Query No. 45

Subject:           

Appointment of the statutory auditors as internal auditors immediately  after 

completion  of  their  tenure  as  statutory auditors.1

A. Facts of the Case

1. A company is a Government of India undertaking and is under the administrative  control  of  the  Department  of  Fertilisers,  Ministry  of Chemicals and Fertilisers, Government of India. As per the querist, the statutory auditors  of  the  company are  appointed  by  the  Company  Law Board under section 619(2) of the Companies Act, 1956.

2. According to  the  querist,  during the  course  of  statutory audit,  the statutory  auditors  become  well  versed  with  the  company’s  procedures, policies,  systems,  etc.  They  have  greater  insight  in  the  accounts  and affairs  of  the  company  for  carrying  out  a  more  effective  and  more purposeful audit.

3. The management of the company decided to utilise the services of the statutory auditors for internal audit in the subsequent year when the tenure of the statutory auditors was over. Initially, the company appointed a firm of chartered accountants as internal auditors for one year and then re-appointed them in the subsequent years.

4. The  statutory  auditors  of  the  subsequent  year  appointed  by  the Company Law Board under section 619(2) of the Companies Act, 1956, (after  completion  of  the  tenure of  earlier  auditors)  have  commented  in the supplementary report submitted to Comptroller and Auditor General of India under section 619(3) that the appointment of erstwhile statutory auditors  as  internal  auditors  of  the  company,  immediately  after  the completion of their tenure as statutory auditors, is not a healthy practice.

5. According to  the  querist,  the  appointment  of  statutory auditors  as internal auditors immediately after completion of their tenure as statutory auditors  does  not  violate  any  rules  and  regulations.  The  Institute  of Chartered  Accountants  of  India  also  does  not  debar  statutory  auditors from accepting internal audit work immediately after completion of their term as statutory auditors. In fact, during the term of statutory audit also, a statutory auditor can render other services like certification, management services, taxation matters, etc. As per the querist, the view that appointment of erstwhile statutory auditors as internal auditors immediately after the completion of their tenure as statutory auditors is not a healthy practice, does not hold good.

B. Query

6. The querist has sought the opinion of the Expert Advisory Committee as to whether the appointment of statutory auditors as internal auditors, immediately after completion of their tenure as statutory auditors, is not a  healthy practice  and  whether  such  an  appointment  violates  any rules and regulations of the Institute of Chartered Accountants of India.

C. Points considered by the Committee

7. The Committee notes from paragraph 1 above that the querist has stated that the auditors of the company are appointed by the Company Law  Board.  The  Committee,  however,  notes  that  after  the  Companies (Amendment)  Act,  2000,  under  section  619(2)  of  the  Companies  Act, 1956, the auditors are appointed or reappointed by the Comptroller and Auditor General of India. The Committee further notes that before such amendment, the auditors were appointed or re-appointed by the Central Government  on  the  advice  of  the  Comptroller  and  Auditor  General  of India.

8. The Committee notes that there are no specific rules and regulations debarring the appointment of the statutory auditors as internal auditors for the immediately succeeding period for which they are no longer the statutory auditors. The  Committee,  however, notes  in  this  context,  that the  Department  of  Company Affairs  has  issued  the  following  Circular No. 29/76[1/1/76-CV-V] dated 27.8.1976 as corrected by Circular No. 5/ 77[1/1/76-CL-V] dated 8.4. 1977 (DCA), which provides that a statutory auditor cannot be the internal auditor, evidently for the same reporting period.

“A statutory auditor cannot be the internal auditor

A question has been raised whether a statutory auditor of a company can also be its internal auditor, which has been carefully examined in this Department and its view is as follows:

The internal auditor is appointed by the management and hence is in the  position  of  an  employee,  whereas  the  statutory  auditor  is appointed  by  the  company  in  accordance  with  the  provisions  of section 224, and the auditor is required to perform the duties enjoined on him under section 227 and rules/orders issued thereunder. In this connection, reference may also be made to paragraphs 4 (A)(vi) and (xi) of the Manufacturing and other Companies (Auditor’s Report) Order, 1975 in accordance with which the statutory auditor has to include  in  his  report  under  section  227  whether  there  is  adequate internal  control  procedure  commensurate  with  the  size  of  the company and the nature of its business for the purchase of stores, raw materials including components, plant and machinery, equipment and other assets and in the case of companies having more than Rs. 25  lakh  paid  up  share  capital,  whether  there  is  any  internal  audit system  commensurate  with  the  size  and  nature  of  business.  It  is, therefore,  obvious  that  if  the  statutory  auditor  of  the  company  is also the internal auditor, it will not be possible for him to give an independent  and  objective  report  under  section  227,  read  with paragraphs 4(A) of the said Order. As such, in the opinion of this Department,  a  statutory  auditor  of  a  company  cannot  also  be  its internal auditor.”

9. The Committee further notes that the Guidance Note on Independence of  Auditors,  issued  by the  Institute  of  Chartered  Accountants  of  India, provides as follows:

“Independence of the auditor has not only to exist in fact, but also appear to so exist to all reasonable persons. The relationship between the auditor and his client should be such that firstly he is himself satisfied about his independence and secondly no unbiased person would be forced to the conclusion that, on an objective assessment of  the  circumstances,  there  is  likely  to  be  an  abridgement  of  the auditor’s independence.”

10. The Committee, from the above, is of the view that although there are no rules and regulations debarring the appointment of the statutory auditors  as  internal  auditors  for  the  immediately  subsequent  period  in which they are no longer the statutory auditors, yet the member should, before  accepting  the  appointment,  use  his  judgement  in  deciding  as  to whether his independence would be adversely affected by accepting the appointment of internal auditor for the period immediately after completion of his tenure as statutory auditor. If the member feels that his independence to carry out his professional duties would be adversely affected, he should desist from accepting the appointment.

D. Opinion

11. On the basis of the above, the Committee is of the opinion that there are no rules and regulations debarring the appointment of statutory auditors as  internal  auditors  immediately  after  completion  of  their  tenure  as statutory auditors. However, before accepting the appointment, the member should use his judgement in deciding as to whether his independence to carry out his professional duties would be adversely affected in accepting the  appointment  of  internal  auditor  for  the  period  immediately  after completion of his tenure as statutory auditor. It is not only essential that the member is independent but it should also appear so.

1Opinion finalised by the Committee on 18.12.2001.