Understanding Annual Audit in India: An Overview

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The following is an excerpt from the April 2014  edition of India Briefing Magazine, titled “An Introduction to India’s Audit Process.”

Audit season in India can be a hectic and confusing time for foreign invested enterprises (FIEs) operating in the country. While most foreign executives in India leave auditing to chartered accountants and professional services firms, it is important to maintain at least a basic understanding of the audit process, how to prepare an FIE for audit,  and key considerations that should be taken into account.

There are two primary objectives associated with annual audit in India. The first objective is for auditors to report to shareholders and the government whether or not the company’s balance sheet provides a true and fair reflection of its state of affairs and any profit or loss derived during the financial year. The second, an incidental objective, concerns the detection and prevention of fraud and error. Hiring an experienced firm to complete annual audit in a timely and accurate manner is critical to achieving both of these objectives.

The Basics

Audits of company accounts have been compulsory in India since the passing of the first Companies Act in 1913. Since then, the Institute of Chartered Accountants of India (ICAI), a statutory body established under the Chartered Accountants Act, 1949, has regulated the profession of chartered accountants in India and ensured the maintenance of India’s accounting standards. All chartered accountants are members of the ICAI, and must comply with the standards stipulated by the ICAI and the Audit and Assurance Standards Board (AASB).

Essentially, an audit is the inspection of an individual, business or organization’s accounts, and is traditionally completed by an independent individual or firm with specialized skills and knowledge of auditing procedures in the country in question. In other words, accountants verify that a company’s business transactions were recorded accurately, and provide a true and fair reflection of that company’s financial situation.

The importance of the audit process cannot be understated, as the results can be used for the following purposes:

  • Helping investors know the financial health of the company
  • Assuring the government that the company is properly discharging its legal duties
  • Helping lenders evaluate the credibility of the company
  • Drawing management’s attention to any shortcomings in the company’s business operations
  • Helping management improve business efficiency

Auditing Objectives

As mentioned earlier, there are two key objectives associated with annual audit in India: expressing to shareholders and the Indian government a true and fair view of the company’s financial statements, and detecting and preventing instances of fraud and error.

Ensuring a company’s balance sheet provides a true and fair reflection of its current state of affairs requires an auditor who, after completing the audit process, will express their opinion of the company’s financial statements via an auditor’s report. These financial statements should include:

  • Balance Sheet
  • Profit & Loss Account
  • Cash Flow Statement
  • Notes to Accounts

A “true and fair view” can only be satisfied if the financial statements are accurate and not misleading. A company can expect the auditor to feel they have provided a true and fair assessment if the following criteria are satisfied:

  • The accounts are prepared with reference to the entries in the account books
  • Entries are supported by proper vouchers, documents, or other evidence
  • No entry in the account book is omitted while preparing the financial statements, and nothing is included in the financial statements that were not in the account books
  • The financial statements are prepared in accordance with the relevant accounting standards

An incidental objective associated with annual audit in India is the detection of errors or fraud in a company’s financial statements. If an irregularity is detected, the auditor has a duty to report the details to management, who is then expected to remedy such an error.

Types of Audits

Basic audits in India are generally classified into two main types:

  • Statutory Audits
  • Internal Audits

Statutory audits are conducted to report the current state of a company’s finances and accounts to the Indian government and shareholders. Such audits are performed by qualified auditors working as external and independent parties. The audit report of a statutory audit is made in the form prescribed by the government agency.

Internal audits are conducted at the behest of internal management in order to check the health of a company’s finances, and analyze the organization’s operational efficiency. Internal audits may be performed by an independent party or by the company’s own internal staff.

In India, every company whose shares are registered on the stock exchange must have an internal auditing system in place. A company whose shares are not listed on the stock exchange, but whose average turnover during the previous three years exceeds INR50 million, or whose share capital and reserves at the beginning of the financial year exceeds INR5 million, must also have an internal auditing system in place. The statutory auditor of the company must additionally report on the company’s internal auditing system of the company in the final report.

Statutory Audits

In India, statutory audits are conducted for each fiscal year (April 1 to March 31) and not the calendar year. The two most common types of statutory audits in India are:

  • Tax Audits
  • Company Audits

Tax Audits

Tax audits are required under Section 44AB of India’s Income Tax Act 1961. This section mandates that those whose business turnover exceeds INR10 million, and those working in a profession with gross receipts exceeding INR2.5 million, must have their accounts audited by an independent chartered accountant. The audit report is made using Form 3CD along with either Form 3CA (for companies) or Form 3CB (for entities not included under Form 3CA). It should be noted that the provision of tax audits are applicable to everyone, be it an individual, a partnership firm, a company, or any other entity. The tax audit report is to be completed by September 30 after the end of the previous fiscal year. Non-compliance with the tax audit provisions may attract a penalty of 0.5 percent of turnover or INR100, 000, whichever is lower. There are no specific rules regarding the appointment or removal of a tax auditor.

Company Audits

The provisions for company audits are contained in the Companies Act 1956 and Companies Act 2013 as applicable. Every company, irrespective of its nature of business or turnover, must have its annual accounts audited each financial year. For this purpose, the company and its directors must first appoint an auditor at the outset. Thereafter, at each annual general meeting (AGM), an auditor is appointed by the shareholders of the company who will hold the position from one AGM to the conclusion of the next AGM. After the completion of the term, the auditor must be changed.

Only an independent chartered accountant or a partnership firm of chartered accountants can be appointed as the auditor of a company. The following persons are specifically disqualified from becoming an auditor per the Companies Act:

  • A body corporate
  • An officer or employee of the company
  • A person who is partnered with an employee of the company, or employee of an employee of the company
  • Any person who is indebted to a company for a sum exceeding INR1,000 or who has guaranteed to the company on behalf of another person a sum exceeding INR1,000
  • A person who has held any securities in the company after one year from the date of commencement of the Companies (Amendment) Act, 2000

The auditor is required to prepare the audit report in accordance with the Company Auditor’s Report Order (CARO) 2003. CARO requires an auditor to report on various aspects of the company, such as fixed assets, inventories, internal audit systems, internal controls, and statutory duties, among others. The audit report must be obtained before holding the AGM, which itself should be held within six months from the end of the financial year.

Audit Reporting

As discussed earlier, audits are conducted to ensure a company’s financial statements present a true and fair view of its financial affairs. Therefore, the auditor’s opinion expressed in the ultimate report is based on the information gathered during the audit and the verification of financial statements. Upon completing the report, the auditor may express one of the following four opinions:

  • Unqualified Opinion
  • Qualified Opinion
  • Disclaimer of Opinion
  • Adverse Opinion

Unqualified Opinion

An unqualified opinion is expressed when the auditor concludes that the financial statements give a true and fair view in accordance with the financial reporting framework used for the preparation and presentation of the financial statements. It confirms that:

  • Generally accepted accounting principles are consistently applied in the preparation of financial statements
  • Financial statements comply with the relevant statutory requirements and regulations
  • There is adequate disclosure of all material matters relevant to the proper presentation of financial information (subject to statutory requirements)

Qualified Opinion

A qualified opinion is expressed when the auditor concludes that an unqualified opinion cannot be expressed, but that the effect of any disagreement with management is not so material and pervasive as to require an adverse opinion, or the limitation of scope is not so material and pervasive as to require a disclaimer of opinion. A qualified opinion should be expressed as being “subject to’” or “except for” the effects of the matter to which the qualification relates.

Disclaimer of Opinion

A disclaimer of opinion is expressed when the possible effect of a limitation on scope is so material and pervasive that the auditor has not been able to obtain sufficient and appropriate audit evidence and is, therefore, unable to express an opinion on the financial statements.

Adverse Opinion

An adverse opinion is expressed when the effect of a disagreement is so material and pervasive to the financial statements that the auditor concludes that a qualification of the report is not adequate to indicate the misleading or incomplete nature of the financial statements.

This article is an excerpt from the April 2014  edition of India Briefing Magazine, titled “An Introduction to India’s Audit Process.” In this edition of India Briefing Magazine, we provide readers with an overview of India’s annual audit process and offer important tips for the smooth navigation of the country’s audit regulations and accounting standards. We additionally outline key differences between the widely accepted IFRS and IAS protocols, and a number of key considerations FIEs should keep in mind to mitigate the risk of fraud of error in an organization.

Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.

For further details about investment restrictions or to contact the firm, please email india@dezshira.com, visit www.dezshira.com, or download the company brochure.

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