Brief facts of the enquiry

Company A is a private limited company falling under Medium-Sized Company (MSC) as per the third Schedule of the Companies Act, 2017 on the basis of paid-up capital, turnover, and the number of employees in the financial year 2018 ended on June 30, 2018. Auditor B is a firm of chartered accountants with no QCR rating and has audited the financial statements for that year.

In the financial year 2019, the turnover of the company exceeded Rs. one billion and the same auditor B audited the financial statements for that year.

For the financial year 2020, the same auditor B issued his consent in October 2019 and was appointed in AGM held in the same month. At that time Auditor B was ignorant whether the turnover of the company would increase or decrease till the receipt of financial data in the month of September 2020 for audit and started audit for that year. But when he finalized the audit, he found that the turnover of the company was again above Rs. one billion. Now he is unable to withdraw from the audit of financial statements for that year because he finalized his audit work and the financial year of the company also expired on June 30, 2020, and a new auditor can also not be appointed for that year.

In the above situation, what are the responsibilities of auditor B and of company A? Whether auditor B can issue an audit report for that year or not?

The Auditing Standards and Ethics Committee’s comments and conclusion

1.The Committee considers and concludes on audit and ethics-related enquiries after consideration of:

•The particular facts and information provided in each enquiry; and

•The requirements of the International Standards on Auditing as applicable in Pakistan (ISAs), Code of Ethics, and provisions of the Companies Act, 2017 (the Companies Act) relating to the statutory audit and auditor.

The Committee’s analysis and responses to the enquired matters are based on the parameters outlined above and do not include ascertainment of facts relating to the enquired matter or study/evaluation of the legal and statutory obligations.

Requirement for appointment of satisfactory QCR rated statutory auditor

2.The Committee noted that a company is required to appoint a statutory auditor in accordance with the statutory provisions applicable to such a company, including the Companies Act and S.R.O. 1044 (I)/2015 issued by the Securities and Exchange Commission of Pakistan (SECP).

3.Under S.R.O. 1044 (I)/2015, a ‘large-sized company’ is required to appoint a statutory auditor who holds a satisfactory QCR rating under the Quality Control Review (QCR) Program of the Institute.

The relevant extract of S.R.O. 1044 (I)/2015 is provided below:

“….. hereby directs following categories of non-listed companies, designated in terms of the Fifth Schedule to the Ordinance, to appoint Chartered Accountant firms within the meaning of Chartered Accountants Ordinance 1961 and Chartered Accountant Bye-laws 1983 which holds satisfactory rating under the Quality Control Review Program of the Institute of Chartered Accountants of Pakistan as their statutory external auditors, namely:

1) Public Interest Companies;

2) Large-sized Companies; and

3) Public Interest and Large-sized Companies licensed/formed under section 42 and section 43 of the repealed Companies Ordinance.”

Classification of a company as large-sized under the third schedule to the Companies Act

4.The Committee noted that the criteria for the classification of a company for financial reporting purposes, including classification as a ‘large-sized company’, are provided in the third schedule to the Companies Act.

A non-listed company, foreign company, or a non-listed company licensed under section 42 or section 45 of the Companies Act would be a large-sized company, subject to the following criteria:

a)“Non-listed company with:

(i) paid-up capital of Rs.200 million or more; or
(ii) turnover of Rs. 1 billion or more; or
(iii) Employees more than 750.

b)A foreign company with a turnover of Rs. 1 billion or more.

c)Non-listed Company licensed/formed under Section 42 / Section 45 of the Act having annual gross revenue (grants/income/subsidies/donations) including other income/revenue of Rs.200 million and above”.

Regarding the change in classification of a company, ‘Notes’ of the third schedule state that:

2.“The classification of a company shall be based on the previous year’s audited financial statements.

3.The classification of a company can be changed where it does not fall under the previous criteria for two consecutive years”.

5.The Committee observed that in the enquired matter the primary aspect is to determine whether the classification of the company has changed, and resultantly company has become a ‘large-sized company’ in the year ended 2020.

6.The Committee also noted that determining the change in classification of a company for financial reporting purposes emanates from the provisions of the third schedule to the Companies Act (noted in paragraph 4 above). The application of these provisions of the Companies Act requires interpretation, and the Committee, accordingly, engaged with the SECP to seek its clarification on the matter.

7.In response to the Committee’s request for clarification on the submitted fact pattern, SECP explained that:

“Following two checks need to be performed to determine the status of the company for the year 2019-20:

Test 1: As per the previous year’s audited accounts i.e. FY 2018-19, the company has met the criteria of a large-sized company.

Test 2: To change status, the company should have met the criteria for the previous two consecutive years, i.e. 2017-18 and 2018-19. The company has not met the criteria of a large-sized company in the year 2017-18, therefore, it is a medium-sized company for the year 2019-20. Therefore, the applicable accounting framework would be a medium-sized company for the year 2019-20.

Accordingly, the auditor of the company for the year 2019-20 can be a non-QCR rated firm.

However, it should be noted that at the time of appointing an auditor for next year i.e. 2020-21, it is known that the company has to be reclassified as a large-sized company since it has now met the criteria for two consecutive years. Therefore, all necessary steps should be taken, i.e. auditor to be appointed for the year 2020-21 should be a QCR-rated firm.”

8.The Committee, based on the information provided in the enquiry and SECP’s response on the application of the relevant provisions of the third schedule to the Companies Act, concluded that in the enquired fact pattern the statutory auditor for the year ended 2020 can be a non-QCR rated firm, and such auditor can issue the audit report on the financial statements for the year ended 2020.

(Issued in April 2022)