Statutory, Internal, Secretarial, Cost, and Tax Audit in India: Key Points
We examine each type of audit under India’s company law and what classes of companies are required to conduct an audit and appoint auditors.
Audits determine a true and fair view of a company’s financial statements. The Companies Act, 2013 mandates that certain classes of companies, are required to appoint an auditor to conduct an audit of the functions and activities of the company.
India’s Company law prescribes four different kinds of audits for companies, namely statutory audit, internal audit, cost audit, and secretarial audit. Further, section 44AB of the Income Tax Act, 1961, lays down the provisions for income tax audit. The tax audit evaluates whether an individual or company has accurately filed income tax returns for an assessment year.
Here, we examine the concept of each type of audit and explore what classes of companies are required to conduct an audit and appoint auditors.
Audits in India under the Companies Act, 2013
The purpose of the statutory audit is to determine whether a company is providing an accurate representation of its financial situation by examining the information, such as books of account, bank balance, and financial statements.
All public and private limited companies have to undergo a statutory audit. Irrespective of the nature of the business or turnover, these companies are mandated to get their annual accounts audited each financial year.
Meanwhile, a limited liability partnership firm (LLP) must undergo a statutory audit only if its turnover in any financial year exceeds INR 4 million or its capital contribution exceeds INR 2.5 million.
Every company and its directors must first appoint an auditor within 30 days from the date of registration of the company in its first board meeting. At each Annual General Meeting (AGM), the shareholders of the company must appoint an auditor who holds the position from one AGM to the conclusion of the next AGM.
The Companies (Amendment) Act, 2017 maintains that the auditors can only be appointed for a maximum term of five consecutive AGMs. Their appointment need not be ratified in each of the AGMs. However, in individual and partnership firms, auditors cannot be appointed for more than one or two terms, respectively.
Who can conduct a statutory audit?
As per the law, only an independent chartered accountant firm, or chartered accountant, or limited liability partnership firm having majority of partners practicing in India are qualified for appointment as an auditor of a company.
The Companies Act, 2013 specifically disqualifies the following persons from becoming an auditor:
- A corporate body other than the LLP registered under the Limited Liability Partnership Act, 2008;
- An officer or employee of the company;
- A person who is a partner with an employee of the company or employee of a company employee;
- Any person who is indebted to a company for a sum exceeding INR 1,000 or who have guaranteed to the company on behalf of another person a sum exceeding INR 1,000;
- Any person who has held any securities in the company after one year from the date of commencement of the Companies (Amendment) Act, 2000; or
- Any person who has been convicted by a court of an offence involving fraud and a period of 10 years has not elapsed from the date of such conviction.
The Ministry of Corporate Affairs (MCA) recently announced a new format of statutory audits of companies. The MCA notified the Companies (Auditor’s Report) Order, 2020 on February 25, 2020 (CARO 2020). CARO 2020 replaces the earlier order under the Companies (Auditor’s Report) Order, 2016. CARO 2020 requires an auditor to report on various aspects of the company, such as fixed assets, inventories, internal audit standards, internal controls, statutory dues, among others. It is applicable for all statutory audits commencing on or after April 1, 2020 (corresponding to the financial year 2019-20). The order is applicable to all companies covered by CARO 2016; similarly, companies that were excluded from the purview of CARO 2016, such as one person companies, banking and insurance companies, small companies, etc. will stay excluded from the purview of CARO 2020.
Section 138 of the Companies Act, 2013, mandates internal compliance test for certain categories of companies falling within the prescribed threshold – to check the health of a company’s finances and analyze operational efficiency. It is an independent function of management – which entails the continuous and critical appraisal of the functioning of an entity, with a special focus on possible areas for improvement – to strengthen and add value to the entity’s governance mechanisms.
According to the Institute of Chartered Accountant of India, the role of internal audit is to provide independent assurance that an organization’s risk management, governance, and internal control processes are operating effectively. Further, unlike external audits, internal auditors look beyond financial risks and statements to consider wider issues, such as the organization’s reputation, growth, its impact on the environment, and the way it treats its employees.
The internal audit is an independent function of management, which entails the continuous and critical appraisal of the functioning of an entity, with a special focus on possible areas for improvement and how to strengthen and add value to an entity’s corporate governance mechanisms.
Applicability of internal audits
An internal audit must be conducted by either a chartered accountant or a cost accountant. Not all companies are mandated to conduct an internal audit. As per the Companies Act, 2013 and Rule 13 of the Companies (Accounts) Rules, 2014, the following classes of companies have to carry out an internal audit:
- Every listed company;
- Every unlisted public company with paid-up capital exceeding INR 500 million in the previous financial year;
- Every unlisted public company that has a turnover greater than INR 2 billion in the previous financial year;
- Every unlisted public company with outstanding loans and liabilities exceeding INR 1 billion at any point during the previous financial year;
- Every unlisted public company with outstanding deposits exceeding INR 250 million in the previous financial year;
- Every private company that has a turnover of more than INR 2 billion in the previous financial year; and
- Every private company that has had outstanding loans and liabilities exceeding INR 1 billion at any point.
Certain types of businesses in India are mandated to prepare their secretarial audit and secretarial compliance report or will risk being non-compliant under key company legislation and rules of corporate governance.
Who needs a secretarial audit?
Every listed company, public companies with either a paid-up share capital of INR 500 million and upwards, or public companies with a turnover of INR 2.5 billion are required to submit secretarial reports.
However, as per India’s Ministry of Corporate Affairs guidelines, a company with outstanding loans or borrowings from banks or public financial institutions of over INR 1 billion or more will have to undergo a mandatory financial and secretarial audit. It is hereby clarified that the paid-up share capital, turnover, or outstanding loans or borrowings – as existing on the last date of latest audited financial statement – will be taken into account.
A practicing company secretary (PCS) conducts the secretarial audit and prepares the audit report. Companies that are not covered under the provision of section 204 of the Companies Act, 2013 may obtain a secretarial audit report voluntarily, as it provides independent assurance of the company’s compliance.
A cost audit is the verification of the cost account, and functions as a check on the company’s adherence to cost accounting standards. Cost accounting is used to understand the company’s total cost of production by assessing its variable and fixed costs. Through a cost audit, the company can take a closer look at their cost of production and find effective ways to reduce their cost on labor, materials, and overheads.
Who should maintain cost records?
Maintenance of cost records apply to a company in the following cases:
- If the company is engaged in the production of goods, or providing services, as prescribed under the law; or
- If the company’s overall turnover from all its products and/or services is INR 350 million or more during the immediately preceding financial year.
Who is mandated to get their cost records audited?
Companies in India should get cost records audited in the following cases:
- The overall annual turnover of the company from all its products and services during the immediately preceding financial year is INR 500 million or INR 1 billion or more, depending on whether the company’s sector is regulated or unregulated; and
- The aggregate turnover of the products and services for which cost records are required to be maintained is INR 250 million or INR 350 million, depending on whether the company’s sector is regulated or unregulated.
Under the Companies Act, company industrial activity has been classified under two categories – regulated and unregulated sectors.
Regulated sectors include industries like petroleum products, drugs and pharmaceuticals, fertilizers, and sugar to name a few. Unregulated sectors cover industries such as arms and ammunitions, cement, tea and coffee, milk products, and turbo jets and propellers, among others.
Companies exempted from cost audit
The cost audit requirement does not apply to the companies that meet the following criteria:
- Companies covered in Rule 3 of the Companies (Cost Records and Audit) Rules, 2014;
- Companies that earn revenue from exports in foreign exchange that exceeds 75 percent of its total revenue; or
- Companies that operate in a special economic zone (SEZ).
A tax audit ensures that the taxpayer has maintained the books of accounts and other records properly, reflecting the taxable income of the assessee accurately. It also verifies whether the assessee has complied with various requirements of income tax law, such as filing income tax returns, income tax deductions, and accurate specification of claims. The provisions pertaining to the tax audit are governed under section 44AB of the Income Tax Act, 1961.
Who needs a tax audit?
A tax audit is applicable on all companies, LLPs, as well as professionals whose turnover crosses a particular threshold limit.
Here is the mandatory tax audit limit for different categories of taxpayers:
- Any individual carrying on a business whose sales, turnover, or gross receipts of the business exceeds INR 10 million; or
- Any individual carrying on a professional whose gross receipts exceeds INR 5 million; or
- Any person carrying on a business where the profits and gains from the business are determined on a presumptive basis under section 44AE, 44BB, or 44BBB, and who has claimed their income to be lower than the profits or gains of their business; and
- Any person carrying on a business whose income is determined on a presumptive basis under section 44AD and who has claimed such income to be lower than the profit of their business yet exceeds the maximum amount which is not chargeable as income tax.
Tax audit limit increased for certain SMEs
The Finance Act 2020 has reduced the compliance burden on small and medium enterprises (SME) by increasing the threshold limit for auditing a person conducting business from INR 10 million to INR 50 million in cases where:
(i) the aggregate of all receipts in cash during the previous year does not exceed five percent of such receipt; and
(ii) aggregate of all payments in cash during the previous year does not exceed five percent of such payment.
To promote digital transactions and further reduce the compliance burden of SMEs, the Union Budget 2021 proposed to increase this threshold from INR 50 million to INR 100 million in the abovementioned cases. This amendment took effect from April 1, 2021 and is applicable for the assessment year (AY) 2021-22 and subsequent assessment years.
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