Auditors have regularly come under the scanner of market regulators due to the scams unearthed at large corporates, including financial institutions such as the most recent ones at Infrastructure Leasing & Financial Services (IL&FS) and Dewan Housing Finance Corporation Ltd. (DHFL). These scams could have been identified at a much early stage if the auditors acted as independent vigilantes and if internal control measures were not compromised with, frequently.
With a view to plug these gaps, the Ministry of Corporate Affairs (the "MCA") has notified the Companies (Auditor's Report) Order, 2020 (the "Order") on February 25, 20201, superseding the Companies (Auditor's Report) Order, 2016 (the "CARO 16"). Under this Order, every auditor is required to include all matters prescribed therein while preparing the annual audit report of a company. Initially this requirement was applicable on all audit reports prepared by auditors from the financial year April 01, 2019 onwards. However, due to the on-going COVID-19 pandemic and with a view to relax the compliance burden of companies, the MCA by a notification dated March 24, 20202 postponed the applicability of the Order to all audit reports prepared from the financial year April 01, 2020 onwards.
The auditor's report being a public document that is relied upon by various stakeholders, the Order aims to tighten the noose around auditors and directors with respect to reporting requirements and disclosure obligations. This article analyzes the applicability of and highlights the key changes introduced under the Order.
2. APPLICABILITY OF THE ORDER
This Order continues to be applicable to all companies mentioned under the CARO 16 and shall apply to every company including a foreign company3, but shall not apply to the following:
- a banking company4;
- an insurance company5;
- a not-for profit making company6;
- a one person company7, and a small company8; and
- a private limited company (not being a subsidiary or holding
company of a public company), having
- a paid-up capital and reserves and surplus not more than Rupees one crore as on the balance sheet date; and
- which does not have total borrowings exceeding Rupees one crore from any bank or financial institution at any point of time in a financial year, and
- which does not have a total revenue (including revenue from discontinuing operations) exceeding Rupees ten crore during a financial year, as per the financial statements.
3. KEY HIGHLIGHTS
An auditor's report shall, in addition to the matters provided under Section 143 of the Companies Act, 2013 (the "CA 13"), also include a statement on all matters detailed in the Order. For the purpose of this article, we have highlighted below only the additional reporting and disclosure requirements that have been newly introduced under this Order.
- The auditor is required to include a statement on whether a company is maintaining proper records and details of both tangible assets (that is property, plant, and equipment) and intangible assets. Further, in cases where the title deeds of all immovable properties disclosed in the financial statements are not held in the name of the company, the auditor is required to provide the following information in a tabular format, (i) the description of the property, (ii) gross carrying value, (iii) name of the owner and whether the owner is a promoter, director, relative or employee, (iv) the reasons for not holding the property in the name of the company, and (v) if there are any disputes pertaining to the property.
- If the company has undertaken a revaluation of either its tangible or intangible assets and where the change is 10% or more of the net carrying value of each asset, the auditor is required to clarify whether the revaluation is based on a registered valuer's valuation.
- Details of any proceedings initiated or pending against the company for holding any benami property under the Benami Transactions (Prohibition) Act, 1988 are also required to be disclosed.
3.2. Inventory and working capital
- The auditor is required to note if there has been any discrepancy of 10% or more, in the aggregate, for each class of inventory and if so, whether such discrepancies have been properly dealt with in the books of account.
- If any banks or financial institutions have sanctioned working capital limits in excess of Rupees five crore on the basis of security of current assets, then the auditor is also required to comment on whether the quarterly statements filed by the company with such banks or financial institutions are as per the books of accounts.
3.3. Loans, advances, guarantee or any security provided
- With respect to loans, advances, guarantees or security provided by a company either to its subsidiaries, joint ventures, associates or any other party, the auditor is required to disclose the total amount extended during the year, the balance outstanding as on the balance sheet date and confirm that none of the loans or advances are prejudicial to the company's interests.
- With respect to loans and advances granted by a company, the auditor is required to note (i) the schedule of repayment of the principal and interest amounts, (ii) whether the repayments are regular, (iii) for any amounts that are due beyond 90 days, whether reasonable steps have been taken by the company for recovery, (iv) whether loans are renewed or fresh loans are granted to settle the overdues of existing loans, (v) the percentage of the aggregate to the total loans or advances in the nature of loans granted during the year, and (vi) the amount and aggregate percentage of loans or advances granted to promoters and related parties which are repayable either on demand or no specific terms of repayment are provided.
3.4. Unrecorded income
If there are any transactions which were not recorded in the books of account but were disclosed as income during that year in the income tax assessments, under the Income-tax Act, 1961, the auditor shall specify if such unrecorded income is properly recorded in the books of account during the year for which the audit is being conducted.
3.5. Default in repayment of loans or borrowings
- Any default by the company in repayment of loans or borrowings or related interest, shall be disclosed in the audit report in a tabular format specifying the nature of borrowing (including debt securities), amounts due, number of days of delay, among other things.
- The auditor shall record in its report if the company has been declared as a willful defaulter by any bank, financial institution or other lender.
- If the loans or funds raised have been utilized for a purpose other than for which it was obtained, then the auditor shall report the amounts so diverted and the purpose for which it was ultimately used.
- If a company has raised funds to meet the obligations of its subsidiaries, associates or joint ventures or has raised a loan by pledging the securities of its subsidiaries, associates or joint ventures, then the details including the nature of such transactions should be reported.
3.6. Fraud and whistle-blower complaints
If the statutory auditor, in the course of performance of his duties, has reason to believe that an offence of fraud, involving an amount of Rupees one crore or above is being or has been committed against the company by its officers or employees, then the auditor is required to report it to the Government of India in Form ADT-4 and should include such details in the audit report. Further, the auditor shall also record whether he has considered the whistle-blower complaints (if any) received by the company.
3.7. Compliance by Nidhi Company
For a Nidhi Company9, any default in payment of interest on deposits or repayment thereof for any period shall be reported by the auditor.
3.8. Internal audit system
The auditor is required to include a comment on whether the internal audit system of a company is commensurate with the size and nature of its business and whether the reports of the internal auditors for the period under audit were considered by the statutory auditor10.
3.9. Compliance of the regulations prescribed by the Reserve Bank of India (the "RBI")
If the company has carried on any non-banking financial or housing finance activities without obtaining a valid certificate of registration from the RBI, then the auditor is required to record the same. If a company is a Core Investment Company (a "CIC") as defined under the RBI regulations, the auditor is required to report whether it has fulfilled the criteria of a CIC and if it is an exempted or unregistered CIC, state whether the company continues to fulfil such criteria. Further, if the group companies also include other CIC's, then the auditor is required to indicate the number of CIC's forming part of the group.
3.10. Cash losses
The auditor shall include in its report whether a company has incurred any cash losses in the financial year or in the immediately preceding financial year and the amount of cash losses so incurred.
3.11. Resignation of statutory auditors
A statement in relation to whether any of statutory auditors have resigned during the year, and if so, whether the auditor has considered the objections, issues or concerns raised by the outgoing auditors.
3.12. Material uncertainty
Based on the financial ratios, information in the financial statements, expected dates of realization of financial assets and payments of financial liabilities, and the board and management plans, the auditor is required to give its opinion on whether any material uncertainty exists as on the date of the audit report and if the company is capable of meeting its liabilities as and when they fall due within a period of 1 year from the date of the balance sheet.
3.13. Corporate social responsibility
With respect to any ongoing corporate social responsibility ("CSR") related projects, the auditor is required to certify if any unspent amount has been transferred to a special account in compliance with the requirements under Section 135 (6) of the CA 13. Similarly, the auditor is also required to report whether any unspent monies which were originally earmarked towards CSR activities have been transferred to a fund in accordance with the requirements under Section 135 (5) of the CA 13, within a period of six months from the expiry of the financial year.
3.14. Consolidated financial statement
It is interesting to note that the requirements under this Order, shall not be applicable to audit reports prepared in relation to consolidated financial statements. However, if any adverse remarks or qualifications are included in the previous audit reports of the companies included in such consolidated financial statements, then the auditor is required to indicate the details of the companies and paragraph numbers of the report containing such qualifications or adverse remarks.
Typically, auditors are expected to undertake an independent due diligence on the affairs of a company such that the audit reports indicate an unbiased view on the activities of the company. This Order is expected to improve the reporting and disclosure standards of companies and protect investors and shareholders against promoter mismanagement, embezzlement or corporate frauds. Requiring detailed comments from an auditor on the financial statements of a company will slowly but surely pave the way for greater transparency and faith in the financial affairs of the company.
3 As per the section 2(42) of the Companies Act, 2013, "foreign company" means any company or body corporate incorporated outside India which,(a) has a place of business in India whether by itself or through an agent, physically or through electronic mode; and (b) conducts any business activity in India in any other manner.
4 As per the clause (c) of section 5 of the Banking Regulation Act, 1949, "banking company" means any company which transacts the business of banking in India; Explanation.--Any company which is engaged in the manufacture of goods or carries on any trade and which accepts deposits of money from the public merely for the purpose of financing its business as such manufacturer or trader shall not be deemed to transact the business of banking within the meaning of this clause.
5 As defined under the Insurance Act,1938.
6 Such a company should be duly registered under section 8 (Formation of Companies with Charitable Objects, etc.) of the Companies Act, 2013.
7 As per the section 2(62) of the CA 13, "one person company" means a company which has only one person as a member.
8 As per the section 2(85) of the CA 13, "small company" means a company, other than a public company,—(i) paid-up share capital of which does not exceed fifty lakh rupees or such higher amount as may be prescribed which shall not be more than ten crore rupees; and (ii) turnover of which as per profit and loss account for the immediately preceding financial year does not exceed two crore rupees or such higher amount as may be prescribed which shall not be more than one hundred crore rupees: Provided that nothing in this clause shall apply to—(A) a holding company or a subsidiary company; (B) a company registered under section 8; or (C) a company or body corporate governed by any special Act.
9 As per the Rule 3 (da) of the Nidhi Rules, 2014, "Nidhi" means a company which has been incorporated as a Nidhi with the object of cultivating the habit of thrift and savings amongst its members, receiving deposits from, and lending to, its members only, for their mutual benefit, and which complies with the rules made by the Central Government for regulation of such class of companies.
10 As applicable only to such companies prescribed under section 138 of the CA 13 read with Rule 13 of The Companies (Accounts) Rules, 2014.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.