Audit and Auditors (Sections 138–148) →

Chapter X of the Companies Act, 2013, Sections 138 to 148, is the statutory architecture of the company audit. It tells you who audits the company internally (Section 138), who audits its financial statements and how that auditor is chosen, rotated, removed and paid (Sections 139 to 142), what the auditor may and must do — including the now-famous duty to blow the whistle on fraud (Section 143), what the auditor is forbidden to do (Section 144), the mechanics of signing and attending (Sections 145 and 146), the price of getting it wrong (Section 147), and the special regime of cost audit (Section 148). The chapter is a favourite of judiciary and CLAT-PG papers because it is dense with numbers — thirty days, ninety days, five years, one crore rupees — and because it sits on a bed of classic case law about the auditor's standard of care. This note walks the provisions in sequence and anchors each to the leading authority. For the foundational concepts of corporate personality that underpin the audit, see our chapter on the introduction to company law.

The statutory scheme of Chapter X

The audit of a company is the independent verification of its books and financial statements by a qualified professional who reports to the members, not to the management. The rationale is structural: management prepares the accounts, and the members — who own the company but do not run it — need an independent check that those accounts present a true and fair view. The Supreme Court captured this beneficiary-protection rationale in Institute of Chartered Accountants of India v. P.K. Mukherji, AIR 1968 SC 1104, observing that an audit is intended for the protection of the shareholders and that the auditor, in examining the accounts maintained by the directors, acts in the interest of the shareholders, who stand in the position of beneficiaries. That insight runs through the whole of Chapter X.

The chapter must be read alongside the financial-statement provisions of Chapter IX (Sections 128 to 137) and the Companies (Audit and Auditors) Rules, 2014, which supply the procedural detail and thresholds left to delegated legislation. The two great themes of the 2013 reform — auditor independence and auditor accountability — animate every section. Independence is secured by rotation, disqualifications and the bar on prohibited services; accountability is secured by mandatory auditing standards, fraud reporting and a stiff penal regime. To understand who within a company is being audited and who appoints the auditor, it helps to have the cast of corporate actors clear; see our note on the definitions of company, director and member.

Section 138 — internal audit

Section 138 is the gateway to the chapter and deals with a different animal from the statutory audit: the internal audit. It provides that such class or classes of companies as may be prescribed shall be required to appoint an internal auditor — who may be a chartered accountant, a cost accountant, or such other professional as may be decided by the Board — to conduct an internal audit of the functions and activities of the company. The internal auditor need not be a chartered accountant and may even be an employee of the company; the function is managerial assurance, not the independent attestation that the statutory auditor provides.

Rule 13 of the Companies (Accounts) Rules, 2014, prescribes the classes of companies required to appoint an internal auditor — broadly, every listed company, and unlisted public and private companies crossing prescribed thresholds of paid-up capital, turnover, outstanding loans or deposits. The internal auditor's reports feed into the company's risk-management and control systems, but they are not a substitute for the statutory audit under Sections 139 to 143. Importantly, an internal auditor under Section 138 is not among the persons obliged to report fraud to the Central Government under Section 143(12) — that duty falls on the statutory auditor, the cost auditor and the secretarial auditor.

Section 139 — appointment of auditors

Section 139 is the longest and most heavily tested provision of the chapter. Its scheme is best learned as a set of timelines. Under Section 139(6), the first auditor of a company other than a Government company is appointed by the Board of Directors within thirty days of the date of registration. If the Board fails to do so, it must inform the members, who shall appoint the first auditor within ninety days at an extraordinary general meeting; the first auditor holds office until the conclusion of the first annual general meeting.

For a Government company — or a company owned or controlled, directly or indirectly, by the Central or a State Government — Section 139(7) routes the first appointment through the Comptroller and Auditor-General of India, who appoints within sixty days of registration. If the C&AG does not, the Board appoints within the next thirty days, and failing that, the members within sixty days at an extraordinary general meeting.

The subsequent auditor is governed by Section 139(1): every company shall, at the first annual general meeting, appoint an individual or a firm as auditor who shall hold office from the conclusion of that meeting till the conclusion of its sixth annual general meeting — that is, for five years — subject to ratification by members at every annual general meeting having been a requirement that was later omitted by the Companies (Amendment) Act, 2017. The company must obtain the auditor's written consent and a certificate that the appointment, if made, will be in accordance with the conditions prescribed, and the appointment must be intimated to the Registrar in Form ADT-1 within fifteen days.

A casual vacancy in the office of auditor is filled under Section 139(8): if caused by resignation, the appointment must be approved by the company at a general meeting convened within three months of the Board's recommendation; in a Government company, the C&AG fills the vacancy within thirty days, failing which the Board does so within the next thirty days.

Rotation of auditors under Section 139(2)

Section 139(2) introduced into Indian law the principle of mandatory rotation of auditors — a direct response to the perception that long auditor tenures erode independence. It applies to listed companies and to such class or classes of companies as may be prescribed; Rule 5 of the Companies (Audit and Auditors) Rules, 2014, extends it to unlisted public companies and private companies above prescribed paid-up-capital and borrowing thresholds.

For companies within its net, Section 139(2) lays down two ceilings. No such company may appoint or re-appoint an individual as auditor for more than one term of five consecutive years, or an audit firm for more than two terms of five consecutive years. On completing the maximum term, the individual or firm is subject to a five-year cooling-off period, during which it is not eligible for re-appointment as auditor in the same company. The proviso also disqualifies, during the cooling-off period, any other firm having common partners with the outgoing firm. The members may, if they wish, resolve that the audit partner and his team be rotated at specified intervals, or that the audit be conducted by more than one auditor — a power that goes beyond the mandatory floor.

Section 140 — removal, resignation and the Tribunal

Section 140 protects auditor independence at the exit as much as Section 139 protects it at the entrance, by making it hard to sack an inconvenient auditor. Under Section 140(1), an auditor appointed under Section 139 may be removed from office before the expiry of his term only by a special resolution of the company, after obtaining the previous approval of the Central Government in the prescribed manner (an application in Form ADT-2 within thirty days of the Board resolution), and after giving the auditor a reasonable opportunity of being heard. The double safeguard — special resolution plus Government approval — is deliberate; it prevents a controlling shareholder from quietly removing an auditor who is asking awkward questions.

A resigning auditor is governed by Section 140(2) and (3): he must file a statement in Form ADT-3 with the company and the Registrar — and additionally with the C&AG in the case of a Government company — within thirty days of resignation, indicating the reasons and other relevant facts. Failure attracts a penalty under Section 140(3).

Section 140(4) preserves the auditor's right to make representations where a retiring auditor is not being re-appointed: a special notice is required for a resolution appointing someone other than the retiring auditor, and the retiring auditor is entitled to have his representation circulated to members. Most significantly, Section 140(5) confers on the National Company Law Tribunal the power, either suo motu or on an application by the Central Government or any person concerned, to direct the company to change its auditor where it is satisfied that the auditor has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud. An auditor against whom such a final order is passed is not eligible to be appointed as auditor of any company for five years and is liable to action under Section 447. The architecture of the Tribunal that exercises this power is explained in the broader corporate-litigation framework; the audit removal power sits within it.

Section 141 — eligibility and disqualifications

Section 141 fixes who may, and who may not, be an auditor. Under Section 141(1), only a chartered accountant within the meaning of the Chartered Accountants Act, 1949, is eligible for appointment; where a firm — including a limited liability partnership — is appointed, only the partners who are chartered accountants are authorised to act and sign on behalf of the firm, and a majority of the partners practising in India must be qualified chartered accountants.

Section 141(3) then lists the disqualifications, which the examiner loves to test as a "which of the following cannot be appointed" question. A person is disqualified if he is: a body corporate other than an LLP; an officer or employee of the company; a partner or employee of such an officer or employee; a person who, or whose relative or partner, holds securities in or beyond prescribed limits in the company, its subsidiary, holding or associate, or is indebted to the company beyond a prescribed amount, or has given a guarantee in connection with the indebtedness of a third party to the company beyond a prescribed amount; a person whose relative is a director or is in the employment of the company as a director or key managerial personnel; a person in full-time employment elsewhere or holding appointment as auditor of more than twenty companies at the date of appointment; a person convicted of an offence involving fraud within the preceding ten years; and a person who, directly or indirectly, renders any of the services proscribed by Section 144.

Section 141(4) closes the loop: where a person appointed as auditor incurs any of these disqualifications after his appointment, he is deemed to have vacated his office, and the resulting vacancy is a casual vacancy to be filled under Section 139(8). The independence logic that drives these bars is the same logic the Supreme Court articulated in P.K. Mukherji — the auditor must be, and be seen to be, free of any interest that competes with his duty to the members.

Section 142 — remuneration of auditors

Section 142 deals with the auditor's pay, and its short text carries an independence point. The remuneration of the auditor is to be fixed in the general meeting or in such manner as may be determined therein, except that the Board may fix the remuneration of the first auditor. The provision ties the auditor's remuneration to the members rather than to the management he is auditing — a safeguard against the conflict that would arise if the directors alone controlled the auditor's fee.

Section 142(2) clarifies that remuneration includes the fee payable to the auditor and the expenses, if any, incurred by him in connection with the audit and any facility extended to him, but excludes any remuneration paid to him for any other service rendered at the company's request. The carve-out matters because Section 144 sharply restricts the "other services" an auditor may render, so the scope for non-audit fees is narrow.

Section 143 — powers and duties of auditors

Section 143 is the heart of the chapter. Section 143(1) gives the auditor a right of access at all times to the books of account and vouchers of the company, whether kept at the registered office or elsewhere, and entitles him to require from the officers of the company such information and explanation as he may consider necessary for the performance of his duties. It also lists specific matters into which he must inquire — for instance, whether loans and advances made by the company have been properly secured, and whether transactions represented merely by book entries are prejudicial to the interests of the company.

Section 143(2) requires the auditor to make a report to the members on the accounts examined by him and on every financial statement laid before the company in general meeting, stating whether, in his opinion and to the best of his information, the accounts give a true and fair view of the state of the company's affairs. Section 143(3) enumerates the specific matters the report must address — among them whether he has obtained all necessary information, whether proper books of account have been kept, whether the financial statements comply with the accounting standards, and, after the Companies (Amendment) Act, 2015, whether the company has adequate internal financial controls with reference to financial statements and their operating effectiveness. Section 143(9) and (10) make compliance with the auditing standards mandatory, the standards being those notified by the Central Government in consultation with the National Financial Reporting Authority. The duty to report truthfully has long been understood as a duty owed to the members; the auditor who certifies what he knows to be false abdicates the very function the Supreme Court described in P.K. Mukherji.

Fraud reporting under Section 143(12)

The single most important innovation of the 2013 Act in this field is the auditor's duty to report fraud. Section 143(12) provides that if an auditor, in the course of the performance of his duties, has reason to believe that an offence of fraud involving an amount of one crore rupees or more is being or has been committed against the company by its officers or employees, he shall report the matter to the Central Government within the prescribed time and manner. The threshold of one crore rupees, and the procedure, are supplied by Rule 13 of the Companies (Audit and Auditors) Rules, 2014.

The mechanics are precise and examinable. The auditor first reports the matter to the Board or audit committee within two days of his knowledge of the fraud, seeking their reply within forty-five days. On receiving the reply, he forwards his report, the reply, and his comments to the Central Government in Form ADT-4 within fifteen days; if no reply is received within forty-five days, he forwards the report noting that fact. Where the fraud involves an amount less than one crore rupees, the auditor reports to the audit committee or the Board, and the fraud must be disclosed in the Board's report. Crucially, Section 143(12) covers only fraud by officers or employees against the company; it does not extend to fraud by third parties such as vendors or customers. Section 143(13) protects an auditor who reports in good faith from any liability for such reporting, and Section 143(15) penalises a failure to report.

The standard of care — watchdog, not bloodhound

How hard must the auditor look? The classic answer comes from English law and has been absorbed into Indian practice. In Re Kingston Cotton Mill Co. (No. 2), (1896) 2 Ch 279, Lopes LJ delivered the enduring formulation: an auditor is a watchdog, but not a bloodhound. He is justified in believing the tried servants of the company in whom confidence is placed by the company, and is entitled to assume that they are honest and to rely upon their representations, provided he takes reasonable care. He is not bound to approach his work with suspicion or with a foregone conclusion that something is wrong; he is bound to bring to bear the skill, care and caution that a reasonably competent, careful and cautious auditor would use.

Indian courts have applied this calibrated standard. In Tri-Sure India Ltd. v. A.F. Ferguson & Co., (1987) 61 Com Cases 548 (Bom), the Bombay High Court declined to fix the auditors with liability for a fraud that had been cleverly concealed by the company's own management, holding that auditors who followed accepted auditing practice and were entitled to rely on the company's internal controls could not be made insurers against every undetected fraud. The earlier English authority in Re London and General Bank (No. 2), (1895) 2 Ch 673, had already established the positive duty: an auditor must not merely verify the arithmetic but must satisfy himself that the balance sheet shows the true financial position, and must convey the truth to the shareholders, not merely a technically accurate but misleading statement. The 2013 Act has, however, raised the floor beneath this case law: mandatory auditing standards under Section 143(9) and compulsory fraud reporting under Section 143(12) mean that the modern auditor's leash is shorter than Lopes LJ's metaphor once allowed.

Section 144 — prohibited services

Section 144 is the independence provision in its purest form. It prohibits the auditor of a company from rendering, whether directly or indirectly, certain non-audit services to the company, its holding company or its subsidiary. The proscribed list includes accounting and book-keeping services, internal audit, design and implementation of any financial information system, actuarial services, investment advisory services, investment banking services, rendering of outsourced financial services, and management services. The rationale is to prevent the auditor from auditing his own work or from becoming so financially dependent on lucrative consulting fees that his audit judgment is compromised.

"Directly or indirectly" is defined expansively to catch services rendered through a relative, a related entity, or any other person connected with the audit firm. An auditor or audit firm that was rendering any of these services on the commencement of the Act was given a transition period to comply. A breach of Section 144 is both a disqualification under Section 141(3)(i) and an offence attracting the penalties in Section 147.

Sections 145 and 146 — signing and attendance

Section 145 requires that the person appointed as auditor of the company sign the auditor's report or sign or certify any other document of the company in accordance with Section 141(2), and provides that the qualifications, observations or comments on financial transactions or matters which have any adverse effect on the functioning of the company, mentioned in the auditor's report, shall be read before the company in general meeting and shall be open to inspection by any member. The provision ensures that an auditor's reservations are not buried; they must be aired to the members who are the auditor's principals.

Section 146 secures the auditor's voice at the annual general meeting. All notices of, and other communications relating to, any general meeting must be forwarded to the auditor, and the auditor must, unless otherwise exempted by the company, attend either himself or through his authorised representative who is qualified to be an auditor. The auditor is entitled to be heard at the meeting on any part of the business that concerns him as auditor. The members' right to question the auditor at the meeting is the live counterpart of the beneficiary-protection rationale; it is the moment at which the audit is answerable to those it serves.

Section 147 — punishment for contravention

Section 147 supplies the penal teeth. If a company contravenes any of Sections 139 to 146, the company is punishable with a fine, and every officer in default is punishable with fine or imprisonment or both. If an auditor contravenes Sections 139, 143, 144 or 145, he is punishable with a fine which shall not be less than fifty thousand rupees or the remuneration of the auditor, whichever is less, extending up to a higher prescribed ceiling. The gravity escalates sharply where the contravention is wilful: if the auditor has contravened the provisions knowingly or wilfully with the intention to deceive the company, its shareholders, creditors or tax authorities, he is punishable with imprisonment for a term which may extend to one year and with a fine of not less than one lakh rupees, extending up to twenty-five lakh rupees.

Section 147(3) requires the convicted auditor to refund the remuneration received and to pay for damages to the company, its statutory bodies or any person for loss arising out of incorrect or misleading statements in the audit report. Section 147(5) extends joint and several liability to all partners of a firm where the firm's partners acted in a fraudulent manner or abetted or colluded in any fraud. The penal scheme thus carries the accountability theme of the chapter to its conclusion: the auditor who fails the members faces fine, imprisonment, disgorgement and damages.

Section 148 — cost audit

Section 148 is the specialised tail of the chapter and is frequently overlooked by candidates. It empowers the Central Government to direct, by order, that particulars relating to the utilisation of material or labour or other items of cost be included in the books of account kept by such class of companies engaged in the production of prescribed goods or the provision of prescribed services, and to direct that the cost records of such companies be audited by a cost accountant in practice. The cost auditor is appointed by the Board on the recommendation of the audit committee, and his remuneration is subject to ratification by the members.

Crucially, the cost audit under Section 148 is separate from and additional to the financial audit under Section 143; a cost accountant conducting the cost audit cannot be the company's financial auditor. The cost auditor must comply with the cost auditing standards, and his report goes to the Board, which forwards it to the Central Government. The qualifications, disqualifications, rights, duties and obligations applicable to financial auditors under Sections 139 to 147 apply, so far as may be, to the cost auditor as well — and the fraud-reporting obligation under Section 143(12) is expressly extended to him.

Exam focus and recurring distinctions

Five propositions recur in objective papers with high frequency. First, the appointment timelines: first auditor by the Board within thirty days, by members within ninety days; in a Government company, by the C&AG within sixty days. Second, the rotation ceilings: one term of five years for an individual, two terms of five years for a firm, with a five-year cooling-off — and the trap that rotation under Section 139(2) applies only to listed and prescribed companies, not to every company. Third, the removal safeguard: special resolution plus previous Central Government approval, the conjunctive requirement being the favourite distractor. Fourth, the fraud-reporting threshold and route: one crore rupees to the Central Government in Form ADT-4 (with the two-day, forty-five-day, fifteen-day sequence), below one crore to the audit committee or Board. Fifth, the standard of care: watchdog, not bloodhound, from Kingston Cotton Mill, as tempered in India by Tri-Sure India and stiffened by the statutory auditing standards.

Two further distinctions are worth carrying forward. The internal auditor under Section 138 need not be a chartered accountant and is not bound by Section 143(12); the statutory auditor under Section 139 must be a chartered accountant and is. And the cost auditor under Section 148 is a cost accountant whose audit is additional to, and never a substitute for, the financial audit. For the constitutional and corporate-governance setting in which these duties operate, the foundational chapters on the incorporation of a company and the Companies Act hub give the necessary background. The audit provisions are, in the end, the mechanism by which the law keeps the separation of ownership and management honest.