The Institute of Chartered Accountants of India (ICAI) has recently issued a Guidance Note on the Companies (Auditor's Report) Order (CARO), 2016 ("the Guidance"). CARO, 2016 ("the Order") is in supersession of the CARO, 2015. The requirements of the Order are supplemental to the Section 143 of the Companies Act, 2013. The Guidance provides explanations and clarifications on the matters specified in the Order on which auditors are required to report. It includes specific guidance on each clause of the Order, relevant provisions of the Companies Act, 2013, word by word comparison of the Order with CARO, 2015 and has an illustrative checklist on the Order, etc.
2.0 Applicability of the Order
The Order shall apply to every company including a foreign company, except:-
(i) a banking company;
(ii) an insurance company;
(iii) section 8 company;
(iv) a One Person Company and a small company; and
(v) a private limited company, not being a subsidiary or holding company of a public company, having paid-up capital and reserves equal to or less than Rs. 1 crore as on the balance sheet date and total borrowings equal to or less than Rs. 1 crore from any bank or financial institution at any point of time during the financial year and total revenue (including revenue from discontinuing operations) equal to or less than Rs. 10 crore during the financial year as per the financial statement.
The Order shall not apply to the auditor's report on consolidated financial statements.
The Guidance provides following explanations in respect of applicability of the Order:-
a) The Order shall apply to foreign companies when an audit of the company is required by the Companies Act, 2013.
b) A small company will be exempted even if it meets criteria for a private limited company.
c) A company registered under section 25 of the Companies Act, 1956 is also exempted from the applicability of the Order.
d) A private limited company will be exempted only if it satisfies all the conditions.
e) For the purpose of determining applicability of the Order on a private limited company, amount of share application money received should not form part of paid-up capital. The paid-up capital should be decreased by the amount of unpaid calls and should be increased by the amount originally paid on forfeited shares. The total amount of reserves & surplus disclosed in the financial statements should be taken. As far as borrowings are concerned, it includes fund-based credit facilities, non-fund based credit facilities to the extent devolved and converted into fund-based credit facilities, interest accrued and due on term loans and outstanding dues in respect of credit card bills.
f) The meaning of financial institution should be taken from the section 451(c) of the RBI Act, 1934, read with the section 2(39) of the Companies Act, 2013. NBFCs are also covered under financial institutions.
3.0 Matters to be included in the Auditor's Report
The auditor should report on the following matters:-
3.1 Clause (i):
(a) Whether the company is maintaining proper records showing full particulars, including quantitative details and situation of fixed assets;
(b) whether these fixed assets have been physically verified by the management at reasonable intervals; whether any material discrepancies were noticed on such verification and if so, whether the same have been properly dealt with in the books of account;
(c) whether the title deeds of immovable properties are held in the name of the company. If not, provide the details thereof.
In this regard, the Guidance provides following explanations and clarifications:-
i. The meaning of proper record and reasonable interval varies from case to case according to the facts and circumstances. So, determination of proper record and reasonable interval is a matter of judgement by the auditor. Proper record can also be maintained in an electronic form.
ii. If custody of the assets has been transferred to any employee then the record should indicate the name and designation of the employee who has custody of the assets.
iii. Intangible assets can be verified with reference to purchase agreements. Patents, trademarks and designs can be verified by the agreements/registration/grant certificates.
iv. The auditor should examine the appropriateness of method of physical verification by considering circumstances relating to each asset.
v. To examine whether a discrepancy on physical verification is material or not, the auditor should consider the cost of the asset in respect of which discrepancy has been found, its nature & situation and other relevant factors. The auditor is not required to provide details or treatment of material discrepancies in the books of account.
vi. The auditor should reconcile the available title deeds of immovable property with the fixed asset register. In case of conversions of partnership or LLP into company or mergers/amalgamation of the company, the auditor should carry out detailed examination of title deeds of immovable property, as in such cases the title deeds may not be transferred. The auditor should ask confirmation from the banks or financial institutions if the title deeds have been mortgaged with the institutions against loans.
3.2 Clause (ii):
Whether physical verification of inventory has been conducted at reasonable intervals by the management and whether any material discrepancies were noticed and if so, whether they have been properly dealt with in the books of account.
To comply with this requirement by the auditor, the Guidance provides following explanations and clarifications:-
i. The periodicity of the physical verification of inventories depends on certain factors, like nature and location of inventories and practicability of carrying out physical verification. Thus, examining whether the interval of verification is reasonable or not is a matter of judgement, which depends on circumstances of each case.
ii. The auditor may check the working papers relating to physical verifications conducted by the management.
3.3 Clause (iii):
Whether the company has granted any loans, secured or unsecured to companies, firms, Limited Liability Partnerships or other parties covered in the register maintained under section 189 of the Companies Act, 2013. If so,
(a) whether the terms and conditions of the grant of such loans are not prejudicial to the company's interest;
(b) whether the schedule of repayment of principal and payment of interest has been stipulated and whether the repayments or receipts are regular;
(c) if the amount is overdue, state the total amount overdue for more than ninety days, and whether reasonable steps have been taken by the company for recovery of the principal and interest.
In this regard, the auditor should apply following procedures in order to make report on above requirements:-
i. The auditor should obtain a list of parties covered in the register maintained under section 189 of the Companies Act, 2013 and should examine all loans granted by the company to identify loans granted to these parties. He should also take into consideration those loans which have been squared-up during the year.
ii. To check whether the terms and conditions of the grant of loans to parties covered in the register maintained under section 189 are not prejudicial to company's interest, the auditor should examine agreements of such loans. Terms & conditions primarily include rate of interest on loans, security, terms of repayment etc.
iii. If the company has a policy to provide loans to its employees at concessional interest rate and the company has given such loan to an employee who is a relative of director of the company, then also the auditor should report such loan under this clause.
iv. The auditor should check carefully the loan agreements or mutually agreed upon letter of arrangement to examine whether the schedule of repayment has been stipulated or not at the time of sanction of loan.
v. It may be possible that the repayment schedule has been stipulated but the repayment is not regular. This type of case should also be reported.
vi. In case of non-banking financial company various directions of the RBI should be taken into consideration for reporting under this clause.
vii. To verify whether the any amount of repayment is overdue or not, the auditor should examine repayment schedule with reference to payments as per the books of account. It will also help to identify those amounts which have been overdue for more than 90 days.
viii. The auditor should exercise his professional judgement to examine whether in case of any amount overdue for more than 90 days, reasonable steps have been taken by the company or not for recovery of the amount. Reasonable steps may include sending of reminders, advocate's or solicitor's notice or any legal action taken by the company. The auditor should ask management's representation in writing for the steps taken.
3.4 Clause (iv):
In respect of loans, investments, guarantees, and security whether provisions of section 185 and 186 of the Companies Act, 2013 have been complied with. If not, provide the details thereof.
Section 185 of the Companies Act, 2013 prohibits advancing, directly or indirectly, of any loan including loan represented by book debt, by a company to any of its directors or to any other person in whom the director is interested or giving any guarantee or provide any security in connection with any loan taken by him or such other persons. There are certain exceptions of this prohibition are also given in the section.
Section 186 of the Companies Act, 2013 prohibits a company, directly or indirectly, to give any loan to any person or other body corporate, to give any guarantee or provide security in connection with a loan to any other body corporate or person and to acquire by way of subscription, purchase or otherwise, the securities of any other body corporate exceeding 60% of its paid-up share capital, free reserves and securities premium account or 100 % of its free reserves and securities premium accounts, whichever is more. It also prohibits a company from making investments through more than two layers of investment companies.
For this requirement, the Guidance provides following explanations and guidelines:-
i. The auditor should obtain the details of directors of a company and of the persons in whom company's directors are interested and should check the applicability of section 185 on the transactions, if any, entered into between the company and its directors and other such persons.
ii. For the purpose of section 186, the details, including opening balances, of loans given to any person or other body corporate, guarantee given or security provided in connection with such type of loans and securities of any other body corporate acquired by way of subscription, purchase or otherwise during the year, should be obtained.
iii. The threshold given in section 186 should be checked at any point of time during the year.
iv. To check compliance with other requirements of section 186, the auditor should examine the related documentation made by the company for the purpose of said section.
3.5 Clause (v):
In case, the company has accepted deposits, whether the directives issued by the Reserve Bank of India and the provisions of sections 73 to 76 or any other relevant provisions of the Companies Act, 2013 and the rules framed thereunder, where applicable, have been complied with? If not, the nature of such contraventions be stated; If an order has been passed by Company Law Board or National Company Law Tribunal or Reserve Bank of India or any court or any other tribunal, whether the same has been complied with or not?
Sections 73 to 76 of the companies Act, 2013 and the related rules, the Companies (Acceptance of Deposits) Rules, 2014 deal with acceptance and repayment of public deposits by the company.
The Guidance has provided the following explanations for the purpose of this clause:-
i. In case of large number of deposits, the auditor should examine the system of acceptance of deposits and maintenance of records in respect of deposits and should perform reasonable test check to ensure operating effectiveness of the system.
ii. Operating effectiveness of internal controls implemented by the company in order to ensure that the deposits accepted remain within the limits specified, should be examined.
iii. Ask from the management for any order passed by the Company Law Board or National Company Law Tribunal or Reserve Bank of India or any court or any other tribunal for contraventions of sections 73 to 76 and any other relevant provisions of the Companies Act, 2013. The steps taken by the management to comply with such orders should also be examined.
iv. The auditor should obtain representation letter from the management whether the company has complied with the directives of the RBI, the provisions of section 73 or 76 and any order passed by relevant authorities as mentioned above.
3.6 Clause (vi):
Whether maintenance of cost records has been specified by the Central Government under sub-section (1) of section 148 of the Companies Act, 2013 and whether such accounts and records have been so made and maintained.
Explanations provided by the Guidance for the purpose of this clause are as follows:-
i. First of all the auditor should check whether requirement of maintenance of cost records specified under section 148(1) of the Companies Act, 2013 is applicable to the company or not. If yes, he should obtain a list of books or records made and maintained by the company.
ii. The auditor should obtain representation letter in writing from the management whether cost records are required to be maintained for any products or services of the company and the same have been made and maintained also.
iii. The requirement of this clause should be reported even if maintenance of cost records is required but cost audit is not mandatory for the company.
3.7 Clause (vii):
(a) Whether the company is regular in depositing undisputed statutory dues including provident fund, employees' state insurance, income-tax, sales-tax, service tax, duty of customs, duty of excise, value added tax, cess and any other statutory dues to the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as on the last day of the financial year concerned for a period of more than six months from the date they became payable, shall be indicated;
(b) Where dues of income tax or sales tax or service tax or duty of customs or duty of excise or value added tax have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned. (A mere representation to the concerned Department shall not be treated as a dispute).
For the purpose of this clause, the Guidance provides following guidelines:-
i. The purpose behind this clause is to ascertain how regular the company is in depositing statutory dues. It indicates that the auditor has to consider only those statutory dues applicable on the company which are required to be deposited regularly. The auditor is not required to report those statutory dues imposed by appropriate authority from time to time depending on occurrence or non-occurrence of certain events.
ii. The words "any other statutory dues" indicate that the auditor should consider all type of dues under various statutes which are applicable to the company. So, the auditor should have general understanding of all statutory dues applicable to the company with regards to nature of business. Payment of rent and interest on late payment of rent when imported goods have been stored in the bonded warehouse, are also treated as statutory dues.
iii. The auditor may ask from the management about the statutes under which the company is required to pay any statutory dues and should examine the policies of the company adopted for identification and payment of applicable statutory dues.
iv. If a company didn't have taxable income till last due date of advance tax payment but after that date it earned certain taxable income and, hence, interest had been levied for short and late payment of advance tax under relevant provisions of the Income Tax Act, 1961, then it should not be taken as irregular payment of statutory dues.
v. The auditor should take an amount as disputed amount only when there are positive evidences that the company has not accepted the demand for payment of statutory dues and so the company has gone into appeal. Application filed for rectification of amount under section 154 of the Income Tax Act, 1961 should also be considered as positive evidence. Examination of sustainability of the claim of the company under appeal is not necessary.
vi. It may be possible that the appellate authority has decided a case of disputed amount in favour of the company but the Department has filed appeal against the decision to a higher authority. In such case the amount should be treated as disputed amount. In such case, the amount should be treated undisputed after the decision of appellate authority till the time the Department makes an appeal to higher authority.
vii. Obtain a written representation from the management of the company which contains disputed cases and amounts, list of undisputed statutory dues outstanding for a period of more than 6 months from the date they became payable and a statement that the information provided by them are complete.
3.8 Clause (viii):
Whether the company has defaulted in repayment of loans or borrowing to a financial institution, bank, Government or dues to debenture holders? If yes, the period and the amount of default to be reported (in case of defaults to banks, financial institutions, and Government, lender wise details to be provided).
The Guidance provides following explanations in respect of this clause:-
i. Under this clause the auditor has to report about all defaults existing as at the balance sheet date, irrespective of time of occurrence of the defaults. So, defaults occurred during previous years and existing at the balance sheet date should also be reported.
ii. The term 'Government' does not include a Government Company, Foreign Company, Corporation, PSU, Boards and Authority.
iii. The auditor should obtain a list of loans and borrowing from financial institution, bank, Government and the repayment schedules of the same & dues to debenture holders from the management. Debenture trust deed should also be examined. After obtaining repayment schedules the auditor should check whether the repayments made are as on due dates of repayment. The auditor should obtain confirmation from the concerned parties as to the status of loans or borrowings.
iv. If during the year any loan has been rescheduled or any default has been made good by the company then the auditor should state this in his report.
3.9 Clause (ix):
Whether moneys raised by way of initial public offer or further public offer (including debt instruments) and term loans were applied for the purposes for which those are raised. If not, the details together with delays or default and subsequent rectification, if any, as may be applicable, be reported;
Main points of the Guidance in respect of this clause are as follows:-
i. This clause envisages that the companies should disclose the end-use of money raised by the Initial Public Offers (IPO) or Further Public Offers(FPO) (including debt instruments) in the Notes to accounts of financial statement.
ii. The auditor should have general understanding of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. It specifies certain disclosure requirements by the companies in the financial statement with respect to utilization and unutilization of monies raised from public.
iii. The companies do mention end-use of money raised through IPO or FPO (including debt instruments) in the offer document. So, the auditor should examine offer document and should verify the same with the amount of end-use of money disclosed in the financial statement.
iv. Not only term loans obtained from banks or financial institutions should be examined but also term loans taken form entities or persons other than banks/financial institutions would also be examined by the auditor.
v. In case of term loans, the end-use of the funds is mentioned in the sanction letter or the documents containing the terms and conditions of the loan. So, the auditor should examine such documents to know the purpose of raising funds and should compare with actual utilizations of those funds.
vi. Suppose a company borrowed fund to acquire capital assets. In such case if the company utilised those funds for the purpose of acquisition of improved model of the same capital assets, then it should not be construed that the funds have not been utilised for the purpose for which it was raised.
3.10 Clause (x):
Whether any fraud by the company or any fraud on the Company by its officers or employees has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated.
Explanations in respect of this clause as provided by the Guidance are as follows:-
i. This clause requires to report about the fraud by the company or any fraud on the company by its officers or employees which has been noticed or reported by the management. So, the auditor is not required to discover frauds. But, it does not provide any relief to the auditor from his responsibility to consider fraud and error during audit of financial statement.
ii. The auditor should discuss with its team members about the chances of material misstatements in the financial statements resulting from fraud and also should enquire from the management about known frauds or suspected frauds.
iii. The auditor should examine internal audit report, minutes of the audit committee and minute book of the board meeting.
iv. A written representation from the management should be obtained that it has disclosed all significant facts in respect of frauds to the auditor and that it acknowledges its responsibility to frame and implement internal control system to prevent and detect frauds, etc.
3.11 Clause (xi):
Whether managerial remuneration has been paid or provided in accordance with the requisite approvals mandated by the provisions of section 197 read with Schedule V to the Companies Act? If not, state the amount involved and steps taken by the company for securing refund of the same.
The Guidance provides following instructions:-
i. The clause is applicable only in case of public companies as section 197 of the Companies Act, 2013 is applicable only to public companies.
ii. For the purpose of this clause the auditor has to check that managerial remuneration paid by the company is in accordance with the provisions of section 197, read with Schedule V of the Companies Act, 2013.
iii. The auditor has to report the amount of managerial remuneration paid in excess of limit prescribed under section 197 and Schedule V. Any amount subsequently recovered by the company from managerial personnel should not be deducted from the amount of excess remuneration.
iv. System implemented by the company for the purpose of recovery of excess remuneration paid should also be examined and reported.
3.12 Clause (xii):
Whether the Nidhi Company has complied with the Net Owned Funds to Deposits in the ratio of 1: 20 to meet out the liability and whether the Nidhi Company is maintaining ten per cent unencumbered term deposits as specified in the Nidhi Rules, 2014 to meet out the liability;
Following instructions have been provided by the Guidance:-
i. "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 such rules as are prescribed by the Central Government for regulation of such class of companies.
ii. The auditor should obtain from the management the computations of net owned funds and deposit liability computed as per Nidhi Rules, 2014 and then should examine the requirements of this clause.
3.13 Clause (xiii):
Whether all transactions with the related parties are in compliance with sections 177 and 188 of Companies Act, 2013 where applicable and the details have been disclosed in the Financial Statements etc., as required by the applicable accounting standards.
For the purpose of this clause the Guidance contains following guidelines:-
i. Section 177 of the Companies Act, 2013 requires that shall approve related party transactions and modifications to such transactions should be approved by the Audit Committee of the company.
ii. Section 188 of the Companies Act, 2013 provides that no company shall enter into any contract or arrangement with a related party with respect to certain specified transactions without the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions as may be prescribed. Specified transactions include sale, purchase or supply of any goods or materials, leasing of property of any kind, availing of or rendering of any services etc. There are certain exceptions to this provision that are also given in the section.
iii. The auditor should obtain from the management a list of related parties of the company along with type of relationship with them and transactions with such related parties. These related party transactions should be checked for whether the same have been approved by the Audit Committee or not.
iv. The auditor can refer to Standards on Auditing (SA) 550, "Related Parties". SA 550 provides auditor's responsibilities regarding related party transactions and related party relationships during audit of financial statements. It can help the auditor to identify significant related party transactions required to be reported under this clause.
v. A representation letter from the management should be obtained that the management has disclosed to the auditor the name of related parties, type of relationship &related party transactions and that they have accounted for and disclosed such information appropriately.
3.14 Clause (xiv):
Whether the company has made any preferential allotment or private placement of shares or fully or partly convertible debentures during the year under review and if so, as to whether the requirement of section 42 of the Companies Act, 2013 have been complied with and the amount raised have been used for the purposes for which the funds were raised. If not, provide the details in respect of the amount involved and nature of non-compliance.
Section 42 of the Companies Act, 2013 deals with offer or invitation for subscription of securities on private placement. As per the sub-section (1) of the section, without prejudice to the provisions of section 26, a company may, subject to the provisions of this section, make private placement through issue of a private placement offer letter.
The Guidance provides following explanations for this clause:-
i. Under this clause the auditor has to report not only on compliance with section 42 of the Companies Act, 2013 but also the Companies (Prospectus and Allotment of Securities) Rules, 2014.
ii. To check whether the amounts raised through preferential allotment or private placement of shares or fully or partly convertible debentures have been used for the purposes for which the funds were raised, Form PAS-4 should be examined. Form PAS-4 is Private Placement Offer Letter. This form contains information in respect of the purposes and objects of the private placement offer. So, the auditor can compare the purpose for which funds were raised as mentioned in the Form PAS-4 with actual utilization of the funds.
3.15 Clause (xv):
Whether the company has entered into any non-cash transactions with directors or persons connected with him and if so, whether the provisions of section 192 of Companies Act, 2013 have been complied with.
Section 192 of the Companies Act, 2013 provides that no company shall enter into an arrangement by which— (a) a director of the company or its holding, subsidiary or associate company or a person connected with him acquires or is to acquire assets for consideration other than cash, from the company; or (b) the company acquires or is to acquire assets for consideration other than cash, from such director or person so connected, unless prior approval for such arrangement is accorded by a resolution of the company in general meeting and if the director or connected person is a director of its holding company, approval under this sub-section shall also be required to be obtained by passing a resolution in general meeting of the holding company.
Instructions provided by the Guidance are as follows:-
i. There are two reporting requirements specified in this clause. First, whether the company has entered into any non-cash transactions with director or persons connected with directors. Second requirement is to whether the company has complied with the provisions of section 192. Second reporting requirements arise only when answer of the first is in affirmative.
ii. The meaning of term 'persons connected with him' can be taken as the meaning of the term 'to any other person in whom the director is interested' as given in the section 185(1) of the Companies Act, 2013.
iii. The auditor should obtain written representation from the management as to whether the company has entered into any non-cash transactions with the directors or persons connected with the directors. Further, to examine existence of such non-cash transactions, the auditor should check following documents:-
a) Form MBP 1, Notice of Interest by Director (the Companies (Meetings of Board and its power) Rules, 2014)
b) Form MBP 2, Register of Loans, Guarantees, Security and Acquisition made by the Company (the Companies (Meetings of Board and its power) Rules, 2014)
c) Form MBP 4, Register of Contracts with Related Party and Contracts and Bodies etc. in which Directors are Interested (the Companies (Meetings of Board and Its Powers) Rules, 2014)
d) Fixed Assets Register
e) Minutes of the General Meeting and Directors Meeting
f) Report on Annual General Meeting (the Companies (Management and Administration) Rules, 2014)
If any non-cash transaction is found then auditor should check compliance with the provisions of section 192 of the companies Act, 2013.
3.16 Clause (xvi):
Whether the company is required to be registered under section 45-IA of the Reserve Bank of India Act, 1934 and if so, whether the registration has been obtained.
As per section 45-IA of the Reserve Bank of India Act, 1934 without obtaining a registration certificate a non-banking financial company shall not commence the business of a non-banking financial institution.
The Guidance provides following instructions:-
i. The functions of a non-banking finance company (NBFCs) are similar to banks. However, there are certain differences between NBFCs and banks. NBFCs can't accept demand deposits can't issue cheque drawn on itself, etc.
ii. So, the auditor should examine the functions of the company in order to check whether the company is a NBFC or not, if yes, then check that the company has obtained registration certificate under section 45-IA of the RBI Act, 1934.