav, Reassessing Auditor’s Role in the Indian Corporate Governance, Corporate Governance and Corporate Social Responsibility: A Way of Life, Ed. 2011, pp. 91-105.

[17] Royal Mail Steam Packet Co., R v. Kylsant, 1933.

[18] Radheshyam Prasad, Role of Audit to protect the investors interest under Companies Act, 2013, January, 2014. 

[19] P. Saxena, Auditors Independence: Learning from Americas experience, Charted Accountancy Journal, August 1993, pp. 71-73.

[20] Ruchika Jha, Auditor and its position under Company Law, Lawtimesjournal, ed. March 3, 2020.

[21] Mitrendu Roy, Siddharta Saha, Statutory Auditors Independence in India: An empirical analysis from the Stakeholders interest perspective, Vikalpa: Journal for Decision Makers, March 8, 2016.  

[22] Jesse F. Dillard, Daniel Jensen, The Auditor’s Report: An Analysis of Opinion, The Accounting Review Journal, Vol. 58, No. 4, pp. 787-798, October, 1983.

[23]  Nicholas J. Pope, Understanding the Four types of Audit Report, Digital Insights, ed. July 1, 2019. https://insights.diligent.com/audit-reporting/understanding-four-types-audit-reports/

[24] Abdullah Mohammed Ayedh, Effectiveness of Internal Audit, International Journal of Science and Research (IJSR), Vol. 7 Issue 1, January 2013.

[25] Jesse F. Dillard, Daniel Jensen, The Auditor’s Report: An Analysis of Opinion, The Accounting Review Journal, Vol. 58, No. 4, pp. 787-798, October, 1983.

[26]Krishnendu Malakar, Powers, Duties, Liabilites of Company Auditor under the Companies Act, 2013, International Research Journal of Inter-discpilnary & Multi-dispcipilary Studies (IRJIMS), Vol. 2, Issue 8, September 2016, pp. 50-55.

[27] Radheshyam Prasad, Role of Audit to protect the investors interest under Companies Act, 2013, January, 2014. 

[28] London and General Bank, 1895 2 Ch. 682.

[29] re Kingston Cotton Mills Company, 1986.

[30]Krishnendu Malakar, Powers, Duties, Liabilites of Company Auditor under the Companies Act, 2013, International Research Journal of Inter-discpilnary & Multi-dispcipilary Studies (IRJIMS), Vol. 2, Issue 8, September 2016, pp. 50-55.

[31]Newton v. Birmingham Small Arms Co., 1906 2 Ch. 378.