Clause 4(vii) of CARO, 2003 requires the auditor to comment whether the company has an internal audit system commensurate with the size and nature of the business. The clause is required to be commented upon by the auditor in case of companies having a paid-up capital and reserves exceeding rupees 50 lakhs as at the commencement of the financial year concerned, or having an average annual turnover exceeding five crores rupees for a period of three consecutive financial years immediately preceding the financial year concerned. This clause has a mandatory application for the listed companies irrespective of the size of paid-up capital and reserves or turnover. It may be noted that the Order does not specify the date with reference to which the listing status of the company should be determined. In this regard, it is clarified that if the company is listed on a recognised stock exchange as on the date of the balance sheet, it should be considered as listed for the purpose of this clause. In respect of non-listed companies the clause is applicable only if:
- the paid-up capital and reserves of the company are more than rupees fifty lakhs as at the commencement of the financial year; or
- average annual turnover exceeds rupees five crores for a period of three consecutive financial years immediately preceding the financial year concerned.
In other words, companies which have a paid-up capital and reserves of rupees fifty lakhs or less as at the commencement of the financial year as well as the companies which have an average annual turnover of rupees five crores or less for a period of three consecutive financial years immediately preceding the financial year concerned are excluded from the applicability of the clause. A company may either have its own internal audit department or entrust the work of internal audit to an outside agency. In the case of a group of concerns, it is also quite common to have a central internal audit department. The arrangement which is more suitable will depend upon the circumstances of each company but generally, where a company is small, it may find it expensive to have its own internal audit department staffed by personnel having the requisite qualifications. The auditor has to examine whether the internal audit system is commensurate with the size of the company and the nature of its business. The following are some of the factors to be considered in this regard:
- What is the size of the internal audit department?
- What are the qualifications of the persons who undertake the internal audit work?
- To whom does the internal auditor report?
- What are the areas covered by the internal audit?
- Has the internal auditor adequate technical assistance?
- What are the reports which are submitted by the internal auditor or what other evidence is there of his work?
- What is the follow-up?
It is important to note that the Companies Act, 1956 does not require a company to necessarily have an internal audit system. However, where such a system does not exist, the Order requires the auditor to mention the fact in his report. Moreover, since this part of the Order refers only to such companies which are either listed or companies having a paid-up capital and reserves in excess of rupees 50 lakhs or an average annual turnover in excess of rupees 5 crores for a period of three consecutive financial years immediately preceding the financial year concerned, it is desirable that such a company has an internal audit system. It is equally important to note that the internal audit system is a part of the overall internal control system. Therefore, the scope of the internal audit and the extent of its coverage will, to some extent, depend upon the existence or otherwise of other forms of internal control. This is also a factor to be considered when evaluating the adequacy of the internal audit system.