Accounting and Audit Related Issues, Related Party Transactions and Vigil Mechanism – Governance, Risk Management, Compliances and Ethics Important Questions
Question 1.
P Pvt. Ltd. was incorporated under the Companies Act, 1956 on 3rd October, 2011. The Authorised Share Capital of the Company is ₹ 75 crores. The present Paid-up Share Capital of the Company is ₹ 60 crore. The turnover of the company for financial year 2017-18 was ₹ 150 crores and because of good overseas marketability of the company’s product, the turnover of the company for the year ended 31st March, 2019 increased to ₹ 210 crores.
The Secretarial Auditor of the company advised that the company should have internal audit in place, but the Managing Director of the company argued that since it is a private company, so it is not required.
Based on the facts in the above case, answer the following questions:
i. Whether internal audit is compulsory for the Private Limited?
ii. In the above case if the company had been an Unlisted Public Limited and Turnover for year ended 31 st March, 2019 would be ₹ 190 crore, , what would have been your answer?
iii. Can Company Secretary be appointed as Internal Auditor in an Unlisted Public Company where he is already appointed as Key Managerial Personnel
Answer:
i. As per section 138 of the Companies Act, 2013 read with Rule 13(1)(c) of The Companies (Accounts) Rules, 2014 every private company having the following shall be required to appoint an internal auditor:
- Turnover of two hundred crore rupees or more during the preceding financial year.
- Outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year.
In the present case; the turnover of the P Pvt. Ltd. is higher than ₹ 200 crore, for the year ended 31st March, 2019, it is mandatory for P Pvt. Ltd. to appoint an internal auditor.
ii. As per section 138 of the Companies Act, 2013 read with Rule 13(1)
(b) of The Companies (Accounts) Rules, 2014 every unlisted public company having:
a. Paid up share capital of fifty crore rupees or more during the preceding financial year.
or
b. Turnover of two hundred crore rupees or more during the pre-ceding financial year.
or
c. Outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year.
or
d. Outstanding deposits of twenty five crore rupees or more at any point of time during the preceding financial year shall be required to appoint an internal auditor.
In the present case; the paid up capital of P Pvt. Ltd is higher than ₹ fifty crores, hence the company needs to appoint the internal auditor.
iii As per Section 138 of the Companies Act, 2013 an internal auditor, shall either be a chartered accountant or a cost accountant, or such other professional as may be decided by the Board.
Explanation to Rule 13 of The Companies (Accounts) Rules, 2014 states that the internal auditor may or may not be an employee of the company.
In view of the above the Company Secretary who is appointed as Key Managerial Personnel in the company can be appointed as an internal auditor of the company.
Question 2.
Apart from Statutory Audit, for some class of companies, Internal Audit is also mandatory. Which companies are required to have Internal Audit as per the provisions of the Companies Act, 2013?
Answer:
Section 138 of the Companies Act, 2013 read with Rule 13 of the Companies (Accounts) Rules, 2014 provides for the mandatory appointment of an internal auditor who shall either be a chartered accountant or a cost accountant, or such other professional as may be decided by the Board to conduct internal audit of the functions and activities for classes of company given below –
Every listed company : Every unlisted public company having –
- Paid up share capital of 50 crore rupees or more during the preceding financial year; or
- Turnover of 200 crore rupees or more during the preceding financial year; or
- Outstanding loans or borrowings from banks or public financial institutions exceeding 100 crore rupees or more at any point of time during the preceding financial year; or
- Outstanding deposits of 25 crore rupees or more at any point of time during the preceding financial year.
Every private company having –
- Turnover of 200 crore rupees or more during the preceding financial year; or
- Outstanding loans or borrowings from banks or public financial institutions exceeding 100 crore rupees or more at any point of time during the preceding financial year.
Question 3.
M Pvt. Ltd. was registered in the year 2001 as a Private Limited Company and continuing with the same status. It is having a paid-up share capital of ₹ 65 crore as on 31st March, 2019. The present company’s auditor, X, Chartered Accountant, (a Proprietor Firm) who was appointed as auditor of the company in the year 2014. The term of the said auditor is going to expire and company wants to re-appoint the same person, since he is having well acquaintance with the company’s officials and its working.
Based on the above facts, answer the following questions :
i. Whether X can be reappointed as Statutory Auditor of the Company?
ii. In the above case if, instead of the Individual Person as an auditor, the company would have appointed any Firm of Chartered Accountants, and now the tenure of the said firm is expiring, whether this firm is eligible for reappointment?
iii. In the given case, if the paid-up capital of the company is ₹ 5 crore and having cash credit limit and term loan facility from a bank to the tune of ₹ 55 crore, what would have been your answer?
Answer:
i. As per Section 139(2) of the Companies Act, 2013 read with Rule 5(b) of the Companies (Audit and Auditors) Rules, 2014:
All private limited companies having paid up share capital of rupees fifty crore or more shall not appoint or re-appoint:
- An individual as auditor for more than one term of five consecutive years’.
- An audit firm as auditor for more than two terms of five consecutive years.
Cooling off period – An individual auditor who has completed his term of five consecutive years shall not be eligible for re-appointment as auditor in the same company for five years from the completion of his term.
Conclusion – In the present case as the paid up share capital of the company is more than ₹ 50 Crore, Mr. X cannot be appointed as Statutory Auditor for the second term.
ii. As per Section 139(2) of the Companies Act, 2013 read with Rule 5 of the Companies (Audit and Auditors) Rules, 2014:
All private limited companies having paid up share capital of rupees fifty crore or more shall not appoint or re-appoint:
- An individual as auditor for more than one term of five consecutive years.
- An audit firm as auditor for more than two terms of five consecutive years.
Cooling off period:
- An audit firm which has completed its term shall not be eligible for re-appointment as auditor in the same company for five years from the completion of such term:
- Provided further that as on the date of appointment no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of five years.
Conclusion:
In the present case, the firm of Chartered Accountants will not be eligible for the reappointment for five years on the completion of the term.
iii. In the present case the company is having paid up share capital of ₹ 5 crore i.e. within the threshold limit of ₹ 50 crore, however, since the company has borrowing facility from a bank of ₹ 55 crores (i.e. exceeding the threshold limits of ₹ 50 crores), the company cannot re-appoint X as its auditor.
Question 4.
Answer the following in brief; Briefly explain the role of due diligence report in helping to curb occurrence of related party transactions.
Answer:
Section 188(1) of Companies Act, 2013 provides that except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to
- Sale, purchase or supply of any goods or materials
- Selling or otherwise disposing of, or buying, property of any kind
- Leasing of property of any kind .
- Availing or rendering of any services
- Appointment of any agent for purchase or sale of goods, materials, services or property
- Related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company
- Underwriting the subscription of any securities or derivatives thereof, of the company
Hence Due Diligence Report of such transactions has its own importance. Due diligence report is system of curbing related party transactions from occurring. Audit committee should seek a due diligence report with regard to all proposed material transactions which should highlight potential conflict of interest.
Therefore, the companies should have well articulated policies specifying that transactions beyond a certain threshold limits and transactions of certain nature would require a pre-clearance from the audit committee.
Question 5.
Under the Energy Department, Govt, of Tamil Nadu, three Companies as Government Company were incorporated as below:
- A Ltd. for Generation of Electricity
- B Ltd. for Transmission of Electricity
- C Ltd. for Distribution of Electricity
Further, three subsidiaries namely X Ltd., Y Ltd. and Z Ltd. were incorporated as wholly owned subsidiary companies of C Ltd. C Ltd. purchases the Power (Electricity) from A Ltd. and sell all Power to subsidiary Companies, Subsidiary Company through B Ltd. distributes the Power in the State. Apart from that, C Ltd. also purchases cables from manufacturer and sells it to Subsidiary Companies with margin of 5% on sale price. In the power supply, C Ltd. also charge 0.05 paisa per unit as service charge from Subsidiary Companies.
During the Audit, Auditors raised the question that there are lot of related party transactions and directors and members are same in all the Companies. Further, Chairman is also common. Neither the Board nor the Members of the Company approved any transaction which comes under the definition of Related Party Transaction. The Company Secretary replied that the transactions are preapproved by Energy Department, Govt, of Tamil Nadu but Auditor is dissatisfied with this reply.
In such situation, check the validity of the transactions between related parties.
Answer:
Following are the legal provisions of Related party transactions :
1. All related party transactions require the approval of the Audit Committee as per section 177 of the Companies Act, 2013 except to a transaction, referred to in section 188 of the Companies Act, 2013, between a holding company and its wholly owned subsidiary company, as stated under fourth proviso to section 177(4) of the Companies Act, 2013. Up to certain limits, the approval of the Board is required and above the limits, approval of the members must be taken.
2. As per proviso two of section 188(1) of the Companies Act, 2013 member of the company shall not vote where he is related party. However as per proviso three of section 188(1) of the Companies Act, 2013, if 9096 or more members are related party, members can vote. As per proviso four of section 188(1) of the Companies Act, 2013, the approval of the Board is not required where the transactions are on arms length basis in ordinary course of business.
3. Further, as per proviso five of section 188(1) of the Companies Act, 2013, the approval of members is not required in case of transaction between holding and wholly owned subsidiary.
As per the exemption notification dated 5th June, 2015 issued by Ministry of Corporate Affairs, the first and second proviso to sub-section( 1) to section 188 of the Companies Act, 2013 shall not apply to:
- A Government Company where the contracts/arrangements to be entered into by it with any other Government Company.
- A Government company (other than a listed company), in respect of contracts/arrangements other than those mentioned in (a) above, if it has obtained approval of the administrative ministry of the concerned Central/State Government.
Conclusion In this case, C Ltd., being a Government company has entered into the following transactions:
- Purchase of power from A Ltd. (Government Company)
- Sale of power to subsidiary companies ( all Government companies, as they are subsidiaries of a Government company)
- X Ltd, Y Ltd. and Z Ltd. (wholly owned subsidiaries, being Government companies) distribute power through B Ltd. (Government company)
- Purchase of cables from a manufacturer and sale to its Subsidiary – companies (Government companies)
- Levy of service charges at 0.05 paise per unit on its Subsidiary companies (Government companies)
Therefore, in the present case, assuming that the transactions are at arm’s length and in the ordinary course of business, neither the approval of the Board nor the members of the company is required and the related party transactions would be valid.
Question 6.
Write short note on the following; related party transactions.
OR
“Related party transactions have always been viewed with the concern”.
In this context, briefly narrate the changes made under the Companies Act, 2013.
OR
What do you mean by ‘related party transaction’? What are the provisions of listing agreement related to monitoring of related party transactions?
Answer:
Regulation 2(1)(zc) of SEBI (LODR) Regulations, 2015, defines related party transaction a transfer of resources, services or obligations between a listed entity and a related party, regardless of whether a price is charged and a “transaction” with a related party shall be construed to include a single transaction or a group of transactions.
Regulation 23 of SEBI (LODR) Regulations, 2015 provides for monitoring of related party transactions:
1. The listed entity shall formulate a policy on materiality of related party transactions and on dealing with related party transactions.
2. Approval of Audit Committee: All related party transactions shall require prior approval of the audit committee.
3. Omnibus approval: Audit committee may grant omnibus approval for related party transactions proposed to be entered into by the listed entity subject to the following conditions-
a. The audit committee shall lay down the criteria for granting the omnibus approval in line with the policy on related party trans-actions of the listed entity and such approval shall be applicable in respect of transactions which are repetitive in nature.
b. The audit committee shall satisfy itself regarding the need for such omnibus approval and that such approval is in the interest of the listed entity.
c. The omnibus approval shall specify:
- The name(s) of the related party, nature of transaction, period of transaction, maximum amount of transactions that shall be entered into.
- The indicative base price/current contracted price and the formula for variation in the price if any.
- Such other conditions as the audit committee may deem fit provided where the need for related party transaction cannot be foreseen and aforesaid details are not available, audit committee may grant omnibus approval for such transactions subject to their value not exceeding rupees one crore per transaction.
d. The audit committee shall review, at least on a quarterly basis, the details of related party transactions entered into by the listed entity pursuant to each of the omnibus approvals given.
e. Such omnibus approvals shall be valid for a period not exceeding one year and shall require fresh approvals after the expiry of one year.
4. Approval of the shareholders: All material related party transactions shall require approval of the shareholders through resolution and the related parties shall abstain from voting on such resolutions whether the entity is a related party to the particular transaction or not.
5. Exemptions: The provisions of sub-regulations (2), (3) and (4) shall not be applicable in the following cases:
- Transactions entered into between two government companies.
- Transactions – entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.
Question 7.
Secretarial audit is a process to check compliance with provisions of all applicable laws and rules regulations procedures. Elaborate and discuss provisions of the Companies Act, 2013 with regard to Secretarial Audit.
Answer:
As per section 204(1) of Companies Act, 2013 read with Rule 9 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, the following companies are required to obtain
Secretarial Audit Report:
- Every listed company
- Every public company having a paid-up share capital of fifty crore rupees or more
- Every public company having a turnover of two hundred fifty crore rupees or more.
- Every company having outstanding loans or borrowings from banks or public financial institutions of one hundred crore rupees or more.
Circular dated February 8, 2019 specifies that while the annual secretarial audit shall cover a broad check on compliance with all laws applicable to the entity, listed entities shall additionally, on an annual basis, require a check by the PCS on compliance of all applicable SEBI Regulations and circulars/guidelines issued thereunder, consequent to which, the PCS shall submit a report to the listed entity in the manner specified in this circular.
Question 8.
“The NFRA is an independent regulator established under Section 132 of the Companies Act, 2013 to oversee the auditing profession”. Discuss.
Answer:
The NFRA is an independent regulator established under Section 132 of the Companies Act, 2013 to oversee the auditing profession. The NFRA has been established as an independent regulators for enforcement of auditing standards and ensuring the quality of audits to strengthen the independence of audit firms and therefore enhance investor and public confidence in financial disclosures of companies. The powers and functions of NFRA are majorly pertaining to oversee the auditing profession that may be studied under the following points –
1. To investigate either suo-motu or on a reference made by the Central Government in matters of professional misconduct committed by any member or Chartered Accountants firm.
2. To make recommendations to the Central Government on formulation and laying down of accounting standards and auditing policies for adoption by companies or their auditors.
3. To monitor and implement compliance relating to accounting standards and auditing policies as prescribed.
4. To oversee the quality of service of professions associated with compliance of accounting standards and auditing policies and suggest measures for improvement.
5. NFRA shall have equivalent powers as a civil court under the Code of Civil Procedure, 1908. It can exercise the powers related to:
- dis-covery and production of books or other documents as specified by NFRA
- summoning and enforcing the attendance of persons and examining them on oath
- inspection of books, registers and other documents of any person
- issuing commissions for examination of witness or other documents.
6. NFRA may impose penalties:
- Not less than one lakh rupees which may extend up to five times of the fees received in case of individuals
- Not less than ten lakh rupees which may extend up to ten times of the fees received in case of firms.
7. NFRA may consider an investigation based on monitoring and com-pliance review of auditor or audit firm upon recommendations by Member- Accounting and Member- Auditing.
(Note: This list is inclusive and not exhaustive)
Question 9.
Write short notes on the following; Whistle blower mechanism.
Answer:
Every listed company and the companies belonging to the following class or classes shall establish a vigil mechanism for their directors and employees to report their genuine concerns or grievances :
- The Companies which accept deposits from the public.
- The Companies which have borrowed money from banks and public I financial institutions in excess of fifty crore rupees.
Question 10.
You are a company secretary of a listed company. The company has i borrowings from the Banks/FIs worth Rs. 75 crores, which is in the form of Term Loan and Working Capital Finance. You noticed that the company is not having Vigil Mechanism in place. Suggest the suitable strategy to the Board for establishment of Vigil Mechanism in the company quoting the relevant provisions of the Companies Act, 2013 and SEBI (LODR) Regulations, 2015.
Answer:
Vigil Mechanism under Companies Act, 2013 –
Section 177(9) of the Companies Act, 2013 provides that every listed company or such class or classes of companies, as may be prescribed, shall establish a vigil mechanism for directors and employees to report genuine concerns in such manner as may be prescribed.
Rule 7 of the Companies (Meetings of Board and its Powers) Rules, 2014 provides that every listed company and the companies belonging to the following class or classes shall establish a vigil mechanism for their directors and employees to report their genuine concerns or grievances:
- The Companies which accept deposits from the public.
- The Companies which have borrowed money from banks and public financial institutions in excess of fifty crore rupees.
Vigil mechanism under SEBI (Listing Obligations and Disclosure Regulations), 2015
Regulation 22 of SEBI (LODR) Regulations, 2015 provides that every listed entity shall establish a vigil mechanism for directors and employees to report concerns about unethical behaviour, actual or suspected fraud or violation of the listed entity code of conduct or ethics policy
Conclusion:
Since the company is a listed company, it should establish vigil mechanism as per both Section 177(9) of the Companies Act, 2013 and SEBI (LODR) Regulations, 2015 with following provisions :
The audit committee shall oversee the vigil mechanism through the committee and if any of the members of the committee have a con-flict of interest in a given case, they should recuse themselves and the others on the committee would deal with the matter on hand.
The vigil mechanism shall provide for adequate safeguards against victimisation of employees and directors who avail of the vigil mechanism and also provide for direct access to the Chairperson of the Audit Committee or the director nominated to play the role of Audit Committee, as the case may be, in exceptional cases.
In case of repeated frivolous complaints being filed by a director or an employee, the audit committee or the director nominated to play the role of audit committee may take suitable action against the con-cerned director or employee including reprimand.
The details of establishment of such mechanism shall be disclosed by the listed entity on its website and in the Board’s report.
Question 11.
Write a note on the following; Functions and duties of NFRA.
Answer:
Following are the function & duties of NFRA as per section 132(2) of Companies Act 2013.
- Maintain details of particulars of auditors appointed in the companies and bodies corporate specified in rule 3 of NFRA Rules.
- Recommend accounting standards and auditing standards for approval by the Central Government.
- Monitor and enforce compliance with accounting standards and auditing standards.
- Oversee the quality of service of the professions associated with ensuring compliance with such standards and suggest measures for improvement in the quality of service.
- Promote awareness in relation to the compliance of accounting standards and auditing standards.
- Co-operate with national and international organisations of independent audit regulators in establishing and overseeing adherence to accounting standards and auditing standards.
- Perform such other functions and duties as may be necessary or incidental to the aforesaid functions and duties.
Question 12.
Briefly explain the following; Powers of NFRA under section 132 of Companies Act, 2013.
Answer:
Section 132(4) of Companies Act, 2013 states that notwithstanding anything contained in any other law for the time being in force, the National Financial Reporting Authority shall –
a. Have the power to investigate, either suo motoor on a reference made to it by the Central Government, for such class of bodies corporate or persons, in such manner as may be prescribed into the matters of professional or other misconduct committed by any member or firm of chartered accountants, registered under the Chartered Accountants Act, 1949:
Provided that no other institute or body shall initiate or continue any proceedings in such matters of misconduct where the National Financial Reporting Authority has initiated an investigation under this section.
b. Have the same powers as are vested in a civil court under the Code of Civil Procedure, 1908, while trying a suit, in respect of the following matters, namely:
- Discovery and production of books of account and other documents, at such place and at such time as may be specified by the National Financial Reporting Authority.
- Summoning and enforcing the attendance of persons and examining them on oath.
- Inspection of any books, registers and other documents of any person referred to in clause (b) at any place.
- Issuing commissions for examination of witnesses or documents.
c. Where professional or other misconduct is proved, have the power to make order for –
- Imposing penalty
- Debarring the member or the firm being appointed as an auditor or internal auditor or undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body corporate or performing any valuation as provided under section 247.
For a minimum period of six months or such higher period not exceeding ten years as may be determined by the National Financial Reporting Authority.
Question 13.
Write a note on the following; Types of Whistle blowers.
Answer:
Following are the types of whistle blowers:
1. Internal : When the whistle blower reports the wrong doings to the officials at higher position in the organization. The usual subjects of internal whistle blowing are disloyalty, improper conduct, indiscipline, insubordination, disobedience etc.
2. External : Where the wrongdoings are reported to the people outside the organization like media, public interest groups or enforcement agencies it is called external whistle blowing.
3. Alumini : When the whistle blowing is done by the former employee of the organization it is called alumini whistle blowing.
4. Open : When the identity of the whistle blower is revealed, it is called Open Whistle Blowing.
5. Personal : Where the organizational wrongdoings are to harm one person only, disclosing such wrong doings it is called personal whistle blowing.
6. Impersonal : When the wrong doing is to harm others, it is called impersonal whistle blowing.
7. Government : When a disclosure is made about wrong doings or unethical practices adopted by the officials of the Government.
8. Corporate: When a disclosure is made about the wrongdoings in a business corporation, it is called corporate whistle blowing.
Question 14.
Write a note on the following: Whistle Blowing under Sarbanes-Oxley Act, 2002 (SOX).
Answer:
Section 302 of Sarbanes Oxley Act of 2002, an Act enacted by U.S. congress to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes contains following provisions for whistle blowers:
- Make it illegal to “discharge, demote, suspend, threaten, harass or in any manner discriminate against” whistle blowers.
- Establish criminal penalties of up to 10 years for executives who re-taliate against whistle blowers.
- Require board audit committees to establish procedures for hearing whistle blower complaints.
- Allow the secretary of labour to order a company to rehire a terminated employee with no court hearing.
- Give a whistleblower the right to a jury trial, bypassing months or years of administrative hearings.
Question 5.
Briefly explain, Vigil mechanism under SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.
Answer:
Following are the provisions of Vigil mechanism under SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015:
1. The listed entity shall formulate a vigil mechanism for directors and employees to report genuine concerns. [Regulation 22(1)]
2. The vigil mechanism shall provide for adequate safeguards against victimization of director(s) or employee(x) or any other person who avail the mechanism and also provide for direct access to the chair-person of the audit committee in appropriate or exceptional cases. [Regulation 22(2)]
3. The listed entity shall disseminate the details of establishment of vigil mechanism/Whistle Blower policy.
4. The disclosure regarding the details of establishment of vigil mechanism, whistle blower policy, and affirmation that no personnel has been denied access to the audit committee shall be made in the section on the corporate governance of the annual report.