Ministry emplaces Stringent Auditing norms to curb Corporate Scams

CS Jaya Sharma 30 Mar 2020 966 Views 0 comment Print Company Law | Articles

The Ministry of Corporate Affairs (MCA) on Tuesday, February 25, 2020 notified the Companies (Auditor’s Report) Order, 2020 (CARO 2020) revamping the Companies (Auditor’s Report) Order, 2016 (CARO 2016) , making it mandatory for companies to disclose all complaints to the auditor while ushering enhanced due diligence and disclosures on the part of auditors.

RATIONALE BEHIND CARO 2020

The notification of Companies (Auditor Report) Order, 2020 (CARO 2020) is a major initiative taken by the Ministry of Corporate Affairs, Government of India in consultation with National Financial Regulatory Authority with the objective of restoring the trust of the various stakeholders in the financial statements of India.

Rational Behind CARO 2020

Under the revised CARO 2020, auditors are now required to report more extensively on many crucial aspects including frauds, loan defaults, whistle blower complaints, evergreening of loans and benami properties.

Representation of funds, transfer of properties, ability to discharge liabilities, and disclosures on loans, guarantees, and investments of a company will now come under auditor scrutiny.

CARO 2020 has been introduced to overcome the lacuna in financial reporting & to avoid IL&FS like situation. MCA inevitably prosecuted Deloitte and BSR Associates based on the Serious Fraud Investigation Report (SFIO) for their failure to detect and report the scams that took place involving IL&FS and its 21 entities when they were the auditors of the IL&FS

Misappropriation of loans, guarantees and securities and violation of end-use terms by IL&FS led to a liquidity crisis. Some 88 cases of evergreening of loans were noted by the SFIO in its investigation of IL&FS. Evergreening of loan means granting new loans for repayment of old loans to prevent a default.

To curb similar corporate scams, the Ministry of Corporate Affairs has specified the understated items to be reported in auditor’s report.

APPLICABILITY OF CARO 2020

The criteria of eligibility of companies on which the CARO, 2020 shall be applicable has not been changed and hence it shall be applicable to all those companies on which CARO, 2016 was applicable.

It shall apply to every company including a foreign company as defined in clause (42) of section 2 of the Companies Act, 2013, except–

Banking company;
Insurance company;
Section 8 company;
One Person Company;
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 one crore rupees as on the balance sheet date and which does not have total borrowings exceeding one crore rupees from any bank or financial institution at any point of time during the financial year and which does not have a total revenue as disclosed in Scheduled III to the Companies Act (including revenue from discontinuing operations) exceeding ten crore rupees during the financial year as per the financial statements.

MATTERS TO BE SUBSUMED IN AUDITOR’S REPORT

To curb corporate scams, the Ministry of Corporate Affairs has specified following items on which an auditor must include a statement in its report, via recent notification on CARO 2020:

The CARO, 2020 includes certain additional clauses, as compared to CARO, 2016, and CARO, 2016 have been re-drafted to stimulate detailed comments from the auditors. Number of reporting clauses in paragraph 3 has been increased to 21 from the earlier 16 clauses.
CARO, 2020 focuses on reporting of “Property, Plant & Equipment”. Earlier reporting was required on all fixed assets.
Reporting on “Revaluation of Property, Plant & Equipment” by the company.

Whether the company has revalued its Property, Plant & Equipment (including Right to use assets) or intangible assets or both during the year.

A specific format has been provided for reporting the details of such immovable properties whose title deeds are not held in the name of the company but are disclosed in the financial statements.
Reporting of proceedings under the Benami Transactions (Prohibition) Act, 1988. If there are proceedings which are either intitated or pending against the Company for holding any benami property under the Benami Transactions (Prohibition) Act, 1988 and rules made thereunder, auditor will have to report whether the same is appropriately disclosed in the financial statements. There is already specific reporting in the main audit report on proper disclosure of financial impact of the litigations, to that extent this reporting can overlap.
Auditor also needs to specifically comment on coverage and procedure adopted for inventory management.
Discrepancies of 10% or more in the aggregate of each class of inventory noticed during physical verification of inventory shall be reported by the auditor to elicit transparency.
The auditor is obliged to provide specific details as to whether the Company has been sanctioned working capital limits in excess of Rs. 5 crores, in aggregate, from banks or financial institutions on the basis of security of current assets and whether the quarterly returns/statements filed by the Company with such banks or financial institutions are in agreement with the books of account of the Company.
Reporting of investments in or providing of guarantee or security or granting any loans or advances to companies, firms, LLPs or any other parties.

The auditor is to report in detail on the investments made by the company in, any guarantee or security provided or any loans or advances in the nature of loans granted, secured or unsecured, to companies, firms, Limited Liability Partnerships or any other parties during the year that they are not prejudicial to the interests of the company.

The auditor shall report as to whether term loans were applied for the purpose for which the loans were obtained, in case of any discrepancy, the amount of loan so diverted and the purpose for which it is used shall also be reported.

A specific format has been prescribed to report the period and the amount of default by the company in repayment of loans or other borrowings or in the payment of interest thereon to any lender.
The auditor is required to report as to whether any fraud by the company or any fraud on the Company has been noticed or reported during the year, if yes, nature of the fraud reported and the amount involved is to be indicated in the CARO report.
Reporting of compliances with the RBI directives and the provisions of Companies Act in regard to deemed deposits.
Reporting with respect to transactions not recorded in the books of accounts surrendered or disclosed as income in the Income Tax proceedings.
Cash losses incurred in the financial year and in the immediately preceding financial year has to be considered in the report.
Issues, objections or concerns raised by the outgoing auditors shall be taken into consideration by the auditor before considering any decision.
The audit report shall state whether the company is a declared wilful defaulter by any bank/ financial institution/other lenders.
The auditor is to report whether the company has conducted any Non-Banking Financial transaction or Housing Finance activities without a valid Certificate of Registration from the Reserve Bank of India.
Reporting on management of whistle blower complaints received during the year by the company.
The auditor is obliged to comment his opinion with respect to financial ratios, ageing and expected dates of realization of financial assets and payment of financial liabilities, other information accompanying the financial statements, the auditor’s knowledge of the Board of Directors and management plans, that no material uncertainty exists as on the date of the Audit Report, that company is capable of meeting its liabilities existing at the date of balance sheet as and when they fall due within a period of one year from the balance sheet date.
Details of the subsidiary companies and the sub-clauses’ number containing qualifications/adverse remarks by the respective auditors shall be included in the CARO reports of the companies included in the consolidated financial statements.

REPERCUSSIONS OF CARO 2020 ON KMPs

While the disclosures are rigorous for auditors, they are stringent for Key Managerial Personnels (KMPs) as well. As a result, a KMP’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.

CONCLUSON

The CARO, 2020 is expected to improve the overall quality of reporting by the statutory auditors on the financial statements of the companies and thereby lead to greater transparency and faith in the financial affairs of the companies. By this, it is expected to have a greater inflow of investment by and in Indian companies, in pursuance of its objective of strengthening the corporate governance framework under the Companies Act, 2013 to attain the national objective of becoming a $ 5 Trillion economy.

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