Auditor’s Report on the
financial statements of a limited 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 auditor 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. Under the powers
conferred by S. 227(4A), the Central Government first issued an order
called the manufacturing and other companies (auditor’s 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. With changes 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 (Auditor’s Report) Order, 2003. This can be
called ‘CARO-2003’ which has come into force from 1st July 2003. There are
33 items in CARO on which the auditor has
to make specific comments. Some of the items in MAOCARO-1988 and
CARO-2003 are common and some items from MAOCARO
are omitted. Since some additional responsibilities are
being placed on the auditor under CARO-2003, the discussion in
this article is mainly restricted to the new items added under this new order.
3. Applicability :
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 companies :
(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 conditions :
(a) Its paid up capital and
reserves do not exceed Rs.50 lacs;
(b) It has not accepted any
(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
(i) The term ‘Reserves’ 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 ‘Public
Deposits’ is not defined. Therefore, meaning given to this term u/s.58A of
the Act can be assigned to this term.
(iii) The term ‘Turnover’
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
(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, finance and investment
company and chit fund company, etc. in the same manner as
defined in 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
3.5 Para 4 of CARO states that
the Auditor’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.
4.1 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. This requirement is now deleted.
4.3 CARO now requires the
auditor to state whether the ‘going concern’ 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
5. Inventories :
5.1 The reporting requirement
under CARO in respect of following matters relating to inventories is the same
as in MAOCARO :
(i) Whether physical
verification of inventories is conducted by the management at reasonable
(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. This is a new 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
change in the method of valuation is required to be
given or taken by company :
6.1 The reporting requirement
under this head according to MAOCARO and CARO in respect of the following items
is more or less the same :
(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 loans :
(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 prima facie not
prejudicial to the interest of the company.
(ii) Whether payment of the
principal amount and interest are also regular. In this clause the word ‘payment’
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
are interested and to 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, 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
6.3 Para 4(A)(ix) 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
applied to all 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.
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.
audit system :
MAOCARO provided that the
auditor should report whether the company has an internal audit 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 companies :
(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.
of public deposits :
The reporting by the auditor with
regard to public deposits 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.
of cost records :
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.
11.1 The requirement of report-ing whether undisputed statutory
dues such as Provident Fund, Investor Education and 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 in MAOCARO, has 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.
12.1 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 ‘Net
Worth’ and ‘Cash Losses’ 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 bring uniformity in our approach. It may be noted that in
the guidance note on terms used in Financial Statements issued by ICAI, the term
‘Net Worth’ is explained as ‘The excess of the book value of assets (other
than fictitious assets) of an enterprise over its liabilities’. In the above
guidance note the term ‘Cash Loss’ is explained to mean the ‘net loss’
as per accounts after excluding non-cash costs, such as depreciation,
of dues of banks, etc. and creation of securities :
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
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.
prejudicial to the interest of the company :
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
the stock exchange, and compare the same with the issue price under the
use of borrowed funds :
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 ‘term loan’ 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 to be studied by the
(ii) If the company has raised
‘short-term’ funds, the auditor will have to report if such funds are used
for long-term investment. Similarly, if ‘long-term’ 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
(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.
about frauds :
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
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
of the MAOCARO items deleted :
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 CARO :
(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.
investment, chit fund, nidhi or mutual benefit companies :
As stated earlier, separate
classification for such companies made in Para 4(D) 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 applicable :
(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
(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 matters :
(a) Whether the net-owned
fund to liability ratio is more than 1 : 20 as at the balance
(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, whether proper records have been maintained, timely
entries are made and such investments are in the name of the company.
of Audit Report :
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 auditor should state his 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
sum up :
From the above comparison of the provisions of
MAOCARO and the new 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 auditor’s report u/s.227(4A) has been
issued by the Government in consultation 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 confidence 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. When such major changes are being made, the
Institute should have suggested to the Government to issue an ex-posure draft 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
any accounting 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.