CHAPTER I

Appointment, Remunaration,Powers, Duties And Liabilities of the Auditor

AppointmentAnd Audit of share capital and Pre-Incroparation Profit

Qualifications
In this lesson you are being told about the appointment, powers, duties and liabilities of the
auditor. You have already known about the importance of a auditor in a Company, whether a
Public Ltd. Company or a Private Ltd. Company. The accounts of the Company are to be audited
annually by a qualified auditor. Hence the question is, who is a qualified auditor. The answer to
this question can be sought in Section 226 of the Companies Act, which states, "a person shall
not be qualified for appointment as auditor of a Company unless he is a Chartered Accountant
within the meaning of the Chartered Accountants Act 1949". A firm whereof all the partners
practising as a Chartered Accountants in India, may also be appointed by its firm's name as an
auditor of a company and the partner of the firm may act in the name of the firm.
A person holding a certificate under the Restricted Auditors Certificate (Part B States) Rules
1956, is also qualified to act as an auditor of a company.
The Central Government has powers to make rules poviding for the grant, renewal, suspension
or cancellation of such certificates to persons. It also has got powers to prescribe conditions and
restrictions for such purposes. But is has to notify to this effect in the official gazette (Section
216(2) (b).
Thus to be a qualified, auditor should have passed the examination of the Institute of Chartered
Accountants of India and be a member of the Institute of the Chartered Accountants : or
He should hold a certificate of practice under the Restricted Auditors Certificate (Part B States)
Rules 1956.
If he does not possess either of the qualifications, he is not qualified to act as an auditor of a
company.
Disqualifications
From the above it is clear that the following can not act as an auditor of a Company :
[Section 226 (3)].& (4)
(i) a body corporate ;
(ii) an officer or an employee of the company. (Officer here means a director, managing director,
manager or secretary);
(iii) a person who is a partner or who is in the employment or an officer or employee of the
company;

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(iv) a person who owes the company more that Rs. 1,000/- or who has given a guarantee of
provided any security in connection with the indebtedness of any third person to the company
amounting to more that Rs. 1,000/-.
(v) a person who is disqualified for appointment as an auditor of the company's subsidiary or
holding company or a subsidiary of a holding company.
(vi) A person holding any security after a period of one year from the date of commencemence
of the companies (Amendment) Act, 2000.
Thus it is quite clear that the persons governed by the above stated clauses of Sec. 226(3) are
disqualified from being appointed as an Auditor of a Company.
Company auditor : Appointment and Removal
(i) a body corporate1 (because of its characteristic feature of limited liability); or
(ii) an officer or employee of the company under audit; or
(iii) a person who is a partner, or who is in the employment of an officer or employee of the 
company; or
(iv) a person who is indebted to the company for an amount exceeding one thousand rupees, or
who has given any guarantee for an amount exceeding one thousand rupees; or
(v) a person holding security, i.e. an instrument which carries voting rights of that company; and
(vi) under section 226 (4), a person who has been disqualified for appointment as an auditor of a
company on above-mentioned grounds, shall also not be eligible for appointment with any other
body corporate which may be that company's subsidiary or that company's holding company or
that company's fellow subsidiary.
Appointment of auditors - Section 224
Under section 224 of the Act detailed provisions regarding appointment of statutory auditors
have been laid down. This section [except sub-sections 224 (A) and 224 (1B)] is applicable to all
kinds of companies. The Act has vested the power to appoint auditors with directors,
shareholders, the Central Government and the Comptroller and Auditor General of India.
Appointment by directors
* First Auditors (i) The board of directors shall appoint the first auditor(s) of a company within
one month of the date of registration of the company by a valid resolution.
(ii) The auditor so appointed shall hold office till the conclusion of first annual general meeting.
* Casual Vacancy - The directors have been empowered to fill any casual vacancy in the office
of the auditor, except one, which is caused by prior resignation of an auditor. Any auditor
appointed in a casual vacancy shall hold office until the conclusion of next annual general 
meeting.
Appointment by shareholders
* First Auditors - In case the directors fail to appoint first auditor(s), the shareholders shall 
appoint the auditor at a general meeting by passing a resolution.
* Subsequent Auditors
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(i) By ordinary resolution
As per provisions of section 224 (1), subsequent auditors are to be appointed at each annual
general meeting by the shareholders by passing a resolution. The auditor so appointed shall hold
the office from the conclusion of that meeting until the conclusion of the next annual 
general meeting.
(ii) By special resolution

1. `Body corporate' connotes a wider expression than company and is used under the
Companies Act to denote a company incorporated in India, a foreign company, a public
financial institution, a nationalised bank and also a corporation formed under any special
Indian or foreign law except as expressly excluded by the definition.

In case of certain companies, the auditor is to be appointed only with the approval of the
company by a special resolution. Section 224A lays down that in case of a company, in which
not less than twenty-five per cent of the subscribed share capital 1 is held, whether singly or in
any combination, by :
(a) a public financial institution or a Government company or Central Government or any State
Government; or
(b) any financial or other institution established by any provincial or State Act in which a State
Government holds not less than 51% of the subscribed share capital; or
(c) anationalised bank or a general insurance company.
the auditor is to be appointed or re-appointed by a special resolution only.
(iii) In case of appointment of subsequent auditors the company must inform the auditor within
seven days of appointment;
(iv) The auditor within seven days of receipt of information from the company, must inform the
Registrar in writing whether he has accepted or rejected it.
* Casual Vacancy—If a casual vacancy in the office of auditor arises by his resignation, such
vacancy should only be filled by the company in a general meeting. In case a casual vacancy
arises because of any other reason except resignation, the shareholders can appoint the auditor
only if directors fail to fill the vacancy.

Appointment by the Central Government

(i) If a company, at an annual general meeting, fails to appoint or re-appoint an auditor(s), the
Central Government may appoint a person to fill the vacancy under powers conferred upon it by
section 224(3). The expression. `fails to appoint or re-appoint' also includes refusal to accept the
appointment by the auditor.
(ii) The said company has to give notice of the above fact to the Government and, if a company
fails to give such notice within seven days of the annual general meeting, the company and every
officer of the company who is in default shall be punishable with fine, which may extend up to
five thousand rupees.
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(iii) The appointment by the Central Government is made from the panel of names suggested by
the applicant company.
(iv) It may be noted that if appointment of a person as an auditor is void ab initio, it should not
be treated as a casual vacancy, rather this would give rise to powers of the Central Government
under section 224(3).
Appointment by the Comptroller and Auditor General
In case of Government companies, the Comptroller and Auditor General appoints or re-appoints
the auditor(s).
Compulsory re-appointment
Ordinarily, an auditor appointed by whatsoever authority, is to be compulsorily re-appointed by
passing a resolution at the anuual general meeting. However, the retiring auditor shall not be re-
appointed in the following cases :

1. Subscribed share capital includes equity as well as preference share capital.

 (i) if he is not qualified for re-appointment; or
(ii) if he has given the company notice in writing about his unwillingness to be re-appointed; or
(iii) if a resolution has been passed at the meeting—
(a) appointing somebody other than him; or
(b) providing expressly that he shall not be re-appointed; or
(iv) if a notice has been given of any resolution proposing the appointment of some other person
in place of the retiring auditor (even if such a resolution could not be proceeded with due to
death, incapacity or disqualification of that person proposed as auditor); or
(v) if auditor is unable to comply with the ceiling on number of audits under section 224(1B).
Even for re-appointment of a retiring auditor, passing of a resolution is essential. There cannot
be any automatic re-appointment.
Ceilling on number of Audits
A person of a firm can act as an auditor of a limited number of companies. No company or its
Board of directors shall appoint or reappoint any person (who is in full time employment
elsewhere), or a firm as its auditor, if such a person or a firm is, at the date of such appointment
or reappointment holding appointments as auditor of the specified number of companies.
However the `specified number' will not include audit of private companies.
Special Resolution and the appointment of an Auditor
The Companies Amendment Act 1974, by its Section 224-A, requires passing of a special
resolution for the appointment or re-appointment of an auditor(s) at the each annual general
meeting, in case of companies where less than 25% of the subscribed capital is held whether
singly or in any combination by......
(a) a public financial institution or a Government Company or a Central Government or any
State government; or
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(b) any financial or other institution established by any Provincial or State Act in which the State
Government holds not less than 51% of the subscribed share capital or;
(c) a nationalized bank or an insurance company carrying on general insurance business.
Failure to pass a special resolution in the annual General Meeting by the Company, gives a right
to the Central Government to appoint a person(s) to be the auditor of the company.

Removal of an auditor - Section 224 (7) and Section 225

The removal of an auditor can be discussed under the following heads :
1. Removal before the expiry of the term—section 224 (7) of the Act includes provisions relating
to removal of an auditor of a company before the expiry of term. These are :
(a) Removal of first auditor :- The company (and not the board of directors) in a general meeting
can remove the first auditor appointed by the directors before the expiry of the the term. In this
case the prior approval of the central Government is not needed for removal of first auditor.
(b) Removal of subsequent auditor :- Any subsequent auditor can be removed from office before
the expiry of his term, by the shareholders at a general meeting only after obtaining the prior
approval of the central government.
The only purpose of obtaining the prior approval of shareholders through general meeting and
the central government is to prevent directors of the company to remove an auditor without
adequate and justified reasons.
2. Removal after the Expiry of the term
The auditor can be removed after the expiry of his term of office, as per the procedures laid
down in section 225. According to the section, for removal of a retiring or appointing another
auditor in his place, the following procedures mut be observed.
1. Special notice : A special notice of intention to move such resolution must be given to the 
company by shareholders (holding ten percent voting rights), who wish to nominate some other
person for appointment, at least fourteen (14) days before the annual general meeting.
2. Notice to be sent to retiring auditor : On receipt of such a notice, the company must sent a
copy thereof to the retiring auditor.
3. Right of retiring auditor make a representation : The retiring auditor has a right to make a
written representation (not exceeding a reasonable length) to the company. He may also ask the
company to notify such representatives to the shareholders of the company.
4. Right to get representation circulated : The company, on receipt of representations, shall 
mention the fact of representations being made in the notice of the meeting and send a copy there
of to every member of the company to whom the notice of one meeting is sent. However, if the
representations are not sent because of the default of the company or late receipt, these may be
read out during the meeting.
5. Ground for exemption : If the central government, on the application by the company or any
other aggrieved person, is satisfied that the auditors securing needless publicity or defamatory 

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publicity, it can exempt the company from sending the copy of representations to the members or
reading them out at the general meeting.
6. Right to attend meeting : The auditor to be removed has right to attend the general meeting
where his removal is to be discussed. He has also a right to speak at such meeting.
7. Passing of resolution : The general meeting may, by passing a resolution remove the auditor.

Remuneration of an Auditor
The appointing authority fixes the remuneration of an auditor. Thus it is clear that where the
auditor is appointed by the Board, it is to fix the remuneration; if he is appointed by the Share
Holders in the General Meeting, the remuneration is to be fixed in the Annual General Meeting ;
if he is appointed by the Central Government, the remuneration is to be fixed by it. The General
Meeting can also lay down the manner of fixing the remuneration.
The retiring auditor, when reappointed in the General Meeting, shall get the remuneration, which
he was already getting, in the absence of any resolution passed for refixing his remuneration.
When an auditor is required to do some extra work, he is entitled to claim extra-remuneration for
such work. Such extra-remuneration payable to him is to be shown in the Profit and Loss
Account of the Company also. (Schedule VI Part II Clause B).
Any sum paid by the Company in respect of the auditor(s) expenses shall be deemed to be
included in his remuneration,

RIGHTS AND POWERS OF AN AUDITOR

An auditor gets the following rights and powers from the companies Act, to enable him to
discharge his duties as an Auditor in a faithful manner......
1.Right to inspect books of accounts (S, 227(1))
 The auditor has a right to see the books and the vouchers of the Company, at all times, The
books here mean the account books as well as the Statutory, statistical and costing books,
Vouchers mean documentary evidence of any nature concerning the books and accounts under
Audit, He has a right of free and complete access at all times of even the books and vouchers of
the Branch. This has been decided in the Cuff vs. London and County Land Building Co. Ltd.
(1912) case.
2. Right to ask for information and clarifications. (S. 227 (1) ),
The auditor has a right to call information and explanations from the directors and officers of the
Company. This information and explanation should be necessary for discharging his duties as an
auditor while auditing the books of account of the Company.
3. Right to get notice of the general meeting and attend it. (S. 231).

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The auditor has a right to receive notice of the general meeting and attend it. It is not necessary
that the accounts of the Company are to be discussed in these meetings. He can attend every
meeting of the shareholders.
4. Right to make a statement in the meeting.
The auditor has a right to make statement in the shareholder's meeting relating to the accounts of
the company only. But he is not bound to make any statement, unless the Chairman of the
meeting asks him to do so. In such a case also, he should answer questions relating to accounts
only.
5. Right to be indemnified. (Section 633).
The auditor has a right to be indemnified out of the assets of the company for all legitimate
expenses incurred by him in defending a law suit filed against him for any Civil or Criminal
proceedings, provided he has been acquitted in these cases by the court.
6. Right to visit the Branches.
The auditor has a right to visit each and every branch of the company, in connection with the
audit of these branches or of the Company, provided these branches do not have a separate
auditor and further, these branches have not been granted exemption by the Central Government
for being audited.
7. Right to take legal and technical advice.
The auditor has a right to take legal, expert or technical advice in connection with the
performance of his work. But he should give his own opinion in the audit report and not that of
the experts. Such a decision has been given in Re : London and General Bank (1895).
8. Right to ask for remuneration.
The auditor has a right to ask for the remuneration, after completing the audit work of the
company. In case of his dismissal after his appointment too, he is entitled to his fees.
9. Right to sign the audit report (S. 229).
The auditor has a right to sign the audit report. But where the auditor is a firm, a partner of such
firm has a right to sign the audit report, provided he is a practising Chartered Accountant in
India. Such partner is also entitled to sign or authenticate any other document of the Company
required by law to be signed or authenticated by the auditor.
10. Right to correction of wrong statements.
The auditor has a right to correct any wrong statement made by the directors in the general
meeting. But this statement must relate to the accounts of the company which he has audited.

DUTIES OF AN AUDITOR
Duties of an auditor can be stated under two heads : A. Duties under the Companies Act; and B.
Duties as per the Legal Decisions. Let us see these duties under these heads separately.
A. Duties under the Companies Act
The auditor has the following duties under the Companies Act:
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1. To make special enquiries and investigations in connection with the following matters (Sec.
227 (IA) ).
(i) whether loans and advances made by the company on the basis of security have been properly
secured and whether the terms on which they have been made are not prejudicial to the interest
of the company of its members;
(ii) whether transactions of the company which are represented merely by book entries are not
prejudical to the interests of the company;
(iii) where the company is not an investment company within the meaning of Section 372 or a
banking company, whether so much of the assets of the company as consist of shares, debentures
and other securities have been sold at a price less than that at which they were purchased by the
company ;
(iv) whether loans and advances made by the company have been shown as deposits ; (v)
whether personal expenses have been charged to revenue accounts ;
(vi) whether it is stated in the books and papers of the company that any shares have been
allotted for cash, whether cash has actually been received in respect of such allotment, and if no
cash has actually been so received, whether the position as stated in the account books and the
balance sheet is correct, regular and not misleading.
2. To make report to the shareholders. (Section 227 (2, 3 & 4) ).
The auditor of the company is duty bound to make report to the members of the company on the
accounts examined by him and on every balance sheet, every profit and loss account laid before
the company in the general meeting during his tenure of office. The auditor has to make a report
to the members and not to the directors, though his appointment may have been made by the
directors. The duty of the auditor is over as soon as he submits the report to the Secretary of the
company. It is none of his concern to know whether the same has reached to the hands of the
members of the company.
The Audit Report must expressly state the following besides other necessary things ;
(a) whether in his opinion and to the best of his information and according to the explanations
given to him the accounts give the information required by the Act and in the manner so
required.
(b) Whether the balance sheet gives true and fair view of the company's affairs as at the end of
the financial year and the profit and loss account gives a true and fair view of the profit and loss
of its financial year;
(c) whether he has obtained all the information and explanations required by him for the
purposes of his audit;
(d) whether, in his opinion, proper books of account as required bylaw have been kept by the
company, and proper returns for the purposes of his audit have been received from the branches
not visited by him;
(e) whether the company's balance-sheet and profit and loss account dealt with by the report are
in agreement with the books of account and returns.
3. Duty to state the reasons for the answers in negative.

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In case of the answers to any of the points stated above are in negative, the auditor is required to
explain the reason for the answer in his report.
4. Duty to include in the report the matters as directed by the Central government.
Section 227 (4A) empowers the Central Government to require by order, that the auditor's report
will include a statement on such matters as may be specified therein. Before making any such
order the Central Government may consult the Institute of Chartered Accountants of India in
regard to the classes of description or companies and other ancilliary matters proposed to be
specified therein.

5. Duty to sign the audit report. (Section 229).

It is the duty of the auditor to sign the audit report before sending is to the secretary of the
company.
6. Duty to give a report upon the Prospectus (Section 56 (1) ).
The auditor is required to give his report upon the Prospectus issued by an existing company. He
should also give his report on the assets, liabilities and Profit and Loss of such company.
7. Duty to certify the Statutory Report. (Section 165 (4) ).
The auditor has to certify the correctness of the Statutory Report with regard to the following:
(a) the number of shares which have been allotted by the company whether for cash or for
consideration other than cash;
(b) the total amount of cash received by the company in respect of all the shares allotted,
distinguished as aforesaid;
(c) an abstract of the receipt of the company and the payments made.
8. Duty to declare the solvency of the Directors, (Section 488 (2) (b)),
The auditor has to declare that solvency of the directors in case of the Voluntary Liquidation of
the company,
9. Duty to give a report upon the Profit and Loss Account and the Balance Sheet enclosed with
the Declaration of Solvency. (Section 488 (2) (b)).
The auditor has to give his report upon the profit and loss account and the balance sheet which is
enclosed with the Declaration of solvency made by the Directors of the company, in the case of
Voluntary Liquidation of the Company,
10. Duty to assist the Investigators (Section 240 (v) (b)).
In case the affairs of the company are to be investigated, the auditor should assist the
Investigators in every possible manner. He should produce his working papers relating to audit
when asked for by the Investigators.
11. Duty to assist the Advocate General.
If the Advocate General is making any enquiry against the directors, the auditor is duty bound to
help him in his work.
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B. Duties According to the Legal Decisions
Certain matters have been taken to the court of law from time to time and the courts have in their
decisions fixed certain duties upon the auditors. These duties in short are enumerated here.
1. Duty to inform the members and shareholders about the contravention of the provisions of the
company Law.
2. Duty to enrol himself with the Institute of Chartered Accountants of India and to obtain a
certificate to practice from it.
3. Duty to acquaint himself with the provisions of the company law and also enquire from his
predecessor about it in writing,
4. Duty not to canvass for and also approach and press any member of the company for his
appointment as an auditor of the company.
5. Duty to enquire about the true and fair state of affairs of the company and submit his proper
report.
6. Duty to verify himself cash in hand and not to be negligent in his work.
7. Duty to see the Debenture Trust Deed and verify whether the debentures issued by the
company are according to the terms laid down in the trust Deed.
8. Duty to verify the investments himself.
9. Duty to perform his task with ability, care and skill.
10. Duty to verify the inventories and the ledger accounts.
11. Duty to personally inspect all securities and see that they are in the safe custody of the
Secretary of the Company.
Various courts have penalised the auditors for non-performance of the above stated duties and
therefore, the auditor should take note of these duties also.

LIABILITIES OF AN AUDITOR
Liabilities of an auditor of a company differ from those appointed by a firm, The Companies Act
has defined the duties of a company auditor and the liabilities arise on account of these duties.
For the sake of convenience the liabilities are divided under the following headings:
A. Civil Liability;
B. Criminal Liability;
C. Liability towards third parties;
D. Liability for libel;
In all the four cases the auditor can be held liable for one or more causes given hereunder.
(a) Liability for Negligence under the law of Agency;

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(b) Liability for Misfeasance under the Statutes—Companies Act and Indian Penal Code. Let us
now discuss these liabilities in some detail.
 
A. Civil Liability
Liability for Negligence: Under the law of Agency the auditor is liable for negligence and in
such a case has to pay damages to the aggrieved party or parties. If the company suffers a loss on
account of the acts of the auditor, he has to make good this loss. The auditor shall not be held
liable for negligence, if the company does not suffer any loss. He shall also not be held liable for
the loss suffered by the company without his negligence. In order to hold him responsible for
negligence, the following points are to be proved by the party (ies)..,...
 (a) that he was negligent;
(b) that as a result of his negligence the company has suffered the loss ; and
(c) that the loss was suffered by the person to whom the auditor owed a duty. He cannot be
relieved of his liability by an agreement entered in between him and his client.
`Negligence' includes the following acts—
(a) Not to see the Articles of Association and not to object payment of dividends out of capital;
(b) Not to get statements of accounts from the creditors and find out the errors and frauds.
(c) Not to verify Cash and Petty Cash;
(d) Not to report to the client about the insufficient provision for bad and doubtful debts, which
results in inflating the profits for dividends, thus paying dividends out of capital.
Liabilities for Misfeasance : The term `misfeasance* implies a breach of trust or duty. Where the
auditor performs his duties negligently and the company suffers a loss on this account, the
auditor is held liable for Misfeasance and he has to indemnify the company for such loss. He is
also liable for damages u/s 543 of the Companies Act. The court can, on application made by the
liquidator of the Company, charge the auditor for misfeasance and ask him to make good the
loss. However, the auditor has a right to appeal to the court u/s 633 of the companies Act and he
can be excused partly or fully by the court if it is satisfied that he has acted honestly and
reasonably. Thus relief can be granted only in the case of Civil liability and not in the case of
Criminal liability.
B. Criminal Liability
Criminal liability of the auditor arises under the following Acts:
1. Under the Indian Penal Code ;
2. Under the Companies Act;
3. Under the Income-tax Act;
4. Under the Life Insurance Corporation Act;
5. Under the Banking Companies Act;
6. Under the Chartered Accountants Act.
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1. Under the Indian Penal Code : He is criminally liable, when he issues or signs a certificate
required by law to be given or signed or relating to any fact for which such certificate is
admissible as evidence, knowing or believing that such certificate is false in any material point.
He shall be punishable in the same manner as if he has given false evidence. (Section 197).
2. Under the Companies Act: He is criminally liable for the following acts—
(a) forauthorising the issue of a false prospectus. The penalty for this act is a fine uptoRs.
50.000/- or imprisonment upto a period of 2 years, or both. (S. 63)
(b) for fraudulently inducing persons to invest money by purchasing shares or debentures of the
company. The punishment is imprisonment for a term extending upto 5 years or a fine extending
uptoRs. 1,00,000/- or both. (S. 68).
 (c) for making a fraudulent report required under section 227 i.e. if the report is made not in
conformity with the requirements of Section 227 or any document of the company is signed or
authenticated by him which is also not in conformity with the above section or the report is
signed or any other document is signed or authenticated by any person other than the auditor
himself and such other person is not authorised to do so. The punishment is a fine uptoRs.
10,000 in both the above cases.
(d) For falsification of books. If it is proved that the auditor has been guilty of destroying,
mutilating, altering, falsifying or secreting of any books, papers or securities or is privy to the
making of any false or fraudulent entry in any register, book of account or document belonging
to the company, he shall be punishable with imprisonment extending to seven years and also be
liable to fine. (Section 539).
(e) for delinquency i.e. making a false statement wilfully, in the course of winding up of the
company or certifying a false return, report, balance-sheet or giving a false certificate or
certifying a false document in the course of winding up of a company. All these acts make him
liable for criminal offences and the liquidator can directly prosecute him or refer the matter to
the Registrar. (Section 545).
(f) For rendering false statements either in the balance sheet or any other document or destroying
or mutilating any voucher or document, the auditor shall be punishable with imprisonment upto a
period of two years and also shall be liable to fine.
Criminal offences include the following acts, for which he is punishable with fine or
imprisonment or both—
(a) Wilfully submitting a false report;
(b) Concealment of frauds in the account books;
(c) Destroying the vouchers and documents concerning account books;
(d) damaging the property of the company;
(e) Abetting in the falsification of the account;
(f) Certifying wilfully the false accounts;
(g) Making a false statement knowingly to be false;
(h) Accepting bribe during the course of discharging his duties as an auditor.

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3. Under the Income tax Act: The auditor is criminally liable for encouraging or abetting his
client to make a false statement or declaration regarding his taxable income. The liability for
such offence is imprisonment upto 6 month or fine or both. (Section 278).
4. Under the Life Insurance Corporation Act: The auditor is criminally liable for making a false
statement wilfully on a material point relating to the return, report, balance sheet or any
document. The punishment is imprisonment and fine. (Section 104).
5. Under the Banking Companies Act: The auditor is criminally liable, if he makes a false
statement knowingly relating to a return, report, balance sheet or any other document or conceals
a fact. The punishment is imprisonment upto a period of three years. (Section 46).
Auditor is treated like a public servant and shall be punishable like a public servant for criminal
breach of trust. (Section 46 A). He is also liable to Public Examination and if found guilty by a
court can be declared unqualified for appointment as an auditor for 5 years. (Section 46 A).
 6. Under the Chartered Accountant Act, 1949 : the auditor is liable for misconduct, which is
defined under section 122 of the Act. Cases of professional misconduct are dealt in the various
schedules of the Act.

C. Liabilities Towards Third Parties

Auditor is not liable to third party or parties as a general rule. He is liable to his employer only.
However, if the third parties are able to prove the following points he shall be liable towards
thein too—
(a) that the statement was untrue in fact;
(b) that the person making it knew that it was untrue or was recklessly can consciously ignorant
whether it was true or not;
(c) that the statement was made with the intention that the third party should act upon it;
(d) that the third party did act on the faith of the statement in the prospectus.
The controversy whether the auditor is liable to the third party is now set at rest and the auditor
is now held liable on account of the following reasons—
(a) Certifying the improper accounting procedure due to which embezzlement of an 
employed of the client could not be detected.
(b) Negligence committed by the employee of the auditor;
(c) Errors committed in the preparation of final accounts,

1) Liability for Libel

A libelous or slanderous statement made by an auditor will not hold him liable if he has made
such statement bonafide and without any malice. But if he has made such a statement outside the
scope of his duties, he shall be held liable.
Liability of an honorary Auditor

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An auditor, whether he is paid or honorary, is liable or his acts and omission. The agreement
with his client is very much valid in the eye of the law even though there is no monetary
consideration involved.
Liability of a Joint Auditor
The Companies Act is silent over the issue. But the statement issued by the Institute of Chartered
Accountants of India, on the subject of the liability of Joint Auditors is to be followed in such
cases. The gist of this statement is ; the entire work pertaining to audit is to be divided in
between the auditors and they shall be responsible for their part only, where the work cannot be
divided in any manner, all joint auditors will be responsible.

Liability of Local Auditors

If a company has many branches in the country as well as abroad arid appoints local auditors for
the branches, the auditor of the Head Office shall not be held responsible for the acts of the local
auditors, provided the auditor at the Head Office states clearly in his audit report that he had
completely relied upon the statements and figure supplied by the local auditors.

AUDIT OF SHARE CAPITAL TRANSACTIONS

Share capital may be defined as the capital raised by a company by the issue of shares. Section
86 of the Companies Act provides that the share capital of a company limited by shares shall be
of two kinds only, namely,

1. Preference Share Capital

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 2. Equity Share Capital

The audit of share capital is necessary on incorporation as well as when further shares are issued,
and the same is explained in the following part of this section.

Audit of Shares Issued for Cash

While conducting audit of share capital transactions, the auditor has to check the following.

1. Ensure that the requirements as laid down in Section 69 and 149, in this connection have
been duly complied with.
2. See that the issue of shares is properly authorised and that there is no over issue beyond
the limit as prescribed in the memorandum.
3. See that the provision relating to rights of shareholders are duly complied with.
4. Ensure that generally accepted accounting principles are followed while preparing the
accounts.

While auditing the amount of share capital, the auditor will have to follow the procedures as
stated below:

1. Application stage
1. He should check the original applications and compare the entries in the
application and allotment book with the help of these applications.
2. He should compare entries in the application and allotment book with those in the
cash book and the bank statement.
3. He should ensure that the amount received on application is not less than five
percent of the nominal value of shares [Section 69 (3)].
4. He should ensure that the application money is deposited into a scheduled bank
until the certificate to commence business is obtained or they are returned in
accordance with the provisions of Section 69(5).
5. He should vouch the amount refunded to unsuccessful applications with copies of
letters of regret sent to them.
6. He should check the totals in the application and allotment book and see that
appropriate journal entries have been passed accordingly.
2. Allotment stage
1. The auditor should examine the Director’s minute book to verify approvals for
allotment.
2. He should check copies of letters of allotment and letters of regret with entries in
the application and allotment book.
3. The money received on allotment should be vouched by comparing the entries in
the applications and allotment book with the cash book or bank statement.
4. He should check the postings in the share register of the amount received on
application and allotment with the totals in the application and allotment book.
5. He should see that the total of shares issued does not exceed the total authorised
capital according to the memorandum.
6. He should see that the totals have been correctly made and that proper entry has
been passed for this purpose.
3. Call stage
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 1. The auditor should examine the Director’s minute book for verifying approval for
call money.
2. He should check the entries in the calls book from the copies of call letters.
3. In order to verify the amount of calls in arrear, he should compare the total
amount due on calls as per registers and the actual money received as per cash
book or statement of bank account.
4. He should also verify the calls in advance received by the company.
5. He should check the postings from the calls book and the cash book into the share
register.
6. He should see that the appropriate entries have been passed in the books
accordingly.
4. Other aspects
1. The auditor should see that the shares issued by the company are within the
amount of authorised capital of the company.
2. He should see that the allotment of shares has been made in conformity with the
conditions as stipulated in the prospectus.
3. If the shares are issued through underwriters, the auditor should see the contracts
with the underwriters to ascertain whether the terms and conditions have been
complied in full by the underwriters. In this respect, he should also see that the
commission given to the underwriters does not exceed the statutory limit.

Audit of Shares Issued for Consideration Other Than Cash

Shares may be issued for consideration other than cash under the following circumstances:

1. Issue of shares against purchase consideration to the vendor for the business taken over
by the company.
2. Issue of shares against services rendered to the underwriters, promoters or any other
special service rendering agencies by way of payment of their remuneration or for any
expenses incurred by them.
3. Issue of shares to the existing shareholders as bonus shares.

In order to issue shares for consideration other than cash, the auditor should follow the
procedures as explained in the following segment.

1. Issue of shares to vendors/promoters

Examination of contract   The auditor should examine the contract entered into by the company
with the vendors/promoters to know the amount of purchase consideration and the mode of
payment. For the purchase consideration settlement, the mode of payment would be according to
the prospectus. So, the auditor should also examine the prospectus to see the mode of payment.

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 1. Checking of Director’s minute book   The decision regarding issue of shares to the
vendors/promoters are taken at the Board meeting. The resolution passed by the Directors
for allotment of shares to vendors/promoters should be confirmed from the minute book.
2. Filing of contracts with the Registrar   Such contracts are required to be filed with the
registrar of companies within 30 days from the date of allotment.
3. Allotment of shares to the nominees   If shares have been allotted to the nominees of the
vendors/promoters, the auditor should examine the vendor’s/promoter’s authority given
to them in their favour.

2. Issue of shares to underwriters

1. Examination of the contract   The auditor should examine the contract with the
underwriters. It is required to know the terms and conditions of the contract between the
company and the underwriters.
2. Examination of the prospectus   The auditor should also examine the prospectus of the
company to see the mode of payment. The auditor should verify whether the right for the
payment of commission in the form of shares has been mentioned in the prospectus or
not.
3. Director’s minute book   He should examine the resolution of the directors by reference
to the Director’s minute book.  
4. Examination of the articles of association   He may confirm the amount of underwriting
commission from the Articles of Association. In fact, in the Articles of Association the
maximum limit of underwriting commission that can be given to the underwriters and the
mode of payment and procedure to be followed are mentioned.

3. Issue of bonus shares

1. Examination of the Articles of Association   The auditor should examine the Articles of

Association to ascertain whether the articles permit capitalisation of profit and also
whether the company had a sufficient number of un-issued shares for allotment as bonus
shares.  
2. Assurance about the compliance of SEBI Guidelines   The auditor should ensure that
SEBI Guidelines (Chapter XV of the SEBI [D & IP] guidelines, 2000) relating to issue of
bonus shares have been complied with.  
3. Checking of allotment book   The auditor should trace the allotment of shares as per
particulars contained in the allotment book or sheets into the register of members.

4. Confirmation about the fulfilment of legal requirements   The auditor should confirm

that all statutory requirements relevant to the issue of shares have been complied with.
The company has to file the particulars of the bonus shares allotted with the Registrar
together with a copy of the resolution on the basis of which allotment of bonus shares has
been made.  
5. Inspection of the minute book of shareholders   The auditor should inspect the minute
book of shareholders for the resolution authorising declaration of the bonus and
Director’s minute for the resolution appropriating profits for being applied in payment of
shares to be allotted to shareholders as bonus shares.  
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 6. Checking of accounting entries   The auditor should also check the accounting entries
passed for issue of bonus shares and confirm that they are in conformity with the legal
requirements and basic accounting principles.

4. Issue of sweat equity shares

As per explanation to Section 79A of the Companies (Amendment) Act, 1999, the term “Sweat
Equity Shares” means the equity shares issued by the company to its employees or Directors at a
discount or for consideration other than cash for providing know-how or making available rights
in the nature of intellectual property rights or value additions, by whatever name called.

The auditor should cover the following aspects while checking the issue of sweat equity share
transactions:

1. Authorised by a special resolution   The issue of sweat equity shares is authorised by a

special resolution passed by the company in the general meeting.  
2. Details about share issues are specified   The resolution specifies the number of shares,
current market price, consideration, if any, and the class or classes of Directors or
employees to whom such equity shares are to be issued.  
3. Minimum time gap for issue   Not less than one year has, at the date of the issue, elapsed
since the date on which the company was entitled to commence business.  
4. SEBI guidelines   The sweat equity shares of a company, whose equity shares are listed
on a recognised stock exchange, are issued in accordance with the regulations by the
SEBI.  
5. Issue out of already issued share type   The sweat equity shares issued by the company
should be of a class of shares already issued by the company.

Shares Issued at a Discount

According to Section 79 of the Companies Act, a company can issue shares at a discount subject
to the fulfilment of the following conditions:

 The issue should be authorised by an ordinary resolution of the company and sanctioned
by the central government.
 No such resolutions shall be sanctioned by the company law board in case the maximum
rate for discount exceeds 10% unless the Board is of the opinion that a higher rate of
discount is justified by the special circumstances of the case.
 The issue should be made within two months of the sanction by the company law board,
but not earlier than one year after the date of commencement of business.
 The shares should be of a class already issued by the company.

Auditor’s duty

1. The auditor should confirm that all the conditions of Section 79 have been duly complied
with.
2. He should also see that the amount of discount, not yet written off, is shown separately in
the balance sheet under the head “miscellaneous expenditure”.

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 3. The auditor should check that the appropriate entries have been passed in the books of
accounts.

Shares Issued at a Premium

According to Section 78 of the Companies Act, a company can issue shares at a premium subject
to the fulfilment of the following conditions:

1. Where a company issues shares at a premium, whether for cash or otherwise, a sum equal
to the aggregate amount or value of the premium on those shares shall be transferred to
an account, to be called the “Securities Premium Account”-Section 78 (1).
2. The securities premium account may be applied by the company in the following matters:
o In paying up un-issued shares of the company to be issued to members of the
company as fully paid bonus shares
o In writing off the preliminary expenses of the company
o In writing off the expenses of, or the commission paid or discount allowed on any
issue of shares or debentures of the company
o In providing for the premium payable on the redemption of any redeemable
preference shares or of any debentures of the company-Section 78 (2)

Auditor’s duty

1. The auditor should examine the prospectus, the Articles of Association and the minutes
book of the Directors to ascertain whether they permit the issue of shares at a premium
and, if so, the rate.
2. He should check the amount of premium received.
3. He should also check that the share premium received has been taken to the ‘Securities
Premium Account’ and shown on the liabilities side of the balance sheet under the head
“reserves and surplus”.
4. He should see that the ‘Securities Premium Account’ if utilised has been utilised for the
purposes as specified in Section 78.

Calls in Arrear

Calls in arrear refer to that portion of the share capital, which has been called up, but not yet paid
by the shareholders. When a shareholder fails to pay the amount due on allotment and/or calls,
the allotment account and/or calls account will show debit balance equal to the total unpaid
amount of each instalment. Generally such amount is transferred to a special account called
‘calls in arrear’ Account.

The balance of ‘calls in arrear account’ at the end is shown in the balance sheet as a deduction
from respective share capital account.

Interest on calls in arrear may be collected by the directors from the shareholders if the Articles
of Association so provide. If the company has adopted ‘Table A’, then it can charge interest @
5% p.a. from the due date to the actual date of collection of call money.

Auditor’s duty
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 1. The amount due from shareholders in respect of calls in arrears should be verified by
reference to the share register.
2. If any calls are due from directors, they should be shown separately in the balance sheet.
3. Often the articles provide that interest be charged on calls in arrears, the adjustment of
interest in such a case should be verified.
4. The auditors should also check that the appropriate entries have been passed in the books
of accounts and ensure that calls in arrear are properly shown in the balance sheet.

Calls in Advance

A company, if permitted by the articles, may accept from members, either the whole or part of
the amount remaining unpaid on any shares held by him as calls in advance. But the amount so
received cannot be treated as a part of the capital for the purpose of any voting rights until the
same becomes presently payable and duly appropriated (Section 92 of the Companies Act).

A company, if so authorised by the articles, may pay dividend in proportion to the amount paid
Fupon each share, where a larger amount is paid up on some shares than that on other (Section
93 of the Companies Act).

Interest may be paid on calls in advance if Articles of Association so provide. If the company has
adopted ‘Table A’, then it is required to pay interest @ 6% p.a. from the date of receipt to the
due date (Article 18 of Table A). Such interest is a charge against profit. However, such interest
can be paid out of capital, when profits are not available for such payment.

Auditor’s duty

1. The auditor should see that the provisions regarding payment of calls in advance exist in
the articles.
2. He should see that calls in advance have not been treated as part of the share capital and
are shown separately in the balance sheet.
3. He should ensure that the payment of interest on calls in advance does not exceed the
percentage stated in the articles.
4. He should vouch the receipt of such amount and the payment of interest thereon by
inspecting the relevant entries in the cash book or passbook.

Forfeiture of Shares

If a shareholder fails to pay the calls made on him, the Directors may have the power of
forfeiting the shares held by him. The Directors are empowered, subject to the fulfilment of
certain conditions, to remove his name from the register of members and to treat the amount
already paid by him forfeited to the company.

But it should be noted that shares could be forfeited only if the articles authorise the directors to
do so. Forfeiture shall be void, if it is contrary to the provisions of the articles. Forfeiture of
shares can ordinarily be made only for non-payment of calls, but the articles may provide for
forfeiture on grounds other than non-payment of calls.

Conditions to be fulfilled before forfeiting shares

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 1. Notice to the shareholder   Before forfeiting any shares, the defaulting member must be
served with a notice requiring him to pay the unpaid amount of call together with interest.
The notice must mention the day on or before which the payment is to be made and also
mention that in the event of non-payment, the shares will be liable to forfeiture.

2. Resolution of the board   If the requirements of the above notice are not complied with,
the shares may be forfeited by a resolution of the directors.

Auditor’s duty

1. The auditor should ascertain that the articles authorise the board of directors to forfeit the
shares and that the power has been exercised by the board in the best interest of the
company.
2. He should verify the amount of call which was outstanding in respect of each of the share
forfeited.
3. He should also ascertain that the procedure in the articles has been followed, viz. the
notice given (14 days, according to Table A) to the defaulting shareholders, warning
them that in the event of non-payment by a specified date, the shares shall be forfeited.
4. The auditor should verify the entries recorded in the books of account consequent upon
forfeiture of shares to confirm that the premium, if any, received on the issue of shares
has not been transferred to the forfeited shares account.

Re-issue of Forfeited Shares

A forfeited share is merely a share available to the company for sale and remains vested in the
company for that purpose only. Re-issue of forfeited shares is not allotment of shares but only a
sale. When shares are re-issued, return of the forfeited shares need not be filed under Section
75(1) of the Companies Act, 1956.

The share, after forfeiture in the hands of the company, is subject to an obligation to dispose it
off. In practice, forfeited shares are disposed off by auction. These shares can be re-issued at any
price so long as the total amount received for those shares is not less than the amount in arrear on
those shares.

Auditor’s duty

1. The auditor should ascertain that the Board of Directors has the authority under the
articles to re-issue forfeited shares.
2. He should refer to the resolution of the Board of Directors when re-allotting forfeited
shares.
3. He should vouch the amount collected from person to whom the shares have been
allotted and also check the entries recorded for this purpose.
4. The auditor should see that the total amount received on the shares, including that
received prior to forfeiture, is not less than the par value of shares.
5. He should also verify that the surplus resulting on the re-issue of shares is credited to the
capital reserve account.
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AUDIT OF PRE-INCORPORATION PROFIT

In many cases, a new company is formed to acquire exclusively an existing business unit and
take it over as a going concern, from a date prior to its own incorporation. In such cases, the
business unit is purchased first and the registration of the acquiring company takes place later.

The profit earned during the pre-incorporation period is called ‘pre-incorporation profit (loss)’.
Legally, this profit is not available for dividend, since a company cannot earn profit before it
comes into existence. Profit earned before incorporation of a company is a capital profit and its
accounting treatment is totally different from post-incorporation profit.

Accounting Treatment of Pre-incorporation Profit/Loss

Pre-incorporation profit

Any profit prior to incorporation may be dealt with as follows:

 Credited to capital reserve account

 Credited to goodwill account to reduce the amount of goodwill arising from acquisition
of business
 Utilised to write down the value of fixed assets acquired.

Pre-incorporation loss

Any loss prior to incorporation may be dealt with as follows:

 Debited to goodwill account

 Debited to capital reserve account arising from acquisition of business
 Debited to a suspense account, which can be written-off later.

Auditor’s duty

1. The auditor should examine the methods of calculating such profits and profits
subsequent to incorporation.
2. He should ensure that such profits are not distributed as dividend to shareholders as these
are in the nature of capital profits.

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