Rotation of Auditor Meaning Procedure & Rules

The following article is a detailed explanation of the provisions pertaining to Rotation of Auditor. Section 139(2) of the Companies Act, 2013 deals with the Rotation of Auditor. The article clearly explains the provisions for Rotation of Auditor, Procedure for Rotation of Auditor, Class of companies covered in rotation scheme, etc.

Every company is required at its first annual general meeting (AGM) to appoint an individual or a firm as an auditor. The auditor shall hold office from the conclusion of that meeting till the conclusion of its 6th AGM and thereafter till the conclusion of every 6th meeting.

Individual Auditors are to be compulsorily rotated every 5 years and audit firm every 10 years in listed companies & certain other classes of companies, as may be prescribed. Transition period of 3 years provided to the companies to comply with the mandatory rotation of auditor requirement.

Introduction: Rotation of Auditors

Rotation of Auditor Meaning Procedure & Rules

Section 139(2) of the Companies Act, 2013 (the Act) has mandated all listed companies and certain categories of unlisted public companies and Private companies to mandatorily rotate their auditors (whether such auditor is an individual or a firm) once their auditor has served office as an auditor for a period of 10 or more consecutive years (Rotation Period).

In this regard, the third Proviso to Section 139(2) of the Act has provided a moratorium period, wherein companies incorporated prior to 1 April 2014, have been provided a time period of 3 years from such date to comply with the requirement to rotate their auditors.

Therefore, beginning 1 April 2017, all companies who are required to rotate their auditors under the Act, will have to rotate their existing auditors (Current Firm), if the Current Firm has held office as such company’s auditor for a period of 10 years or more.

Rotation of Auditor Section 139(2)

The section 139(2) of the Companies Act, 2013 has introduced the system of rotation of auditors which is applicable to –

  1. listed companies; or
  2. all companies belonging to such class or classes of companies as prescribed under Rule 5 of the Companies (Audit and Auditors) Rules 2014.

Class of companies covered in rotation scheme

According to Rule 5 of the Companies (Audit and Auditors) Rules, 2014 and for the purposes of sub-section (2) of section 139, the class of companies shall mean the following classes of companies excluding one person companies and small companies:-

  1. all unlisted public companies having paid up share capital of rupees 10 crore or more;
  2. all private limited companies having paid up share capital of rupees 20 crore or more;
  3. all companies having paid up share capital of below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of rupees 50 crore or more.

The concept of rotation of auditors shall not apply to one person companies and small companies.

The provisions for rotation of auditors under sub sections 2,3 and 4 of section 139 are given below:

In case of an individual as auditor:

  1. No individual shall be appointed or re-appointed as auditor for more than 1 term of 5 consecutive years.
  2. An individual auditor, who has completed his term of 5 consecutive years, shall not be eligible for reappointment as auditor in the same company for 5 years from the date of completion.

In case of a firm as an auditor:

  1. No audit firm shall be appointed or re-appointed as auditor for more than 2 terms of 5 consecutive years.
  2. An audit firm which has completed its 2 terms of 5 consecutive years, shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such terms.
  3. If any firm/LLP which has one or more partners who are also partners in the outgoing audit firm/LLP cannot be appointed as auditors during the 5 year period. In other words, if two or more audit firms have common partner(s), and one of these firms has completed its 2 terms of 5 consecutive years, none of such audit firms shall be eligible for re-appointment as auditor in the same company for 5 years.

The aforementioned provisions can be explained by the following examples.

Example 1: Mr. X has completed 5 years in M/s ABC Ltd. in FY 2012-13. Now, he is not eligible for re-appointment for next 5 years in M/s ABC Ltd.

Example 2: Firm XYZ has completed 10 years in M/s ABC Ltd. Now, he is not eligible for re-appointment for next 5 years M/s ABC Ltd.

Example 3: If Mr. X is a common partner in firm XYZ and Firm VWX, then Firm VWX is also not eligible for appointment as auditor in M/s ABC Ltd for that 5 years (i.e. from 2013-14 ).

Rotation of Auditor – Transition Period

There is a transition period of three years, from date of enactment of the 2013 Act, to comply with this requirement. All listed companies or specified companies will have to comply with the above provisions relating to rotation of auditors within 3 years from the date of commencement of this Act i.e. within 31st March 2017.

The aforementioned provisions can be explained by the following illustration in a better manner.

If ABC & Co. is auditor of M/S XYZ Ltd. and the balance sheet of M/S XYZ Ltd. is being signed by Mr. A who is also a partner in other firm PQR & Co. If the original tenure of appointment of ABC & Co. is expiring on 20th August, 2020. The firm PQR & Co. can’t take the appointment of auditor of M/S XYZ Ltd. for the period of five years starting from 21st August, 2020 and up to 20th August, 2025.

In the above example, PQR & Co. can take the advantage of being appointed as auditor on a date starting after the expiry of financial year 2020-2021. In simple words, PQR & Co. is being eligible for appointment of auditor of M/S XYZ Ltd. after the start of new financial year from the expiry of original tenure of ABC & Co., as the proviso mentions only of one preceding financial year.

Right of removal or resignation not affected [4th proviso to Section 139(2)]

  1. The right of the company to remove an auditor before expiry of one or two term(s) of 5 consecutive years shall not be affected due to any provision contained in section 139(2).
  2. The right of auditor to resign from the office of auditor before expiry of one or two term (s) of 5 consecutive years shall not be affected due to any provision contained in section 139(2).

Rotation of Auditor – Internal Rotation (sub-section 3 of Section 139)

Besides the above rotation, the members of the company may also resolve to provide that –

  1. in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as may be resolved by members; or
  2. the audit shall be conducted by more than one auditor

Rotation of Auditor – Position of Joint Auditors

According to sub-rule 4 of Rule 6 of The Companies (Audit and Auditors) Rules, 2014, where a company has appointed two or more individuals or firms or a combination thereof as joint auditors, the company may follow the rotation of auditors in such a manner that both or all of the joint auditors, as the case may be, do not complete their term in the same year.

Manner and procedure for Rotation of Auditor

Manner of rotation of auditor by the companies on expiry of their term:

Rule 6 of The Companies (Audit and Auditors) Rules, 2014 prescribes the following manner of rotation of auditors by the companies:

1. In case the company is required to constitute an audit committee, the procedure shall be as follows:

  1. The Audit Committee shall recommend to the Board, the name of an individual auditor or of an audit firm who may replace the incumbent auditor on expiry of the term of such incumbent.
  2. The Board shall consider the recommendation of the audit committee.
  3. The Board shall make its own recommendation for appointment of the next auditor by the members in the AGM.

2. In case the company is not required to constitute an audit committee, the procedure shall be as follows:

  1. The Board shall itself consider the matter of rotation of auditors.
  2. The Board shall make its own recommendation for appointment of the next auditor by the members in the AGM.

3. In case of an auditor (whether an individual or audit firm), the period for which the individual or the firm has held office as auditor prior to the commencement of the Act shall be taken into account for calculating the period of five consecutive years or ten consecutive years, as the case may be.

4. The incoming auditor or audit firm shall not be eligible if such auditor or audit firm is associated with the outgoing auditor or audit firm under the same network of audit firms.

5. If a partner, who is in charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of 5 years.

Explanation I – For the purposes of these rules the term “same network” includes the firms operating or functioning, hitherto or in future, under the same brand name, trade name or common control.

Explanation II – For the purpose of rotation of auditors,-

  1. a break in the term for a continuous period of five years shall be considered as fulfilling the requirement of rotation;
  2. if a partner, who is in charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of five years.

Conclusion

The above all the information Prepared on the basis of the Relevant Provisions under the Companies Act 2013. For better Understanding Cross check the Companies Act 2013. For any doubts and quarries comment below.