Verification of the constitution and powers – A company can function within the limits prescribed by the documents on the basis of which it has been registered. It raises its capital from the public on certain conditions, specified in the Prospectus. Before commencing business, to purchase a property or to have subscription to its capital underwritten. On this account, it is essential that the auditor, prior to starting the audit of a company, shall examine :
- The Memorandum of Association.
- The Articles of Association.
- Contracts entered into with vendors and other persons relating to purchase of property, payment of commission, etc.
A company cannot enter into a contract before it has been registered. What is more, a public company cannot commence business until the certificate of commencement of business has been granted to it by the Registrar of Companies. It is, therefore, the duty of the auditor to take into account, while examining the transaction entered into by the company, the dates when these were entered into for confirming the validity. With a view to carrying out the audit effectively, it is necessary that the auditor should know the authority structure of the company. Under Section 291 of the Act, the Board of Directors of a company are entitled to exercise all such powers, and to do all such acts and things, as the company is authorised to do. However, the Board shall not exercise any power or do any act or thing which is directed or required by any legislation (including the Companies Act) or by the memorandum or articles of the company, to be exercised or done by the company, in general meeting. Section 292 specifies six types of decisions that can be taken by the Board of Directors only in Board’s meetings. These relate to :
- making calls on partly paid shares.
- issue of debentures,
- borrowing monies otherwise than on debentures,
- investing the funds of the company, and
- making loans.
The transaction barring the first three can be delegated to any of the following :
- a committee of directors,
- managing director,
- any other principal officer of the company, or
- principal officer of the branch office, in relation to the branch.
Apart from the above, a number of other functions are also carried out by the Board. A few of such functions are stated herein by way of examples :
- Adopting of accounts before the same submitted to the auditor for their report-Section 215.
- Appointment of the first auditors and filling of casual vacancy – Section 224.
- Investment in shares of companies within the limits specified in Section 372A.
- Entering into contracts with persons who are directors of the company or related to or associated with the directors as are specified in Section 297 of the Act.
Some of the matters which only the shareholders can sanction at a general meeting :
- Appointment and fixation of remuneration of auditors in the annual general meeting – Section 224.
- Declaration of dividends – Regulation 85, Table A.
- Appointment of relatives of directors etc. to an office or place of profit in the company under Section 314 of the Act.
- Sale, lease or a disposal of the whole of the company’s undertaking or a substantial part of it and donations above a certain limits [Section 293(1)].
Matters which require sanction of the Central Government :
Loans to directors by a company other than a banking or a finance company (Section 295). For verifying the foregoing transactions and others authorised by the directors or shareholders, the auditor should refer to the minutes of the meeting at which these have been considered. Further, for judging the validity or otherwise of section accorded, the relevant provision of law must be referred to. A few such instances are given below :
- Appointment of Directors (Section 256).
- Disqualifications of Directors (Section 274).
- Conduct of Board Meeting (Sections 285-290).
- General powers of Board (Section 291).
- Powers which the Board must exercise only at a meeting (Section 292).
- Restriction on powers of the Board regarding disposal of the undertaking or part of it etc. (Section 293).
- Prohibitions and restrictions regarding political contributions (Section 293A).
- Power of Board and other persons to make contributions to the National Defence Fund, etc. (Section 293B).
- Restriction on advancing loans to Directors, etc. (Section 295).
- Restriction on a Director or his relative, a firm in which a director or relative is a partner; or any other partner of the firm or a private company of which such a director is a member or director to enter into a contract of sale or purchase of goods except with the sanction of the Board of Directors (Section 297).
- Restriction on an interested director in participating in or voting at Board’s proceedings (Section 300).
- Disclosure of interest by directors (Section 299).
- Register of contracts, Companies or firms in which directors are inspected (Section 301)
- Remuneration of directors (Section 309).
- Restraint on a director’s holding offices or places of profit (Section 314).
- Restraint on payment of compensation for loss of office to a director (Sections 318 to 321).
- Restriction on loans, etc., to companies under the same management (Section 370).
- Regulation of inter-corporate loans and investments (Section 372A).
Special considerations involved in the examination of certain documents
- Memorandum of Association – It is a charter containing particulars of business activities that the company can undertake and the powers it can exercise in regard thereto. Only on a consideration thereof it is possible for the auditor to determine whether a transaction which has been entered into by the company is intra vires, i.e. the company is authorised to enter into it. If a company enters into a transaction which is ultra vires, the shareholders, though entitled to claim the profit arising on such a transaction, may restrain the management from charging the loss, if any, has been suffered thereon, to the company. If the auditor fails to detect and report the transaction which are ultra vires the company, he would be guilty of negligence. Generally the Memorandum of Association of companies is drawn up comprehensively in order that the company may be able to enter into a wide variety of transactions which it may be required to do for carrying out one or more of its objects. Nevertheless, sometimes occasions arise when a company, inadvertently, or deliberately, enters into a transaction which is ultra vires objects to powers. In such a case, the shareholders may decide to restrain the management from charging to the company the losses suffered by the company in respect of such a transaction.
- Articles of Association – These are rules and regulations for the internal management of the company; and they define the rights of different classes of shareholders, conditions under which calls can be made, the maximum and minimum number of directors the company can have, their qualifications, disqualifications and removal, etc. The terms and conditions of these provisions have relevance to the examination of transaction, that the auditor is required to carry out. He should, therefore, study the Articles and include extracts from them in his permanent audit file. The auditor, who fails to take note of the provisions in the Articles in the verification of statements of accounts, would be guilty of professional negligence. While delivering judgment in the case, Leeds Estate Building and Investment Co. v. Shepherd, Starling J. said, “It is the duty of the auditor to see that the balance sheet is a true and correct representation of the company’s affairs. It was no excuse that the auditor had not seen the articles when he knew of their existence.” The auditor must, therefore, acquaint himself with the provision of the Articles of the company and should apply this knowledge in the verification of the transactions of the company.
- Prospectus – It is a formal document which a public company must issue before it makes the allotment of shares under section 56. It must contain all the terms and conditions on which subscription to the shares is sought to be obtained from the public e.g. the company may stipulate, that it would obtain a quotation for its shares at a Stock Exchange or that it shall purchase a property which is considered valuable for the company or that it has obtained the services of technical experts whose services will be valuable for setting up the factory. In case the company fails to carry out any of these undertakings or if any statement made by it ultimately is proven to be false, the shareholder has the option to claim refund of the amount paid by him. The auditor should, therefore, study carefully all the conditions and stipulations made in the prospectus and, in case any of them has not been carried out, to draw the attention of shareholders thereto. It may be noted that the right to claim refund is restricted to such of the shareholders who subscribed for shares on the basis of prospectus. A shareholder who has purchased the shares from stock exchange or otherwise cannot claim
refund. Section 60A inserted by the Companies (Amendment) Act, 2000 has introduced the concept of “Shelf Prospectus”. Such prospectus would enable companies engaged in financial activities to raise money by way of offer of securities more than once during its validity and, in such case, only an information memorandum stating certain material particulars. Section 60B has introduced the concept of “red-herring” prospectus. Accordingly, section 60B involves concept of information memorandum also.