Internal Auditor under Companies Act, 2013 – Applicability, Rules & Practical Insights
Internal audit plays a crucial
role in strengthening corporate governance and ensuring that a company’s
internal controls, risk management systems, and compliance mechanisms are
functioning effectively. Under the provisions of the Companies Act, 2013, certain
classes of companies are mandatorily required to appoint an internal auditor.
Section 138 of the Companies Act,
2013, read with Rule 13 of the Companies (Audit and Auditors) Rules, 2014, lays
down the framework for applicability, eligibility, and scope of internal audit.
The objective behind this provision is to ensure that companies with
significant financial size or operations maintain a proper internal check
system to detect inefficiencies, fraud, and non-compliance at an early stage.
The applicability of internal
audit depends upon the nature and size of the company. In the case of
private companies, the law mandates appointment of an internal auditor if
the turnover during the preceding financial year is ₹200 crore or more, or if
the company has outstanding loans or borrowings from banks or public financial
institutions exceeding ₹100 crore at any point of time during the preceding
financial year. It is important to note that even if any one of these
conditions is satisfied, the requirement becomes mandatory.
As far as eligibility is
concerned, the internal auditor may be a chartered accountant, cost accountant,
or any other professional as may be decided by the Board of Directors. The
internal auditor may or may not be an employee of the company, thereby giving
flexibility to companies to either appoint an in-house professional or engage
an external expert. However, independence in audit functions is a fundamental
principle, and therefore, the statutory auditor of the company cannot be
appointed as the internal auditor. This restriction ensures that there is
no conflict of interest and that the audit process remains unbiased and
objective.
The scope, functioning, and
periodicity of internal audit are determined by the Audit Committee, where
applicable, or by the Board of Directors. Internal auditors are expected to
evaluate internal controls, risk management processes, operational efficiency,
and compliance with applicable laws and regulations. In practice, internal
audit acts as a continuous monitoring mechanism, unlike statutory audit which
is periodic in nature.
Thus, Section 138 ensures that companies with substantial operations are subject to an additional layer of scrutiny, ultimately leading to better governance, transparency, and accountability.
Question
PT Pvt. Ltd., has a paid-up
capital of ₹75 lakh and reserves of ₹7 crore. Over the last three consecutive
financial years, immediately preceding the financial year under audit, its
turnover has been ₹120 crore, ₹250 crore, and ₹310 crore respectively. During
one of the management meetings, the Managing Director suggested that presently,
they may not be required to appoint internal auditors. However, if need arises,
they can appoint Jain and Gupta Associates, (Chartered Accounting firm) the
Company’s statutory auditor, as its internal auditor to ensure compliance.
With reference to the provisions of the Companies Act, 2013, evaluate whether the contention of Managing Director is tenable.
Answer
In the given case, PT Pvt. Ltd.
is a private company. As per Section 138 of the Companies Act, 2013 read with
Rule 13 of the Companies (Audit and Auditors) Rules, 2014, a private company is
required to appoint an internal auditor if its turnover during the preceding
financial year is ₹200 crore or more.
In this case, the turnover of the
company in the immediately preceding financial year is ₹310 crore, which
exceeds the prescribed limit of ₹200 crore. Therefore, the company is
mandatorily required to appoint an internal auditor. Hence, the contention of
the Managing Director that internal audit is not presently required is
incorrect and not tenable.
Further, although the Act allows
the appointment of a chartered accountant as an internal auditor, the statutory
auditor of the company cannot be appointed as the internal auditor due to
conflict of interest and lack of independence in audit functions. Therefore,
the proposal to appoint Jain and Gupta Associates, who are already acting as
statutory auditors of the company, as internal auditors is also not valid.
Accordingly, PT Pvt. Ltd. is required to mandatorily appoint an internal auditor, and the views expressed by the Managing Director are not in accordance with the provisions of the Companies Act, 2013.
Further Note on Applicability to Other Companies
Apart from private companies,
Section 138 of the Companies Act, 2013 also prescribes mandatory internal audit
requirements for unlisted public companies and listed companies,
which is important from both exam and practical perspective.
1. Listed Companies
All listed companies are mandatorily required to appoint an internal auditor, irrespective of their turnover, capital, or borrowings. The law does not prescribe any threshold for listed entities because they deal with public funds and are subject to higher standards of corporate governance and transparency. Therefore, internal audit becomes a compulsory compliance requirement for every listed company.
2. Unlisted Public Companies
In the case of unlisted public
companies, the requirement to appoint an internal auditor arises if any one of
the following conditions is satisfied:
- Paid-up share capital of ₹50 crore or more, or
- Turnover of ₹200 crore or more, or
- Outstanding loans or borrowings from banks or public
financial institutions exceeding ₹100 crore at any point of time during
the preceding financial year, or
- Outstanding deposits of ₹25 crore or more at any
point of time during the preceding financial year
Thus, even if a company does not
meet all conditions, satisfying any one of the above triggers the
requirement of internal audit.
📚 Questions Ans answers (MCQs – Internal Audit)
Which of the following companies is mandatorily required
to appoint an internal auditor under Section 138?
A. Every private company
B. Every public company
C. Companies meeting prescribed thresholds
D. Only listed companies
Answer: C. Companies meeting prescribed thresholds
A private company is required to appoint an internal
auditor if its turnover during the preceding financial year is:
A. ₹100 crore or more
B. ₹150 crore or more
C. ₹200 crore or more
D. ₹300 crore or more
Answer: C. ₹200 crore or more
In case of a private company, internal audit is required
if outstanding loans or borrowings exceed:
A. ₹50 crore
B. ₹75 crore
C. ₹100 crore
D. ₹200 crore
Answer: C. ₹100 crore
Which of the following is correct regarding listed
companies?
A. Internal audit is optional
B. Internal audit is mandatory irrespective of thresholds
C. Applicable only if turnover exceeds ₹200 crore
D. Applicable only if capital exceeds ₹50 crore
Answer: B. Internal audit is mandatory irrespective
of thresholds
An unlisted public company must appoint an internal
auditor if its paid-up capital is:
A. ₹25 crore or more
B. ₹50 crore or more
C. ₹75 crore or more
D. ₹100 crore or more
Answer: B. ₹50 crore or more
Internal auditor can be:
A. Only Chartered Accountant
B. Only Cost Accountant
C. Only employee of the company
D. Chartered Accountant, Cost Accountant, or other professional
Answer: D. Chartered Accountant, Cost Accountant, or
other professional
Which of the following statements is correct?
A. Internal auditor must be an employee
B. Internal auditor cannot be an employee
C. Internal auditor may or may not be an employee
D. Internal auditor must be appointed by shareholders
Answer: C. Internal auditor may or may not be an
employee
Who appoints the internal auditor?
A. Shareholders in AGM
B. Board of Directors
C. Central Government
D. Registrar of Companies
Answer: B. Board of Directors
Which auditor cannot be appointed as internal auditor?
A. Cost Auditor
B. Secretarial Auditor
C. Statutory Auditor
D. Internal employee
Answer: C. Statutory Auditor
For applicability of internal audit, which period is
considered?
A. Current financial year
B. Next financial year
C. Preceding financial year
D. Any financial year
Answer: C. Preceding financial year
An unlisted public company must appoint an internal
auditor if its turnover is:
A. ₹100 crore
B. ₹150 crore
C. ₹200 crore
D. ₹250 crore
Answer: C. ₹200 crore
Outstanding deposits threshold for unlisted public
company is:
A. ₹10 crore
B. ₹25 crore
C. ₹50 crore
D. ₹100 crore
Answer: B. ₹25 crore
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