[Opinion] Consequences of Non-appointment of Internal Auditor under the Companies Act 2013

1. Internal Audit

As per the definition given by the Institute of Internal Auditors, USA, internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. Internal audit is performed by professionals with an in-depth understanding of the business culture, systems, and processes, the internal audit activity provides assurance that internal controls in place are adequate to mitigate the risks, governance processes are effective and efficient, and organizational goals and objectives are met.

1.1 Purpose of internal audit

The internal audit is done by checking whether the company has complied with all the applicable laws and thereafter, a report is prepared by the Internal Auditor stating the compliances and material deviations if any. The internal auditor has to ensure that he should keep in mind the requirements with respect to internal audit as per the Companies Act, 2013.

The Companies Act 2013 does not prescribe any format or procedure in the Act to conduct an internal audit or to prepare a report thereof. Therefore, the companies have the privilege to conduct the internal audit as per their size and requirements. However, the report so prepared is required to mention the compliances and the deviations found if any and the method to rectify the errors so found. The process should be given due weightage as it analyses the state of affairs of the Company and should be conducted fairly and transparently with reference to the risk and internal checks and internal control mechanism.

2. Regulation governing the Internal Audit

The Companies Act 2013 vide its section 138 (1) has a provision stating that such class or classes of companies as may be prescribed shall be required to appoint 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 of the company. The relevant section is reproduced from the Companies Act for ready reference

2.1 Section 138(1) of Companies Act 2013

Section 138(1) of the Companies Act 2013,spells out that”Such class or classes of companies as may be prescribed shall be required to appoint an internal auditor, who shall either be a chartered accountant or a cost accountant, or such other professional as may be decided by the Boardto conduct an internal audit of the functions and activities of the company.” Rule 13 of Companies (Accounts) Rules 2014, spells out the class of companies which are required to appoint an internal auditor.

3. Companies covered under internal audit

According to Rule 13 of the Companies (Accounts) Rules, 2014 following class or classes of companies shall be required to appoint an internal auditor or firm of internal auditors, namely:

(a) every listed company;

(b) every unlisted public company having-

(i) paid up share capital of 50 crore rupees or more during the preceding financial year; or
(ii) turnover of 200 crore rupees or more during the preceding financial year; or
(iii) outstanding loans or borrowings from banks or public financial institutions exceeding 100crore rupees or more at any point of time during the preceding financial year; or
(iv) outstanding deposits of 25 crore rupees or more at any point of time during the preceding financial year; and

(c) every private company having-

(i) turnover of 200 crore rupees or more during the preceding financial year; or
(ii) 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.

4. Penal provisions for default/non-compliance

Section 450 of the Companies Act 2013 provides that if a company or any officer of a company or any other person contravenes any of the provisions of this Act or the rules made thereunder, or any condition, limitation or restriction subject to which any approval, sanction, consent, confirmation, recognition, direction or exemption in relation to any matter has been accorded, given or granted, and for which no penalty or punishment is provided elsewhere in this Act the company and every officer of the company who is in default or such other person shall be liable to a penalty of ten thousand rupees, and in case of continuing contravention, with a further penalty of one thousand rupees for each day after the first during which the contravention continues, subject to a maximum of two lakh rupees in case of a company and fifty thousand rupees in case of an officer who is in default or any other person.

5. Consequences of default/non-compliance

To understand the consequences of any default while complying with the provisions of section 138(1) of the Companies Act 2013 relating to the appointment of internal auditor in specified class (es) of companies, let us go through the decided case law by the Registrar of Companies, Gujarat, Dara & Nagar Havelion this matter on 2nd January 2023 in respect of M/s Indu Nissan Oxo Chemical Industries Limited.

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