Companies (Auditor’s Report) Order, 2020: Key Changes in the Disclosure Requirements

By an order dated February 25, 2020 (effective February 29, 2020), the Ministry of Corporate Affairs introduced the Companies (Auditor’s Report) Order, 2020 (‘CARO 2020’). The CARO 2020 supersedes the Companies (Auditor’s Report) Order, 2016 (‘CARO 2016’), substantially enhancing the scope of disclosures in the auditor’s report and requiring auditors to make qualitative judgements in relation to certain matters (set out in further detail below).

CARO 2020 is applicable on and from the financial year commencing April 1, 2019, thereby having an immediate impact on companies for the upcoming annual audit exercise for the financial year ending on March 31 2020. Like CARO 2016, CARO 2020 does not cover banking companies, insurance companies, companies licensed under Section 8 of the Companies Act, 2013, one person companies or small-sized private companies satisfying certain specified criteria. However, CARO 2020 increases the rigor with which statutory audits are required to be carried out, to the benefit the investors and other stakeholders. Our analysis below, is divided into two parts: (i) enhanced disclosure requirements; and (ii) qualitative judgments.

Enhanced Disclosure Requirements

Assets: Disclosures relating to assets of the company must now include: (i) details (provided in a specified format) of immovable properties (disclosed in the financial statements) whose title deeds are not held in the name of the company; (ii) details of re-valuation of a company’s assets including right of use assets and intangible assets, and if such re-valuation is based on a valuation by a registered valuer; (iii) any change of 10% or more in the aggregate of the net carrying value of each class of assets; and (iv) details of any proceedings that have been initiated or are pending against the company, for holding any benami property and if the company has appropriately disclosed such details in its financial statements.

Additionally, auditors are now required to report separately on tangible and intangible assets of the company. Auditors are also required to include a confirmation regarding the maintenance of proper records by the company, showing full particulars of intangible assets. Further, CARO 2020 has quantified the disclosure requirement for material discrepancies in the auditor’s reports at, 10% or more – i.e., if the discrepancies arising from physical verification of inventory is 10% or more (in aggregate) for each class of inventory, then the same must be disclosed.

Amounts Borrowed/Lent or Invested (Including Guarantees or Securities Provided): Disclosures relating to amounts borrowed, lent or invested by the company must now also include:

i.       details regarding whether the company has received sanction of working capital limits, in excess of Rs 5,00,00,000 in aggregate, from banks or financial institutions on the basis of security over current assets, and whether quarterly returns or statements filed by the company with such banks or financial institutions are in agreement with the accounts of the company. Details of any discrepancies are also required to be provided;

ii.     the following disclosures relating to loans/advances in the nature of loans, investments made and guarantee/security provided, by the company (certain requirements are not applicable when the principal business of the company is to give loans):

•        whether any such transactions have been undertaken during the year;

•        segregation of aggregate amounts during the year and balance outstanding at the end of the year between subsidiaries, joint ventures and associates on the one hand, and others on the other hand;

•        disclosures relating to ‘ever greening’, i.e., in respect of any loan/advance granted which has fallen due during the year, and which has been renewed/fresh loans granted to settle the overdue of existing loans given to the same parties. The disclosures required comprise of aggregate amounts and percentage of the aggregate to the total loans or advances granted during the year; and

•        whether there are any loans/advances in the nature of loans granted by the company either repayable on demand or without specifying any terms or period of repayment. If so, disclosure is required of the aggregate amounts, percentage thereof to the total loans granted and aggregate amount of such loans granted to promoters and related parties;

iii.       enhanced disclosures in relation to defaults in repayment of amounts borrowed or payment of interest thereon;

iv.        details of whether the company has been declared a willful defaulter by any bank, financial institution or other lender;

v.         details of utilization of funds raised on short term basis for long term purposes including the nature and amount;

vi.        details of whether term loans were applied for the purpose for which the loans were obtained;

vii.      details of funds taken by the company on account of or to meet the obligations of its subsidiaries, associates or joint ventures; and

viii.   details of whether the company has raised loans against pledge of securities held by it in its subsidiaries, joint ventures or associate companies and details of default in repayment of such loans.

Other Matters

Other key matters required to be disclosed by auditors are whether: (i) the auditors have reported an occurrence of fraud under Section 143(12) read with Rule 13 of the Companies (Audit and Auditors) Rules, 2014 with the Central Government; (ii) the company is regular in depositing undisputed statutory dues of goods and services tax; (iii) the company has incurred cash losses during the year and in the immediately preceding financial year – and if so, the amount of such cash losses; and (iv) any transactions that are not recorded in the accounts have been surrendered or disclosed as income during the year in the tax assessments under the Income-Tax Act, 1961. Conversely, disclosures required in relation to excess managerial remuneration paid, which were required to be included in the auditor’s report under CARO 2016, have been deleted.

Qualitative Judgements

Business Operations/Financial Statements

Under CARO 2020, auditors are now required to: (i) provide an opinion on whether the coverage and procedure of physical verification of inventory by the management is appropriate; (ii) in respect of loans (including advances in the nature of loans), investments and guarantees provided – details regarding whether the terms thereof are not prejudicial to the company’s interest; (iii) details regarding whether the company has an internal audit system commensurate with the size and nature of its business; (iv) details regarding whether the auditor has considered whistle-blower complaints, if any, received during the year by the company in his audit; (v) details regarding whether the auditor has considered reports of internal auditors for the period under audit; and (vi) in case the statutory auditor of the company has resigned during the year – whether the issues, objections or concerns raised by the outgoing auditor have been taken into consideration by the auditor.

Compliance with Laws

Under CARO 2020, auditors are further required to opine on: (i) 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; (ii) whether the company is a Core Investment Company (‘CIC’) and if yes, whether it fulfills the conditions applicable to it as a CIC (including, if it is an unregistered or exempt CIC, criteria applicable to an unregistered or exempt CIC), and whether the group has more than one CIC; if yes, the number of such CICs which are part of the group.

Once the provisions in this regard are notified, then auditors will also be required to state whether, the company has transferred unspent amounts (required to be spent as a part of its corporate social responsibility obligations) to the fund specified in Schedule VII of the Companies Act, 2013, and in relation to ongoing projects, whether the unspent amount has been transferred to the special account referred in Section 135(6) of the Companies Act, 2013.

Compliance with Financial Obligations

The auditor is required, on the basis of specified criteria, to confirm whether it is of the opinion that no material uncertainty exists as on the date of the audit report on whether the company is capable of meeting its liabilities (as on the date of the balance sheet) as and when they fall due within a period of one year from the balance sheet date.

To conclude, the role of an auditor has always been that of a watchdog. The nature and extent of these changes (in conjunction with other recent developments) may beckon the question of whether this role is changing in the current landscape.

Date: March 17, 2020