Fiduciary Duty of An Auditor - Companies Act, 1956

The Companies Act, 1956 requires that every balance sheet and profit and loss account of a company should give a "true and fair view" of the state of affairs of the company as at the end of the financial year and that they should comply with the requisite accounting standards. To find whether proper books and accounts as required by law have been maintained and whether they represent a true and fair view, the auditor is appointed.

Every company in compliance with the sections 224, 225 and 226 of the Companies Act, 1956 appoints an auditor in a general meeting. The powers and duties of an auditor for the purpose of carrying out audit in a company are laid down in section 227.

Fiduciary relationship with members of the company

The auditor owes a duty to the shareholders of the company to ensure that the rights of the shareholders are safeguarded. An auditor has a fiduciary relationship vis-a` vis the shareholders as a body.

The audit is intended for the protection of the shareholders and the auditor is expected to examine the accounts maintained by the directors with a view to inform the shareholders of he true financial position of the company.

It was held by the Supreme court in Institute of Chartered Accountants v. P.K Mukherjee that "directors occupy a fiduciary position in relation to the shareholders and in auditing the accounts maintained by the directors, the auditor acts in the interests of the shareholders who are in a position of beneficiaries ". A similar view was also reflected in CIT v. Dandekar.

Auditor's Right to inspect

Section 227 of the Companies Act facilitates the auditor's duty to report a true and fair view of the company's financial status, by giving the auditor the right to inspect and examine the books and accounts, balance sheet and vouchers and other documents as may be necessary for the purpose of audit report.
The auditor can also require any information or explanation from any officers of the company. It is obligatory on the officers to furnish any such information as required by the auditor.

In addition to this, the auditor may inquire for the purpose of audit in relation to six specific matters as described in sub-section 1A of section 227. He may also attend the general meetings of the company or require the minutes of any meetings if he thinks necessary.

The auditor must take reasonable care to ascertain that books furnished by the company show the company's true position. The auditor may also carry his search outside the books by conducting any inspection or inquiry under the powers given by section 227.

The auditor must not confine himself to checking arithmetical accuracy of the balance sheets and accounts but must also see that they reflect the true and fair view of the company's financial affairs.

Auditor's Duty to Report

Section 227 requires the auditor to make a report to the members of the company in a general meting of the company on the books and accounts, balance sheets, profit and loss account, vouchers and any other documents examined. The auditor also has the additional duty to report to the shareholders whether in his opinion the company has properly kept the books of account or not.

The report should also state
# Whether the auditor has obtained all information and explanations, which are to 'the best of his knowledge and belief' necessary for his purpose.
# Whether in his opinion all proper books of accounts and other necessary documents adequate for the purpose of the audit have been furnished by the company or not.
# Whether the balance sheets and profit and loss accounts are in agreement with the books of accounts and returns of the company
# Any observation or comments on the functioning of the company, especially, which may have an adverse effect on the company.

The Institute of Chartered Accountants (ICAI) have, in their "Statement of Accounting Principles" stated that an auditor must discharge his professional responsibility with high ethical standards. It is also stated by the ICAI, that an auditor when making a report should not-
1. fail to disclose a material fact known to him, which is not disclosed in a financial statement with which he is concerned in a professional capacity.
2. fail to report a material mis-statement known to him to appear in a financial statement with which he is concerned in a professional capacity.
3. fail to obtain sufficient information to warrant the expression of an opinion or his exceptions are sufficiently material to negate the expression of an opinion.
Further, Clause (6) Part I, Second Schedule of the Chartered Accountants Act, 1949, provides that, failure of an auditor to report a known material mis- statement in the financial statements of a company, with which he is concerned in a professional capacity, shall be deemed to be 'professional misconduct'.

Liabilities of an Auditor

An auditor must fully realize his moral obligations to third parties and in view of the fact that the reports made by him are likely to be relied on, he must use his utmost skill and care that the statements issued do reflect the true and accurate state of affairs and free from any ambiguity.

Section 227 of the companies act imposes a penalty on the auditors for non-compliance of sections 227 and 229 with payment of fine if the default is willful.
An auditor is liable to make good the loss the members or investors of a company may suffer as a result of the negligence on his part in the due performance of his duties. If there is fraud on his part, the auditor will be liable in tort. Claims may arise from the auditor failing to detect defalcations or discover errors that may have put the company to loss.

For the auditor to be held liable for fraud, it is necessary to prove the following four facts-
1. the statement signed by him was untrue in fact;
2. that the auditor knew that it was untrue or was recklessly ignorant whether it was true or not;
3. that the statement was made with the intent that the other party should act on it; and
4. that the other party did act in reliance on it and suffered damage.

The Companies Act, 1956 also imposes criminal liability under section 628 on any person who intentionally makes a false statement through any return, report, certificate, balance sheet, prospectus, statement or other documents. The auditor who makes a false statement in his report that the balance sheet presents the true and fair view of the company's financial affairs is also liable.

Therefore, under this section the auditor will be liable if
1. the statement complained of is false in material particular;
2. it has been made in any return, report, certificate, prospectus, statement, balance sheet or some other document required by or for the purposes of any of the provisions of the Act;
3. it has been made willfully knowing it to be false.

The shareholders of the company have mainly to depend upon the good faith and efficiency of the auditor appointed to check the accounts and certify the balance sheet of the company. It is of the highest importance that auditor's should perform their duties with scrupulous care, skill and vigilance to ensure that no transaction is illegal or improper and if he has reason to believe so, he must report it. Thus, the auditor must certify what he does not believe to be true and he must take reasonable care before he believes what he certifies to be true.

The author can be reached at: kundusubhashis@legalserviceindia.com / Print This Article

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