Auditorâ€™s Report on the financial statements of a limitedÂ company audited under the Companies Act, 1956, is gaining importance year after year. That is the reason why, with changing environment in the commercial world, amend-ments are being made in S. 227 of the Companies Act. The auditorÂ of a company is required to give his report in accordance with the provisions of S. 227 of the Companies Act. S. 227(1A) requires him to make certain specific enquiries during the course of audit and report if there are any adverse comments on the matters listed in that section. It is proposed to enlarge the scope of this enquiry by amendments proposed by Companies (Amendment) Bill, 2003, recently introduced in the Rajya Sabha. S. 227(3) lays down certain matters necessarily required to be reported upon by the auditor in his report. Recently this requirement has been enlarged, and there is also a proposal in the Companies (Amendment) Bill, 2003, to further enlarge its scope. S. 227(4A) authorises the Central Government to specify certain matters on which the auditor has to report along with his report u/s.227(3). The Central Government can pass an order u/s.227(4A) in consultation with the Institute of Chartered Accountants of India.
2. UnderÂ theÂ powers conferred by S. 227(4A), the Central GovernmentÂ firstÂ issued an order called the manufacturing and otherÂ companiesÂ (auditorâ€™sÂ report) order, 1975, (MAOCARO-1975). This order came into force from 1-1-1976 and applied to all companies engaged in manu-facturing, service, trading and finance activities. There were in all 22 items on which auditor was required to give his specific report.Â WithÂ changesÂ in economic environment, the above order was replaced by another order called MAOCARO-1988 which come into force on 1-11-1988. This order contained 27 items on which auditor was required to make specific comments depending on the nature of activities of the company. It may be noted that the 1988 order replaced 1975 order after 13 years. Now, after 15 years, the Central Government has issued, in consultation with ICAI, a new order u/s.227(4A) called the Companies (Auditorâ€™s Report) Order, 2003. This can be called â€˜CARO-2003â€™ which has come into force from 1st July 2003. There are 33 items in CARO on which the auditor has toÂ makeÂ specificÂ comments. Some of the items in MAOCARO-1988 and CARO-2003 are common andÂ someÂ itemsÂ fromÂ MAOCARO areÂ omitted.Â SinceÂ someÂ additional responsibilities are being placed on the auditor under CARO-2003,Â theÂ discussionÂ in this article is mainly restricted to the new items added under this new order.
3. ApplicabilityÂ :
3.1 CARO came into force on 1-7-2003. It applies to all Companies, including foreign companies defined u/s.591 of the Companies Act (Act). It is, however, provided that this order shall not apply to follow-ing companiesÂ :
(i) A banking company
(ii) An insurance company
(iii) A company registered
u/s.25 of the Act
(iv) A private limited company which satisfies the following conditionsÂ :
(a) Its paid up capital and reserves do not exceed Rs.50 lacs;
(b) It has not accepted any public deposits;
(c) Its turnover does not exceed Rs.5 crores; and
(d) Its outstanding loan from any bank or financial institution does not exceed Rs.10 lacs.
If any of the above conditions are not satisfied, the above order will apply to the private limited company.
3.2 It may be noted that MAOCARO-1988, did not apply to banking, insurance and S. 25 companies. However, CARO gives relief to small private limited companies which satisfy the above conditions. If we analyse the above conditions, the following conclusions can be drawnÂ :
(i) The term â€˜Reservesâ€™ is not defined. Therefore, revaluation reserves, capital reserves, etc. will have to be included. However, the credit balance of Profit & Loss Account will not be included.
(ii) The expression â€˜Public Depositsâ€™ is not defined. Therefore, meaning given to this term u/s.58A of the Act can be assigned to this term.
(iii) The term â€˜Turnoverâ€™ is not defined. Therefore, the term as defined by ICAI for the purpose of Schedule VI and for other accounting purposes can be considered for this purpose also.
(iv) The outstanding loan from banks or financial institutions should not exceed Rs.10 lacs. It is not clarified whether this position is to be considered as at the end of the accounting year. This will require clarification from the Government or ICAI. In the absence of such clarification, the order will apply if the outstanding balance at any time during the year exceeds Rs.10 lacs. Further, such loan may be on account of overdraft, cash credit, packing credit, term loan, etc.
3.3 As stated earlier, MAOCARO-1988 applied to companies engaged in manu-facturing, trading, service and financial activities. On the same lines CARO applies to all such companies, excluding private companies which satisfy the above conditions. Para 2 of the above order, therefore, defines the terms manufacturing and mining company, processing company, trading and service company,Â financeÂ andÂ investment companyÂ andÂ chitÂ fundÂ company, etc. in the same manner as definedÂ inÂ Para 2 of MAOCARO.
3.4 Para 3 of CARO clarifies that this order will apply to audit reports given in respect of financial statements for the accounting periods ending on or after 1st July 2003. In other words, in respect of accounting period ending on or before 30th June 2003, MAOCARO-1988 will apply even if the auditor has given his report u/s.227 on or after 1-7-2003.
3.5 Para 4 of CARO states that the Auditorâ€™s report u/s.227 shall include specific statement on matters listed in this Para. Therefore, as in MAOCARO, the auditor will have to give his opinion on all the matters listed in this Para.
4. Fixed assetsÂ :
4.1 The reporting requirement under CARO with reference to maintenance of proper records showing particulars and location of fixed assets, physical verifica-tion by management at reason-able intervals and treatment of material discrepancies in the books of accounts is the same as in MAOCARO.
4.2 MAOCARO required the auditor to state about revalua-tion and basis of revaluation of the fixed assets during the year. ThisÂ requirement is now deleted.
4.3 CARO now requires the auditor to state whether the â€˜going concernâ€™ concept is af-fected if a substantial part of the fixed assets have been disposed off during the accounting period under report. The auditor will now be required to examine the reasons for disposal of a sub-stantial part of the fixed assets and to give his opinion whether the reporting on financial statements on going concern concept is proper.
5. InventoriesÂ :
5.1 The reporting requirement under CARO in respect of following matters relating to inventories is the same as in MAOCAROÂ :
(i) Whether physical verification of inventories is conducted by the management at reasonable intervals.
(ii) Whether procedure for physical verification of inventories is reasonable and adequate. If not, inadequacies to be reported.
(iii) Whether material discrepancies noticed on physical verification are properly dealt with in the books of accounts.
5.2 CARO requires the auditor to report whether the company is maintaining proper records of inventories.Â ThisÂ isÂ aÂ newÂ require-ment. Hitherto, the auditor was required to examine whether proper records for inventories were maintained as part of his audit procedure. Now he will have to make a specific mention about adequacy of these records in his audit report.
5.3 MAOCARO required the auditor to report whether the valuation of inventories was proper in accordance with normally accepted accounting principles and whether this was on the same basis as in the preceding year. If there was any deviation which had material effect in the accounts, the same was required to be reported. Now, this reporting requirement is deleted. This is because AS-2 dealing with valuation of inventory has now become mandatory u/s.211(3C) of the Act and material effect due to changeÂ inÂ theÂ methodÂ ofÂ valuation is required to be reported.
6. Loans given or taken by companyÂ :
6.1 The reporting requirement under this head according to MAOCARO and CARO in respect of the following items is more or less the sameÂ :
(i) Secured or unsecured loans granted or taken by the company to or from companies, firms or other parties in which directors are interested and are covered by S. 301 of the Act.
(ii) Whether rate of interest and other terms and conditions of such loans are prima facie prejudicial to the interest of the company.
6.2 CARO requires the auditor to now report on the following items relating to the above loansÂ :
(i) The auditor has to give the number of persons and the amount involved in the transactions required to be entered in the register maintained u/s.301. It appears that this information is to be given in respect of all such parties even if the rate of interest and other terms and conditions are primaÂ facie not prejudicial to theÂ interest of the company.
(ii) Whether payment of the principal amount and interest are also regular. In this clause the word â€˜paymentâ€™ is used. It appears that the intention is for reporting the regularity of repayment of the principal and payment of interest on loan.
(iii) Whether the company has taken reasonable steps for recovery or payment of principal and interest if any loan granted or taken is overdue and the amount exceeds Rs.1 lakh.
(iv) The above information is to be given in respect of loans granted or taken by the company separately.
(v) Whether transactions that need to be entered into the register in pursuance of S. 301 of the Act have been so entered. This will require the auditor to verify all transactions with companies, firms and other parties in which directors areÂ interestedÂ andÂ toÂ examine whether these transactions have been recorded in the register maintained u/s.301 of the Act.
(vi) If the total value of the transactions with any one party covered by the requirement of S. 301 of the Act in any financial year exceeds Rs.5 lacs, the auditor will have to report whether each of these transactions has been made at prices which are reasonable having regard to the prevailing market prices at the relevant time. This will mean that the auditor will have to obtain list of such parties in which directors are interested as provided in S. 297 and S. 299 of the Act,Â and determine whether transactions for sales, services, purchases, expenditure etc. with these parties are at market prices. In MAOCARO this limit was Rs.50,000/- for each party for each financial year. Further, the auditor could consider the prices charged in similar transactions with other parties while determining the market prices. This flexibility is not given in CARO.
6.3 ParaÂ 4(A)(ix)Â of MAOCARO required the auditor to examine transactions of loans or advances in the nature of loans and report whether the parties are repaying such loans and interest thereon as per the stipulated terms. This Para appliedÂ toÂ allÂ loans and advances in the nature of loans. This requirement applied to parties other than those covered by S. 301. This requirement is now deleted subject to information to be given in respect of parties covered by S. 301 as stated above.
7. Internal control
The requirements of reporting on the existence of internal control procedures commen-surate with the size of the company and the nature of business, for purchase of inventory and fixed assets and for sale of goods is the same in CARO as in MAOCARO. In addition, CARO provides that the auditor should report whether there is continuing failure to correct major weaknesses in internal control procedures.
8. Internal audit systemÂ :
MAOCARO provided that the auditor should report whether the company has an internal auditÂ system commensurate with its size and nature of business. This requirement applied in respect of a company having paid up capital exceeding Rs.25 lacs as at the commencement of the financial year or having an average turnover exceeding Rs.2 crores for a period of three consecutive financial years immediately preceding the relevant financial year. CARO now provides that this reporting requirement about internal audit system will apply to any of the following companiesÂ :
(i) Listed company
(ii) Any other company with paid up capital and reserves exceeding Rs.50 lacs as at the commencement of the financial year, or
(iii) Any company having an average turnover exceeding Rs.5 crores for a period of 3 consecutive financial years immediately preceding the relevant financial year.
It may be noted that in (ii) above, the reserves will include all reserves but will not include credit balance of profit and loss account.
9. Acceptance of public depositsÂ :
TheÂ reportingÂ byÂ theÂ auditorÂ with regardÂ toÂ publicÂ depositsÂ accepted by a company u/s.58A/58AA or any contravention, is the same under MAOCARO and under CARO. There is one additional requirement under CARO, under which the auditor has to report whether the company has complied with any order passed by the Company Law Board in respect of such public deposit.
10. Maintenance of cost recordsÂ :
The reporting requirements with regard to maintenance of cost records by the company as prescribed u/s.209(1)(d) of the Act are the same under MAOCARO and CARO.
11. Statutory duesÂ :
11.1 The requirement of report-ingÂ whetherÂ undisputedÂ statutory dues such as Provident Fund, InvestorÂ EducationÂ andÂ Protection Fund, ESIC, Income-tax, Wealth tax, Sales Tax, Customs Duty, Excise Duty, Cess, etc. with various statutory authorities have been deposited regularly, and the extent of outstanding dues in arrears as on the last day of the financial year for a period exceeding six months, as inÂ MAOCARO,Â hasÂ been retained in CARO more or less in the same form. Items of Investor Education Protection Fund, Cess and other statutory dues, if any, have been added in CARO.
11.2 CARO puts additional reporting requirement with regard to disputed taxes viz., Income-tax, Wealth Tax, Sales Tax, Customs Duty, Excise Duty and Cess, which have not been deposited by the company. The auditor will have to report about the amounts involved in such disputes and the forum where the dispute is pending. For this purpose, a mere repre-sentation to the Department will not constitute the dispute. In other words, if a dispute is raised before any appellate authority, statutory authority, court, etc., only then it will constitute a dispute. It appears that the disputed taxes will include interest due thereon and penalty, if any, levied and disputed.
12. Accumulated lossesÂ :
12.1 MAOCARO required the auditor to report whether the company was a Sick Company u/s.3(1)(o) under SICA-1985. This requirement is deleted in CARO.
12.2 However, CARO provides that the auditor should report, in the case of a company which has been registered for a period of not less than 5 years, whether the accumulated losses of the company at the end of the relevant financial year are not less than 50% of its net worth and whether it has incurred cash losses in that financial year and immediately preceding such financial year. This is a new requirement which will give signal about the impending financial sickness of the company. The terms â€˜Net Worthâ€™ and â€˜Cash Lossesâ€™ have not been defined in CARO and we will have to give them the normal meaning as understood by accountants. It is possible that ICAI will explain the meaning of these terms when it issues a statement on CARO to bringÂ uniformityÂ inÂ ourÂ approach. It may be noted that in the guidance note on terms used in Financial Statements issued by ICAI, the term â€˜Net Worthâ€™ is explained as â€˜The excess of the book value of assets (other than fictitious assets) of an enterprise over its liabilitiesâ€™. In the above guidance note the term â€˜Cash Lossâ€™ is explained to mean the â€˜net lossâ€™ as per accounts after excluding non-cash costs, such as depreciation, amortisation, etc.
13. Repayment of dues of banks, etc. and creation of securitiesÂ :
13.1 CARO has put additional responsibilities on auditors who will now have to report about defaults in repayment of dues to a financial institution, bank or debenture holders. If there is any default, the period and amount involved in the default should be reported. This report-ing requirement will require the auditor to ascertain the due dates for repayment of loans taken from the banks and financial institutions as well as loans taken against debentures. If there is any delay in repayment, it will have to be reported even if the delayed payment is made before the end of the accounting year. The requirement under this clause is about repayment of dues. Therefore, it appears that default or delay in payment of interest to banks, financial institutions or debenture holders is not required to be reported.
13.2 The auditors now have to report whether the company has created securities required to be created in respect of debentures issued by the company.
14. Transactions prejudicial to the interest of the companyÂ :
14.1 CARO now requires the auditor to report whether the company has given any guarantee for loans taken by others from a bank or financial institution where the terms and conditions are prejudicial to the interest of the company. In other words, if any loan taken by a staff member or an associate concern is guaranteed by the company, the auditor will have to examine whether any counter guarantee is taken by the company and whether such counter guarantee gives sufficient comfort against any liability that may arise if the lender invokes the guarantee.
14.2 The auditor has also to report under CARO whether the price at which shares issued by the company under preferential allotment to parties or companies covered u/s.301 of the Act is prejudicial to the interest of the company. For this purpose, the auditor will have to study the share price movement if the shares of the company are quoted or to work out the intrinsic price of the shares if they are not quoted in theÂ stock exchange, and compare the same with the issue price under the preferential allotment.
15. End use of borrowed fundsÂ :
CARO has placed additional responsibility on the auditor who will now have to report about end use of the borrowed funds in the following cases. For this purpose, the auditor will have to examine the cash flow statement in greater detail so that any diversion of funds can be ascertained.
(i) If any â€˜term loanâ€™ is taken by the company, whether such loan is used for the purpose for which it is taken. For this purpose, the loan documents, sanction letters and other relevant correspondence will have toÂ beÂ studiedÂ byÂ the auditor.
(ii) If the company has raised â€˜short-termâ€™ funds, the auditor will have to report if such funds are used for long-term investment. Similarly, if â€˜long-termâ€™ funds are raised and they are used for short-term investments, the auditor will have to report. He will have to indicate the nature of loan and nature of investment and the amount involved. The terms short-term and long-term are not defined in CARO. The auditor will have to use his judgement for this purpose. ICAI may explain these terms in the statement on CARO so that some uniform approach can be adopted.
(iii) When the management has disclosed about the end use of money raised by a public issue, the auditor will have to report that he has verified such end use.
16. Reporting about fraudsÂ :
CARO requires the auditor to report whether during the financial year any fraud on the company is noticed. Similarly, he has also to report whether he has noticed that the company has committed any fraud on others. If the auditor has not noticed any such fraud, but the same is reported to the company or by the company, he will have to refer to such report in the audit report. The reporting of the fraud may be in the media. It appears that the auditor will have to take note of such media reports also and refer to the same in his audit report, if such reports are found to be authentic.
The auditor has to state in the audit report the nature of such fraud and the amount involved. There is no requirement to report about the steps taken by the company in respect of such fraud.
17. Some of the MAOCARO items deletedÂ :
17.1 In the MAOCARO, various reporting items in Para 4 were divided in four parts, viz.,
(A) Manufacturing and
(B) Service companies,
(C) Trading companies and
(D) Finance, investment, chit fund, nidhi or mutual benefit companies.
This classification is absent in CARO and therefore all items in Para 4 of CARO will apply to all companies to the extent applicable.
17.2 The following reporting items contained in MAOCARO do not find place in CAROÂ :
(i) The unserviceable or damaged stores, raw materials or finished goods whether determined and adequately provided in the accounts. This deletion is because this item is now covered in AS-2 (Valuation of Inventories).
(ii) Maintenance of reasonable records about sale and disposal of realisable by-product and scrap. This deletion is also in view of AS-2 which is now mandatory.
(iii) Personal expenses charged to revenue account. This deletion is because the auditor has to report on this item u/s.227(1A) of the Act.
(iv) In the case of service company, it was necessary to report consumption of materials and stores and about allocation of man-hours to the job. This item is now deleted.
(v) In the case of trading company, it was necessary to report about determination and provision for damaged goods. This is deleted in view of mandatory nature of AS-2.
18. Finance, investment, chit fund, nidhi or mutual benefit companiesÂ :
As stated earlier, separate classification for such companies madeÂ inÂ ParaÂ 4(D)Â of MAOCARO has now been deleted. But the following reporting require-ments contained in Para 4(D) of MAOCARO have been retained more or less in the same manner and will apply to other companies also to the extent applicableÂ :
(i) Whether adequate documents and records are maintained in cases where the company has granted loans and advances on the basis of security by way of pledge of shares, debentures and other securities. Under CARO, apart from the above, it is necessary to point out in the report the deficiencies in the maintenance of above documents and records.
(ii) Whether the provisions of any special statute applicable to chit fund have been duly complied with.
(iii) As regards Nidhi and Mutual benefit funds/societies, CARO provides that the auditor should report on the following mattersÂ :
(a) Whether the net-owned fund to liability ratio is more than 1Â :Â 20 as at the balance sheet date.
(b) Compliance with the prudential norms on income recognition and provisioning against sub-standard, default and loss assets.
(c) Adequate procedures for appraisal of credit proposals/requests, assessment of credit needs and repayment capacity of borrowers.
(d) Whether repayment schedule of various loans granted by the Nidhi is based on repayment capacity of borrower and would be conducive to recovery of the loan amount.
(iv) If the company is dealing or trading in shares, securities, debentures and other investments,Â whetherÂ proper records have been maintained, timely entries are made and such investments are in the name of the company.
19. Form of Audit ReportÂ :
CARO requires that the auditor should make a statement on the matters contained in the order. This requirement applies even where the answers to any of the questions are unfavourable or qualified. In such cases, the auditorÂ shouldÂ stateÂ hisÂ unfavour-able or qualified answers and the reasons for the same. If the auditor is not able to express his opinion about any of the items contained in the order, he should indicate such fact, and give reasons as to why he is unable to express an opinion.
20. To sum upÂ :
From the above comparison of the provisions of MAOCARO and the newÂ CARO, it is evident that the responsibilities of auditors in the coming years will be tremendously increased. It may be noted that the above order dealing with the auditorâ€™s report u/s.227(4A) has been issued by the Government in consultationÂ with our Institute. It appears that such a major step increasing the responsibilities of our members has been taken by the Institute without taking into confidenceÂ some senior members of the profession who are concerned with audits of large companies and corporations on a day-to-day basis. The first reading of this order shows that many of our members will find it difficult to comply with some of the new reporting require-ments.Â WhenÂ such major changes are being made, the Institute should have suggested to the Government to issue an ex-posureÂ draftÂ of the notification, so that our members can get opportunity to point out the difficulties in implementation and can suggest remedial measures. Such a procedure gives time to members to study the implications of the new requirements, before the final order is brought into force. Further, the Institute also gets sufficient time to issue guidance note explaining the provisions, and to educate the members and students about the manner in which audit procedures should be modified to comply with the new provisions. This order is issued on 12-6-2003 and it comes into force on 1-7-2003. Therefore, the auditors giving audit report on the financial statements for the period ending 31-7-2003 and onwards will have to comply with the new requirements. Some of the new items relating to defaults in repayment of dues, end use of borrowed funds, use of short-term borrowed funds for long-term investments and vice versa, etc. will require examination of transactions throughout the year. Members will like to have guidance in these matters from the Institute. Therefore, ICAI should strongly represent to the Government that this new order should apply to audit reports on accounts of companies for the year commencing on or after 1st July 2003. This procedure is followed by our Institute when anyÂ accountingÂ standard is made mandatory for the purposes of S. 211(3C) of the Companies Act. If this modification is made in the above order, our Institute will get sufficient time to issue guidance to our members and educate them about the new requirements.