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2021

Constitution of Audit Committee and relevant Provisions under the Companies Act, 2013

Constitution of Audit Committee and relevant Provisions under the Companies Act 2013

Section 177 of Companies Act, 2013 lays down the provision the composition and the functions of the committee of audit Committee. The Audit Committee plays critical role in assessment of the Companies’ Financial Information and makes sure that the information is accurate and complete. Further, this section has also made whistle-blowing policy mandatory in India. The Audit Committee is one of the main pillars of the corporate governance system in public companies.

The main objective of an Audit Committee is to improve the integrity in the Financial Statements. It is also responsible for monitoring the internal control process and risk management systems. Charged with the responsibility to oversight of financial reporting and disclosure, the Audit Committee aims to enhance the confidence in the integrity of the company’s financial reports and announcements, the internal control processes and procedures and the risk management systems. 

This article discusses about the composition of the audit committee as well as the functions of the committee under section 177 of the companies act, 2013 along with the penalty for violation under section 178 of the companies act, 2013.

Relevant Provisions:

Various provisions pertaining to the Audit Committee are governed by following sections/Rules:

  • Section 177 of the Companies Act 2013;
  • Rule 6 and 7 of the Companies (Meetings of Board and its Powers) Amendment Rules, 2020;
  • SEBI Advisory in India (Listing Obligations and Disclosure Requirements) Regulations, 2015.

Significance of the Audit Committee:

The working of an Audit Committee prescribed under the Companies Act, 2013 is significantly different from the Companies Act, 1956.
An Audit Committee acts as the operating committee for the Board of Directors of a company.
It is responsible for seeing the financial reporting, internal process and board disclosures.

  • Compliance with the Laws and Regulations;
  • Supports the Board of Directors in the accomplishment of the Planned Objectives of the Company;
  • Enhances the Integrity of the Financial Reporting of the Company;
  • Enables Better Management;
  • In-depth Scrutiny and Focused Attention on the Internal Control.

Applicability of Audit Committee:

The Board of directors of every listed companies and the following classes of companies, as prescribed under Rule 6 of Companies (Meetings of Board and its powers) Rules,2014 shall constitute an Audit Committee.

  1. All public companies with a paid up capital of Rs.10 Crores or more;
  2. All public companies having turnover of Rs.100 Crores or more;
  3. All public companies, having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding Rs.50 Crores or more.

The paid up share capital or turnover or outstanding loans, or borrowings or debentures or deposits, as the case may be, as existing on the date of last audited Financial Statements shall be taken into account for the purposes of this rule.

Composition of the Audit Committee:

In India, the composition of an Audit Committee can be summarized as:

  • A Minimum of Three Directors as Members;
  • 2/3rd of the Members need to be the Independent Directors;
  • The Chairperson shall be an Independent Director;
  • The Company Secretary (CS) needs to act as the ‘Secretary’ to the Audit Committee.

Further, all the members, including the chairman, must be Financially Literate. Out of all, at least one member needs to have Accounting or Financial Management Expertise.

Composition of Audit Committee:

  • Audit Committee shall constitute of minimum 3 Directors, with independent director forming majority.
  • Audit Committee including its Chairperson shall be persons with ability to read and understand the financial statement.
  • The auditors and KMP of the company shall have a right to be heard in the meetings of the Audit Committee when it considers the auditor‘s report but shall not have the right to vote.

Reconstitution of the Audit Committee:

  • Every Audit Committee of a company existing immediately before the commencement of this Act shall be reconstituted within one year of such commencement (i.e. on or before 31st March 2015).

Functions of an Audit Committee:

Every Audit Committee shall act in accordance with the terms of reference specified in writing by the Board which shall, inter alia, include

  • The recommendation for appointment, remuneration and terms of appointment of auditors of the company;
  • Review and monitor the auditor’s independence and performance, and effectiveness of audit process;
  • Examination of the financial statement and the auditors’ report thereon;
  • Approval or any subsequent modification of transactions of the company with related parties;
  • Scrutiny of inter-corporate loans and investments;
  • Valuation of undertakings or assets of the company, wherever it is necessary;
  • Evaluation of internal financial controls and risk management systems;
  • Monitoring the end use of funds raised through public offers and related matters.

Powers of an Audit Committee:

  • To Call for Comments of the Auditor concerning the Internal Control Systems, the Scope of Audit, including the Observations of the Auditors;
  • To Read and Understand the Financial Statements before their submission to the Board;
  • The Power to discuss any issue with the Internal and Statutory Auditor of the Company;
  • The Power to discuss any matter concerning the Financial Statements with the Management of the company;
  • The Power to obtain Professional advice from External Sources;
  • The Power to have full access to the details and information contained in the records.

Disclosure in the Board’s Report:

  • As per section 134(3), the Board’s Reports hall disclose about the composition of an Audit Committee.
  • If in case, the Board has not accepted any recommendation made by the Audit Committee, the same needs to be disclosed in the Board’s report together with the reasons.

Establishment of Vigil Mechanism:

Every listed company and the companies belonging to the following class or classes, as prescribed under Rule 7 of Companies (Meetings of Board and its powers) Rules, 2014 shall establish a vigil mechanism for their directors and employees to report their genuine concerns or grievances:

  • Companies which accept deposits from the public;
  • Companies which have borrowed money from Banks and PFI in excess of Rs.50 Crores.

Companies required to Constitute Audit Committee:

The companies which are required to constitute an audit committee shall operate the vigil mechanism through the audit committee and if any of the members of the committee have a conflict of interest in a given case, they should recuse themselves and the others on the committee would deal with the matter on hand.

Other Companies:

  • The Board of directors shall nominate a director to play the role of audit committee for the purpose of vigil mechanism to whom other directors and employees may report their concerns.
  • The existence of the mechanism may be appropriately communicated within the organization.
  • The details of establishment of Vigil mechanism shall be disclosed by the company in the website, if any, and in the Board’s Report.


Safeguard to Employees & Directors:

  • The vigil mechanism shall provide adequate safeguards against victimization 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.

Action against Frivolous Complaints:

  • 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 concerned director or employee including reprimand.

Meetings of an Audit Committee:

As per the requirements of the Company Law in India, Audit Committee needs to hold meetings of its members at prescribed intervals in a financial year. Details are as follows:

  • The Audit Committee needs to meet at least four times a year;
  • The time gap between the two meetings must not be more than 120 days;
  • The quorum for the meeting shall either be two members or 1/3rd of the members, whichever is more;
  • The quorum of the meeting shall have at least two independent directors.

Furthermore, the auditors and the management of the company will have a Right to be Heard in the Audit Committee Meetings. However, they cannot cast a vote when the committee is considering the Auditor’s Report.

 

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