The Union Government on Monday released draft notes for
clauses of the Companies Act that replaces a six decade old legislation. Life is
set to get tougher for auditors and audit firms, with the draft rules of the Companies
Act proposing to not just make auditors, but even audit firms, liable for
frauds. So far, chartered accountants were penalized but the new law also puts
firms under the spotlight.
In addition, the draft rules have proposed that in case of
conviction, auditors will not only have to refund the remuneration received by
them but also pay damages to authorities as well as individuals, who have been
affected by incorrect or misleading statements in audit reports. The tighter
rules for auditors, including rotation, are the result of the alleged lapses
seen during the Satyam scandal.
As a result, the Companies Act has mandated rotation of auditors.
The government in the draft rules has proposed that the existing audit
assignments, which were taken up before the law was enacted, should also be
counted, while calculating the maximum five-year term that has been prescribed.
The so-called incoming auditor will not be eligible if he has been associated
with the outgoing one by virtue of being part of the same network or is
operating under the same brand. The draft rules have also proposed that where
the company has two or more persons as joint auditors, it will have to follow
the rotation policy in such a way that all the joint auditors do not complete
the term in the same year.
The new rules have given some breather in terms of reporting
on fraud by auditors to the Union government. Auditors are required to report
material fraud within 30 days to the government. Materiality shall mean frauds
happening frequently or those where the amount involved or likely to be
involved is not less than five per cent of net profit or two per cent of
turnover of the company for the preceding financial year. It has also
introduced the concept of class-action lawsuits. For negligence in their
duties, auditors are liable to pay damages to the company or any other person
for losses arising from incorrect statements in the audit report.
Auditors also have to take indemnity insurance against
third-party liabilities, likely to be highly expensive. Auditors fear only the
larger firms will be able to afford higher insurance costs.
The Act also mandates that an audit firm and all its partners are jointly
liable for any fraudulent action of even a single partner. Earlier only the
partner in question had to face the consequences of negligence; with this new
rule, an entire firm of auditors might have to down shutters for the errors of
one partner.
The auditor is now also required to report on whether the
company has adequate internal financial controls system in place and the
operating effectiveness of such controls.
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