Companies (Auditor’s Report) Order, 2020 (CARO 2020) A Clause-by-Clause Professional Analysis with Case Studies, Numerical Illustrations, and Drafting Guidance for Qualified Opinions
Preface and Scope
The Companies (Auditor’s Report) Order, 2020 (hereafter “CARO 2020”) was issued by the Ministry of Corporate Affairs (MCA) under Section 143(11) of the Companies Act, 2013. CARO 2020 applies to audits of financial statements of most companies, subject to the prescribed exemptions. The order expands the auditor’s reporting responsibilities on specific matters that are relevant to governance, stewardship, prudence, and faithful representation. This article provides a comprehensive, clause-by-clause discussion aimed at qualified Chartered Accountants. Each clause is explained with definitions of key terms, audit procedures, intricacies and interpretative issues, corporate case studies, and numerical illustrations. For every clause, we include drafting guidance and sample language for a qualified opinion under that clause where irregularities exist. The analysis cross-references relevant provisions of the Companies Act, 2013, applicable Accounting Standards/Ind AS, and Rules, without reproducing the legal text.
Coverage and Exemptions (High-level)
CARO generally applies to all companies including foreign companies, with notable exemptions for: (a) banking companies, (b) insurance companies, (c) companies licensed to operate under Section 8, (d) One Person Companies, (e) small companies, and (f) certain private companies not meeting prescribed thresholds. Auditors should document applicability on the engagement file at the planning stage, with reference to paid-up capital, reserves, borrowings, and revenue thresholds, and re-assess applicability annually.
Clause 3(i) – Property, Plant and Equipment; Intangible Assets; Revaluation; Benami Properties
What must be reported: Maintenance of proper records (quantitative and situation-wise details), physical verification and material discrepancies, title deeds of immovable properties, revaluation by a Registered Valuer, and proceedings under the Benami Transactions (Prohibition) Act.
Key definitions:
- “Proper records” include description, location, identification numbers, quantity/cost, accumulated depreciation/amortisation, and impairment.
- “Physical verification” means procedures designed to establish existence and condition, with frequency and coverage commensurate with size and risk.
- “Title deeds” include sale deeds, conveyance deeds, lease deeds (for right-of-use assets), and mutation entries where applicable.
- “Material discrepancy” is a variance that could influence economic decisions; auditors should set materiality a priori and evaluate both value and nature.
- “Registered Valuer” refers to a valuer registered under Section 247 read with Rules.
Audit procedures: Walkthrough of fixed asset register, test of additions/disposals, site visits or alternative procedures, reconciliation of physical verification reports with records, legal review of title deeds including name mismatch (old names, amalgamations), impairment indicators (Ind AS 36/AS 28), and revaluation working papers including methodology (income, cost, market approach), assumptions, and independence of valuer.
Intricacies: Leased assets recognition under Ind AS 116 (ROU assets) and whether lease deeds are in the company’s name; assets located at third-party premises; assets under dispute; capital work-in-progress ageing and cost allocations; componentisation under Ind AS 16; benami flags where possession and consideration are in different names without adequate explanation.
Case study: A manufacturing entity capitalised a new plant (₹120 crore). Title deeds for land remain in the name of the promoter’s proprietary firm pending registration. The company claims a business transfer understanding. Risk: asset may not be legally controlled; impairment and capitalisation risk.
Numerical illustration: PPE gross block ₹500 crore; sample verification covers 75% by value. Discrepancies found: 2 CNC machines missing (₹1.8 crore), replaced but not recorded; surplus items on floor (₹0.2 crore). Net discrepancy ₹1.6 crore (0.32% of gross block); materiality at 0.25% of total assets ⇒ material.
Qualified opinion – specimen language: “In our opinion and according to the information and explanations given to us, the Company has not maintained adequate records showing full particulars including quantitative details and situation of certain items of property, plant and equipment. Further, title deeds of immovable properties aggregating to ₹28.4 crore, as per the fixed asset register, are not held in the name of the Company. Accordingly, the Company has not complied with the requirements of Clause 3(i)(b) and 3(i)(c) of CARO 2020.”
Documentation tip: Retain copy-extracts of title deeds, reconciliation of name mismatches, and management representation addressing control and litigations.
Clause 3(ii) – Inventory and Working Capital Borrowings
What must be reported: Physical verification, material discrepancies, and whether quarterly returns/statements filed with banks/financial institutions for working-capital limits above ₹5 crore are in agreement with books.
Key definitions:
- “Material discrepancies” include shortages/excesses outside tolerance bands; consider shrinkage norms.
- “Agreement with books” requires reconciliation and explanation of differences (valuation method, cut-off, goods-in-transit).
Audit procedures: Observe/attend stock counts; test count sheets, cut-off (GRNs/GDNs), price testing, NRV testing (Ind AS 2/AS 2), ageing analysis, obsolete/slow-moving provisions, and reconciliation of stock statements filed to lenders with general ledger/ERP.
Intricacies: Third-party godowns, consignment/stock-in-transit, bill-and-hold, job-work inventory, and borrowings backed by drawing power derived from stock.
Case study: A company reported to bank inventory ₹120 crore; books show ₹102 crore due to NRV write-down of ₹18 crore not reflected in bank statement.
Numerical illustration: If drawing power uses inventory at cost; exclusion of NRV write-down artificially inflates DP by ₹18 crore, potentially overstating eligible borrowing.
Qualified opinion – specimen language: “The Company has working capital facilities in excess of ₹5 crore from banks secured by current assets. Based on our examination, quarterly returns filed with lenders are not in agreement with the books of account, the variance ranging between ₹14.5 crore and ₹19.2 crore during the year. Accordingly, the Company has not complied with Clause 3(ii)(b) of CARO 2020.”
Clause 3(iii) – Investments, Guarantees, Securities and Loans Granted
What must be reported: Whether during the year the company has provided loans, advances in the nature of loans, stood guarantee, or provided security to entities; terms not prejudicial to the company’s interest; schedule of repayments; whether overdue; and loans repayable on demand granted to promoters/related parties.
Key definitions:
- “Prejudicial to the company’s interest” considers pricing (interest, collateral), tenor, subordination, and purpose.
- “Related party” as per Section 2(76) read with Ind AS 24/AS 18.
Audit procedures: Obtain register u/s 189, evaluate Section 185 (loans to directors etc.) and Section 186 (limits, approvals) compliance; examine board/shareholder approvals, interest rates vs market, security, monitoring of end use, and ageing of receivables.
Case study: Parent advanced ₹50 crore to subsidiary interest-free, repayable on demand, used to acquire land held as inventory; no charge created.
Numerical illustration: Market rate 10% p.a.; interest foregone ₹5 crore annually – potential impairment/ ECL under Ind AS 109; disclosure under Ind AS 24.
Qualified opinion – specimen language: “In our opinion, the terms and conditions of loans amounting to ₹50.0 crore provided to subsidiaries are, prima facie, prejudicial to the Company’s interest as such loans are interest-free and unsecured without a defined repayment schedule. The Company has, therefore, not complied with Clause 3(iii)(a) and 3(iii)(c).”
Clause 3(iv) – Compliance with Sections 185 and 186
What must be reported: Whether provisions of Section 185 (loans to directors and entities in which directors are interested) and Section 186 (loans and investments, guarantees and security) have been complied with.
Audit procedures: Map each loan/guarantee/investment/security to 185/186; verify limits (60% of paid-up share capital, free reserves and securities premium or 100% of free reserves and securities premium, whichever is more) or special resolution; rate of interest not less than prevailing yield of one/three/five/ten-year Government security; and board approvals with disclosure.
Case study: Company exceeded Section 186 limits by ₹30 crore without prior special resolution; ratified later.
Qualified opinion – specimen language: “The Company has not complied with Section 186 of the Act in respect of loans and investments aggregating ₹30.0 crore made without obtaining prior approval of shareholders by a special resolution, as required. Accordingly, the Company has not complied with Clause 3(iv) of CARO 2020.”
Clause 3(v) – Deposits and Deemed Deposits
What must be reported: Compliance with directives of the Reserve Bank of India and provisions of Sections 73 to 76 and rules framed; nature of contraventions; and repayment status of deposits.
Intricacies: Advances from customers beyond 365 days without linkage to performance obligations may be deemed deposits; unsecured loans from members without rule-compliant procedures; non-filing of DPT-3; and non-maintenance of liquid deposit for repayment reserve.
Case study: Company collected ₹12 crore from franchisees as refundable security without executing agreements; treated as “advance” for years.
Numerical illustration: Required deposit repayment reserve 20% of maturing deposits in FY; shortfall ₹1.2 crore.
Qualified opinion – specimen language: “In our opinion and according to the information and explanations given to us, the Company has accepted amounts which are in the nature of deposits without complying with the provisions of Sections 73 to 76 of the Act and the Companies (Acceptance of Deposits) Rules, 2014, including maintenance of liquid assets for repayment. The outstanding such amounts aggregate ₹12.0 crore as at year-end.”
Clause 3(vi) – Cost Records under Section 148(1)
What must be reported: Whether maintenance of cost records has been specified and, if so, whether such accounts and records have been made and maintained.
Audit procedures: Obtain MCA notifications; if applicable industry/product, review cost ledgers, quantitative reconciliations between financial and cost records, and cost audit reports.
Qualified opinion – specimen language: “The Central Government has prescribed maintenance of cost records under Section 148(1) for the Company’s products. We have broadly reviewed such accounts and records and are of the opinion that they have not been maintained in all respects, as the quantitative reconcilations and captive consumption records were not available for our review.”
Clause 3(vii) – Statutory Dues (Undisputed and Disputed)
What must be reported: Whether undisputed statutory dues (GST, Provident Fund, ESI, Income-tax, Customs, Duty of Excise, VAT, Cess, etc.) were regularly deposited and if any amounts were outstanding for more than six months; and details of statutory dues not deposited on account of disputes.
Audit procedures: Test monthly returns vs challans, 26AS/TIS, reconciliation of input credits, interest and late fee provisions, and legal status of disputes with ageing.
Case study: GST payable of ₹10.2 crore outstanding > six months due to working capital stress; e-way bill penalties assessed but not provided.
Numerical illustration: Interest at 18% p.a. on ₹10.2 crore for 200 days ≈ ₹1.01 crore; financial statement impact material.
Qualified opinion – specimen language: “The Company has not been regular in depositing undisputed statutory dues, including Goods and Services Tax, with the appropriate authorities. Undisputed amounts outstanding as at year-end for a period of more than six months aggregate ₹10.2 crore.”
Clause 3(viii) – Unrecorded Income
What must be reported: Whether any transactions not recorded in the books have been surrendered or disclosed as income during tax assessments under the Income-tax Act.
Audit procedures: Review income-tax orders, search/survey statements, settlement disclosures, and ensure corresponding recording and tax provisioning in books.
Case study: Income of ₹6.5 crore admitted during survey for unaccounted scrap sales; only ₹3.0 crore recorded.
Qualified opinion – specimen language: “During the year, income of ₹6.5 crore surrendered under the Income-tax Act has not been fully recorded in the books; ₹3.5 crore remains unrecorded. Accordingly, the Company has not complied with Clause 3(viii) of CARO 2020.”
Clause 3(ix) – Borrowings and Use of Funds
What must be reported: (a) Default in repayment of loans or borrowings or in the payment of interest; (b) Whether declared a wilful defaulter; (c) Application of term loans; (d) Short-term funds used for long-term purposes; (e) Funds taken to meet obligations of subsidiaries/associates/JVs; (f) Loans raised on pledge of securities of subsidiaries etc.
Audit procedures: Obtain sanction letters, covenant matrices, repayment schedules, bank confirmations; test end-use of term loans to fixed asset invoices; fund-flow analysis for short vs long-term; examine support/guarantees to group entities; review borrower classification/wilful defaulter lists.
Case study: Term loan ₹200 crore sanctioned for Plant II; ₹40 crore diverted to acquire shares of an unrelated company. Short-term CC used to fund CWIP for six months.
Numerical illustration: Debt service coverage ratio covenant 1.25x; actual 0.92x due to diversion; interest default of ₹3.6 crore for 47 days.
Qualified opinion – specimen language: “The Company has defaulted in repayment of interest amounting to ₹3.6 crore to lenders; delays ranged from 12 to 47 days. Further, a portion of term loans aggregating ₹40.0 crore has not been applied for the purposes for which they were obtained but has been diverted for investment in equity shares. Accordingly, the Company has not complied with Clause 3(ix)(a) and 3(ix)(c) of CARO 2020.”
Clause 3(x) – Funds Raised through IPO/FPO and Preferential Allotment/Private Placement
What must be reported: Whether moneys raised by IPO/FPO (including debt instruments) were applied for the purposes for which obtained; and whether preferential allotment or private placement of shares/convertible debentures are in compliance with Sections 42 and 62.
Audit procedures: Trace offer documents to utilisation schedules, monitor escrow to deployment, board approvals, RPT aspects, and filing of PAS-3, valuation reports, pricing formulae.
Case study: Preferential issue to promoter group at a price below valuation; proceeds used to repay unrelated party loans rather than stated product expansion.
Qualified opinion – specimen language: “Moneys raised by way of preferential allotment aggregating ₹75.0 crore were not applied for the purposes stated in the explanatory statement to the notice of the general meeting. Further, the preferential issue was not in compliance with Section 42 read with Section 62(1)(c) of the Act in respect of pricing and valuation.”
Clause 3(xi) – Fraud and Whistle-blower Complaints
What must be reported: Whether any fraud by the company or on the company has been noticed or reported; whether any report under Section 143(12) has been filed; and whether any whistle-blower complaints were considered.
Audit procedures: Inquiry with management and those charged with governance, review of fraud risk assessments, internal audit reports, vigil mechanism records, and legal files.
Case study: Procurement collusion identified by internal audit (estimated loss ₹2.1 crore); auditor concluded it constitutes fraud by employees.
Qualified opinion – specimen language: “Based on audit procedures and information provided, a fraud by employees involving misappropriation of inventory amounting to ₹2.1 crore was noticed during the year. The matter has not been fully provided for in the financial statements. Accordingly, the Company has not complied with Clause 3(xi).”
Clause 3(xii) – Nidhi Company
What must be reported: Whether the company has complied with (a) Net Owned Funds to Deposits ratio; (b) maintenance of 10% unencumbered term deposits; and (c) default in repayment.
Audit procedures: Validate Nidhi status and Rules compliance, compute NOF:Deposits, examine term deposit lien, and test depositor grievance redressal.
Qualified opinion – specimen language: “The Company has not maintained unencumbered term deposits of not less than 10% of the outstanding deposits as required under the Nidhi Rules, 2014.”
Clause 3(xiii) – Related Party Transactions
What must be reported: Compliance with Sections 177 and 188 and disclosure as required by applicable accounting standards.
Audit procedures: Read RPT policy, minutes of Audit Committee/Board, test approvals and omnibus approvals, benchmark pricing, and verify Ind AS 24/AS 18 disclosures.
Case study: Sale of finished goods to promoter HUF at 8% discount without Audit Committee approval; value ₹28 crore.
Qualified opinion – specimen language: “The Company has entered into related party transactions without obtaining the prior approval of the Audit Committee as required under Section 177(4). Accordingly, the Company has not complied with Clause 3(xiii).”
Clause 3(xiv) – Internal Audit System
What must be reported: Whether the company has an internal audit system commensurate with size and nature of business and whether internal audit reports have been considered.
Audit procedures: Evaluate scope, coverage, independence, frequency, and follow-up; review key findings and management action plans.
Case study: Internal audit outsourced to a small firm; coverage limited to cash and payroll; critical areas like procurement and ITGC omitted in a complex manufacturing entity.
Qualified opinion – specimen language: “In our opinion, the Company’s internal audit system is not commensurate with the size and nature of its operations, as the coverage during the year did not include procurement, inventory management, and IT general controls.”
Clause 3(xv) – Non-cash Transactions with Directors or Persons Connected with Them
What must be reported: Whether the company has entered into any non-cash transactions with directors or persons connected with them and compliance with Section 192.
Audit procedures: Scan ledgers for barter/settlements in kind, sale/purchase of assets with directors, and board/shareholder approvals.
Case study: Transfer of a company vehicle to a director at book value despite significantly higher fair value; no shareholders’ resolution.
Qualified opinion – specimen language: “The Company has entered into non-cash transactions with directors without complying with the provisions of Section 192 of the Act.”
Clause 3(xvi) – Registration under Section 45-IA of RBI Act; CIC; Non-Banking Business
What must be reported: (a) Whether the company is required to be registered under Section 45-IA and has obtained registration; (b) whether it has conducted any NBFC/HFC activities without valid registration; (c) whether it is a Core Investment Company (CIC) and, if so, meets applicable criteria; (d) whether it is an exempted NBFC.
Audit procedures: Review financial assets/income proportion tests, lending/investing patterns, group structure for CIC determination, and RBI returns.
Case study: Treasury subsidiary earns >50% income from financing activities but claims exemption; no CoR obtained.
Qualified opinion – specimen language: “The Company is engaged in the business of financing as its principal business and is required to be registered under Section 45-IA of the RBI Act. No such registration has been obtained. Accordingly, the Company has not complied with Clause 3(xvi).”
Clause 3(xvii) – Cash Losses
What must be reported: Whether the company has incurred cash losses in the financial year and in the immediately preceding financial year; quantify the amounts.
Definitions: Cash loss = loss after adding back non-cash expenses such as depreciation/amortisation/impairment and after adjusting non-cash income.
Audit procedures: Bridge PBT to cash profit/loss; validate add-backs and non-cash charges.
Numerical illustration: PBT (₹-24.0 crore) + Depreciation (₹12.5 crore) + Amortisation (₹1.0 crore) + Impairment (₹0.5 crore) – Unrealised FX gain (₹0.8 crore) = Cash loss ₹-10.2 crore
Qualified opinion – specimen language: “The Company has incurred cash losses of ₹10.2 crore in the current year and ₹6.8 crore in the immediately preceding year.”
Clause 3(xviii) – Resignation of Statutory Auditors
What must be reported: Whether there has been any resignation of the statutory auditors during the year and whether the incoming auditor has considered the issues, objections or concerns raised by the outgoing auditor.
Audit procedures: Read ADT-3, board/audit committee minutes, correspondence, and evaluate opening balances/ scope limitations.
Case study: Outgoing auditor resigned citing management-imposed limitations on inventory observation; incoming auditor expanded procedures accordingly.
Reporting language (illustrative): “There was a resignation of the statutory auditors during the year. We have taken into consideration the issues, objections or concerns raised by the outgoing auditors.”
Clause 3(xix) – Ability to Meet Liabilities Existing at the Balance Sheet Date
What must be reported: Whether, on the basis of financial ratios, ageing, and expected realisation/payment schedules, the auditor is of the opinion that no material uncertainty exists as on the date of the audit report that the company is capable of meeting its liabilities as and when they fall due within a period of one year.
Audit procedures: Liquidity analysis (current ratio, quick ratio), operating cash flows, ageing of receivables and payables, borrowing headroom, unutilised limits, events after reporting period.
Numerical illustration: Current ratio 0.86; projected operating cash flow deficit ₹22 crore; unutilised CC limit ₹15 crore; maturing term loan instalments ₹12 crore. Conclusion: Material uncertainty exists.
Qualified opinion – specimen language: “Based on our examination, a material uncertainty exists that the Company may not be capable of meeting its liabilities as and when they fall due within one year from the balance sheet date. Accordingly, the Company has not complied with Clause 3(xix) of CARO 2020.”
Clause 3(xx) – Corporate Social Responsibility (CSR)
What must be reported: Whether unspent CSR amounts pertaining to ongoing projects have been transferred to special accounts within 30 days and other unspent amounts to a Fund specified in Schedule VII within six months, in compliance with Section 135.
Audit procedures: Recompute CSR obligation (2% of average net profits as per Section 198), verify project approvals, escrow/special account transfers, and utilisation.
Case study: CSR obligation ₹3.2 crore; spent ₹1.1 crore; ongoing projects ₹1.4 crore; unspent other ₹0.7 crore not transferred within due date.
Qualified opinion – specimen language: “The Company has not transferred unspent CSR amounts of ₹0.70 crore, not relating to ongoing projects, to a Fund specified in Schedule VII within six months from the end of the financial year.”
Clause 3(xxi) – Consolidated Financial Statements (CARO reporting for Consolidated Entities)
What must be reported: Whether any qualifications or adverse remarks are contained in the CARO reports of the companies included in the consolidated financial statements; the details of those companies and the paragraph numbers of the CARO reports containing the qualifications or adverse remarks.
Audit procedures: Obtain component auditors’ CARO reports, summarise qualifications, evaluate pervasiveness, and consider impact on the group audit opinion.
Illustration: Two subsidiaries had CARO qualifications under Clause 3(ii) (inventory) and Clause 3(ix) (defaults). The parent’s CARO report should list these with cross-references.
Specimen language: “Based on the CARO reports of the component auditors of two subsidiaries, we draw attention to qualifications reported under Clause 3(ii) relating to inventory and Clause 3(ix) relating to defaults in repayment of borrowings.”
Appendix – Practical Drafting Notes, Checklists and Working Paper Index
- Link each CARO paragraph to specific audit procedures and evidence.
- Quantify wherever practicable.
- Avoid ambiguous terms; use dates, amounts, and clause references.
- Where management disagrees, include their explanations but report facts objectively.
Working Paper Index (indicative): CARO-1 PPE; CARO-2 Inventory; CARO-3 Loans; CARO-4 185/186; CARO-5 Deposits; CARO-6 Cost; CARO-7 Dues; CARO-8 Unrecorded; CARO-9 Borrowings; CARO-10 IPO/Preferential; CARO-11 Fraud; CARO-12 Nidhi; CARO-13 RPT; CARO-14 Internal Audit; CARO-15 Non-cash; CARO-16 RBI/CIC; CARO-17 Cash Losses; CARO-18 Resignation; CARO-19 Liabilities; CARO-20 CSR; CARO-21 Consolidated.
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