1.23     Query

Conduct of an audit of a firm/ company in which a near relative of

the partner of auditors’ firm is a partner/director of the firm/company

   1.A firm of chartered accountants is appointed auditors of M/s. XYZ-a registered partnership firm- to conduct audit u/s 44 AB of the Income-tax Act, 1961. The said firm is also appointed statutory auditors of ABC Ltd. One of the partners of M/s. XYZ and one of the directors of ABC Ltd., is the brother of a partner of the firm of chartered accountants.

2.The querist has sought the opinion of the Expert Advisory Committee on the manner of disclosure of relationship between the auditors and the clients, i.e. M/s. XYZ and ABC Ltd.

                                                                     Opinion                                                    July 23,1986

1.The Committee notes that the Council of the Institute has issued the following Notification, which appears at page 57 of the ‘The Chartered Accountants Act, 1949,’ published by the Institute:

“No. 1-CA (44) 71: In exercise of the powers conferred by clause (ii) of Part II of the Second Schedule to the Chartered Accountants Act, 1949, the Council of Institute of Chartered Accountants of India specifies that a member of the Institute shall be deemed to be guilty of professional misconduct, if he expresses his opinion on financial statement of any business or enterprise in which one or more persons who are his “relatives” within the meaning of Section 6 of Companies Act, 1956 have either by themselves or in conjunction with such member a substantial interest unless he discloses the interest also in his report. Explanation: For this purpose the expression “substantial interest” shall have the same meaning as is assigned thereto under Explanation 3 to Section 13 of the Income Tax Act, 1961”.

2. The Committee also notes that brother is specifically covered by the definition of the term ‘relative’ as per section 6 of the Companies Act, 1956.

3. The Committee further notes that Explanation 3 to Section 13 of the Income-tax Act, 1961, defines substantial interest as follows:

(i)         When the concern is a company, a person shall be deemed to have a substantial interest therein, if its shares, other than preference shares, carrying not less than 20 per cent of the voting power are, at any time during the previous year, owned beneficially by him alone or partly by him and partly by one or more of the other persons referred to in section 13 (3).

(ii)        When the concern is not a company, he shall be deemed to have a substantial interest therein, if he is entitled, or he and one or more of the other persons referred to in section 13 (3) are entitled in the aggregate, at any time during the previous year, to not less than 20 per cent, of the profits of such concern.”

4. The Committee also notes that the Council of the Institute of Chartered Accountants of India has recommended in a note on ‘Independence of Auditors’ 1that “………… if an auditor is a relative of a Director other than a managing or a whole-time Director, the partner of the firm who is so related may not, if he feels that this independence is likely to be affected, perform the audit but should leave it to another partner of the firm”.

5.On the basis of the above, the opinion of the Expert Advisory Committee, in the circumstances of the query is that the auditors should disclose in their report that the relative(s) of the partner of the chartered accountants’ firm has either by himself or in conjunction with the auditor substantial interest (as prescribed in Explanation 3 to Section 13 of the Income-tax Act, 1961) in M/s. XYZ/ABC Ltd.

An illustration of the manner of disclosure is given below:

 “We would like to disclose that a partner of our firm is a relative (as defined under section 6 of the Companies Act, 1956) of a partner of M/s. XYZ/Director of M/s. ABC Ltd., having substantial interest in that firm/company.”

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  1 Compendium of Guidance Notes (1985) p. 119.