A Relative on the Board and Unpaid Fees: When the Firm Has Already Lost Its Eligibility
Kalpataru Weaves Private Limited (KWPL) has paid-up capital of ₹4 crore, free reserves of ₹2 crore, total borrowings of ₹8 crore from an NBFC, turnover of ₹96 crore and 1,100 employees. It is not a subsidiary of a public company. Your firm has been its statutory auditor since FY 2022-23 and is currently auditing FY 2025-26.
Four facts emerge. (i) The engagement partner's spouse was appointed whole-time director of KWPL on 1 January 2026 and resigned on 31 March 2026; the fact was disclosed to you only in May 2026. (ii) KWPL's audit fee of ₹6.8 lakh for FY 2024-25, billed in March 2025, remains unpaid at the date of the FY 2025-26 report. (iii) KWPL's 'internal audit' is performed by two CA article assistants reporting to the CFO. (iv) The fixed-asset register shows plant and machinery of ₹3.1 crore verified by management in FY 2024-25; your physical verification in February 2026 located plant of ₹2.4 crore at the factory and ₹40 lakh at a job worker's premises, and the register was not updated.
1. Assess the firm's eligibility under section 141(3) on facts (i) and (ii), and state what should have happened and what should happen now.
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(i) Relative as director. Section 141(3)(f) disqualifies a person whose relative is a director, or is in the employment of the company as a director or key managerial personnel. A spouse is a relative. The firm became disqualified on 1 January 2026. The spouse's resignation on 31 March 2026 does not retrospectively cure work done or reports signed while the disqualification subsisted. Section 141(4) required the firm to vacate office as soon as the disqualification arose; staying on was a contravention, and any report signed during that window is not a valid report.
(ii) Unpaid fees. Section 141(3)(d)(i) disqualifies a person indebted to the company for more than ₹5 lakh. Overdue professional fees for the preceding year - here ₹6.8 lakh billed in March 2025 and still unpaid - are treated as indebtedness under the Code and the Council's position (the position differs where the fee is genuinely not yet due under agreed terms; that is not the case here). The firm is therefore disqualified while the amount remains outstanding. A guarantee or security above ₹1 lakh is a separate trigger.
What should have happened. The firm should have notified the Board in writing on 1 January 2026 and vacated office, and it should not have allowed fees to remain outstanding beyond the year.
What should happen now. Both disqualifications independently bar the firm from signing. The practical route is immediate resignation so the company can appoint a successor without further delay, with a written notification to the Board setting out the facts, and escalation within the firm to the ethics partner and the quality-management function.
2. If the firm resigns, set out the procedural steps and timelines and what the incoming auditor must do before accepting.
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Resignation. Under section 139(8)(a) a vacancy caused by resignation is a casual vacancy filled by the Board within 30 days, and the appointment must be approved by the members within three months. Under section 140(2) the resigning auditor must file a statement in Form ADT-3 with the company and the Registrar within 30 days of resignation, setting out the reasons and any matter the auditor wishes to bring to the members' attention - here, the disqualification, described factually and without disclosing client confidences. Communicate with the audit committee under SA 260 and consider whether any matter requires reporting under section 143(3).
Incoming auditor, before accepting.
- Communicate in writing with the previous auditor and obtain a no-objection (clause 8 of Part I of the First Schedule); accepting without it is professional misconduct.
- Check the ceiling on company audits under section 141(3)(g) and the firm's other eligibility under section 141(3).
- Treat it as an initial audit engagement under SA 510. The predecessor audited the first nine months of FY 2025-26 in substance, so the incoming auditor needs evidence on opening balances and on the transactions of that period: request access to the predecessor's working papers with the client's written consent, and if access is refused, design alternative procedures.
- Reassess the opening balances and the comparatives; if sufficient evidence cannot be obtained, the opinion may need modification on the comparatives (SA 510 read with SA 710).
- Obtain the audit committee's approval and document the acceptance decision, including the reason for the change.
3. State whether CARO 2020 applies to KWPL, and how you report on the internal audit arrangements and on the fixed-asset verification.
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Applicability. The private-company exemption in CARO 2020 applies only if the company is not a holding or subsidiary of a public company and both (a) paid-up capital plus reserves are ₹1 crore or less and (b) total borrowings are ₹1 crore or less at any time during the year. KWPL fails both: capital plus reserves are ₹6 crore and borrowings are ₹8 crore. CARO 2020 therefore applies in full.
Internal audit. The section 138 read with Rule 13(1) requirement does not apply - for a private company the thresholds are turnover of ₹200 crore or borrowings of ₹100 crore, and KWPL is below both. The CARO clause on the internal audit system applies only to listed companies or companies exceeding specified size thresholds (paid-up ₹50 crore, turnover ₹200 crore, borrowings ₹100 crore, deposits ₹25 crore), none of which KWPL meets, so the clause is reported as not applicable with the reason stated. That does not make the arrangement acceptable: two article assistants reporting to the CFO is a segregation-of-duties weakness in an entity of this size and should be reported to those charged with governance under SA 265 as a significant deficiency.
Fixed assets. CARO requires the auditor to report whether proper records showing full particulars are maintained, and whether physical verification at reasonable intervals revealed material discrepancies. Here the register omits the job-worker location, and the shortfall is ₹30 lakh (₹3.1 crore recorded against ₹2.8 crore located) - about 9.7% of the plant balance. Report it as a material discrepancy not properly dealt with in the books, ask management to investigate and reconcile, and consider whether a write-down or impairment is required under the applicable accounting standards.