1.3 - Query

Relationship between the statutory auditor and other auditor
appointed for limited purpose

1. The querist is a practicing chartered accountant. One of his client is a private limited company (hereinafter referred as ‘X’ Ltd.). The company has appointed another practicing chartered accountant (hereinafter referred as ‘Y’) as ‘stock auditor’, who conducts hundred per cent audit of the stocks of ‘X’ Ltd. The financial year of the company is calendar year. Until 1981, the stock accounts, as certified by ‘Y’, formed part of the accounts, for information required to be given for stocks as per Schedule VI to the Companies Act, 1956 After their adoption by the directors of ‘X’ Ltd., these were sent to querist as the statutory auditor of the company. This practice continued for 5—6 years.

2. ‘Y’ in his Stock Audit Report has made the following observations on the aforesaid practice:

“Item No. 4: The practice of attaching the statements enclosed herewith, with the Audited Balance Sheet of the Company which has been followed so far by the Company is not correct and is not in keeping with the requirements of the Companies Act, 1956. We have therefore to suggest that the same be discontinued with immediate effect”.

3. In the conduct of audit of year 1982, the statutory auditor (i.e. the querist) received from ‘X’ Ltd., the Stock Movement Certificate on 13th August 1983, which was duly signed by ‘Y’, dated 1st July, 1983. The querist submitted his queries to ‘X’ Ltd. on the said Certificate on 23rd August, 1983 and requested for the stock records for the years 1981 and 1982. The querist received modified stock statement on 8th September, 1983, duly certified second time by ‘Y’, dated 1st September, 1983. The querist subsequently raised further queries regarding valuation of work in progress, components, raw materials etc., which were replied to by the company. On 21st October, 1983, the querist sought clarifications from ‘X’ along with some other queries on the two Stock Movement Certificates dated 1st July, 1983 and 1st September, 1983 a copy of which was sent to ‘Y’ for his comments. ‘Y’ clarified vide his letter dated 22nd October, 1983 that the earlier Certificate was no more relevant in view of the modification of stock accounts and therefore was to be cancelled. On 1st November, 1983, the querist once again sent queries on the balance sheet adopted by the directors of ‘X’ Ltd., with a copy to ‘Y’ for his comments since many of the queries related to stocks. ‘X’ Ltd. replied to these queries on 11th November, 1983. On 15th November, 1983, the querist wrote a letter to ‘Y’ stating that unless he hears from him to the contrary, whether the querist could consider that ‘Y’ agrees to the replies sent by ‘X’ Ltd. ‘Y’ replied to the said letter stating therein that in view of the factual nature of the explanations provided by the company which he had verified, he had no additional comments to offer. Thereafter, there was a protracted correspondence between the querist and ‘Y’. As the former was not satisfied with the views expressed by ‘Y’, therefore, the querist wanted to refer the matter to a third party such as the Institute of Chartered Accountants of India since the question of professional relationship was involved. ‘Y’ however felt that there was no such need as no such question was involved and therefore suggested that there should not be any further correspondence between them.

4. In the context of the above facts, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i) Whether the professional responsibility of a fellow member as an internal auditor of a company is confined to his employer only?

(ii) If the answer to (i) above is in the affirmative, how it is consistent with the rule that a member of the Institute in discharging his professional duty will be entitled to rely on the work of a fellow member?

(iii) In the circumstances of the query, if there is an alleged deliberate omission to misguide the statutory auditor rather than assist him in discharge of his duty to the detriment of the statutory auditors and benefits to the client, whether the alleged actions of the fellow member be construed as misconduct?


January 8, 1985

1. The Committee’s opinion as given below is on the matters of principle raised by the querist in para 4 above.

2. The Committee notes that in the ‘Guidance Note on Co-ordination Between the Internal Auditor and Statutory Auditor’, issued by the Research Committee of the Institute of Chartered Accountants of India, it has been stated that “……….the internal auditor being appointed by the management, his reporting responsibility is confined to different levels of management. He is neither obliged nor free to report to outsiders”(Para 3(ii) on page 3), and that “The extent of work undertaken by the Internal Auditor is determined by the management…..” (Para 3 (iii) on page 3).

3. The Committee is of the view that though the statutory auditor can rely upon the work performed by the internal auditor for the purpose of his audit, yet the statutory auditor continues to be responsible to the shareholders for relying on the work of the internal auditor. Thus, he has to be extremely careful while placing such reliance on the work performed by the internal auditor. With this in view, it has been stated in para 5 of the aforesaid Guidance Note: “In order to determine whether and to what extent the statutory auditors may rely on the work of internal auditors, they should review the work of Internal Auditors and consider their competence, objectivity, and work performance”. Para 7 of the Guidance Note further states : “In spite of close co-operation and co-ordination between the Internal and the Statutory Auditors, the ultimate responsibility for reporting on financial statements is that of the Statutory Auditors and he cannot under any pretext take shelter on the plea that he relied blindly on the work of the Internal Auditor”.

4. On the basis of the above, the opinion of the Expert Advisory Committee, on the issues raised by the querist in para 4 above, is as below:

(i) The professional liability of a member as an internal auditor of a company is confined to the employer only.

(ii) In the opinion of the Committee, the above view is not inconsistent with the statutory auditor’s entitlement to rely on the work of the internal auditor, since the former is at liberty not to place such reliance if he considers that the work performed by the internal auditor is not of the quality expected by the statutory auditor.

(iii) The Committee refrains from expressing any opinion on this issue in view of Rule 2 of the Advisory Service Rules.*

* The Rules are given as Appendix A.