No More Hide and Seek

In order to augment transparency in corporate audits, the ministry of corporate affairs has introduced changes to rules governing audit reports of companies. It incorporated specific revelation norms which will not allow business entities to hide facts on the grounds of materiality or probability and announced the notification of the Companies (Audi­tor’s Report) Order 2020 (CARO 2020).

The February 25, 2020, order substitutes the previous 2016 one and applies to financial statements of companies for 2019-2020 and beyond.

The new order adds some more clauses, while some existing ones have been amended or deleted. CARO 2020 is applicable to all classes of companies as specified in CARO 2016.

As per CARO, the auditor has to express a true and fair view about certain clauses in the order and point out qualifications or disparities in italics. The order is annexed to the main audit report in which an auditor gives a declaration on whether the Accounting Standard and Companies Act conformities were complied with.

CARO 2020 has 21 clauses as against 16 in CARO 2016. The changes are:

• The company has to maintain proper records showing full details of property, plant and equipment (PPE) and intangible assets. The management has to report the physical verification of PPE at constant intervals and divergences noticed.
• The auditor has to verify the validity of the title deeds of all immovable properties disclosed in the financial statements. If not, details have to be mentioned in the prescribed report. He has to inform about revaluation of PPE or intangible assets or both. If the change in the net value is more than 10 percent, then the amount has to be disclosed.
• The auditor has to report proceedings initiated or pending against the company for holding benami property under the Benami Transactions Act.
• If the company has obtained a working capital in excess of Rs 5 crore in total from financial institutions on the basis of the security of current assets, the auditor has to verify that the quarterly returns or statements filed with the financial institutions are in accord with the books of accounts.
• If the company has made investments in, provided any guarantee, security, granted loans or advances to companies or LLPs or any other party, it has to be reported by the auditor. If any new loan has been given to clear an old loan or there has been an extension in an existing loan, the amount and percentage of such a loan to the total loan has to be reported.
• Unrecorded transactions surrendered or disclosed as income during the year under the voluntary disclosure or Vivad se Vishwas scheme, etc, have to be reported.
• If the company has been stated as a wilful defaulter by any bank or financial institution or other lenders, the auditor has to disclose it.
• The auditor has to provide an assurance that term loans were applied to the objective for which they were obtained and if not, then the amount of loan and the purpose for which it was obtained has to be reported.
• The following has to be disclosed— funds borrowed for short-term objects but utilized for long-term purposes, funds taken from any entity or person to meet the obligation of its subsidiaries, associates or joint ventures, loans obtained during the year from the pledge of securities held in its subsidiaries, associates and joint ventures.
• The auditor has to disclose whistleblower complaints received during the year.
• The auditor has to examine the efficacy of the internal audit system and whether reports of internal auditors have been considered. He has to verify whether the company has conducted any non-banking financial or housing finance activities without a valid certificate of registration from the Reserve Bank of India.
• If the company is a core investment company (CIC) and the group has more than one CIC, their number has to be indicated.
• If the company has suffered cash losses in the fiscal year and in the previous fiscal year, these losses have to be mentioned.
• The incoming or new auditor has to disclose the reasons and concerns of the outgoing auditor’s resignation.
• True and fair opinion has to be expressed by the auditor about the non-existence of material uncertainty based on financial ratios and management plans.
• Whether completed projects or unspent funds have been dealt with according to the provisions of the Companies Act has to be reported.

The new order will significantly increase paperwork because the auditor has to comment on 50 matters, including sub-clauses, instead of the earlier 21. It remains to be seen how this humongous load adds to transaction cost and postponements.

It is important that audit companies extend a helping hand to implement the rules efficiently. If they don’t, the entire process will be called into question.

While the disclosures are rigorous for auditors, they are stringent for chief financial officers as well. As a result, a CFO’s role would come under increased focus with regard to compliances with certain laws and rules. They should ensure sanity of financial information furnished to banks and proper systems and processes to detect non-compliance or an adverse financial position and take corrective measures.

Overall, the changes proposed under CARO 2020 will lead to greater transparency and faith in the financial affairs of companies. Though it is the responsibility of auditors to report on matters prescribed in CARO, companies will get affected as they need to provide the underlying information.

Moreover, these revisions to enhance reporting requirements are intended to bridge the expectation gap and will provide useful information to users about the underlying financial statements and the findings of the auditor.

Auditors have essentially been compelled to demand more information. This will make CARO 2020 a utilitarian move. The saying, “A good auditor never makes mistakes” will be under increased focus.

— The writer is a tax specialist and financial adviser