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Home » » Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(vii)

Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(vii)

Written By Admin on Sunday, 1 April 2012 | Sunday, April 01, 2012

Clause 4(vii)

in the case of listed companies and/or other companies having a paid-up capital and reserves exceeding Rs. 50 lakhs as at the commencement of the financial year concerned, or having an average annual turnover exceeding five crores rupees for a period of three consecutive financial years immediately preceding the financial year concerned, whether the company has an internal audit system commensurate with its size and nature of its business.

1) This clause requires the auditor to comment whether the company has an internal audit system commensurate with the size and nature of the business. The clause is required to be commented upon by the auditor in case of companies having a paid-up capital and reserves exceeding rupees 50 lakhs as at the commencement of the financial year concerned, or having an average annual turnover exceeding five crores rupees for a period of three consecutive
financial years immediately preceding the financial year concerned. ‘Financial year concerned’ means the financial year under audit.

2) This clause has a mandatory application for the listed companies irrespective of the size of paid-up capital and reserves or turnover. It may be noted that the Order does not specify the date with reference to which the listing status of the company should be determined. In this regard, it is clarified that if the company is listed on a recognised stock exchange as on the date of the balance sheet, it should be considered as listed for the purpose of this clause. In respect of non-listed companies the clause is applicable only if:

(i) the paid-up capital and reserves of the company are more than rupees fifty lakhs as at the commencement of the financial year; or

(ii) average annual turnover exceeds rupees five crores for a period of three consecutive financial years immediately preceding the financial year concerned. 
  

3) In other words, companies which have a paid-up capital and reserves of rupees fifty lakhs or less as at the commencement of the financial year as well as the companies which have an average annual turnover of rupees five crores or less for a period of three consecutive financial years immediately preceding the financial year concerned are excluded from the applicability of the clause.

4) It may be noted that the limit of rupees fifty lakhs applies to the total capital and reserves and not to merely the equity capital. Reference should also be made to paragraphs 17 to 19 of this Statement which specify the considerations for determination of limit of paid-up capital and reserves for determining the applicability of the Order to a private limited company.
 
5) While in respect of companies which are excluded, there is no necessity to make any specific mention in the audit report, the auditor would still be well-advised to make inquiries regarding internal audit since it forms an integral part of the system of internal control which the auditor normally examines as a part of the audit function.

6) The term “turnover” has been explained in paragraph 23 of this Statement. Reference may be made to the said paragraph for the meaning of the term “turnover” for the purposes of this Order.

7) A company may be covered by this clause on the turnover criterion in one year and may not be so covered in another year. Moreover, since average turnover of three financial years immediately preceding the financial year under audit is to be considered, it would follow that a company cannot be covered by this clause during the first three years of its operation on the basis of the turnover criterion. It may also be noted that the financial year may comprise of a period more or less than 12 months.
 
8) A company may either have its own internal audit department or entrust the work of internal audit to an outside agency. In the case of a group of concerns, it is also quite common to have a central internal audit department. The arrangement which is more suitable will depend upon the circumstances of each company but generally, where a company is small, it may find it expensive to have its own internal audit department staffed by personnel having the requisite qualifications.

9) The auditor has to examine whether the internal audit system is commensurate with the size of the company and the nature of its business. The following are some of the factors to be considered in this regard:

(i) What is the size of the internal audit department? In considering the adequacy of internal audit staff, it is necessary to consider the nature of the business, the number of operating points, the extent to which control is decentralised, the effectiveness of other forms of internal control, etc.

(ii) What are the qualifications of the persons who undertake the internal audit work? Internal auditing, as its name implies, is an aspect of audit and, therefore, it is reasonable to expect that the internal audit department should
normally be headed by a chartered accountant and that, depending upon the size of the department, it employs other qualified persons. In deciding the adequacy of the internal audit department, it is, therefore, necessary that
there is adequate number of qualified personnel.

(iii) To whom does the internal auditor report? In general, the higher the level to which the internal auditor reports, the greater will be his independence.
 
(iv) What are the areas covered by the internal audit? Internal audit can cover a large number of areas including operational auditing, organisation and methods studies, special investigations and the like. For the purposes of the Order, however, the important areas which should be covered by internal audit are the examination of the operating systems to ensure that the systems are adequate and functioning in practice. The exact areas to be covered by the internal audit would depend upon the circumstances of each case but the statutory auditor should ask the internal auditor to provide the programme of his work and should determine whether, in his opinion, the coverage is adequate. If he feels it is not, he may suggest to the internal auditor to extend the programme in the required direction.
 
(v) Has the internal auditor adequate technical assistance? In a number of companies, where the operations are highly technical in nature, an internal auditor cannot function effectively unless he has adequate technical assistance. This can be provided either by having full-time technically qualified persons in the internal audit department or by such persons being deputed to the internal audit department for specific assignments. Similar considerations would apply where a large part of the transactions are computerised. In such cases, the internal auditor should have the assistance of persons who are able to audit computer systems.

(vi) What are the reports which are submitted by the internal auditor or what other evidence is there of his work? It is important that the auditor should satisfy himself that not merely does an internal audit system exist but also that it is functioning effectively. He can do so by examining the reports submitted by the internal auditor. 

(vii) What is the follow-up? It is not sufficient that the internal audit system should point out errors in operation or deficiencies in the internal control system. It is equally necessary that there is an adequate follow-up system to
ensure that the errors pointed out are corrected and remedial action taken on the deficiencies reported upon.

10) The auditor should examine the minutes of the meetings of the Board of Directors and audit committee, if any. These minutes would provide the auditor useful evidence regarding the efficiency and efficacy of the internal audit system.

11) It is important to note that the Act does not require a company to necessarily have an internal audit system. However, where such a system does not exist, the Order requires the auditor to mention the fact in his report. Moreover, since this part of the Order refers only to such companies which are either listed or companies having a paid-up capital and reserves in excess of rupees 50 lakhs or an average annual turnover in excess of rupees 5 crores for a period of three consecutive financial years immediately preceding the financial year concerned, it is desirable that such a company has an internal audit system.

12) It is equally important to note that the internal audit system is a part of the overall internal control system. Therefore, the scope of the internal audit and the extent of its coverage will, to some extent, depend upon the existence or otherwise of other forms of internal control. This is also a factor to be considered when evaluating the adequacy of the internal audit system.










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