Understanding Everything About Statutory Audit

A statutory audit refers to a legally required process of reviewing the company's financial records to ensure that they are fair and accurate. It is a mandatory requirement under the Companies Act 2013 for all types of companies in India. Every company must appoint an auditor at its first annual general meeting (AGM) to carry out the statutory audit. The auditor will be responsible for reviewing the company's books, records, systems, and controls, and preparing an audit report with an opinion. The audit opinion can be of four types: unqualified opinion, qualified opinion, adverse opinion, and disclaimer of opinion.

Conducting a statutory audit is important to detect fraud, enhance credibility, and ensure compliance with FEMA and legal requirements, even for NRIs. Non-compliance with the regulations can attract penalties and fines under various sections. It includes a penalty of Rs. 25,000 to Rs. 5,00,000 under the LLP Act, 2008, a fine ranging from Rs. 10,000 to Rs. 1,00,000 on directors and officers, etc. Gathering all the necessary documents, staying informed about the legislative changes, and following established policies are some tips to avoid non-compliance penalties.

Additionally, the requirement for conducting a statutory audit for NRIs depends on the entity and not the individual's NRI status. In this blog, we will walk you through everything you need to know about a statutory audit.

What is a Statutory Audit?

A statutory audit is a mandatory review of a company's financial statements to check that they are accurate, fair, and complete. It includes examining the financial records such as bank balances, transactions, and accounting documents. It is conducted by an external, independent auditor appointed by the company, who reviews the company's books, records, systems, and controls.

The law mandates this type of audit for certain types of companies, such as public limited companies. Also, it improves transparency, trust, and governance in companies' reported financials. The audit report will contain any one of the four opinions: unqualified, qualified, adverse, or disclaimer.

What is the Legal Framework of Statutory Audit in India?

Conducting a statutory audit under the Companies Act 2013 is mandatory for all types of companies in India. According to Section 139 of the Act, every company must appoint its first auditor within 30 days of incorporation. If the Board fails to appoint the auditor within this period, the members must appoint the first auditor within 90 days at an extraordinary general meeting. Subsequent auditors are appointed by the shareholders at the Annual General Meeting (AGM). The auditor will hold office from the conclusion of that meeting till the conclusion of the sixth AGM.

However, the entire team is liable for confirmation in every AGM conducted during the following years. Additionally, under subsection (2) of Section 139, an auditor's eligibility criteria are specified. A firm, an individual, including a limited liability partnership (LLP), can be appointed as an auditor, provided they are eligible and qualified. Apart from conducting the audit, the auditor also needs to prepare a comprehensive report on the company's financial status.

To prepare the report, the auditor needs to do a detailed examination of the company's financial statements. It includes the balance sheet, profit and loss account, and cash flow statement. Moreover, the audit report must specify whether the financial statements give an accurate and fair view of the company's state of affairs.

Who Needs a Statutory Audit in India?

According to the Companies Act 2013, every public limited company and private limited company must conduct statutory audits. The table below lists who is required to conduct statutory audits in India:

Eligibility for NRIs

An NRI's eligibility for a statutory audit mainly applies based on the structure of business they use in India:

• It's mandatory that the NRI owns a company or is involved in a company (Private/Public/Subsidiary).
• It is required for a branch office/liaison office under RBI and FEMA rules.
• Applicable in LLPs only if the turnover exceeds Rs. 40 lakh, or capital exceeds Rs. 25 lakh.
• It is practically needed for fund repatriation and compliance filings.

What is the Process of Conducting a Statutory Audit?

As mandated by the Companies Act 2013, a statutory audit follows a structured process to ensure compliance and accuracy. Here is the statutory audit process you need to follow:

Step 1: Appointing the Auditor

Every company must appoint the first auditor within 30 days of incorporation. Additionally, the subsequent auditors are appointed every year at the Annual General Meeting (AGM).

Step 2: Planning the Audit

The auditor learns how the company works by assessing the risks and internal control measures. After that, an audit plan is prepared by the auditor based on the involved risk, business complexity, and compliance needs.

Step 3: Verifying the Financial Statements

All the financial statements are examined, including balance sheet, profit & loss accounts, cash flow statements, and notes to accounts. After that, every financial transaction, record, and disclosure is cross-checked.

Step 4: Compliance Check

Compliance with the company law provisions, income tax, GST, and other financial regulations is ensured. Next, statutory compliance for TDS, ESI, PF, and other legal obligations is reviewed.

Step 5: Issuance of Auditor's Report & Opinion

Once everything is verified and examined, the statutory auditor is required to mandatorily issue a report with an opinion regarding the company's financial statements and compliance.

What are the Types of Opinions in a Statutory Audit?

Once a statutory audit is done, the auditor issues a report and opinions on the financial statements of the company. Here are the four major types of audit opinions that an auditor can express:

Unqualified Opinion

It is a report that concludes that the company's financial statements are accurate and fair in accordance with the financial reporting framework. It's often called a clean audit, which indicates that the auditors found no issues with the company's financial reporting. It also indicates that the company's operations adhere to the governance principles and applicable laws.

Qualified Opinion

A qualified audit report is issued when the overall statements are fair and accurate, but the auditor wants to highlight a specific issue in the financial statements. It is usually issued when there is some uncertainty like a lawsuit or financial risk, or some important information is not disclosed properly.

Adverse Opinion

An adverse opinion audit report is issued when the financial statements are significantly incorrect or misleading. It is issued when there is a major disagreement with management and errors and material, affecting the overall financial statements. In such cases, the company's board of directors is legally responsible for explaining the reason for this opinion to the members of the company.

Disclaimer of Opinion

It is given when the auditor is not able to form any opinion on the financial statements. It can be either due to the auditor not getting sufficient information or due to there being serious limitations in the audit process.

What is the Importance of a Statutory Audit?

Conducting statutory audits regularly is important to ensure that all your company's finances are accurate and in order. Here are some key reasons that state the purpose of a statutory audit and its importance:

• Legal Compliance: The primary reason for opting statutory audit is to ensure compliance with the Companies Act 2013. Failing to comply with this regulation can attract penalties, fines, and even the prosecution of directors.
• Fraud Detection: Statutory audits help in identifying any misstatements, manipulation, or fraud within the company. It serves as a shield for both the management and the shareholders.
• Credibility and Transparency: Audited reports provide a true and fair view of the company's financial accuracy, helping to enhance confidence among investors, banks, and other stakeholders.
• Access to Funds: Before granting loans or making investments, banks, investors, and venture capitalists may ask for audited financial statements. An audited report will help boost your credibility in the financial market.
• Internal Controls: Auditors often call attention to the weaknesses related to accounting or internal controls of the company during the auditing process. Identifying and resolving these gaps can help companies with operation strengthening.
• Easy Operations for NRIs: A statutory audit helps NRIs ensure compliance with FEMA and other legal requirements. It also helps with easy fund repatriation abroad and maintains transparency in cross-border transactions. Additionally, it simplifies taxation and prevents potential legal issues for NRIs.

What are the Penalties for Non-Compliance with Statutory Audit?

Every company must mandatorily conduct statutory audits as per the Companies Act 2013. Non-compliance with the regulations can lead to penalties under various sections, including:

Penalty Under LLP Act, 2008

If LLPs fail to conduct a statutory audit:

• A penalty of Rs. 25,000 to Rs. 5,00,000 will be imposed. Additionally, a penalty of Rs. 10,000 to Rs. 1,00,000 can be imposed on the designated partners. 

Penalty on the Company

If a company fails to conduct a statutory audit:

• A penalty between Rs. 25,000 and Rs. 5,00,000 will be imposed as per Section 147(1). 

Penalty on Directors & Officers 

The directors & officers will attract:

• A fine ranging from Rs. 10,000 to Rs. 1,00,000. 
• Imprisonment for up to 1 year and even both fine and imprisonment (in case of purposeful non-compliance). 

Penalty on the Auditor 

If an auditor fails to report fraud or financial misstatements:

• As per Section 147(2), a fine of Rs. 25,000 to Rs. 5,00,000 can be imposed. 

In case the auditor falsifies the audit report purposefully, they can be penalized with:

• A fine of up to Rs. 25 lakh or imprisonment for up to 2 years, or
• Both fine and imprisonment. 

Directors Disqualification

If any company fails to file financial records for a continuous period of 3 years, 

• The directors can be disqualified from holding directorship in any company for 5 years as per Section 164(2). 

Other Consequences due to Non-Compliance

Apart from the above-mentioned penalties, non-compliance can even attract other consequences:

• Regulatory Examination: The company may face investigations from MCA, SEBI, RBI, or other regulators. 
• Legal Actions & Business Restrictions: The government may take legal actions that may restrict the operations of the company. 
• Stakeholder Trust Failure: It negatively impacts credibility, affecting investors, lenders and clients. 

Is Statutory Audit Mandatory for NRIs?

The requirement for conducting a statutory audit depends on the entity, instead of the individual's NRI status. Here are some of the mandatory and conditional cases where a statutory audit is mandatory for NRIs:

Mandatory Cases

Conducting an audit under the Companies Act 2013 is compulsory if:

• An NRI is involved in a public company,
• An NRI operates through a branch office/ subsidiary in India,
• An NRI owns or is a director in a private limited company.

Conditional Cases

Conducting a statutory audit under the Companies Act 2013 becomes conditional if:

• An NRI is a part of an LLP; the audit depends on whether the turnover exceeds Rs. 40 lakh or the capital contribution exceeds Rs. 25 lakh.
• An NRI is a sole proprietor or freelancer, statutory audit is not required, but a tax audit may be needed based on income limits. 

NRIs don't need to undergo audits mandatorily. However, a statutory audit becomes unavoidable if they operate through regulated entities.

 Key Scenarios for NRIs for Conducting Statutory Audit

The table below lists some key scenarios for NRIs for conducting a statutory audit:

What are the Common Mistakes to Avoid in Statutory Audits?

Here are some common mistakes to avoid during statutory audits:

• Insufficient Preparation: Businesses often underestimate the amount of work and documentation required for statutory audits. Organizing everything well in advance is crucial to avoid this mistake. 
• Avoidance: Gather all the necessary documents required for the statutory audit. Also, ensure compliance with the relevant laws. Follow the procedure properly and conduct internal audit assessments. 
• Not Understanding Regulatory Requirements: Statutory audits are governed by strict regulations. Companies often face non-compliance issues due to not fully staying updated about the changes in regulations. 
• Avoidance: Stay informed and updated about the legislative changes to ensure that the company remains compliant. 
• Lack of Communication with Auditors: Effective communication is crucial to ensure a successful statutory audit. Companies sometimes fail to maintain proper communication channels with their auditors. It can lead to creating misunderstandings and errors in financial statements. 
• Avoidance: Take regular updates and meetings to ensure both parties are aligned. 
• Ignoring Internal Policies and Procedures: Companies not complying with the internal policies and procedures during audits can lead to significant issues. 
• Avoidance: Follow established policies to ensure consistency and accuracy in reporting. 

To Conclude

Conducting a statutory audit under the Companies Act 2013 is mandatory for every company in India by appointing an auditor. The auditor presents an auditor's report, which provides an opinion on whether a company's financial statements present an accurate and fair view of the company's financial position in accordance with the laws. Statutory audit ensures transparency, accuracy, and fairness in financial reporting. 

Moreover, to ensure accurate financial reporting and prevent penalties, connect with an expert at Savetaxs. We have a team of experts who can assist you with staying compliant with the laws, reporting everything accurately, managing risk and fraud, and avoiding significant penalties. Our team can help businesses navigate complex audit requirements with ease and accuracy. Connect with us right away and be confident that your financial reporting and compliance practices are in safe hands.