BCA Journal CARO 2020 Compliation

A BCAJ ‘CARO 2020’ Compilation
DO CONGLOMERATE
DECODING GST: CARO 2020 SERIES:
CARO 2020 SERIES: PROPRIETY IN ADJUDICATION NON-BANKING FINANCE
LOANS & ADVANCES,
GUARANTEES &
COMPANIES (NBFCs)
[INCLUDING CORE INVESTMENT COMPANIES]
STRUCTURES FACILITATE
INVESTMENTS BUSINESS EFFICIENCY?
BCAJ VOL. 53 ISSUE 10 | JANUARY 2022

BCAJ VOL. 53 ISSUE 7 | OCTOBER 2021
A DIGNIFIED EXIT
REVERSAL OF RETROSPECTIVE
AMENDMENT
SEBI TIGHTENS REGULATIONS FOR

ANTI-ABUSE RULE FOR PEs SITUATED RELATED PARTY TRANSACTIONS –
LAWS AND BUSINESS: IN THIRD JURISDICTIONS (PART 2) – KEY AMENDMENTS AND AUDITOR’s
IT'S GAMING, NOT GAMBLING ARTICLE 10 OF THE MLI RESPONSIBILITIES
October, 2021 January, 2022
CARO 2020 SERIES: ANTI-TAX AVOIDANCE

PPE & INTANGIBLE MEASURES FOR CAPITAL
ASSETS GAINS: ARTICLE 9 OF MLI
BCAJ VOL. 53-A PART 3 | JUNE 2021
UNFAIRNESS AND THE AUDIT: BUILDING

INDIAN TAX SYSTEM PUBLIC TRUST
June, 2021
BCAJ 212 X 278 mm.indd 1 11/30/2020 2:11:02 PM
CONTENTS
Dear Reader,
We take this opportunity to thank you for the success of Volume 53 (April 2021 to March 2022)
of BCA Journal. We published 20 articles (an average of 1.7 articles a month) on Accountancy
and Audits during the year in addition to our monthly features.
In the year just completed, we carried a series of 8 articles on CARO 2020. CA Zubin Billimoria
spearheaded the series. He was supported by CA Manish Sampat, CA Paresh Clerk and
CA Vijay Maniar who co-authored the first three articles. We are pleased to share a compilation
of all the articles in the series.
We thought of putting them all together in a compilation for ease of reference and use during
the course of audits.
Feel free to share this with those you think will benefit from it and be a part of the knowledge
sharing endeavour of BCAS.
Team BCAJ
1 CARO 2020 Series: New Clauses and Modifications - Property, Plant & Equipment &
Intangible Assets | June, 2021 | 5 (Hyperlinked to the article)
2 CARO 2020 Series: New Clauses and Modifications - Inventories and Other Current
Assets | August, 2021 | 9 (Hyperlinked to the article)
3 CARO 2020 Series: New Clauses and Modifications - Loans & Advances, Guarantees &
Investments | October, 2021 | 14 (Hyperlinked to the article)
4 CARO 2020 Series: New Clauses and Modifications - Deposits, Loans and
Borrowings | November, 2021 | 21 (Hyperlinked to the article)
5 CARO 2020 Series: Frauds and Unrecorded Transactions |

December, 2021 | 30 (Hyperlinked to the article)
6 CARO 2020 Series: Non-Banking Finance Companies (NBFCs) [Including Core

Investment Companies] | January, 2022 | 35 (Hyperlinked to the article)
7 CARO 2020 Series: Reporting on Financial Position |

February, 2022 | 42 (Hyperlinked to the article)
8 CARO 2020 Series: Resignation of Statutory Auditors and CSR |

March, 2022 | 47 (Hyperlinked to the article)
BCAJ
READERS, AUTHORS AND CONTRIBUTORS
JULY 2021
APRIL 2021 MAY 2021 JUNE 2021
VOL. 53-A PART 4
VOL. 53-A PART 1 VOL. 53-A PART 2 VOL. 53-A PART 3
PAGES 132
PAGES 132 PAGES 140 PAGES 116
PRICE: R100
PRICE: R100 PRICE: R100 PRICE: R100
T H E B O M B AY C H A R T E R E D A C C O U N TA N T J O U R N A L T H E B O M B AY C H A R T E R E D A C C O U N TA N T J O U R N A L T H E B O M B AY C H A R T E R E D A C C O U N TA N T J O U R N A L T H E B O M B AY C H A R T E R E D A C C O U N TA N T J O U R N A L
C U R I O S I T Y T O C R E AT I V I T Y C U R I O S I T Y T O C R E AT I V I T Y C U R I O S I T Y T O C R E AT I V I T Y
C U R I O S I T Y T O C R E AT I V I T Y
ROLLING OUT CARO 2020 SERIES: ANTI-TAX AVOIDANCE

‘COACHING’ IN PERSONAL
PROFESSIONAL SERVICES FIRMS BRANDING PPE & INTANGIBLE MEASURES FOR CAPITAL
FOR CAs ASSETS GAINS: ARTICLE 9 OF MLI ANNUAL SPECIAL ISSUE
COGNIZANCE OF THE
OFFENCE OF
MONEY-LAUNDERING STRATEGY: CHANGES IN
THE HEART OF PARTNERSHIP
REVISITING UNDERSTANDING
BUSINESS TAXATION IN CASE OF
AUDITING PREPACK CAPITAL GAIN BY
FINANCE ACT, 2021
STANDARDS RESOLUTION
EFFECTS OF THE
JDA STRUCTURING: PANDEMIC ON
A 360-DEGREE VIEW DUAL RESIDENT THE CA PROFESSION
ENTITIES – THE ECONOMY
ARTICLE 4 OF MLI
THE HUMAN PSYCHE
INTRODUCTION AND BACKGROUND OF MLI, INCLUDING APPLICABILITY, WHAT HAS CHANGED AND WHAT IS
UNFAIRNESS AND THE AUDIT: BUILDING UNLIKELY TO GET REVERSED
COMPATIBILITY AND EFFECT INDIAN TAX SYSTEM PUBLIC TRUST
AUGUST 2021 SEPTEMBER 2021

VOL. 53-A PART 5 VOL. 53-A PART 6
PAGES 140 PAGES 124
PRICE: R100 PRICE: R100
THE BOMBAY CHARTERED ACCOUNTANT JOURNAL T H E B O M B AY C H A R T E R E D A C C O U N TA N T J O U R N A L

C U R I O S I T Y TO C R E AT I V I T Y C U R I O S I T Y T O C R E AT I V I T Y
DIGITAL WORKPLACE – MLI SERIES: ANALYSIS OF

WHEN ALL ROADS LEAD TO ROME... ARTICLES 3, 5 & 11 OF THE MLI
ACCREDITED INVESTORS –
THE NEW INVESTOR DIASPORA SPECIAL PURPOSE INDIA’S MACRO-ECONOMIC &
ACQUISITION COMPANIES FINANCIAL PROBLEMS AND SOME
– ACCOUNTING AND TAX ISSUES
VALUATION OF CONTINGENT MACRO-LEVEL SOLUTIONS
CONSIDERATION
BCAJ VOL. 53-A PART 6 | SEPTEMBER 2021

CRYPTOCURRENCIES: DIGITAL WORKPLACE –
TRAPPED IN A LEGAL LABYRINTH (Part - 2) A STITCH IN TIME SAVES NINE
CARO 2020 SERIES: INVENTORIES

AND OTHER CURRENT ASSETS
SHOULD CHARITY SUFFER THE

WRATH OF SECTION 50C?
You are the

pivot of the IMPLICATIONS OF
KEY AMENDMENTS TO
COMPANIES ACT, 2013
BCA Journal
ON MANAGEMENT AND AUDITORS
VO L. 53 I S S U E 7 | O CTO B E R 2021 | PAG E S 13 6 | P R I C E : R 100

Thank You VO L. 53 I S S U E 8 | N OVE M B E R 2 02 1 | PAG E S 13 2 | P R I C E: R 1 0 0
DECODING GST:
CARO 2020 SERIES: PROPRIETY IN ADJUDICATION
LOANS & ADVANCES, CARO 2020 SERIES: DEPOSITS, LAWS & BUSINESS
GUARANTEES & LOANS AND BORROWINGS PARTNERSHIP FIRM:
INVESTMENTS STAMP DUTY ISSUES
TWO-PILLAR SOLUTION TO ADDRESS THE
TAX CHALLENGES ARISING FROM THE
DIGITALISATION OF THE ECONOMY
BCAJ SURVEY ON STATUTORY
AUDITS - PERSPECTIVES ON NFRA
CONSULTATION PAPER
A DIGNIFIED EXIT
REVERSAL OF RETROSPECTIVE
AMENDMENT
LAWS AND BUSINESS:

IT'S GAMING, NOT GAMBLING
VO L . 53 I S S U E 9 | D E C E M B E R 2 0 2 1 | PAG E S 13 6 | P R I C E: R 100 VO L . 5 3 I S S U E 1 0 | J A N UA RY 2 0 2 2 | PAG E S 1 1 6 | P R I C E : R 100 VO L . 53 I S S U E 1 1 | F E B R UARY 2 0 22 | PAG E S 1 20 | P R I C E: R 1 0 0 VO L . 53 I S S U E 12 | MA R C H 2022 | PAG E S 116 | P R I C E : R 100
CARO 2020 SERIES:

DO CONGLOMERATE DOES TRANSFER OF EQUITY PURPOSE OF A COVERED TAX AGREEMENT,
CARO 2020 SERIES: NON-BANKING FINANCE PREVENTION OF TREATY ABUSE THE ESG AGENDA AND IMPLICATIONS FOR
FRAUDS AND UNRECORDED COMPANIES (NBFCs) STRUCTURES FACILITATE SHARES UNDER OFFER FOR SALE – ARTICLE 6 AND 7 OF THE MLI C-SUITE AND CORPORATE INDIA
TRANSACTIONS [INCLUDING CORE INVESTMENT COMPANIES]
BUSINESS EFFICIENCY? (OFS) DURING THE PROCESS OF THE GHOST OF B.C. SRINIVASA SETTY IS NOT
LISTING TRIGGER ANY CAPITAL YET EXORCISED IN INDIA CARO 2020 SERIES: AUDITOR’S REPORTING – GROUP AUDIT
VALUE CHAIN ANALYSIS – GAINS? RESIGNATION OF STATUTORY AUDITORS AND CSR
AND USING THE WORK OF OTHER
ADDING VALUE TO ARM’S
LENGTH PRINCIPLE AUDITORS
ANTI-ABUSE RULE FOR
PEs SITUATED IN THIRD
JURISDICTIONS – ARTICLE 10
OF THE MLI
CARO 2020 SERIES:

REPORTING ON
FINANCIAL POSITION
AUDIT QUALITY MATURITY MODEL

SEBI TIGHTENS REGULATIONS FOR – WHAT IS YOUR SCORE?
ANTI-ABUSE RULE FOR PEs SITUATED RELATED PARTY TRANSACTIONS –
ACCOUNTING TREATMENT OF IN THIRD JURISDICTIONS (PART 2) – KEY AMENDMENTS AND AUDITOR’s
CRYPTOCURRENCIES ARTICLE 10 OF THE MLI RESPONSIBILITIES FUNGIBILITY OF DIRECT TAX AND INDIRECT TAX FOR
INDIVIDUAL INCOME TAXPAYERS AND INCOME TAX RETURNS FILERS
INTERNAL CONTROL CONSIDERATIONS
FOR UPCOMING AUDITS
WE THANK ALL OF YOU FOR THE SUCCESS OF VOLUME 53

4 BOMBAY CHARTERED ACCOUNTANT JOURNAL
BCAJ
CARO 2020 SERIES : NEW CLAUSES AND MODIFICATIONS
PROPERTY, PLANT AND

EQUIPMENT & INTANGIBLE ASSETS
I I
MANISH SAMPAT PARESH CLERK VIJAY MANIAR ZUBIN BILLIMORIA I
Chartered Accountants
CARO 2020 is applicable for the statutory audit of financial statements for periods beginning on or after 1st April,
2021. ICAI had issued a detailed Guidance Note (GN) on the same in June, 2020. A module is also available on the
ICAI Digital Learning Hub. Schedule III was also recently amended inter alia to align the reporting requirements under
CARO 2020 by statutory auditors. BCAJ is pleased to bring you a clause-by-clause analysis via a series of articles
authored by four audit practitioners who have been auditors all their lives. Each article will zoom into a clause or
two and provide a ‘commentary’ on reporting issues and practices, views, and perspectives to supplement the broad
guidance covered by the GN. The purpose of this series is to bring out practical nuances to the reader. The series will
cover only new clauses and modifications and exclude those already covered by CARO 2016. We hope this will steer
and support the readers towards better understanding and reporting. – Editor
MODIFICATIONS / ADDITIONAL Additional reporting

REPORTING REQUIREMENTS a. Whether the company has revalued its PPE (including
The clause on reporting in respect of fixed assets has Right of Use Assets) or intangible assets or both during
been there in the earlier versions, too. CARO 2020 has the year and, if so -
modified parts of the first clause and added reporting whether the revaluation is based on valuation by a
requirements as given below: Registered Valuer, and
if change is 10% or more in the aggregate of the net
Modifications carrying value of each class of PPE or intangible assets.
a. Change in the terminology to Property, Plant and b. Whether any proceedings have been initiated or are
Equipment (PPE) in line with Accounting Standards and pending against the company for holding any benami
Schedule III. property under the Benami Transactions (Prohibition)
b. Separate reporting requirement on maintenance of Act, 1988 and rules made thereunder; and if so, whether
proper records for Intangible Assets. the company has appropriately disclosed the details in
c. No reporting required for non-availability of title deeds, its financial statements.
where the company is a lessee and the lease agreement
is executed in favour of the company. SPECIFIC CONSIDERATIONS
d. In cases where title deeds of immovable properties Specific considerations to be kept in mind whilst reporting
are not held in the name of the company, additional on the above changes are discussed under the following
details in a prescribed format as under are required to be broad heads:
given:
Additional disclosures under amended Schedule III
Descrip- Gross Held Whether Period Reason While reporting on these matters, the auditor will have to
tion carrying in the promoter, held – for not keep in mind the amended Schedule III disclosures as
of the value name director, indicate being under:
property of their range held in
relative or where the name
a. The auditor will have to ensure that there is no material
employee appropriate of the inconsistency between the financial statement disclosures
company and his reporting under the Order. Disclosure of changes
(also in the aggregate net carrying value due to revaluation
indicate
if in of each class of PPE and Intangible Assets by 10% or
dispute) more in the aggregate and whether revaluation is based
on the valuation by a Registered Valuer as defined
BOMBAY CHARTERED ACCOUNTANT JOURNAL 5

BCAJ
in Rule 2 of the Companies (Registered Valuer and pose challenges, especially if the properties are not
Valuation) Rules, 2017. reflected in the books. In such cases, apart from the
normal procedures like review of the minutes, scrutiny of
b. The information as specified earlier in respect of title legal expenses, review of minutes of board of directors,
deeds of Immovable Properties not held in the name audit committee, risk management committee, other
of the company, except that the disclosure should be secretarial records, listing of all pending litigations and
given in the aggregate for the following line items in also obtaining management representation (which have
the Balance Sheet, separately for Land and Align-
Building, been referred to in the Guidance Note). The auditor may
as against the description of each individual ment property also obtain independent confirmation from the legal
as per the Order: counsel as to whether any such proceedings, other
PPE than those in respect of properties reflected in the
Investment property books are pending, as per SA 501 – Audit Evidence -
PPE retired from active use and held for sale, non- Specific Considerations for Selected Items.
current assets held for sale (Ind AS entities)
Others d. The reporting under this clause is required only in
As disclosures under Schedule III are along the lines cases where proceedings are initiated or pending against
required to be given, it is imperative for the auditor the company as ‘benamidar’ and not otherwise. Hence,
to reconcile the information disclosed therein for even if notice is received but no proceedings have
completeness and accuracy. been initiated, reporting is not warranted. The reporting
is required by the auditor of the company holding any
c. In respect of proceedings initiated or pending in respect benami property but not as an auditor of the company
of benami property held, the following details are which is the beneficial owner.
required to be disclosed:
i. Details of such property, including year of acquisition, e. Compilation of data for Intangible Assets: Since the
ii. Amount thereof, requirement for reporting on maintenance of records for
iii. Details of beneficiaries, intangible assets has been newly introduced, many
iv. If held in the books, reference thereof to the item in the companies may not have a proper inventory thereof,
Balance Sheet, except the details of the payments made or expenses
v. If not held in the books, then the facts along with capitalised on an individual basis. This could pose
reasons thereof, challenges to prepare a comprehensive itemised
vi. Where there are proceedings against the company as listing of all intangible assets and reconciling the same
an abettor of the transaction or as the transferor, details with the books. It is imperative that in such cases a one-
thereof shall be provided, time exercise is undertaken to reconstruct the records
vii. Nature of proceedings, status thereof and company’s and the nature of documentary evidence like licences,
view of the same. agreements, internal SOPs (for internally generated
intangibles) which is available is also specified. This
Practical challenges in reporting would also facilitate easy identification in future. Wherever
The reporting requirements outlined above entail certain required, an appropriate management representation
challenges which are discussed below: should be obtained regarding the completeness of the
data.
a. In respect of properties owned jointly with others
where the title deeds are not held in the name of the f. Awareness of the legal requirements: There are
company, the above details are required to the extent of certain situations where the auditor would have to
the company’s share. familiarise himself with the legal requirements. These
mainly pertain to the following:
b. Similarly, if the company has changed its name, this
will require reporting under this clause till the new name i. The provisions of the Benami Property Transactions
is updated in the title deed. Act, 1988 and the related Rules. Though relevant
extracts of current regulations are given in the ICAI
c. Identification of benami properties: The reporting Guidance Note, the auditor will have to keep abreast with
on proceedings in respect of benami properties may the changes therein, if any.

BCAJ
ii. Identifying the list of promoters of the company and

their relatives: Promoter and Relative have not been
defined under the Order. However, amended Schedule III
(for disclosures related to holder of title deeds) states that
both ‘Promoter’ and ‘Relative’ will be as defined under
the Companies Act, 2013. Though a few promoters
could be traced to those named in the prospectus or
identified in the annual return, the auditor will have to rely
on secretarial and other records and / or management
representation to determine those who have control over
affairs of the company directly or indirectly, whether as
a director or shareholder or otherwise, or in accordance
with whose advice, directions, or instructions the Board is
accustomed to act and can be considered as promoters.
In case there is no such party, even then a specific
representation should be obtained.
iii. Ascertaining whether the requirements under the Trade

Mark, Copyright, Patents, Designs and IT Acts as well
as the licensing requirements under telecom, aviation,
pharma and other similar industries have been complied
with in respect of the Intangible Assets.
iv. Being aware of the laws dealing with registration of actually transferred in the name of the acquiring company
immovable properties, including those pertaining to and, hence, would require factual reporting.
specific states.
ii. In case of business combination as per Ind AS 103, where
In case of doubt, the auditor should seek the views the acquiring company has identified intangible assets
of the company’s legal counsel or their own expert. acquired as a part of the transaction, the nature, and basis,
This will be in line with SA 500 – Audit Evidence regarding whether or not the same is in the books of the transferor
using the Managements’ Expert (by assessing the needs to be evaluated and recorded. Further, for intangible
complexity, materiality, risk, independence, competence, assets recorded on consolidated financial statements,
capability and objectivity, amongst other matters) and SA though there is no requirement for reporting by the auditor,
620 – Using the Work of an Auditors’ Expert (by assessing as the Order is only applicable on standalone financial
the complexity, materiality, risk, adherence to quality statements, it would be a good practice for the company to
procedures, competence, capability and objectivity, separately list them in the intangible asset register.
amongst other matters), respectively. In either case, the
requirements of SA 250 – Consideration of Laws and h. Revaluation: As per the ICAI Guidance Note, this
Regulations in an Audit of Financial Statements should clause is applicable only to the entity which adopts the
be complied with. revaluation model. Hence, fair valuation of PPE on first-
time adoption, acquisition of assets / business on slump
g. Business combinations and acquisitions: The sale basis or under business combination, change in ROU
following matters need to be considered in case of such asset due to lease modification as per Ind AS 116, re-
situations: measurement due to changes in foreign exchange rates,
i. In case a company has acquired another entity and etc., will not require reporting under this clause. Further,
the same is merged in terms of an approved scheme, impairment of PPE accounted under cost model is outside
immovable properties of the transferee company are the purview of reporting.
considered deemed to be transferred in the name of the
acquiring company. However, till the time the acquiring In case an entity adopts the revaluation model for PPE
company complies with local / state-specific procedures, and Intangible Assets, there could be two scenarios as
including payment of stamp duty, etc., it would not be under:

BCAJ
i. Valuation by an external valuer: In such cases, the of the accounting framework. The requirements under
fact should be indicated and the auditor should check the SA 540 – Auditing Accounting Estimates, Including Fair
necessary documentation as to whether he is registered Value Accounting Estimates and Related Disclosures
under Rule 2 of the Valuation Rules specified earlier. (covering the extent of use of market specific inputs
In such cases, the auditor needs to ensure that the and their relevance, assessment of comparable
management ensured that the principles laid down in Ind transactions, basis and justification of unobservable
AS 113 on Fair Valuation are adhered to by the valuer. The inputs, amongst others) also need to be kept in
auditor should keep in mind the requirements under SA mind. In case of any doubt, the auditor should seek
500 – Audit Evidence regarding using the Managements’ the assistance of their own valuation expert keeping
Expert, indicated earlier. in mind the requirements under SA 620 – Using the
ii. Internal valuation: The Order does not seem to Work of an Auditors’ Expert, discussed earlier.
mandate that a company needs to get a valuation done
by an external valuer. In such cases, the auditor will CONCLUSION
have to exercise a greater degree of professional The above changes have cast onerous responsibilities on
scepticism and review the basis and assumptions for the auditors and in many cases the auditors would need
arriving at the revised fair value keeping in mind the to go beyond what is stated in the Order because the devil
requirements of Ind AS 113 as indicated earlier, irrespective lies in the details!
FROM UNPUBLISHED ACCOUNTS

Income Taxes - A reconciliation of the income tax provision to the amount computed by applying the statutory income
tax rate to the income before income taxes is as follows:
(in Rs.crore)
Year ended March 31, 2021 Year ended March 31, 2020
Actual Profit Earned Before Income Taxes 23,456 20,498
Adjusted for:
Effect of concealed income (7,506) (5,944)
Effect of understated revenues (3,049) (2,665)
Effect of overstatement of expenses (4,222) (3,690)
Effect of fictitious expenses (2,111) (1,845)
Effect of depreciation claim on non-existing PPE (328) (492)
Reported Profit in P&L Before Income Taxes 6,240 5,862
Enacted tax rate in India 34.94% 34.94%
Computed Expected Tax Expense 2,180 2,048
Effect of evasion using tax havens (505) (475)
Effect of profit shifting (468) (332)
Effect of round tripping (512) (399)
Effect of transfer pricing manipulations (723) (564)
Effect of shell subsidiary companies (634) (495)
Effect of offshore financial centers utilized (390) (304)
Effect of offshore intermediary companies (612) (477)
Effect of aggressive tax law interpretation (770) (601)
Income Tax Benefit as per P&L (2,434) (1,599)
A BCAJ Spoof | Vinayak Pai V]
Do not ask for less responsibility to be free and relaxed – ask for more strength
— Shengyan

BCAJ
CARO 2020 SERIES: NEW CLAUSES

AND MODIFICATIONS
INVENTORIES AND OTHER CURRENT ASSETS

I I I
MANISH SAMPAT PARESH CLERK VIJAY MANIAR ZUBIN BILLIMORIA
(This is the second article in the CARO 2020 series that started in June, 2021)
NEW CLAUSES AND MODIFICATIONS b. Apart from ensuring that proper written instructions
Whilst the clause on reporting in respect of inventories are issued, it is also incumbent for the auditor to point
has been present in the earlier versions, too, CARO 2020 out specific areas where the instructions are not clear or
has modified parts of the first clause and added certain other procedural lapses like inadequate segregation of
reporting requirements in respect of current assets which duties, cut-off procedures not adhered to especially
are given below. for sales and work-in-progress in continuous process
industries, as may be observed. It is important for the
Modifications auditor to comment on the specific areas where he
a. Whether in the opinion of the auditor the coverage feels that the procedures are not adequate rather
and procedure for physical verification of inventories is than commenting that the ‘procedures are generally
appropriate; adequate’.
b. Whether any discrepancy in excess of 10% or more
in the aggregate for each class of inventory was noticed c. Covid-19: The onset of Covid-19 has caused significant
and the same was properly dealt with in the books of disruptions in the business operations of companies which
accounts. could pose challenges in conducting physical verification
of inventories. This, in turn, would make it difficult
Additional Reporting for auditors to ensure compliance with SA 501, Audit
a. Whether at any point of time during the year the Evidence-Specific Considerations for Selected Items,
company has been sanctioned working capital limits which requires the auditor to obtain sufficient appropriate
in excess of Rs. 5 crores in aggregate from banks or audit evidence regarding the existence and conditions
financial institutions, on the basis of security of current of inventories. SA 501 requires attendance at location/s
assets; of physical inventory count, unless impracticable, and
b. Whether the quarterly returns or statements filed by the performing audit procedures on inventory records to
company with such banks or financial institutions are in determine whether the records accurately reflect actual
agreement with the books of accounts and if not, to give inventory count results. Some of the challenges may be
details. broadly analysed under the following situations:
PRACTICAL CHALLENGES IN REPORTING • Management does not conduct an inventory count

The reporting requirements outlined above entail certain (not even any alternative audit procedure) on the
practical challenges which are discussed below: balance sheet date:
In such cases, as per Key Audit Considerations amid
Verification of inventory: Covid-19 issued by ICAI on physical inventory (ICAI’s
a. On the appropriateness of coverage and procedure Covid guidance), the management should inform the
for physical verification of inventory, the auditor will auditors and those charged with governance about the
have to observe the performance of the management’s reasons for the same. However, if carrying out a count
physical count taking procedure, control over movement is not feasible, the auditor would need to evaluate the
of inventory, adequacy of design and effective operations reasonableness of the circumstances and the internal
of internal controls. controls with respect to the existence and condition of

BCAJ
inventory. Depending upon the materiality, the auditor may technologies (i.e., Microsoft Teams, Facetime,
use his judgement to modify his audit report in accordance WhatsApp). In this case, care should be taken by the
with SA 705 (Revised) Modifications to the Opinion in auditor that if inventory items cannot be identified with
the Independent Auditor’s Report. Further, its impact on a unique reference number, etc., there is no chance of
auditor’s opinion on internal financial controls u/s 143(3) replacement of inventory during / after the count to avoid
(i) of the Companies Act, 2013 (‘ICFR’) also needs double counting. It would be advisable to retain the
to be evaluated, in addition to reporting under this recording thereof as part of the audit documentation;
clause regarding coverage of physical verification
Align-
of iii. Consider using an external party, e.g., an independent
inventory. ment CA firm in that location (ICA) or Internal Auditor (IA), in
which case the auditor needs to evaluate
• Physical verification conducted at a date other than a. Objectivity and independence of ICA / IA;
the balance sheet date: b. Inquire for any relationships that may create a threat to
In such cases, the design and operating effectiveness their objectivity;
of controls over inventory would need to be evaluated c. Evaluate their level of competence;
before reporting. Further, the following considerations are d. Determine the nature and extent of work to be assigned;
also relevant: e. Communicate planned use of ICA / CA with those
i. Whether the inventory records are properly maintained; charged with governance;
ii. Understanding reasons for differences in the physical f. Obtain written agreements from the entity for the use of
verification count and the inventory records; ICA / IA for providing direct assistance;
iii. Performing roll-backward procedures, if the inventory g. Direct, supervise and review the work performed by
count is done after the year-end or roll-forward procedures, ICA / IA providing direct assistance, including provide
if inventory count is done during the interim period; instruction / work programme, including sample selection,
iv. Evaluating whether any adjustment is required in roll- communicate management’s inventory count instructions,
forward or roll-backward procedures due to differences etc., and, if possible, supervise the count while it is in
observed as in (ii) above; progress.
v. To consider whether the time between inventory
count date and balance sheet date reflects appropriate When inventory is under the custody and control
assessment of the physical condition of the inventory. of a third party, e.g., bonded warehouse, job worker /
contractor, etc., the auditor shall verify the procedures
• Impracticable for auditor to attend the physical undertaken by the management to evaluate the existence
count: and condition of that inventory. This could be by way
This issue is relevant for the auditor to issue an audit of obtaining confirmation from the third party as to the
opinion on the financial statements and not on CARO quantities and condition of inventory held on behalf of
2020. However, in order to have complete discussion on the entity and / or perform inspection or other procedures
physical verification of inventory, specifically its increased appropriate in the circumstances. The auditor needs to
importance during Covid pandemic times, the same is focus on whether inventory with third party is for a longer
also discussed here. than normal period and obtain reasons for the same.
In the event that it is impractical for the auditor to In the event the entity has specialised inventory where
physically attend the inventory count process, the inventory count is not based on a normal physical
auditor can perform alternative audit procedures to verification process but on the confirmation of quantity /
obtain sufficient appropriate audit evidence regarding the quality by an expert, the auditor will review the certification
existence and condition of the inventory. In addition, to obtained by the entity and compare it with the book records.
evaluate design and test the operating effectiveness of For example, in the case of coal, tonnage is calculated by
internal control over physical verification of inventory, the considering the height, width, length of the stock yard and
following may be considered: the moisture content in the coal to arrive at its tonnage.
The entity will normally take the help of engineers in this
i. Prepare a document substantiating the impracticality process who would be internal or external experts.
and unreasonableness of observing the count in person,
given the Covid-19 situation; a. Appropriate coverage: Even if the company has
ii. Use of web or mobile-based video-conferencing instituted proper procedures for physical verification, it

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is imperative that the coverage thereof is adequate and identified as per AS 2, ‘Valuation of Inventories’ / Indian
appropriate with respect to the nature, size, materiality, Accounting Standard (Ind AS) 2, ‘Inventories’ and the
location, feasibility of conducting physical verification and internal policies of the management. The count at the
risk of material mis-statement involved. This could involve time of physical verification will have to be compared
significant judgement and an interplay of several factors, with the book records and discrepancies in excess of
some of which are discussed hereunder: 10% or more in the aggregate for each class will have to
be reported. It may be worth it to note that the threshold
• Classification of inventory – This is important for limit of discrepancies of 10% should be applied to the
assessing the extent of coverage as also for evaluating value and not to the quantity. Hence, if the inventory has
the impact of discrepancies. Whilst the class of inventory been valued other than at cost, e.g., net realisable value
is broadly specified in the Accounting Standards for (NRV), the discrepancy of 10% needs to be compared
manufacturing and trading companies, the same is with NRV.
not clear for service companies since all of it may not
be amenable for quantification. Further, even if the It is worthwhile to note that this clause deals with
classification for manufacturing and trading companies discrepancies observed during physical verification only
is appropriate to determine the adequacy of verification, and not with discrepancies observed during audit. Further,
an A-B-C analysis is desirable for which the basis would even if the management has a valid explanation for
need to be evaluated for reasonableness. Further, the the discrepancies, the fact needs to be brought out
auditor also needs to examine whether there is a control while reporting under this clause.
system in place to identify and mark slow-moving,
obsolete or damaged inventory. Working capital facilities:
a. This is a new reporting requirement wherein the
• Periodicity of verification – The auditor would need to auditor has to review quarterly returns or statements filed
verify the periodicity of such verification and whether all by the company with banks and financial institutions in
the material items of inventory have been covered at least case the sanctioned working capital limits with them are in
once in a year or as per the systematic plan as designed excess of Rs. 5 crores in aggregate and to report if these
by the management. This would depend upon the nature are not in agreement with the books of accounts.
of inventory, the A-B-C classification discussed above
and the number of locations involved. b. Collation of all working capital facilities: For
calculating the limit of Rs. 5 crores, it is important to note
b. Dealing with discrepancies: The auditor should, that sanctioned amounts (not disbursed amounts)
based on his understanding of the business and operating and both fund and non-fund-based amounts are
effectiveness of internal controls, verify explanations required to be considered at any point of time during
provided by the management for discrepancies between the year (as against only at the year-end) on the
inventory as per the books and as physically verified and basis of security of current assets. This could present
steps taken by them to reconcile. Some of the common challenges in identifying the completeness thereof since
causes for discrepancies are: sanctioned facilities as well as non-fund-based facilities
• Incorrect data entry on receipt are not reflected in the books of accounts. Accordingly,
• Issues not recorded the auditor would need to make specific inquiries and
• Misplaced stocks obtain a representation and corroborate the same with the
• Loss due to theft or natural calamity requisite documentary evidence like sanctioned letters,
• Human errors or incorrect unit of measurement used confirmations from the lenders, review of the minutes,
• Inventory records not updated ROC filings for charge created, etc. The aggregate of the
• Supplier frauds sanctioned limit from all banks and financial institutions is
• Goods distributed as free samples also required to be collated. In case of a company which
• Weight loss / gain due to passage of time operates from multiple locations and working capital
facilities are negotiated locally, care should be taken to
Under the modified (changed) reporting requirement, the ensure that all such sanctioned facilities are combined for
auditor will have to report on any discrepancy noticed in the purpose of reporting under this clause. The auditor
excess of 10% or more in the aggregate for each class will also have to cross-verify the same with the relevant
of inventory. Each class of inventory will have to be disclosures, if any, in the financial statements.

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c. This clause is not applicable to unsecured sanctions or

sanctions on the basis of security other than current assets
or withdrawals above the sanctioned limit, e.g., in case
the company has a combined sanctioned working capital
limit of Rs. 4.75 crores but the same is overdrawn by Rs.
0.30 crore. In this case, the total outstanding working
capital facility is in excess of Rs. 5 crores, however, since
the aggregate sanctioned limit is less than Rs. 5 crores,
this clause would not be applicable.
d. Considering the discussion in paragraphs (b) and

(c) above, in case the sanctioned working capital limit
exceeds Rs. 5 crores, the auditor is required to review
quarterly returns and statements filed by the company
with such banks / financial institutions and report if they
are in agreement with the books of accounts and, if not,
give details thereof.
The auditor will have to consider materiality of

discrepancies, its relevance to the users of financial
statements and their professional judgement while
reporting discrepancies.
e. Each bank and financial institution may have its

own requirements of submission of statements and
returns. These submissions may be monthly, quarterly,
yearly or of any other frequency, including event-
based. However, for the purpose of reporting under this
clause only quarterly statements / returns and that
too which have relevance with the books of accounts MSMEs will have to keep their books of accounts updated
of the company need to be considered, compared and based on which statements / returns submitted to banks
reported. and financial institutions can be compared, failing which
their auditor will issue a disclaimer while reporting under
Though this clause is applicable only if sanctioned this clause.
working capital limits are provided based on the security
of current assets, however, the responsibility of the g. It is hoped that the introduction of this reporting
auditor is to compare all the information provided in requirement would lead to better discipline and
the quarterly statements / returns which can be improvement in internal controls which would result in a
compared with the books of accounts and is not win-win situation for companies, lenders and auditors.
restricted only to current assets. Such information may
include aging of inventory and receivables, trade payable, IMPACT ON THE AUDIT OPINION
property plant and equipment, other information, etc. So Whilst reporting under these clauses, the auditor
long as information can be compared with the books of may come across several situations where he
accounts, it will be the responsibility of the auditor to may need to report exceptions / deviations. In each of
report. these cases, he would need to carefully evaluate the
impact and exercise his professional judgement keeping
f. Challenges for MSMEs: Reconciliation of the details in mind materiality and relevance to the users of financial
of statements / returns submitted to the lenders with statements, not only for reporting under these clauses but
the books of accounts on a quarterly basis could pose also on his opinion on ICFR and / or audit opinion on the
difficulties in case of MSMEs since they may not be financial statements, too. These are broadly examined
regular in updating their accounting records. These hereunder:

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Nature of exception / Possible impact on the audit In such cases, it is imperative that the Board’s Report
deviation report / opinion contains explanations / comments on every reservation
The coverage and procedure • Modification of opinion on ICFR; / adverse comment in the audit report as per section
for physical verification of 134(3)(f) of the Companies Act, 2013 and that there
inventory is not adequate and / • Depending on the facts and
or appropriate circumstances of the case, audit will not be any factual inconsistency between the two
opinion on financial statements if, in the auditor’s judgement, the matter / observation
may have any adverse effect on the functioning of the
Physical verification of • Modification of opinion on ICFR; company.
inventory not conducted by the
company • Depending on the facts and CONCLUSION
circumstances of the case, audit
opinion on financial statements The above changes have cast onerous responsibilities
Discrepancies in the returns / • Depending upon the nature of on the auditors by making them indirectly responsible to
statements submitted to banks the discrepancy, modification on the lenders. Hence, they would also need to go beyond
/ financial institutions audit opinion or reporting on ICFR what is stated in the order since the devil lies in the
reporting, if the discrepancy is in
the books of accounts details!
We become what we think about.

— Earl Nightingale
Life is 10% what happens to me and 90% of how I react to it.

— Charles Swindoll
The mind is everything. What you think you become.

— Buddha

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CARO 2020 SERIES:

NEW CLAUSES AND MODIFICATIONS
LOANS & ADVANCES, GUARANTEES & INVESTMENTS

I I I
MANISH SAMPAT PARESH CLERK VIJAY MANIAR ZUBIN BILLIMORIA
(This is the third article in the CARO 2020 series that started in June, 2021)
BACKGROUND Clause Particulars Nature of

Investments, loans and advances and guarantees play No. Change, if
any
an important role in commercial dealings and also
expose companies to greater risk due to the possibilities (continued)
of defaults which in turn can have an impact on the (not applicable to companies
financial position and solvency of companies. The whose principal business is to give
loans) separately in respect of:
Companies Act, 2013 (‘the Act’) has laid down stringent
• Subsidiaries, joint ventures and
provisions to regulate the same, especially in respect associates
of non-financial companies. Although the earlier • Parties other than subsidiaries,
versions of CARO dealt with specific aspects thereof, joint ventures and associates
CARO 2020 has substantially enhanced the reporting Clause Transactions not Prejudicial: Enhanced
requirements. 3(iii)(b) Reporting
Whether investments made,
guarantees provided, security
SCOPE OF REPORTING given and terms and conditions
The scope of reporting can be analysed under the of loans and advances in the
nature of loans provided are not
following clauses: prejudicial to the interest of the
company
Clause Particulars Nature of Clause Servicing of Loans: Enhanced
No. Change, if 3(iii)(c) Reporting
any In respect of loans and advances
in the nature of loans, whether the
Clause Applicable Transactions: Enhanced schedule of payment of principal
3(iii) Reporting and interest has been stipulated
If during the year the Company and whether they are regular
has made investments in or
provided any guarantee or security Clause Reporting and Recovery of No change
or granted loans or advances in 3(iii)(d) Overdue Amounts: except that
the nature of loans, secured or it is now
unsecured (‘specified investments Reporting of overdue amounts applicable
and loans transactions’) to the and whether reasonable steps also to
following parties reporting of are taken for recovery in respect advances in
certain matters as per sub-clauses thereof the nature of
(a) to (f) below: loans*
• Companies
• Firms Clause Evergreening of Loans and New Clause
• Limited Liability Partnerships or 3(iii)(e) Advances:
• Other parties
Specified details of renewal or
Clause Disclose aggregate amount during New Clause extension or fresh loans granted
3(iii)(a) the year and balance outstanding to settle the overdues of existing
at the balance sheet date with loans and advances given to
respect to above-mentioned loans the same parties (not applicable
/ advances / guarantee / security to companies whose principal
business is to give loans)

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practical challenges, which are discussed below, in

Clause Particulars Nature of
No. Change, if respect of the new Clauses as well as those where
any there are enhanced reporting requirements:
Clause Demand Loans: New Clause
3(iii)(f) Applicable Transactions [Clause 3(iii)]:
Specified details of loans and a. There is significant widening in the scope of reporting
advances in the nature of loans
repayable on demand or without of financial transactions undertaken with all classes
specifying any terms or period of Align-
of entities. Further, the reporting is applicable to all
repayment, in aggregate and to ment companies, except for the exemption provided to
promoters and related parties
companies whose principal business is to give loans.
Clause Compliance: No Change* b. Clauses 3(iii)(a) and (e) dealing with aggregation
3(iv) of specified investments and loans transactions and
Compliance with the provisions
of sections 185 and 186 of the Act evergreening of loans would not apply to companies
with respect to loans, investments, which are primarily engaged in lending activities.
guarantees and security and
reporting of any non-compliances
Aggregation of Specified Transactions [Clause 3(iii)
*Not discussed further (a)]:
a. Identifying subsidiaries: Since this Clause requires
CLAUSE-WISE ANALYSIS OF ENHANCED separately aggregating and reporting loans and advances
REPORTING REQUIREMENTS in the nature of loans to subsidiaries, joint ventures and
associates, the identification thereof is of paramount
Applicable Transactions [Clause 3(iii) and Clause importance. The Guidance Note has clarified that
3(iii)(a)]: these terms should be interpreted in accordance with
• The scope has been enhanced to cover investments the provisions of the Act which could be different, in
made, guarantee or security provided and advances certain cases, from what is defined in the Accounting
granted in the nature of loans in addition to loans granted Standards in the case of subsidiaries which is examined
(‘specified investments and loan transactions’). as under:
• The reporting is extended to all parties and not just those Section 2(87) of the Act defines ‘subsidiary company’ or
covered in the register maintained u/s 189 of the Act. ‘subsidiary’ in relation to any other company, and means
a company in which the holding company – (i) controls the
• The reporting is required only if the above transactions composition of the Board of Directors; or(ii) exercises or
have been entered into ‘during the year’. controls more than one-half of the total voting power either
on its own or together with one or more of its subsidiary
Transactions not Prejudicial [Clause 3(iii)(b)]: companies. Thus, the Act emphasises on legal control
• The scope has been enhanced to cover investments which is similar to what is considered for the purpose of
made, guarantees provided, security given and also Accounting Standard 21 (AS 21) Consolidated Financial
advances in the nature of loans and guarantee provided, Statements for companies adopting Indian GAAP. The
in addition to loans. concept of control and, therefore, subsidiary relationship
under Ind AS 110, is much broader. Existence of factors
• Replacement of the word ‘such’ by ‘all’ means that this such as de facto control, potential voting rights, control
clause applies to all loans / advances granted during the through de facto agents, power to enforce certain
year. decisions, etc., have to be considered, which are not
considered for the purpose of section 2(87). Hence, for
Servicing of Loans [Clause 3(iii)(c)]: companies adopting Ind AS there could be differences
The scope has been enhanced to cover advances in the between what is disclosed in the accounts and what
nature of loans in addition to loans. is required to be reported under this Clause, which
would need to be reconciled to ensure completeness
PRACTICAL CHALLENGES IN of reporting. The auditors of Ind AS companies will need
REPORTING to take utmost care about this distinction while dealing
The reporting requirements outlined above entail certain with this Clause.

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b. Tracking of transactions entered into and settled (c) discussed later.

in the same year: This Clause requires reporting the
aggregate of specific transactions entered during the Specified investments and loans transactions are not
year even if the same are settled during the year. This prejudicial [Clause 3(iii)(b)]:
may provide challenges to ensure completeness of the a. The auditor will have to evaluate design and test
transactions where the volumes are substantial and the the operating effectiveness of controls over specified
auditor would in such cases have to test the design as transactions as these could be highly subjective. For
well as operating effectiveness of the internal controls and example, valuation based on which investments in
undertake test-checking of the transactions. A specific unlisted securities are made specifically into equity. Also,
representation should also be obtained that all such the auditor will have to comment upon commitments
transactions which have been squared off / settled during made in the earlier years but the transaction is entered
the year have been considered in the details provided by into during the reporting period.
the management.
b. Whether investments are prejudicial: The auditors
c. Identifying advances in the nature of loans: This is will have to use their judgement judiciously while reporting
by far the most far-reaching change since what constitutes under this Clause. They will have to evaluate adherence
‘advance is in the nature of a loan’ would depend upon to the processes and controls discussed above at the
the facts and circumstances of each case and involve time of making the investment and not evaluate based
significant judgements which would need to be exercised on hindsight, specifically for investments in unlisted
by the auditors based on their past experience and the securities. The auditor will consider the company’s
understanding of the business. The following guiding financial position, its leverage, purpose of making the
principles may be kept in mind; however, these are not to investment, valuation based on which the investment is
be considered as exhaustive: made, if the valuation is based on third party valuation
report, whether the investee is a related party and
An advance against a purchase order, in accordance specifically if it is controlled by promoters, related party
with the normal trade practice, would not be an advance / employee of promoter, compliance with SA 620 Using
in the nature of a loan. the Work of Auditor’s Expert, compliance with regulations,
An advance given for an amount which is far in excess etc., to determine whether investments are prejudicial to
of the value of an order, or for a period which is far in the company’s interest.
excess of the period for which such advances are usually
extended as per the normal trade practice, then such an c. Transactions with entities which are consolidated:
advance may be in the nature of a loan to the extent of In many cases, companies infuse additional funds in
such excess. subsidiaries / joint ventures / associates or other entities
When a trade practice does not exist, a useful guide which are their strategic investments and which have
would be to consider the period of time required by the financial difficulties, or to meet their financial commitments.
supplier for the execution of the order, based on the time Such infusion per se would not be construed as prejudicial
between the purchase of the raw material and the delivery to their interest, unless it is proved that it is not for
of the finished product. Any advance which exceeds this genuine business purposes or not in accordance with
period would normally be an advance in the nature of a the company’s policies or with the applicable legal and
loan unless there is evidence to the contrary. regulatory guidelines. Hence, each specified investment
A stipulation regarding interest may normally be an and loan transaction would need careful assessment by
indication that the advance is in the nature of a loan but the auditor.
this by itself is not conclusive and there may also be
advances which are not in the nature of a loan and which d. Transactions undertaken by NBFCs: Since NBFCs
carry interest. are also covered for reporting under this Clause, this would
present a specific challenge since it is their business to
It is imperative that the auditor not only scrutinises all undertake specified investments and loans transactions
advances given but also old outstanding advances and hence such transactions are likely to be voluminous.
where further amounts are given during the year to ensure In such instances, the auditor would need to ensure that all
their propriety and reasonableness for the purposes of applicable and reportable transactions are undertaken in
reporting under this Clause as well as under Clause 3(iii) accordance with the guidelines issued by the RBI which

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would inter alia include the Board-approved policies for reporting under this Clause.
loans and investments as well as for risk assessment
and other processes relating thereto laid down by the Evergreening of Loans and Advances [Clause 3(iii)
company since any material and significant deviation (e)]:
could result in transactions which are prejudicial to Amendment of Disclosures in the Auditors Report
the company’s interest. Before proceeding further, it is relevant to note that whilst
reporting under this Clause the auditor would have to
Hence, for reporting under this Clause apart from keep in mind the amendment in the Companies (Audit
deviations in any specific significant transaction, any and Auditors) Amendment Rules, 2021 whereby the
general non-compliance which is material would also following additional matters need to be covered in their
need to be reported. main audit report with effect from the financial year
2021-22:
e. Salary and other similar advances to employees: In
case of companies which have a policy of granting salary, (i) ‘Whether the management has represented that,
festival, medical and similar advances, the same would to the best of its knowledge and belief, other than as
be construed as advances and not advances in the nature disclosed in the notes to the accounts, no funds
of loans. However, the auditor should review the policy in have been advanced or loaned or invested (either
respect thereof and in case of any material transaction, from borrowed funds or share premium or any other
specifically with related parties who are employees or key sources or kind of funds) by the company to or in
managerial persons, which are not in accordance with any other person(s) or entity(ies), including foreign
the policy, or which may be considered as advances in entities (“Intermediaries”), with the understanding,
the nature of loans, as the same may be required to be whether recorded in writing or otherwise, that the
reported. Intermediary shall, whether directly or indirectly, lend
or invest in other persons or entities identified in any
Servicing of Loans [Clause 3(iii)(c)]: manner whatsoever by or on behalf of the company
a. Transaction in the form of advances in the nature of (“Ultimate Beneficiaries”) or provide any guarantee,
loans: Due to the reasons discussed under Clause 3(iii) security or the like on behalf of the Ultimate
(a) earlier, the auditors would have to use their judgement Beneficiaries’;
to identify whether servicing thereof is regular, or else
they would need to indicate separately the names of (ii) ‘Whether the management has represented that,
such parties individually together with the amounts and to the best of its knowledge and belief, other than as
the extent of delay. Further, in case no repayment term is disclosed in the notes to the accounts, no funds have
specified, the auditor will have to report such fact. been received by the company from any person(s)
or entity(ies), including foreign entities (“Funding
b. Restructuring transactions undertaken by NBFCs: Parties”), with the understanding, whether recorded in
NBFCs undertake restructuring of loans and advances writing or otherwise, that the company shall, whether
due to various reasons in accordance with RBI guidelines, directly or indirectly, lend or invest in other persons or
including in terms of the Covid-19 Regulatory Package. entities identified in any manner whatsoever by or on
This may result in a moratorium on repayments or behalf of the Funding Party (“Ultimate Beneficiaries”)
conversion of overdue interest into funded interest term or provide any guarantee, security or the like on
loans. In such cases, since the originally stipulated terms behalf of the Ultimate Beneficiaries’;
are not adhered to, it would need to be reported under
this Clause. (iii) ‘Based on such audit procedures that the auditors
have considered reasonable and appropriate in the
As per the Guidance Note, the name of each entity which circumstances, nothing has come to their notice that
is not regular in repayment of principal and payment of has caused them to believe that the representations
interest needs to be disclosed separately. This may be under (i) and (ii) above contain any material
a challenge to NBFCs in view of large number of delays misstatement’.
and / or restructuring, specifically during Covid times. The
better option in such cases would be to consolidate such Keeping in mind the above reporting requirements and
entities into various logical buckets for the purpose of certain other matters, the following are some of the

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practical challenges that could arise in reporting under keep in the mind the amended Schedule III disclosures
this Clause: which are as under:
a. Identification of Ultimate Beneficiaries: Consequent Following disclosures shall be made where loans or advances in the
to the above disclosures made in the financial statements, nature of loans are granted to promoters, directors, KMPs and the
auditors need to check the details of those disclosures related parties (as defined under the Companies Act, 2013), either
severally or jointly with any other person that are:
and check all such transactions with the respective (a) repayable on demand or
documents and other correspondence to identify whether (b) without specifying any terms or period of repayment
any such transaction gets covered for reporting under this
Type of borrower Amount of loan Percentage to the total
Clause. In this regard, the auditors should also take a or advance in the Loans and Advances in
representation from the management. nature of loan the nature of loans
b. Transactions within group entities / related parties: outstanding
In case of complex group structures, it would be difficult Promoters
to establish a clear audit trail for the transactions, thus
Directors
making it difficult to identify any such transaction.
c. Determining the Total Loans and Advances in KMPs
the nature of loans (‘the denominator’): This Clause
Related Parties
requires reporting of the percentage of such transactions
to the aggregate value of loans and advances in the Keeping in mind the above reporting requirements, the
nature of loans. However, determining the denominator following are some of the practical challenges that could
could pose challenges especially for advances arise in reporting under this Clause:
in the nature of loans for the reasons discussed
earlier. Accordingly, it is imperative for the auditors to a. Identification of Promoters: Promoter has not been
reconcile the denominator, especially for advances in defined under the Order. However, the amended Schedule
the nature of loans with the financial statements to III states that ‘Promoter’ will be as defined under the
ensure completeness. Companies Act, 2013. Although a few promoters could
d. The auditor will also need to track loans which have be traced to those named in the prospectus or identified in
fallen due for repayment up to the balance sheet date the annual return, the auditor will have to rely on secretarial
and which have been renewed / extended / settled post- and other records and / or management representation
balance sheet date but before the date of the audit report, to determine those who have control over the affairs
as the same is required to be reported under this Clause of the company directly or indirectly, whether as
during the year as well as the following year. director or shareholder or otherwise or in accordance
e. Finally, the RBI in the Master Circular dated 1st July, with whose advice, directions, or instructions the
2014 on Prudential Norms on Income Recognition, Board is accustomed to act upon, to be considered as
Asset Classification and Provisioning Pertaining promoters. In case there are no such persons, then also
to Advances, has reiterated that the basic objective a specific representation should be obtained.
of restructuring of loans by banks was to preserve the
economic value of the borrower units and not evergreening b. Identification of Related Parties (subsidiaries):
of problem accounts. Borrower Accounts should be taken Similar considerations as discussed earlier for reporting
up for restructuring by the banks if the financial viability under Clause 3(iii)(a) would be relevant for reporting
is established and there is a reasonable certainty of under this Clause. In this context, the auditor would need
repayment from the borrower, as per the terms of the to reconcile the disclosures under this Clause with what
restructuring package and looking into their cash flows is disclosed in the financial statements (for companies
of and assessing the viability of the projects / activity adopting Ind AS) as well as in terms of the disclosures
financed. Accordingly, the auditors should be vigilant under Schedule III as specified above, to ensure
with regard to all restructuring proposals requested completeness.
for by the borrowers.
c. Transactions undertaken by NBFCs: Since there
Demand Loans [Clause 3(iii)(f)]: is no specific exemption granted to NBFCs, the auditor
Additional Disclosures under amended Schedule III: should consider the specific guidelines issued by the
While reporting under this Clause, the auditor will have to RBI for granting of demand and call loans, which are

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summarised hereunder:
Nature of Exception / Deviation Possible Impact on the
• The Board of Directors of every applicable NBFC Audit Report / Opinion
granting / intending to grant demand / call loans shall
The company has not maintained • Reporting on Internal
frame a policy for the same. records to identify and compile data Financial controls over
• Such policy shall stipulate the following: required for reporting under Clause Financial Reporting
3(iii)(a)
(i) A cut-off date within which the repayment of demand Investments made, guarantees • Modified opinion under
or call loan shall be demanded or called up; provided, security given and the terms SA 706
(ii) The sanctioning authority shall record specific and conditions of the grant of all loans
and advances in the nature of loans
reasons in writing at the time of sanctioning demand or and guarantees are prejudicial to the
call loan, if the cut-off date for demanding or calling up company’s interest, there may be
such loan is stipulated beyond a period of one year from implications on the main audit report due
to non-compliance with the following
the date of sanction;
SAs:
(iii) The rate of interest which shall be payable on such • Consideration of laws and regulations
loans; (SA 250)
(iv) Interest on such loans, as stipulated, shall be payable • Fraud (SA 240)
• Related party transactions (SA 550)
either at monthly or quarterly rests;
(v) The sanctioning authority shall record specific Loans and advances on the basis of Disclosure in the audit
security have not been properly secured report u/s 143(1) of the
reasons in writing at the time of sanctioning demand or
and the terms thereof are prejudicial to Act
call loan, if no interest is stipulated or a moratorium is the interests of the company
granted for any period;
If the auditor concludes that there are • Modified opinion under
(vi) A cut-off date, for review of performance of the loan, loans or advances in the nature of loan SA 706
not exceeding six months commencing from the date of granted which have fallen due during the
sanction; year have been renewed or extended
or fresh loans granted to settle the
(vii) Such demand or call loans shall not be renewed
overdues of existing loans given to the
unless the periodical review has shown satisfactory same parties, there may be implications
compliance with the terms of the sanction. on the main audit report, such as
consideration of fraud risk factors as per
SA 240
In case the auditor has identified any deviation, he may
consider reporting the same under this Clause or cross- If the auditor concludes that the • Modified opinion under
company has granted loans or advances SA 706
reference the same to the disclosures made in the
in the nature of loans either repayable
financial statements depending upon the materiality of on demand or without specifying any
the transaction. terms or period of repayment, there may
be implications on the main audit report
due to non-compliance with the following
d. Determining the Total Loans and Advances in SAs:
the nature of loans (‘the denominator’): This Clause • Consideration of laws and regulations
requires reporting of the percentage of such transactions (SA 250)
• Fraud (SA 240)
to the aggregate value of loans and advances in the • Related party transactions (SA 550)
nature of loans. However, determining advances in
the nature of loans could pose a challenge, for the In such cases, it is imperative that the Board’s Report
reasons discussed earlier. contains explanations / comments on every reservation /
adverse comment in the audit report as per section 134(3)
Impact on the Audit Opinion: (f) of the Companies Act, 2013 and that there is no factual
Whilst reporting on these Clauses, the auditors may come inconsistency between the two.
across several situations wherein they may need to report
exceptions / deviations. In each of these cases they would CONCLUSION
need to carefully evaluate the impact of the same on the The above changes have cast onerous reporting
audit opinion by exercising their professional judgement responsibilities on the auditor for various critical aspects
to determine the materiality and relevance of the same to of movement of funds as under:
the users of the financial statements. These are broadly • Evaluating design and operating effectiveness of
examined hereunder: internal controls around specified investment and loan

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transactions, whether with related parties or otherwise, • Identifying sticky specified transactions and reporting.
including layering and round-tripping of funds, etc., if any. Accordingly, it needs to be seen whether an audit remains
• Detailed analysis of financing transactions, including an audit or becomes more of an investigative exercise
advances in the nature of loans. requiring greater forensic skills!
https://bit.ly/3MeYc2y
Commit as many mistakes as possible, remembering only one thing:

don't commit the same mistake again. And you will be growing
— Osho

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CARO 2020 SERIES:

DEPOSITS, LOANS AND BORROWINGS

ZUBIN BILLIMORIA
Chartered Accountant
(This is the fourth article in the CARO 2020 series that started in June, 2021)

Companies need funds on a regular basis and tap various No. change, if
any
sources for the same, from retail / small depositors
(commonly referred to as public deposits) to large in respect of the above, the nature
lenders. In respect of public deposits there are stringent of such contraventions be stated;
• If an order has been passed by
guidelines laid down by the RBI and the MCA which the Company Law Board or the
need to be complied with, including for amounts which National Company Law Tribunal
are deemed to be in the nature of deposits. Further, the or the Reserve Bank of India or
any court or any other tribunal,
lenders and depositors also need an assurance that the whether the same has been
companies are using the same for the stated purposes complied with or not;
and not as a funding tool within group entities and would
Clause Default in repayment of loans / Enhanced
be able to repay the same as per the stipulated terms as 3(ix)(a) other borrowings and interest: Reporting
well as an assurance about the future stability and liquidity
• Whether the company has
of the company. The Companies Act, 2013 (‘the Act’) defaulted in repayment of loans
has also laid down stringent provisions to regulate the or other borrowings or in the
same, especially in respect of non-financial companies. payment of interest thereon to any
lender;
CARO 2020 has also accordingly enhanced the reporting
• If yes, the period and the amount
requirements substantially. of default to be reported as per the
format below:
SCOPE OF REPORTING • Nature of borrowing including debt
securities
The scope of reporting can be analysed under the • Name of lender*
following clauses: • Amount not paid on due date
• Whether principal or interest
• No. of days delay or unpaid
Clause Particulars Nature of • Remarks, if any
No. change, if * lender-wise details to be
any provided in case of defaults to
banks, financial institutions and
Clause Deemed Deposits: Enhanced Government
3(v) Reporting
In respect of deposits accepted by Clause Wilful defaulter: New Clause
the company or amounts which 3(ix)(b)
are deemed to be deposits: Whether the company is declared
• Whether the directives issued a wilful defaulter by any bank or
by the Reserve Bank of India and financial institution or other lender.
the provisions of sections 73 to 76
or any other relevant provisions Clause Application of term loans for New Clause
of the Companies Act and the 3(ix)(c) prescribed purposes:
rules made thereunder, where
applicable, have been complied • Whether term loans were applied
with; for the purpose for which the loans
• In case of any contraventions were obtained;
• If not, the amount of loan so

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on the borrowings in addition to repayment of principal

Clause Particulars Nature of
No. change, if amount.
any • If there is a default in the repayment of borrowings, the
(continued)
format for reporting, the period and amount of default has
now been prescribed.
diverted and the purpose for which
it is used may be reported.
PRACTICAL CHALLENGES IN
Clause Short-term funds utilised for long- New Clause REPORTING
3(ix)(d) term purposes: Align-
ment The reporting requirements outlined above entail certain
• Whether funds raised on short- practical challenges, which are discussed below, in
term basis have been utilised for
respect of the clauses where there are enhanced
long-term purposes;
• If yes, the nature and amount to reporting requirements as well as new clauses:
be indicated.
Clause Funds borrowed for meeting New Clause Deemed Deposits [Clause 3(v)]:
3(ix)(e) obligations of group companies: a) Inclusive nature of the definition: The Act vide
section 2(31) provides an inclusive definition of deposits
• Whether the company has taken
any funds from any entity or by stating that deposits include:
person on account of or to meet • any receipt of money by way of deposit or loan or in any
the obligations of its subsidiaries, other form by a company; but
associates or joint ventures;
• If so, details thereof with nature • does not include such categories of amounts as may be
of such transactions and the prescribed in consultation with the RBI (no such amounts
amount in each case. have been prescribed till date).
Clause Loans raised against pledge of New Clause
3(ix)(f) securities of group companies: In spite of the inclusive nature of the definition, Rule 2(1)
• Whether the company has
(c) of the Companies (Acceptance of Deposits) Rules,
raised loans during the year on 2014, makes certain exclusions from the definition of
the pledge of securities held in deposits. These are broadly indicated hereunder:
its subsidiaries, joint ventures or • Amounts received from the Central or State
associate companies;
• If so, give details thereof; and Government or guaranteed by them, as also from any
• Report if the company has other statutory or local authorities constituted under an
defaulted in repayment of such Act of Parliament or any State Legislature;
loans raised.
• Amounts received from foreign Governments or
other prescribed foreign sources / entities, subject
CLAUSE-WISE ANALYSIS to the provisions of FEMA and the regulations framed
OF ENHANCED REPORTING thereunder;
REQUIREMENTS • Amounts received from banks, public financial
Deemed Deposits [Clause 3(v)]: institutions, insurance companies and regional
• The scope has been enhanced to cover amounts which financial institutions;
are deemed to be in the nature of deposits as per the • Amounts received against issue of commercial paper or
Companies (Acceptance of Deposits) Rules, 2014. similar instruments in accordance with the RBI guidelines;
Default in repayment of loans / other borrowings and • Amount received by one company from another company
interest [Clause 3 (ix)(a)]: (inter-corporate deposits);
• The scope of this clause has been extended to cover • Amounts received towards subscription of securities,
all borrowings other than loans and hence would include including share application money, in pursuance of an
debentures, commercial paper, subordinated debt and offer made in accordance with the provisions of the Act.
inter-corporate deposits. However, such amounts need to be allotted or adjusted
• The scope of the clause has been expanded to all within 60 days. If the same are not refunded within 15
borrowings from any lender and not just restricted to days from the completion of 60 days the same would
borrowings from financial institutions, banks, Government be treated as deposits. Also, no adjustment of such
or dues to debenture holders, as was the case earlier. amounts for any other purpose would be permissible;
• The scope of reporting has been extended to interest • Any amounts received from a person who at the time

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of receipt was a Director of the company, provided that requirements. For example, for any advance / deposits
he has submitted a declaration that the amount is not / amount received by a company from a vendor, there
given out of funds acquired by him by borrowings would be internal checks to ensure that the balance
from others; is appropriated against supply or goods / services
• Amount raised through issue of bonds or debentures provided by the vendor within the stipulated time limit of
which are secured by a first or ranking pari passu with 365 days.
the first charge on the assets of the Company (other
than intangible assets) referred to in Schedule III and Default in repayment of loans / other borrowings and
which are compulsorily convertible into shares within a interest [Clause 3 (ix)(a)]:
period of five years; a. Companies adopting Ind AS: Such companies are
• Any amount received from an employee subject to the likely to face certain specific challenges which need to
following conditions: be kept in mind whilst considering the various reporting
requirements which are as under:
(i) It does not exceed his annual salary under a contract • The borrowings need to be considered on the basis of
of employment; and the legal form rather than on the basis of the substance
(ii) It is in the nature of a non-interest-bearing security of the arrangements as is required in terms of Ind AS
deposit; 32 and 109. Accordingly, redeemable preference shares
• The following amounts received in the course of or for though considered as financial liabilities / borrowings
the purposes of business: under Ind AS, will not be considered for reporting under
(i) Advances for supply of goods or provision of this clause since legally they are in the nature of share
services provided they are appropriated / adjusted capital. Similarly, optionally or fully convertible debentures
against the supply of goods or provision of services within though considered as compound financial instruments or
365 days from the date of receipt of the advance, unless equity under Ind AS, will not be considered for reporting.
they are the subject matter of dispute; • The interest charged to the P&L Account is computed
(ii) Advance received in connection with the on the basis of the Effective Interest Rate (EIR) method
consideration for immovable property under an which would include certain other charges. However, for
agreement or arrangement, provided the same is identifying the unpaid interest the contractual payments
adjusted against the property in terms of the agreement need to be considered.
or arrangement; • Ind AS 107 requires disclosure of the maturity analysis of
(iii) Security deposit for the performance of a contract the financial liabilities showing the contractual repayments
for the supply of goods or provision of services; under different liquidity buckets. The auditors shall cross-
(iv) Advances received under a long-term contract check the work papers for reporting under this clause
for supply of capital goods, other than those under (ii) with the Ind AS disclosures. Similar considerations would
above. apply to the disclosures with respect to the defaults in
Accordingly, deposits which are technically not in loan repayments under paragraphs 18 and 19 of Ind AS
the nature of deposits by virtue of the definition but 107 as well as under Schedule III.
substantially having the character of deposits are also
required to be reported upon. b. Reschedulement proposals: If the company has
submitted an application for reschedulement to the
b) Higher risk of non-compliance: The risk of non- lenders, which is under different stages of processing,
compliance would be even higher in case of deemed the same would also be considered as a default and
deposits. The auditor should obtain the list of amounts need to be reported. However, if the application for
received in the course of, or for the purposes of, the reschedulement of loan has been approved by the
business of the company (e.g., advances, security bank or financial institution concerned during the year
deposits, credit balances, etc.) and assess whether covered by the auditor’s report, the auditor should state
these amounts comply with the above requirements in his audit report the fact of reschedulement of loan. The
to determine whether such amounts would constitute Guidance Note issued by ICAI has clarified that where
deemed deposits. He should also review the internal reschedulement of loan has been approved subsequent
control systems and processes of the client to ensure to the balance sheet date, the auditor should report the
that there are adequate checks and balances in place defaults during the year. However, he may mention this
to ensure that there is no non-compliance with the fact in the remarks column.

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c. Covid-19 restructuring proposals: In case a Where a company is a declared wilful defaulter by any
company which has availed of the concessions in terms bank or financial institution or other lender, the following
of the Covid regulatory package notified by the RBI, the details shall be given:
compliance with the same would not be considered as a a. Date of declaration as wilful defaulter,
default. In such cases, the auditor may consider making b. Details of defaults (amount and nature of defaults),
an appropriate reference in the report. * ‘wilful defaulter’ here means a person or an issuer
who or which is categorised as a wilful defaulter by any
d. Challenges for NBFCs and highly leveraged bank or financial institution (as defined under the Act) or
companies: Such companies are likely to face certain consortium thereof, in accordance with the guidelines
specific challenges which need to be kept in mind whilst on wilful defaulters issued by the Reserve Bank of
considering the various reporting requirements which are India.
as under:
• The auditor shall review the company’s internal control Whilst reporting, the auditor should make a cross-
systems and test the design and operating effectiveness reference to the above disclosures made in the financial
of the company’s treasury activities and liquidity statements to ensure that there are no inconsistencies.
management to identify defaults on a timely basis since
it would not be practical to verify each individual case of Before proceeding further, it is important to analyse the key
default due to the volume of transactions. The auditors requirements as per the RBI guidelines for identification
shall also verify the procedures that the company has and classification of wilful defaulters, since that acts as
in place to avoid any defaults in repayment of loan or the trigger-point.
payment of interest. Further, in such cases the auditor
can also consider obtaining and reviewing the latest Key requirements as per the RBI Guidelines
credit rating report and whether there is a mention (RBI Circular RBI/2014-15/73DBR.No.CID.
about any defaults. Similarly, any decline in credit rating BC.57/20.16.003/2014-15 dated 1st July, 2014):
should trigger an element of professional scepticism Wilful default: A ‘wilful default’ would be deemed to have
about whether there is a default by the company. Finally, occurred if any of the following events is noted:
an appropriate representation should be obtained from • The unit has defaulted in meeting its payment /
the management. repayment obligations to the lender even when it has the
• In respect of NBFCs which have issued subordinated capacity to honour the said obligations;
debt and perpetual instruments (PDI) in terms of the • The unit has defaulted in meeting its payment / repayment
RBI guidelines, care would need to be taken to check obligations to the lender and has not utilised the finance
whether any events / triggers have taken place in terms from the lender for the specific purposes for which finance
of the RBI guidelines to make repayments, especially of was availed but has diverted the funds for other purposes;
the principal amounts and whether the same have been • The unit has defaulted in meeting its payment / repayment
complied with. The key RBI guidelines which need to be obligations to the lender and has siphoned off the funds
kept in mind are as under: so that the funds have not been utilised for the specific
(i) Subordinated debt is not redeemable at the instance purpose for which finance was availed, nor are the funds
of the holder or without the consent of the supervisory available with the unit in the form of other assets;
authority of the NBFC; • The unit has defaulted in meeting its payment / repayment
(ii) Non-deposit-taking NBFCs with asset size of Rs. obligations to the lender and has also disposed of or
500 crores and above shall issue PDI as plain vanilla removed the movable fixed assets or immovable property
instruments only. However, they may issue PDI with a given for the purpose of securing a term loan without the
‘call option’ for a minimum period of ten years from the knowledge of the bank / lender.
date of issue and the call option shall be exercised only
with the prior approval of RBI. The identification of the wilful default should be made
keeping in view the track record of the borrowers and
Wilful defaulter [Clause 3 (ix)(b)]: should not be decided on the basis of isolated transactions
Additional disclosures under amended Schedule III: / incidents. The default to be classified as wilful should
While reporting under this clause, the auditor will have to be intentional, deliberate and calculated. The key trigger-
keep in mind the amended Schedule III disclosures which points for identification of wilful default indicated by RBI
are as under: are:

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• Diversion of funds as wilful defaulter. In that case, the auditor shall consider
• Siphoning of funds performing the audit procedures under Standard on
Auditing SA 501 Audit Evidence – Specific Considerations
Diversion of funds: for Selected Items that requires the auditors to perform
This would be construed to include any one of the certain procedures, as indicated hereunder, as also make
undernoted occurrences: appropriate disclosures whilst reporting under this Clause
a) Utilisation of short-term working capital funds for long- as well as in the financial statements under the amended
term purposes not in conformity with the terms of sanction; Schedule III.
b) Deploying borrowed funds for purposes / activities or • Obtain a list of litigation and claims;
creation of assets other than those for which the loan was • Where available, review the management’s assessment
sanctioned; of the outcome of each of the identified litigation and
c) Transferring borrowed funds to the subsidiaries / group claims and its estimate of the financial implications,
companies or other corporates by whatever modalities; including costs involved;
d) Routing of funds through any bank other than the • Seek confirmation from the entity’s external legal counsel
lender bank or members of the consortium without prior about the reasonableness of management’s assessments
permission of the lender; and provide the auditor with further information if the list
e) Investment in other companies by way of acquiring is considered by the entity’s external legal counsel to be
equities / debt instruments without approval of lenders; incomplete or incorrect;
f) Shortfall in deployment of funds vis-à-vis the amounts • If the entity’s external legal counsel does not respond
disbursed / drawn and the difference not being accounted appropriately to a letter of general inquiry, the auditor may
for. seek direct communication through a letter of specific
inquiry;
Siphoning of funds: • Consider meeting the entity’s external legal counsel to
The term ‘siphoning of funds’ should be construed to occur discuss the likely outcome of the litigation or claims, for
if any funds borrowed from banks / FIs are utilised for example, where the matter is a significant risk.
purposes unrelated to the operations of the borrower,
to the detriment of the financial health of the entity or of the c) It is possible that the company may not have been
lender. The decision as to whether a particular instance declared as wilful defaulter as at the date of the balance
amounts to siphoning of funds or diversion of funds would sheet but has been so declared before the audit report is
have to be a judgement of the lenders based on objective issued. As per paragraph 6 of SA 560 Subsequent Events,
facts and circumstances of the case. Generally, siphoning the auditor shall perform audit procedures designed to
of funds would occur when the funds are diverted to group obtain sufficient appropriate audit evidence that all events
companies without proper approvals. occurring between the date of the financial statements
and the date of the auditor’s report that require adjustment
Keeping in mind the above reporting requirements, of, or disclosure in, the financial statements have been
the following are some of the practical challenges identified. It is, therefore, clarified that the auditor should
that could arise in reporting under this Clause: also consider whether the company has been declared
a) If the company has not been declared a wilful defaulter as wilful defaulter as on the date of the audit report. The
but has received a show cause notice in accordance with declaration of the company as a wilful defaulter will
the RBI Circular, the auditor may consider disclosing this be published on the RBI website after the lender
fact under this Clause. In case a show cause notice is not has followed the due process in terms of the above-
received by the company, the auditor should also obtain referred RBI Circular.
a representation letter from the management that the
company has neither been declared as a wilful defaulter Application of term loans for prescribed purposes
nor has it received any show cause notice. This would [Clause 3 (ix)(c)]:
normally be the case when the company has defaulted Additional disclosures under amended Schedule III:
and the same has been reported under Clause 3(ix)(a) While reporting under this Clause, the auditor will have to
earlier. keep in mind the amended Schedule III disclosures which
are as under:
b) It is possible that the company is legally disputing the Where the company has not used the borrowings from
bank’s / financial institution’s declaration of the company banks and financial institutions for the specific purpose

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for which these had been taken at the balance sheet date, • Investment in capital market or payment of long-term
the company shall disclose the details of where they have debt from the existing CC limits;
been used. • Purchase of immovable properties / assets for personal
use of the promoters / directors / KMPs;
‘Utilisation of borrowed funds and share premium’ • Current ratio of less than one may indicate that the
This Clause is applicable in case where the company has company has diverted working capital loans for long-term
advanced or loaned or invested funds (either borrowed purposes.
funds or share premium or from any other source) to
any other person(s) or entity(ies) (Intermediaries) with c) Under Ind AS, certain loans may be treated as
the understanding that the Intermediary shall, inter alia, compound financial instruments (part debt, part equity).
directly or indirectly lend or invest in the other persons The auditor shall cover the entire proceeds of the loans
or entities identified in any manner whatsoever by or from the bank / FI for the purpose of reporting under the
on behalf of the company (Ultimate Beneficiaries). In Clause.
such a case, the company shall provide in the financial
statements certain details such as: date and amount of Short-term funds utilised for long-term purposes
funds advanced or loaned or invested in Intermediaries [Clause 3 (ix)(d)]:
with complete details of each Intermediary; date and Additional disclosures under amended Schedule III:
amount of fund further advanced or loaned or invested Refer to Clause 3(ix)(c) earlier.
by such Intermediaries to other Intermediaries or Ultimate
Beneficiaries along with complete details of the Ultimate Keeping in mind the above reporting requirements,
Beneficiaries; and, declaration that relevant provisions the following are some of the practical challenges
of the Foreign Exchange Management Act, 1999 and that could arise in reporting under this Clause:
the Companies Act have been complied with for such a) The auditor is required to state the nature of application
transactions and the transactions are not violative of the of funds if the company has financed long-term assets
Prevention of Money-Laundering Act, 2002. out of short-term funds. The auditor can determine the
nature of application of funds only if there is a direct
Whilst reporting, the auditor should make a cross- linkage between the funds raised and the asset. The
reference to the above disclosures made in the financial determination of direct relationship between the particular
statements to ensure that there are no inconsistencies. funds and an asset from the balance sheet may not
always be feasible. The auditor shall obtain adequate
Keeping in mind the above reporting requirements, audit evidence supporting the movement in funds. If the
the following are some of the practical challenges quantum of long-term funds raised is less than the funds
that could arise in reporting under this Clause: used for long-term assets, this may imply that some of the
a) In case of any loans / advances / payments to related long-term assets have been financed through short-term
parties or promoters / promoter group entities or any funds.
investments made in other companies, auditors need to
exercise greater professional scepticism to ensure that b) Often, it may not be possible to establish a direct link
the payments are genuine and for the purposes as per between the funds and the assets / utilisation, since
the sanctioned terms. money is fungible. The auditor shall determine the overall
deployment of the source and application of funds of the
b) Reference should be made to the RBI Circular on wilful company. The auditor may also review the cash flow
defaulters referred to earlier to identify possible instances statement to determine whether short-term funds have
of diversion of funds, since the purpose for which the been used for long-term purposes. Instances where
funds are used / diverted are required to be reported / short-term funds would have been utilised for long-term
disclosed. Some instances of diversion of funds are: purposes would include, for example, where the company
• Payment to capital goods vendors from CC limits when has utilised funds from bank overdraft facilities in long-
there was shortfall in term loan sanctioned; term investments or long-term projects or fixed assets.
• Meeting company’s margin money from CC limits for Similarly, there may be cases where the company raises
expansion / modernisation / technical upgradation of monies from public deposits due for repayment within
existing project; two to three years for the purpose of acquiring long-term
• Investment in subsidiary / Group companies; investments, unless the company is able to demonstrate

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that a bulk of these deposits are renewed. is required for reporting under this Clause, which
would need to be reconciled to ensure completeness
c) In case of NBFCs and Ind AS companies the ALM / of reporting. The auditors of Ind AS companies will need
Maturity Analysis disclosures need to be referred to for to take utmost care about this distinction while dealing
the purposes of identifying any maturity mismatches. with this Clause.
Further, in such cases the auditor should also check
whether the company’s treasury / finance department The definition of ‘associate’ under the Act extends to
uses any liquidity / working capital management tools an entity that is significantly influenced by the investor
and if so to check the design and operating effectiveness company. Significant influence may be achieved in
of the internal controls around the same. If the quantum cases where the company is accustomed to act as per
of long-term funds raised is less than the funds used for the directions of the investor company. Such a significant
long-term assets, this may imply that some of the long- influence may be as a result of shareholders’ agreements,
term assets have been financed through short-term funds. too. Therefore, the definition of ‘associate’ can be quite
These considerations would equally apply to all entities broad vis-a-vis the Accounting Standards.
where the volume of borrowings is significant.
b) Determining the reporting boundaries: This presents
Funds borrowed for meeting obligations of group several challenges and raises certain issues which are
companies [Clause 3 (ix)(e)]: discussed below:
Additional disclosures under amended Schedule III: • The Clause refers to any funds taken from any entity.
Refer to Clause 3(ix)(c) earlier. However, both these terms have not been defined;
• Whilst the Guidance Note has specified that the word
Keeping in mind the above reporting requirements, entity would include banks, FIs, companies, LLPs, Trusts,
the following are some of the practical challenges Government or others irrespective of the legal form,
that could arise in reporting under this Clause: normally in case of trusts and others the purpose
a) Identifying subsidiaries and associates: Since this for which the funds have been given may not be
Clause requires to separately report on funds borrowed clearly specified in the absence of any statutory
for meeting the obligations of subsidiaries, joint ventures requirements and lack of proper documentation.
and associates, the identification thereof is of paramount This would make it difficult for the auditor to establish a
importance. The Guidance Note has clarified that these proper audit trail for the utilisation of funds, and hence he
terms should be interpreted in accordance with the needs to exercise a heightened degree of professional
provisions of the Act which could be different, in certain scepticism. He should also consider obtaining a suitable
cases, from what is defined in the Accounting Standards management representation in this regard;
in the case of subsidiaries which is examined as under: • Further, whilst the funds would include both short-term
Section 2(87) of the Act defines ‘subsidiary company’ or and long-term funds as clarified in the Guidance Note,
‘subsidiary’ in relation to any other company, means a there is no clarity as to whether it would cover both
company in which the holding company – (i) controls the borrowed funds and share capital. A plain reading
composition of the Board of Directors; or (ii) exercises or seems to suggest that even funds raised by issue of
controls more than one-half of the total voting power either shares should be considered. In such cases, the auditor
at its own or together with one or more of its subsidiary should refer to the Offer Letter / Prospectus to identify
companies. Thus, the Act emphasises on legal control whether the funds are to be utilised for granting loans and
which is similar to what is considered for the purpose of advances to or making investments in or meeting other
Accounting Standard 21 (AS 21) – Consolidated Financial obligations of group companies. The same should also
Statements for companies adopting Indian GAAP. The be corroborated with the reporting under Clause 3(x)(a)
concept of control and, therefore, subsidiary relationship and (b).
under Ind AS 110 is much broader. Existence of factors • Finally, the auditor should consider the procedures
such as, de facto control, potential voting rights, control performed for reporting under Clause 3(ix)(c) earlier
through de facto agents, power to enforce certain wherein he would have identified diversion of funds, and if
decisions, etc., have to be considered, which are not required he should cross-reference the same for reporting
considered for the purpose of section 2(87). Hence, for purposes.
companies adopting Ind AS there could be differences
between what is disclosed in the accounts and what c) Challenges for NBFCs, highly leveraged companies

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and companies with a large number of group b) Negative lien / residual / floating charge: There may
companies: Such companies are likely to face certain be cases where the company has a negative lien on its
specific challenges which need to be kept in mind whilst investments in subsidiaries, joint ventures and associate
considering the various reporting requirements which are companies. It may be noted that such negative lien is not
as under: a pledge. Sometimes, loan agreements have a general
• The auditor shall review the company’s internal control or residual or floating charge on all securities without
systems and test the design and operating effectiveness specific pledge of any security. Reporting under this
to identify whether there is proper monitoring of the Clause will be applicable only when the securities held in
usage of funds as per the sanctioned terms or approved the subsidiaries, etc., are pledged for obtaining such loan
purposes; by the company.
• The auditor shall review the company’s internal control
systems and test the design and operating effectiveness to c) Validity / legality of pledge: In case of any doubts
identify whether related parties and the transactions with on the validity or legality of the pledge, the auditor may
them are identified and appropriately recorded. He should consider obtaining confirmation from the company’s
also perform adequate and appropriate procedures under lawyers by performing the procedures as per SA 501
SA 500 on Related Parties. In particular, the auditor shall referred to earlier. For this purpose the auditor should be
inspect or inquire about the following for indications of aware of the requirements as under:
the existence of related party transactions or transactions • Section 77 of the Companies Act, 2013 dealing with
that the management has not previously identified or registration of charges;
disclosed to the auditor: • Section 12 of the Depositories Act, 1996 read with
a) Bank, legal and third-party confirmations obtained as Regulation 58, SEBI (Depositories and Participants)
part of the auditor’s procedures; Regulations, 1996.
b) Minutes of meetings of shareholders and of those In case the auditor based on his inquiries and / or
charged with governance; discussion with the legal personnel observes any
c) Such other records or documents as the auditor non-compliance with respect to the above, he should
considers necessary in the circumstances of the entity; consider inviting attention to the same in his report
d) The entity’s ownership and governance structures; so that the lender / pledgee is aware of the same.
e) The types of investments that the entity is making and
plans to make; and d) The auditor may consider giving a reference to the
f) The way the entity is structured and how it is reporting of defaults under Clause 3(ix)(a) earlier in case
financed. of any defaults without specifying the extent of default.
Loans raised against pledge of securities of group Impact on the audit opinion:
companies [Clause 3 (ix)(f)]: Whilst reporting on these Clauses, the auditors may
Additional disclosures under amended Schedule III: come across several situations wherein they may need
Registration of charges or satisfaction with Registrar to report exceptions / deviations. In each of these cases,
of Companies they would need to carefully evaluate the impact of the
Where any charges or satisfaction are yet to be registered same on the audit opinion by exercising their professional
with the Registrar of Companies beyond the statutory judgement to determine the materiality and relevance of
period, details and reasons thereof shall be disclosed. the same to the users of the financial statements. These
Whilst reporting, the auditor should make a cross- are broadly examined hereunder:
reference to the above disclosures made in the financial
statements to ensure that there are no inconsistencies. Nature of exception / deviation Possible impact on the audit
report / opinion
Keeping in mind the above reporting requirements,
The company has not complied • Modified opinion under SA
the following are some of the practical challenges with the RBI directives or sections 706
that could arise in reporting under this Clause: 73 to 76 or other applicable • Key audit matter under SA
provisions of the Act or relevant 701
Rules or orders of any statutory
a) Identifying subsidiaries and associates: Similar authority which may have
considerations as discussed under Clause 3(ix)(e) earlier implications on the main audit
would apply.

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Nature of exception / deviation Possible impact on the audit Nature of exception / deviation Possible impact on the audit
report / opinion report / opinion
(continued) (continued)
report due to non-compliance auditor may have to consider

with the following SAs: the impact of impairment or
• Consideration of laws and provisioning and whether the
regulations (SA 250) same is consistent with the
• Fraud (SA 240). purpose of loans taken by the
[Clause 3(v)] company and whether there is
a breach in the loan covenants.
• In extreme cases, where • Modified opinion under SA The auditor shall consider
there are continuing defaults in 706 requirements of the auditing
repayment of loans / borrowings • Emphasis of matter under standards, in particular SA 240
by the company, there may SA 705 The Auditor’s Responsibilities
be uncertainties around the • Key audit matter under SA Relating to Fraud in an Audit of
appropriateness of Going 701 (in case of restructuring Financial Statements
Concern assumption in the subsequent to the Balance [Clause 3(ix)(e)]
financial statements. The auditor Sheet date)
shall follow the requirements of Where the company has raised Modified opinion under SA 706
SA 570 (Revised) Going Concern loans during the year on the
in such cases. pledge of securities held in
• Restructuring of loan its subsidiaries, joint ventures
subsequent to the balance or associate companies and
sheet date but before the date of if the company has defaulted
auditor’s report. in repayment of such loans,
[Clause 3(ix)(a)] the auditor may have to
consider audit issues such as
Where the company has been • Modified opinion under SA requirements of the auditing
declared a wilful defaulter, there 706 standards, in particular SA 570
may be uncertainties around • Key audit matter under SA Going Concern and SA 240
the appropriateness of Going 701 (where the Company is The Auditor’s Responsibilities
Concern assumption in the disputing the same) Relating to Fraud in an Audit of
financial statements. The auditor Financial Statements
shall follow the requirements of [Clause 3(ix)(f)]
SA 570 (Revised) Going Concern
in such cases
[Clause 3(ix)(b)]
In such cases, it is imperative that the Board’s Report
Where the company has not Modified opinion under SA 706 contains explanations / comments on every reservation /
applied term loans for the adverse comment in the audit report as per section 134(3)
purpose for which the loans
were obtained, there may (f) of the Companies Act, 2013 and that there is no factual
be uncertainties around the inconsistency between the two.
appropriateness of Going
Concern assumption in the
financial statements. The auditor CONCLUSION
shall follow the requirements The above changes have cast onerous reporting
of auditing standards, in responsibilities on the auditor, especially towards the
particular SA 240 The Auditor’s
lenders for various critical aspects as under:
Responsibilities Relating to
Fraud in an Audit of Financial • Identifying defaults on timely basis.
Statements • Monitoring the end use of funds.
[Clause 3(ix)(c)] • Providing red flags towards Going Concern and fraud-
Where the company has taken Modified opinion under SA 706 related issues.
any funds from any entity or
person on account of or to meet
Accordingly, the auditors would need to exercise greater
the obligations of its subsidiaries,
associates or joint ventures, the degree of professional scepticism during the course of
their audits.
Without self-discipline, success is impossible, period

— Lou Holtz

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CARO 2020 SERIES:

FRAUDS AND UNRECORDED TRANSACTIONS

ZUBIN BILLIMORIA
(This is the fifth article in the CARO 2020 series that started in June, 2021)

In the recent past regulators and other stakeholders No. change, if
have been increasingly concerned with the increase any
in frauds by companies and the perceived lack of Clause Unrecorded Transactions: New Clause
attention by the auditors in respect thereof. This trust 3(viii)
Whether any transactions
deficit is attempted to be bridged by CARO 2020 not recorded in the books of
by significantly increasing the reporting responsibilities accounts have been surrendered
for auditors with regard to fraud and unreported or disclosed as income during
the year in the tax assessments
transactions. under the Income-tax Act, 1961
(43 of 1961); and if so, whether
SCOPE OF REPORTING the previously unrecorded income
The scope of reporting can be analysed under the has been properly recorded in the
books of accounts during the year
following clauses:
Clause Particulars Nature of ANALYSIS OF ENHANCED REPORTING

No. change, if REQUIREMENTS
any Frauds noticed or reported [Clause 3(xi)(a)]:
Clause Frauds noticed or reported: Enhanced * The scope has been widened by removing the words
3(xi)(a) Reporting ‘officers or employees’.
Whether any fraud by the company
or any fraud on the company has
been noticed or reported during PRACTICAL CHALLENGES IN
the year; if yes, the nature and the REPORTING
amount involved is to be indicated The reporting requirements outlined above entail certain
practical challenges which are discussed below in respect
Clause Reporting on Frauds: New Clause
3(xi)(b) of the Clause where there is enhanced reporting as
Whether any report under sub- well as the new Clauses:
section (12) of section 143 of the
Companies Act has been filed Frauds noticed or reported [Clause 3(xi)(a)]:
by the auditors in Form ADT-4 as
prescribed under rule 13 of the a) Conflict with responsibilities under SA 240: For
Companies (Audit and Auditors) complying with SA 240, the auditor is primarily concerned
Rules, 2014 with the Central with frauds which cause material misstatements to the
Government
financial statements, which are intentional and broadly
Clause Whistle-Blower Complaints: New Clause cover misstatements from fraudulent financial reporting
3(xi)(c) and misappropriation of assets. This is in conflict with
Whether the auditor has the CARO requirements whereby the terms ‘noticed
considered whistle-blower
or reported’ are very wide. Accordingly, the auditor is
complaints, if any, received during
the year by the company required to report not only the frauds noted or detected
by him pursuant to the procedures performed in terms of

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SA 240 and reported by him u/s 143(12), but also frauds one crore or above, is being or has been committed
detected by the management whilst reviewing the internal against the company by its officers or employees, the
controls or internal audit or whistle-blower mechanism or auditor shall report the matter to the Central Government.
Audit Committee and brought to the auditor’s notice.
b) Concept of materiality: Once a fraud is noticed, it (2) The auditor shall report the matter to the Central
appears that it needs to be reported irrespective of the Government as under:
materiality involved. Whilst there is no clarity in respect (a) the auditor shall report the matter to the Board or the
thereof in the Guidance Note under this Clause, para Audit Committee, as the case may be, immediately but
37 of the Guidance Note specifies that whilst reporting not later than two days of his (acquiring) knowledge
on matters specified in the Order, the auditor should of the fraud, seeking their reply or observations within
consider the materiality in accordance with the principles forty-five days;
enunciated in SA 320. Accordingly, the auditors should (b) on receipt of such reply or observations, the auditor
apply appropriate judgement whilst reporting under this shall forward his report and the reply or observations
Clause. It may be noted that even the FRRB and QRB of the Board or the Audit Committee along with his
in the course of their review reports have not been comments (on such reply or observations of the Board or
favourably inclined to the concept of taking shelter under the Audit Committee) to the Central Government within
the garb of materiality for reporting under this Clause. fifteen days from the date of receipt of such reply or
c) Challenges in detection: An auditor may find it difficult observations;
to detect acts by employees or others committed with (c) in case the auditor fails to get any reply or observations
an intent to injure the interest of the company or cause from the Board or the Audit Committee within the stipulated
wrongful gain or loss, unless these are reflected in the period of forty-five days, he shall forward his report to the
books of accounts; examples include receiving payoffs Central Government along with a note containing the
from vendors and tampering with QR codes during the details of his report that was earlier forwarded to the Board
billing and collection process. In such cases the auditors or the Audit Committee for which he has not received any
would need to corroborate their inquiries based on their reply or observations;
knowledge of the business / industry coupled with the (d) the report shall be sent to the Secretary, Ministry of
results of the evaluation of the internal controls, the Corporate Affairs in a sealed cover by Registered Post
robustness of the code of conduct and ethics policies, with Acknowledgement Due or by Speed Post followed by
instances of past transgressions in respect thereof, etc. an e-mail in confirmation of the same;
(e) the report shall be on the letterhead of the auditor
Reporting on Frauds [Clause 3(xi)(b)]: containing postal address, e-mail address and contact
Before proceeding further, it would be pertinent to note telephone number or mobile number and be signed by the
the following statutory requirements: auditor with his seal and shall indicate his Membership
Number; and
Section 143(12) of Companies Act, 2013 (f) The report shall be in the form of a statement as
Notwithstanding anything contained in this section, if an specified in Form ADT-4.
auditor of a company, in the course of the performance
of his duties as auditor, has reason to believe that an (3) In case of a fraud involving lesser than the amount
offence involving fraud is being or has been committed specified in sub-rule (1), the auditor shall report the
against the company by officers or employees of the matter to the Audit Committee constituted u/s 177 or
company, he shall immediately report the matter to the to the Board immediately but not later than two days of
Central Government within such time and in such manner his knowledge of the fraud and he shall report the matter
as may be prescribed. specifying the following:
(a) Nature of fraud with description;
Rule 13 of the Companies (Audit and Auditors) Rules, (b) Approximate amount involved; and
2014 deals with reporting of frauds by auditor and (c) Parties involved.
other matters:
(1) If an auditor of a company, in the course of the (4) The following details of each of the frauds reported
performance of his duties as statutory auditor has reason to the Audit Committee or the Board under sub-rule
to believe that an offence of fraud, which involves or is (3) during the year shall be disclosed in the Board’s
expected to involve, individually an amount of rupees Report:

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(a) Nature of fraud with description; fraud was genuinely detected through vigil / whistle-
(b) Approximate amount involved; blower mechanism and review the follow-up in respect
(c) Parties involved, if remedial action not taken; and thereof. This could have an impact on reporting under
(d) Remedial actions taken. sub-clause (c) discussed subsequently.
* Reporting is required only when there is sufficient reason
(5) The provision of this rule shall also apply, mutatis to believe and there is sufficient knowledge (i.e., evidence)
mutandis, to a Cost Auditor and a Secretarial Auditor of occurrence. Mere suspicion is not sufficient.
during the performance of his duties u/s 148 and u/s 204,
respectively. Keeping in mind the above reporting requirements,
the following are some of the practical challenges
Form and content of Form ADT-4 that could arise in reporting under this Clause:
a) Full details of suspected offence involving fraud (with
documents in support), a) Reporting by predecessor auditor: The requirement
b) Particulars of officers / employees who are suspected for reporting pertains to any report which has been filed
to be involved in the offence, during the financial year under audit. Accordingly, if the
c) Basis on which fraud is suspected, auditor has been appointed for the first time, he would
d) Period during which the suspected fraud has occurred, need to consider whether the predecessor auditor has
e) Date of sending report to BOD / Audit Committee and reported to the Central Government during the financial
date of reply, if any, received, year prior to his term being concluded before the AGM.
f) Whether auditor is satisfied with the reply / observations In such cases it is better that the incoming auditor seeks
of the BOD / Audit Committee, a specific clarification from the predecessor auditor and
g) Estimated amount involved in the suspected fraud, also obtains a management representation and makes a
h) Steps taken by the company, if any, in this regard, with mention accordingly in his report.
full details of references. b) Post-balance sheet events: If the auditor has
identified the fraud and initiated the communication
Guidance Note issued by ICAI procedures outlined earlier before the year-end but has
The ICAI has also published a Guidance Note on Reporting filed his report with the Central Government subsequent
of Frauds u/s 143(12) of the Companies Act, 2013 to to year-end till the date of the report, he would need to
assist the auditors in discharging their responsibilities. report on the same specifically under this Clause. In such
Some of the main issues addressed by the Guidance cases, he should also consider the impact on the financial
Note are as under and which need to be kept in mind statements and disclosures of Events subsequent to
whilst discharging the responsibilities for reporting under the balance sheet date under AS 4 and Ind AS 10, as
this Clause: applicable.
* The requirement is to report only on frauds in the course c) Monetarily immaterial frauds: Monetarily immaterial
of performance of duties as an auditor. frauds below Rs. 1 crore have to be reported by the
* Only frauds committed against the company by its auditor to the Audit Committee constituted u/s 177. In
officers or employees are required to be reported. cases where the Audit Committee is not required to
Thus, frauds committed by vendors and outsourced be constituted u/s 177, then the auditor shall report
service providers are not required to be reported. monetarily immaterial frauds to the Board of Directors. In
The requirements of SA 240 need to be kept in mind. either case, a disclosure needs to be made in the Board
Accordingly only frauds involving financial reporting Report as outlined earlier. Though there is no specific
or misappropriation of assets are covered Thus, reporting responsibility under this Clause, it would be a
the scope for reporting under this Clause is much good practice to make a reference to the same under this
narrower than under sub-clause (a) discussed earlier. Clause.
* If any frauds are detected during the course of other d) Cost audit and secretarial audit: Reporting on fraud
attest / non-attest functions like quarterly reporting and u/s 143(12) is required even by the cost auditor and
they are likely to have a material effect on the financial the secretarial auditor of the company and it is possible
statements, the same would also need to be reported. that a suspected offence involving fraud may have been
* There is no responsibility to report frauds if the same reported by them even before the auditor became aware
are already detected. However, in such cases the auditor of the fraud in the course of his audit procedures under
should apply professional scepticism as to whether the SA 240. In such cases, if a suspected offence of fraud

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has already been reported by the cost auditor and the Director nominated to play the role of Audit Committee
secretarial auditor, he need not report the same to the may take suitable action against the Director or employee
Audit Committee u/s 177 or the Board of Directors and concerned, including reprimand.
thereafter, where applicable, to the Central Government,
since he has not per se identified the suspected offence Requirements under SEBI LODR
of fraud. It is, however, advisable that the report factually Regulation 4(2)(d) of the SEBI LODR Regulations also
clarifies the position. mandates all listed entities to devise an effective whistle-
blower mechanism enabling Directors, employees or any
Whistle-Blower Complaints [Clause 3(xi)(c)]: other person to freely communicate their concerns about
The establishment of a whistle-blower mechanism is illegal or unethical practices.
mandatory for certain class of companies and therefore
the auditor should consider the requirements prescribed Regulation 46(2)(e) of SEBI LODR Regulations requires
in the Act and in SEBI (Listing Obligations and Disclosure a listed company to disseminate on its website details
Requirements) Regulations, 2015 (SEBI LODR of establishment of its vigil mechanism / whistle-blower
Regulations) in this regard. Section 177(9) of the Act policy. Further, the role of the Audit Committee also
requires certain class of companies to establish a vigil includes review of the functioning of the whistle-blower
mechanism for their Directors and employees to report mechanism.
their genuine concerns or grievances:
Keeping in mind the above reporting requirements,
Requirements under Companies Act, 2013 the following are some of the practical challenges
Section 177(9) read with Rule 7 of the Companies that could arise in reporting under this Clause:
(Meetings of Board and its Powers) Rules, 2014 provides a) Anonymous complaints: The auditor needs to
for establishment of a vigil mechanism. consider every complaint received by the company
including anonymous complaints while deciding the nature,
(1) Every listed company and the companies belonging timing and extent of audit procedures. The auditor should
to the following class or classes shall establish a vigil also evaluate whether such complaints are investigated
mechanism for their Directors and employees to report and resolved by the company in an appropriate and
their genuine concerns or grievances: timely manner. Further, in case of anonymous complaints
(a) the companies which accept deposits from the he needs to exercise greater degree of professional
public; scepticism to ascertain whether they are frivolous or
(b) the companies which have borrowed money from motivated. Also, any other information which is available
banks and public financial institutions in excess of in the public domain should also be considered.
fifty crore rupees. b) Companies not covered under the Regulatory
(2) The companies which are required to constitute an Framework: The reporting requirements under this
Audit Committee shall oversee the vigil mechanism Clause do not distinguish between listed, public interest
through the committee and if any of the members of the entities and other entities, including those in the SME
committee have a conflict of interest in a given case, sector where there is no regulatory requirement to
they should recuse themselves and the others on the establish a formal whistle-blower / vigil mechanism. In
committee would deal with the matter on hand. such cases the auditor needs to make specific inquiries
(3) In case of other companies, the Board of Directors and obtain appropriate representation which needs to be
shall nominate a Director to play the role of an Audit corroborated for adequacy and appropriateness based
Committee for the purpose of vigil mechanism to whom on the understanding obtained about the entity and its
other Directors and employees may report their concerns. operating and governance environment. Finally, any
(4) The vigil mechanism shall provide for adequate information which is available in the public domain should
safeguards against victimisation of employees and also be considered.
Directors who avail of the vigil mechanism and also c) Forensic investigations: In case a forensic audit /
provide for direct access to the Chairperson of the Audit investigation has been initiated pursuant to a whistle-
Committee or the Director nominated to play the role of blower complaint, the auditor needs to check the reports
Audit Committee, as the case may be, in exceptional cases. issued and discuss the observations and conclusions with
(5) In case of repeated frivolous complaints being filed the auditor / investigation agency if required and report
by a Director or an employee, the Audit Committee or the accordingly.

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d) Outsourcing arrangements: The auditor should a proportion of the total tax along with interest and penalty
perform independent procedures, including getting direct needs to be paid (depending on the type of the pending
confirmation for whistle-blower complaints received which dispute) for full and final settlement.
are managed by a third party like an external internal * The scheme confers immunity from prosecution, penalty
audit firm. and interest in respect of proceedings for which the
taxpayer has opted to avail the Scheme.
Unrecorded Transactions [Clause 3(viii)]: * The Act also provides that the tax disputes so settled
Before proceeding further, it would be pertinent to note cannot be reopened in any other proceeding by the
the following statutory requirements: Income Tax Department or any other designated authority.
Undisclosed income under the Income-tax Act, 1961 Keeping in mind the above reporting requirements,
‘Undisclosed income’ as per section 158B includes any the following are some of the practical challenges
money, bullion, jewellery or other valuable article or thing that could arise in reporting under this Clause:
or any income based on any entry in the books of accounts a) Scope: The emphasis is on the words surrendered
or other documents or transactions, where such money, or disclosed which implies that the company must have
bullion, jewellery, valuable article, thing, entry in the books voluntarily admitted to the addition of such income in the
of accounts or other document or transaction represents income tax returns filed by the company. What constitutes
wholly or partly income or property which has not been voluntary admission poses several challenges especially
or would not have been disclosed for the purposes of where the company has pending tax assessments which
this Act, or any expense, deduction or allowance claimed have been decided up to a particular stage and the
under this Act which is found to be false. company chooses not to file an appeal. In such cases, the
auditor needs to review the submissions and statements
Vivad Se Vishwas Scheme filed in the course of assessment to ascertain whether the
The Union Budget 2020 was presented by the Finance additions to income were as a consequence of certain
Minister on 1st February, 2020 with an underlying objective transactions not recorded in the books. This would involve
to support the Government’s target of making India a $5 use of professional judgement and consideration of the
trillion economy by 2025. Several policy and tax-related materiality factor.
announcements were made with primary focus on b) Submissions under the Vivad Se Vishwas Scheme:
improving the ease of living and the ease of doing business In case the company has opted for disclosures under
in India. One of the key proposals was introduction of a the said Scheme, a view can be taken that the same
direct tax dispute resolution scheme, namely, Vivad Se constitutes voluntary surrender and disclosure and hence
Vishwas Scheme which translates to ‘From Dispute needs to be reported under this Clause with appropriate
towards Trust’, i.e., trust as the basis of partnering with factual disclosures.
the taxpayers towards building the nation. The Scheme
proposes to settle direct tax disputes relating to personal CONCLUSION
income tax and corporate tax between taxpayers and the Frauds are now an inherent part of corporate life and
tax Department. The Government of India enacted the the auditors will have to live with them. The reporting
Direct Tax Vivad Se Vishwas Act, 2020 (‘the Act’) on requirements outlined above will hopefully provide
17th March, 2020 to give effect to this Scheme. them with the necessary tools to cope with them and
provide greater comfort to the various stakeholders. In
An overview of the Scheme: conclusion, life will never be cushy for the auditors
* If a taxpayer elects to take recourse under the Scheme, and they would always be on the razor’s edge!
The word "queue" is the only word in the English language that is still pronounced
the same way when the last four letters are removed.
— Social Media

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CARO 2020 SERIES:

NON-BANKING FINANCE COMPANIES (NBFCs)

[INCLUDING CORE INVESTMENT COMPANIES]
ZUBIN BILLIMORIA
(This is the sixth article in the CARO 2020 series that started in June, 2021)

Non-Banking Financial Companies (NBFCs) are entities No. change, if
where generally public money is involved and therefore any
they have always been subject to greater scrutiny and Clause Conduct of Business: New Clause
attention by the regulators (primarily, the Reserve Bank 3(xvi)(b)
of India [RBI] and the National Housing Bank [NHB]). Whether the company has
conducted any Non-Banking
There are several classes of NBFCs each of which has Financial or Housing Finance
a separate set of criteria / conditions to fulfil to continue activities without a valid Certificate
carrying on their business. Core Investment Companies of Registration (CoR) from the
Reserve Bank of India as per the
(CICs) are also a separate class of NBFCs which could Reserve Bank of India Act, 1934
be used as a tool to camouflage transactions amongst
group companies. Clause CICs: New Clause
3(xvi)(c)
In the past there have been instances where the 3(xvi)(d) Whether the company is a Core
Investment Company (CIC) as
general public has lost money in such companies. defined in the regulations made
Hence, to protect the interest of society, responsibilities by the Reserve Bank of India and,
have been cast on auditors to report some aspects of if so, whether it continues to fulfil
these companies so that regulators can take necessary the criteria of a CIC, and in case
the company is an exempted
action based on the red flags (if any) raised by the or unregistered CIC, whether it
auditors. continues to fulfil such criteria
Whether the Group has more than
SCOPE OF REPORTING one CIC as part of the Group; if
The scope of reporting can be analysed under the yes, indicate the number of CICs
which are part of the Group
following clauses:
Clause Particulars Nature of *No change and hence not discussed

No. change, if
any PRACTICAL CHALLENGES IN
Clause RBI Registration: No change* REPORTING
3(xvi)(a) The reporting requirements outlined above entail certain
Whether the company is practical challenges in respect of the new clauses which
required to be registered u/s 45-IA
of the Reserve Bank of India Act, are discussed below:
1934 (2 of 1934) and, if so,
whether the registration has RBI Registration [Clause 3(xvi)(b)]:
been obtained
Before proceeding further, it would be pertinent to note
the following statutory requirements:

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NBFCs months after registration cannot be treated as financial

As per section 45-I(f) of the RBI Act, 1934, an NBFC assets and receipt of interest income on fixed deposits
is a company incorporated under the Companies Act, with banks cannot be treated as income from financial
2013 or 1956 which carries on the business of a financial assets as these are not covered under the activities
institution or carries on the principal business of receiving mentioned in the definition of ‘financial Institution’ in
deposits or lending in any manner. section 45-I(c) of the RBI Act, 1934. This is because
bank deposits constitute near money and can be used
As per section 45-I(c) of the RBI Act, the business of only for temporary parking of idle funds, and till the
a financial institution means the business of financing commencement of the NBFI business for the initial six
by way of loans and advances, hire-purchase finance, months after registration.
acquisition of stocks, equities, debentures, any other
marketable securities, etc., insurance business, etc. Housing Finance Activities
Housing Finance Activities are carried on by Housing
Exclusions from definition Finance Institutions. The term ‘Housing Finance Institution’
The NBFC business does not include entities whose is not defined in the RBI Act. However, reference can be
principal business is the following: made to the National Housing Bank Act, 1987 which
• Agricultural activity defines such institutions and the definition is as follows:
• Industrial activity ‘housing finance institution’ includes every institution,
• Purchase or sale of any goods excluding securities whether incorporated or not, which primarily transacts
• Sale / Purchase / Construction of any immovable or has as one of its principal objects the transacting of
property – Providing of any services. the business of providing finance for housing, whether
directly or indirectly;
The following NBFCs are not required to obtain
any registration with the RBI, as these are already Housing finance companies are defined under the
registered and regulated by other regulators: Housing Finance Companies (National Housing
• Merchant Banking Companies Bank) Directions, 2010 as follows:
• Stock broking companies registered with SEBI ‘housing finance company’ means a company incorporated
• Venture capital funds under the Companies Act, 1956 (1 of 1956) which
• Insurance companies holding a certificate of registration primarily transacts or has as one of its principal objects
issued by IRDA the transacting of the business of providing finance for
• Chit Fund Companies as defined in section 2, Clause (b) housing, whether directly or indirectly.
of the Chit Fund Act, 1982
• Nidhi Companies as notified u/s 620(A) of the Companies Earlier, Housing finance companies were supposed to
Act, 1956. be registered with the National Housing Bank. However,
based on the amendments made to the National Housing
Meaning of principal business Bank Act, 1987 through the Finance (No. 2) Act, 2019
The RBI has defined1 financial activity as principal now registrations of HFC’s are within the ambit of RBI.
business to bring clarity to the entities that will be All earlier HFCs having obtained registrations under the
monitored and regulated as NBFCs under the RBI Act. National Housing Bank Act, 1987 shall be deemed to be
The criteria are called the 50-50 test and are as under: registered with the RBI and such HFCs shall comply with
• The company’s financial assets must constitute 50% of the prescribed conditions.
the total assets AND
• The income from financial assets must constitute 50% Specific Responsibilities of Auditors (Master Direction
of the total income. - Non-Banking Financial Companies Auditor’s Report
(Reserve Bank) Directions, 2016):
The RBI, vide its Circular Ref: RBI/2011-12/446 DNBS Conducting Non-Banking Financial Activity without a valid
(PD) CC. No. 259/03.02.59/2011-12 dated 15th March, Certificate of Registration (CoR) granted by the Bank is an
2012 has clarified that parking of funds in bank deposits offence under chapter V of the RBI Act, 1934. Therefore, if
without commencing NBFI activities within a period of six the company is engaged in the business of a non-banking
financial institution as defined in section 45-I(a) of the RBI
1 Vide Circular DNBS (PD) C.C. No. 81 / 03.05.002 / 2006-07 Act and meeting the Principal Business Criteria (Financial

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asset / income pattern) as laid down vide the Bank’s press a) Any company which is a financial institution carrying on
release dated 8th April, 1999, and directions1 issued by as its principal business - asset finance, the providing
DNBR, the auditor shall examine whether the company of finance whether by making loans or advances or
has obtained a Certificate of Registration (CoR) from the otherwise for any activity other than its own; and
Bank. b) Any company which is a financial institution carrying on
as its principal business the acquisition of securities
Categorisation of NBFCs and is not in any other category of NBFC as defined by
NBFCs have been categorised as under based on the RBI in any of its Master Directions.
whether they accept public deposits as well as based on
their assets size and type of activities. Factoring Companies:
a) They should be registered with the RBI u/s 3 of the
Systemically Important Non-Deposit-taking NBFC Factoring Regulation Act, 2011.
(NBFC-ND-SI): b) The financial assets in the factoring business
The following are the key conditions which are required to should constitute at least 50% of the total assets and
be complied with by such companies as per the relevant the income derived from the factoring business is not
RBI directions: less than 50% of the total income.
a) A minimum asset size of Rs. 500 crores is required to
be maintained. ‘Factoring business’ means the business of acquisition
b) If the asset size post registration falls below Rs. 500 of receivables of assignor by accepting assignment of
crores in a given month due to temporary fluctuations such receivables or financing, whether by way of making
and not due to actual downsizing, the NBFCs shall loans or advances or otherwise against the security
continue to meet the reporting requirements and shall interest over any receivables but does not include –
comply with the extant directions as applicable to (i) credit facilities provided by a bank in its ordinary course
NBFC-NDSI till the submission of its next audited balance of business against security of receivables;
sheet to the RBI. A specific dispensation letter from the (ii) any activity as commission agent or otherwise for sale
RBI should be obtained in this regard. of agricultural produce or goods of any kind whatsoever
c) It has net owned funds of Rs. 200 lakhs as per the or any activity relating to the production, storage, supply,
latest audited balance sheet unless it undertakes specific distribution, acquisition or control of such produce or
business activities as indicated subsequently. goods or provision of any services (as defined in the
Factoring Regulation Act, 2011).
Non-Systemically Important Non-Deposit-taking
NBFC (NBFC-ND-NSI) Infrastructure Debt Fund NBFC (IDF-NBFC):
The following are the key conditions which are required to a) The sponsor entity should be registered as an
be complied with by such companies as per the relevant Infrastructure Finance Company [IFC] (see below).
RBI directions: b) The sponsor entity should comply with the following
A) Asset size should be below Rs. 500 crores. conditions:
B) It has net owned funds of Rs. 200 lakhs as per the (i) It has obtained the prior approval of the RBI to sponsor
latest audited balance sheet unless it undertakes specific an IDF-NBFC.
business activities as indicated subsequently. (ii) It shall be allowed to contribute a maximum of 49%
to the equity of the IDF-NBFCs with a minimum equity
Deposit-taking NBFC (NBFC-D): holding of 30% of the equity of the IDF-NBFC.
A) It has net owned funds of Rs. 200 lakhs as per the (iii) Post investment in the IDF-NBFC, the sponsor must
latest audited balance sheet unless it undertakes specific maintain minimum Capital to Risk Assets Ratio (CRAR)
business activities as indicated subsequently. and Net Owned Funds (NOF) prescribed for IFCs.
B) It complies with the various operational provisions for c) The IDF-NBFC shall comply with the following
acceptance, renewal, repayment of public deposits and conditions:
other related matters in terms of the NBFC Acceptance (i) It has Net Owned Funds of Rs. 300 crores or more.
of Public Deposits (RBI) Directions, 2016. (ii) It invests only in Public Private Partnerships (PPP)
and post commencement operations date (COD)
Investment and Credit Company: infrastructure projects which have completed at least
It is an NBFC which satisfies the following criteria: one year of satisfactory commercial operations.

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(iii) It has entered into a Tripartite Agreement (involving b) The entity does not have a leverage ratio [ratio of
the IDF-NBFC, the concessionaire and relevant outside liabilities excluding borrowings / loans from
project authority) in accordance with the prescribed group companies to owned funds] of more than
guidelines. seven.
(iv) It shall have at the minimum a credit rating grade c) There is a Board-Approved Policy for undertaking the
of ‘A’ of CRISIL or equivalent rating issued by other business as an Account Aggregator, including the pricing
accredited rating agencies such as FITCH, CARE and thereof which at least provides the matters as laid down
ICRA. in the guidelines.
(v) It shall have at the minimum CRAR of 15% and Tier
II Capital shall not exceed Tier I Capital. ‘Business of an Account Aggregator’ means the
business of providing under a contract, service in the
NBFC – Micro Finance Institutions (NBFC-MFIs): following matters:
a) It has net owned funds of Rs. 500 lakhs (except if it is (i) retrieving or collecting such specified financial
registered in the North Eastern Region, in which case information [as prescribed by the RBI] pertaining to its
the requirement is Rs. 200 lakhs). customers, as may be specified by the RBI from time to
b) It has a capital adequacy ratio consisting of Tier I time; and
and Tier II Capital which shall not be less than 15%. (ii) consolidating, organising and presenting such
The total of Tier II Capital at any point of time shall not information to the customer or any other financial
exceed 100% of Tier I Capital. information user [an entity registered with and regulated
c) It needs to ensure that not less than 85% of the net by any financial sector regulator{RBI, SEBI, IRDA and
assets (total assets other than cash and bank balances PFRDA}] as may be specified by the RBI
and money market instruments) are in the nature of provided that the financial information pertaining to
qualifying assets. [As defined in the RBI Guidelines.] the customer shall not be the property of the Account
Aggregator, and not be used in any other manner.
NBFC – Infrastructure Finance Company (NBFC-IFC):
a) It does not accept deposits. NBFC Peer-to-Peer Lending Platform (NBFC P2P):
b) A minimum of 75% of its total assets are deployed in a) The entity has net owned funds of Rs. 200 lakhs and
‘infrastructure lending’. [See note below] above.
c) It has Net Owned Funds of Rs. 300 crores or more. b) There is a Board-Approved Policy for undertaking the
d) It shall have at the minimum a credit rating grade business on the Peer-to-Peer Lending platform, including
of ‘A’ of CRISIL or equivalent rating issued by other the pricing thereof which at least provides the matters as
accredited rating agencies such as FITCH, CARE and laid down in the guidelines.
ICRA.
e) It shall have at the minimum CRAR of 15% (with a ‘Peer-to-Peer Lending Platform’ means an intermediary
minimum Tier I capital of 10%). providing the services of loan facilitation via online
medium or otherwise, except as indicated hereunder,
‘Infrastructure lending’ means a credit facility to the participants who have entered into an
extended by an NBFC to a borrower by way of term arrangement with an NBFC P2P to lend on it or to avail
loan, project loan subscription to bonds / debentures of loan facilitation services provided by it.
/ preference shares / equity shares in a project (i) Not to raise deposits as defined by or u/s 45-I(bb) of
company acquired as a part of the project finance the Act or the Companies Act, 2013;
package such that subscription amount to be ‘in the (ii) Not to lend on its own;
nature of advance’ or any other form of long-term (iii) Not to provide or arrange any credit enhancement
funded facility for exposure in the infrastructure sub- or credit guarantee;
sectors as notified by the Department of Economic (iv) Not to facilitate or permit any secured lending linked
Affairs, Ministry of Finance, Government of India, to its platform; i.e., only clean loans will be permitted;
from time to time. (v) Not to hold, on its own balance sheet, funds
received from lenders for lending, or funds received
NBFC Account Aggregator: from borrowers for servicing loans; or such funds as
a) The entity has net owned funds of Rs. 200 lakhs and stipulated below;
above. (vi) Not cross-sell any product except for loan-specific

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insurance products. concern assumption and accordingly ensure consistency

in reporting. This is particularly relevant for specific
Securitisation and Reconstruction Companies classes of NBFCs as indicated earlier and whether
a) The entity has net owned funds of Rs. 200 lakhs and they are undertaking only the prescribed activities
above. and complying with the specific conditions as laid
b) It should undertake the business of securitisation and down. He should use his judgement based on the facts
asset reconstruction in accordance with the prescribed and circumstances and apply professional scepticism and
guidelines for which there is a proper Board-Approved ensure factual reporting, as deemed necessary. If required
policy, covering the following matters, amongst others: he should obtain management representation only as
(i) Acquisition of financial assets. additional evidence and not as a substitute for other audit
(ii) Rescheduling of debts. procedures. Finally, he should also seek guidance as per
(iii) Enforcement of security interest. SA 250 dealing with reporting responsibilities due to non-
(iv) Settlement of dues payable by the borrower. compliance with laws and regulations.
(v) Conversion of debt into equity.
(vi) Realisation plan. Change / takeover of management. d) Reporting under the RBI guidelines: The auditor
(vii) Issue of security receipts and related matters. should keep in mind the specific certification and reporting
responsibilities under the NBFC Auditors Report (Reserve
Keeping in mind the above reporting requirements, Bank) Directions, 2016 to report any non-compliances
the following are some of the practical challenges or exceptions, as prescribed (which includes carrying on
that could arise in reporting under this Clause: business on the basis of a registration certificate), as well
a) Entities engaged in other than NBFI activities: The as any other deviations, especially those impacting specific
auditor may come across situations in which a company classes of companies as indicated above. In such cases
engaged in other than NBFI activities holds funds in there should be consistency in reporting both under the
financial assets which may be in excess of 50%, pending Directions as well as under this Clause with appropriate
deployment in the business, or due to other business / cross-referencing and linking.
commercial reasons. In such cases the auditor needs to
examine the objects of the company in the Memorandum CICs [Clause 3(xvi)(c) and (d)]:
of Association, minutes of the Board / other committee Before proceeding further, it would be pertinent to note
meetings, business plans, etc., and also whether the the following statutory requirements:
company has corresponded with the RBI and accordingly
make a factual mention under this Clause. He should use Definition of Core Investment Companies – CIC’s
his judgement based on the facts and circumstances and Core Investment Companies are defined as companies
apply professional scepticism. If required, he should obtain which comply with the following conditions as on the date
management representation only as additional evidence of the last audited balance sheet:
and not as a substitute for other audit procedures. i. it holds not less than 90% of its net assets in the form
of investment in equity shares, preference shares, bonds,
b) NBFCs not requiring registration under the RBI debentures, debt or loans in group companies;
Act: For such entities as identified above, the auditor ii. its investments in the equity shares (including
should check whether they have obtained registration instruments compulsorily convertible into equity shares
from SEBI or other applicable regulators since strictly within a period not exceeding ten years from the date
they are also regarded as NBFCs in terms of the RBI of issue) in group companies and units of Infrastructure
guidelines and accordingly appropriate factual reporting Investment Trust only as sponsor constitute not less than
is recommended. This aspect is not covered in the 60% of its net assets as mentioned in Clause (i) above…
Guidance Note and a clarification from the MCA and / or provided that the exposure of such CICs towards InvITs
the ICAI on the same is desirable. shall be limited to their holdings as sponsors and shall not,
at any point in time, exceed the minimum holding of units
c) Withdrawal / revocation / suspension / surrender and tenor prescribed in this regard by SEBI (Infrastructure
of Certificate of Registration: The auditor should check Investment Trusts) Regulations, 2014 as amended from
whether the certificate of registration is withdrawn, revoked, time to time.
suspended or surrendered and ascertain the reasons for iii. it does not trade in its investments in shares,
the same and whether the same could affect the going bonds, debentures, debt or loans in group companies

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except through block sale for the purpose of dilution or Investment Company (CIC-ND-SI). All CIC-ND-SI
disinvestment; are required to apply to RBI for grant of certificate of
iv. it does not carry on any other financial activity referred registration. Every CIC shall apply to the RBI for grant of
to in sections 45-I(c) and 45-I(f) of the Reserve Bank of certificate of registration within a period of three months
India Act, 1934 except from the date of becoming a CIC-ND-SI.
a. investment in
(i) bank deposits, CIC-ND-SI who do not have asset size of more than
(ii) money market instruments, including money market Rs. 100 crores and Core Investment Companies that do
mutual funds and liquid mutual funds, not have access to public funds are exempted from the
(iii) government securities, and registration requirement with RBI. This exemption is
(iv) bonds or debentures issued by group companies not applicable to CICs who intend to make overseas
b. granting of loans to group companies and investment in the financial sector. However, these
c. issuing guarantees on behalf of group companies. CICs shall pass a Board Resolution that they will not,
in the future, access public funds.
Definition of Group Companies
‘Companies in the Group’ means an arrangement CICs investing in Joint Venture / Subsidiary /
involving two or more entities related to each other Representative Offices overseas in the financial sector
through any of the following relationships: shall require prior approval from the RBI.
a) Subsidiary-parent (defined in terms of AS 21),
b) Joint venture (defined in terms of AS 27), Raising of Tier II Capital by NBFCs
c) Associate (defined in terms of AS 23), ‘Tier II capital’ includes the following:
d) Promoter - promotee [as provided in the SEBI a) Preference shares other than those which are
(Acquisition of Shares and Takeover) Regulations, 1997] compulsorily convertible into equity;
for listed companies, b) Revaluation Reserves at discounted rate of 55%;
e) a related party (defined in terms of AS 18), c) General provisions (including that for Standard
f) Common brand name, and Assets) and loss reserves to the extent these are not
g) investment in equity shares of 20% and above. attributable to actual diminution in value or identifiable
potential loss in any specific asset and are available to
Note: Even in case of entities which adopt Ind AS, meet unexpected losses, to the extent of one and one
it appears that the group companies would have fourth per cent of risk weighted assets;
to be identified as per the criteria prescribed in the d) Hybrid debt capital instruments [a capital instrument
respective local Accounting Standards. which possesses certain characteristics of equity as well
as of debt];
Definition of Net Assets: e) Subordinated debt [see below]; and
Net Assets means total assets as appearing on the assets f) Perpetual debt instruments issued by a non-deposit-
side of the balance sheet but excluding taking NBFC which is in excess of what qualifies for
* cash and bank balances; Tier I Capital, to the extent the aggregate does not
* investment in money market instruments; exceed Tier I capital.
* advance payments of taxes; and
* deferred tax asset. Subordinated Debt
It means an instrument which fulfils the following
Registration requirements conditions:
CICs having total assets of Rs. 100 crores or more a) It is fully paid-up;
either individually or in aggregate along with other CICs b) It is unsecured;
in the group and which raise or hold public funds2 c) It is subordinated to the claims of other creditors;
are categorised as Systematically Important Core d) It is free from restrictive clauses; and
e) It is not redeemable at the instance of the holder
2 ‘Public funds’ includes funds raised either directly or indirectly through public
deposits, inter-corporate deposits, bank finance and all funds received or without the consent of the supervisory authority of
from outside sources such as funds raised by issue of Commercial Papers, the non-banking financial company.
debentures, etc., but excludes funds raised by issue of instruments compulsorily
convertible into equity shares within a period not exceeding ten years from the
date of issue Keeping in mind the above reporting requirements,

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the following are some of the practical challenges preference shares from the public though considered as
that could arise in reporting under this Clause: financial liabilities / borrowings under Ind AS, will not be
a) Identifying subsidiaries and associates: Since considered in the definition of public funds since legally
this Clause requires identification of investments in they are in the nature of share capital. Similarly, optionally
group companies, viz., subsidiaries, joint ventures and convertible debentures raised from the public though
associates under the respective Accounting Standards considered as compound financial instruments or equity
under Indian GAAP, there could be practical challenges under Ind AS, will be considered in the definition of public
for companies adopting Ind AS, since the definitions funds since only funds raised by issue of instruments
therein could be different. compulsorily convertible into equity shares within a
period not exceeding ten years from the date of issue are
There is emphasis on legal control under AS 21, 23 and exempted from the definition of public deposits.
27 for companies adopting Indian GAAP. The concept of * Such NBFCs raising Tier II capital (including any
control and, therefore, subsidiary relationship under Ind AS subordinated debt) from the public would need
110 is much broader. Existence of factors such as de facto to carefully examine the terms and conditions and
control, potential voting rights, control through de facto accordingly ensure that any instrument which is in
agents, power to enforce certain decisions, etc., have to the nature of equity in terms of Ind AS 32 and 109
be considered, which are not considered for the purpose is not considered ‘public funds’ as referred to earlier.
of section 2(87). Hence, for companies adopting Ind AS In respect of hybrid instruments, the predominant legal
there could be differences between what is disclosed characteristics would need to be considered even if
in the accounts as group companies and what is certain portion is classified as equity in terms of Ind AS 32
required for identifying CICs under this Clause, which and 109. The auditors of Ind AS companies will need to
would need to be reconciled to ensure completeness take utmost care about this distinction while dealing with
of reporting. The auditors of Ind AS companies will need this Clause.
to take utmost care about this distinction while dealing
with this Clause. c) Reporting under the RBI guidelines: Similar
considerations as discussed under Clause 3(xvi)(b)
b) Companies adopting Ind AS: One of the criteria earlier would apply.
for exemption of CIC-ND-SI with asset size of less
than Rs. 100 crores from registration is that it does not CONCLUSION
accept ‘Public Funds’ as defined above. Companies The additional reporting responsibilities have placed
adopting Ind AS are likely to face certain practical specific responsibilities on the auditors in the light of
challenges as under: several recent failures in the sector and the expectation
* The borrowings need to be considered on the basis bar has been substantially raised amongst the various
of the legal form rather than on the basis of the stakeholders. Accordingly, they would need to be
substance of the arrangements as is required in equally adept both at pole vaulting as well as long
terms of Ind AS 32 and 109. Accordingly, redeemable jump to cross the raised bar!
Muddy water is best cleared by leaving it alone.

— Alan Watts

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CARO 2020 SERIES:

REPORTING ON FINANCIAL POSITION

ZUBIN BILLIMORIA
(This is the seventh article in the CARO 2020 series that started in June, 2021)

One of the most important assumptions underlying the No. change, if
preparation of the financial statements is ‘going concern’. any
The trigger for the same rests on two underlying pillars- (continued) the financial statements, the
namely, cash losses and the ability to meet the existing auditor’s knowledge of the Board
financial liabilities within the foreseeable future, generally of Directors and management
plans, whether the auditor is
within one year from the balance sheet date. of the opinion that no material
uncertainty exists as on the date
The reporting requirements discussed hereunder on of the audit report that company
the above two pillars are very relevant in the scenarios is capable of meeting its liabilities
existing at the date of balance
whereby the companies are facing financial stress, or net sheet as and when they fall due
worth has been eroded or in case of companies where within a period of one year from
there are significant doubts on their continuing as a going the balance sheet date.
concern. These situations are particularly relevant in
current times of stress on the business due to the COVID PRACTICAL CHALLENGES IN
pandemic. REPORTING
The reporting requirements outlined above entail certain
SCOPE OF REPORTING practical challenges, which are discussed below:
The scope of reporting can be analysed under the
following clauses: Cash Losses [Clause 3(xvii)]
Clause Particulars Nature of Keeping in mind the above reporting requirements,

No. change, if the following are some of the practical challenges
any that could arise in reporting under this Clause:
Clause Cash Losses: New Clause
3(xvii) a) No clarity on the definition of Cash Losses: The term
Whether the company has incurred ‛cash losses’ is neither defined under the Companies Act,
cash losses in the financial year
and in the immediately preceding 2013 nor in the Accounting Standards / Indian Accounting
financial year, if so, state the Standards. However, the ICAI, in its Guidance Note on
amount of cash losses. Terms Used in the Financial Statements issued in
Clause Financial Position Including New Clause 1983, has defined the term ‛Cash Profit’ as ‛the net profit
3(xix) Financial Ratios: as increased by non-cash costs, such as depreciation,
On the basis of the financial ratios, amortisation, etc. When the result of the computation
ageing and expected dates of is negative, it is termed as cash loss’. This definition is
realisation of financial assets and too inclusive and needs to be updated to keep pace with
payment of financial liabilities,
the changing trends and developments on the accounting
other information accompanying
front in the past couple of decades, like accounting for

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Deferred Tax, Unrealised Forex gains or losses, fair value g) Trade Payables Turnover Ratio
adjustments, actuarial gains and losses for employee
benefits etc. While the ICAI Guidance Note has touched h) Net Capital Turnover Ratio
upon some of these aspects, there is no authentic
guidance/clarity, making it open to differing interpretations i) Net Profit Ratio
and difficulty in comparing and analysing different entities.
It would be desirable to disclose the mode of arriving at the j) Return on Capital Employed
cash loss in the financial statements. Necessary changes
could be considered by the ICAI and / or the regulators. k) Return on Investment
b) Companies adopting Ind AS: For such entities, the Explanation to be provided for any changes by more than
profit/loss after tax excludes items considered under 25% compared to the preceding year.
Other Comprehensive Income (OCI) and hence it is
imperative that proper care is taken to identify and give Whilst reporting, the auditor should refer to the above
effect to only the cash components of items recognised disclosures for the relevant ratios such as current ratio,
in OCI like realised fair value/revaluation changes inventory turnover ratio, trade receivables turnover
and forex gains and losses. For this purpose the cash ratio, trade payables turnover ratio and capital
component recognised under OCI should be considered turnover ratio, amongst others, made in the financial
for the period under report. Further, for computation statements to ensure that there are no inconsistencies.
of the cash profit/loss for the immediately preceding
financial year, the restatements, if any, as per Ind Before proceeding further, it is important to analyse the
AS-8 – Accounting Policies, Changes in Accounting definition of Financial Assets and Financial Liabilities
Estimates and Errors, especially for prior period under Ind AS-32 since these terms are neither defined
errors relating to periods earlier than the corresponding under the Companies Act, 2013 nor under Indian
previous year. This should be clearly disclosed whilst GAAP, since the reporting is with respect to these
reporting under this clause. items as opposed to the other items in the financial
statements.
Financial Position including Financial Ratios [Clause
3(xix)]: Accordingly, companies to whom Ind AS is not
applicable should also consider the said definitions
Before proceeding further it would be pertinent to note the for identifying financial assets and liabilities.
following statutory requirements:
Definition of Financial Assets and Financial Liabilities
Additional Disclosures under amended Schedule III: under Ind AS-32
While reporting under this Clause, the auditor will have to A financial asset is any asset that is:
keep in the mind the amended Schedule III disclosures (a) cash;
which are as under:
(b) an equity instrument of another entity;
The following ratios need to be disclosed:
a) Current Ratio (c) a contractual right:
b) Debt Equity Ratio (i) to receive cash or another financial asset from another
entity; or
c) Debt Service Coverage Ratio
(ii) to exchange financial assets or financial liabilities
d) Return on Equity Ratio with another entity under conditions that are potentially
favourable to the entity; or
e) Inventory Turnover Ratio
(d) a contract that will or may be settled in the entity’s own
f) Trade Receivables Turnover Ratio equity instruments and is:

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(i) a non-derivative for which the entity is or may be instruments in accordance with paragraphs 16A and
obliged to receive a variable number of the entity’s own 16B, instruments that impose on the entity an obligation
equity instruments; or to deliver to another party a pro rata share of the net
assets of the entity only on liquidation and are classified
(ii) a derivative that will or may be settled other than by the as equity instruments in accordance with paragraphs
exchange of a fixed amount of cash or another financial 16C and 16D, or instruments that are contracts for
asset for a fixed number of the entity’s own equity the future receipt or delivery of the entity’s own equity
instruments. For this purpose the entity’s own equity instruments. As an exception, an instrument that meets
instruments do not include puttable financial instruments the definition of a financial liability is classified as an
classified as equity instruments in accordance with equity instrument if it has all the features and meets the
paragraphs 16A and 16B, instruments that impose on the conditions in paragraphs 16A and 16B or paragraphs
entity an obligation to deliver to another party a pro rata 16C and 16D.
share of the net assets of the entity only on liquidation
and are classified as equity instruments in accordance Keeping in mind the above reporting requirements,
with paragraphs 16C and 16D, or instruments that are the following are some of the practical challenges
contracts for the future receipt or delivery of the entity’s that could arise in reporting under this Clause:
own equity instruments.
a) Inclusive nature of various parameters/data points:
A financial liability is any liability that is: This clause requires the auditors to comment based on
(a) a contractual obligation : the following parameters/data points:
(i) to deliver cash or another financial asset to another • Financial Ratios

entity; or
• Ageing and expected dates of realisation of financial
(ii) to exchange financial assets or financial liabilities assets and repayment of financial liabilities
with another entity under conditions that are potentially
unfavourable to the entity; or • Other information accompanying the financial statements
in the Annual Report e.g. Directors Report, MD&A etc.
(b) a contract that will or may be settled in the entity’s own
equity instruments and is: • Auditors knowledge of the plans of the Board of Directors
and other management plans.
(i) a non-derivative for which the entity is or may be
obliged to deliver a variable number of the entity’s own Whilst the parameters described in this clause appear to
equity instruments; or be inclusive, the auditors would have to go on the basis of
the data and information which is available, except for the
(ii) a derivative that will or may be settled other than financial ratios, which are now mandatory as per Schedule
by the exchange of a fixed amount of cash or another III requirements. Certain specific challenges, especially
financial asset for a fixed number of the entity’s own for non-NBFC entities and MSMEs, are highlighted
equity instruments. For this purpose, rights, options or subsequently since they may not have all the information
warrants to acquire a fixed number of the entity’s own stated above, or the same may be sketchy or incomplete.
equity instruments for a fixed amount of any currency are
equity instruments if the entity offers the rights, options b) Companies adopting Ind AS: Such companies are
or warrants pro rata to all of its existing owners of the likely to face certain specific challenges which need to
same class of its own non-derivative equity instruments. be kept in mind whilst considering the various reporting
Apart from the aforesaid, the equity conversion option requirements which are as under:
embedded in a convertible bond denominated in foreign
currency to acquire a fixed number of the entity’s own • The financial liabilities need to be considered based
equity instruments is an equity instrument if the exercise on the legal form rather than the substance of the
price is fixed in any currency. Also for these purposes the arrangements as is required in terms of Ind AS-32 and
entity’s own equity instruments do not include puttable 109. Accordingly, redeemable preference shares though
financial instruments that are classified as equity considered financial liabilities/borrowings under Ind AS

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will not be considered for reporting under this clause a capital intensive industry even a lower current ratio
since legally they are in the nature of share capital. may be acceptable due to higher level of funds blocked
Similarly, optionally or fully convertible debentures in long term capital intensive assets.
though considered compound financial instruments
or equity under Ind AS will not be considered • These ratios cannot be standardised for all the entities,
for reporting. and the same needs to be tailored to the industries. A
comparison would also be required with the peer group/
• Ind AS-107 requires disclosure of the maturity analysis of competitors. It would be a good practice for auditors to
the financial liabilities showing the contractual repayments obtain from the Management the basis of certain key
under different liquidity buckets. The auditors shall cross- ratios based on specific facts and circumstances.
check the work papers for reporting under this clause with
Ind AS disclosures. • Each entity operates under different conditions hence
ratios relevant to entities shall be considered whilst
c) Challenges for non NBFCs and Small and Medium reviewing the data.
Enterprises: Non NBFCs, may not have a formalised
Asset Liability Management (ALM) system, which is • While calculating ratios auditor should ensure that
required to be maintained in terms of the RBI guidelines proper classification is done for current and non-current
to identify liquidity and maturity mismatches. Accordingly, assets and liabilities. The same may not always be
the auditors of such entities would need to take greater in line with the definition under Schedule III or under
care to review the data and come to appropriate the Accounting Standards since certain items which
conclusions to report under this clause. It would not be may be current under these definitions may not
a bad idea to impress upon the Management of such necessarily be payable within the following year.
entities to adopt the RBI guidelines and build up an An example could be the provision made for leave
appropriate ALM framework to the extent possible and encashment which could be entirely classified as
based on cost-benefit analysis. In the case of MSMEs, current as per the definitions under Schedule III or the
whilst it may not be possible to have formalised ALM accounting standards since legally the entity does
reporting systems, the auditors would have to ensure that not have an unconditional right to defer settlement
data about the ageing of financial assets and liabilities beyond the next twelve months if all the employees
is generated based on appropriate assumptions as per decide to encash their leave though practically this
the conditions in which the entity is working. Further, in is a remote possibility. Accordingly, for analysis
terms of capabilities, MSME entities may not be equipped and reporting under this clause, only the current
enough to ensure the quality of the data and the controls portion as identified by the actuary would need to be
governing the same. A greater degree of professional considered since that is the most likely amount which
scepticism needs to be exercised in such cases, as would be settled within the next twelve months.
discussed below.
(ii) Expected date of realisation of financial assets
d) Applying significant judgements and heightened and financial liabilities: In the case of NBFCs it will be
level of professional scepticism: The auditors would easy to verify the expected date of realisation of assets
have to use professional judgement and an increased and liabilities as those entities will have Asset Liabilities
level of professional scepticism in respect of the following Management mechanism to analyse the due dates, as
matters whilst performing their audit procedures for required in terms of the RBI guidelines. However, such
reporting under this clause: a mechanism may not exist in case of other entities.
Consequently, the auditor will have to put extra effort
(i) Financial Ratios: while reviewing the expected date of realisation of
• Financial ratios may not always provide conclusive assets and repayment of liabilities in entities other than
evidence, and hence auditors will have to also consider NBFCs, especially where the contractual terms are
various other documents / information as discussed not specified. The auditors should prevail upon such
in the following bullets rather than relying only on entities to develop and strengthen their MIS and internal
the quantitative thresholds which they represent. An controls to capture the necessary data, and the same
example is that of an ideal current ratio of 1.33:1 which should be subject to proper verification in accordance
is the benchmark to reflect strong liquidity. However, for with relevant auditing standards.

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(iii) Other Information accompanying the Financial these plans and corroborate the same based on their
Statements: These documents generally comprise understanding of the entity and the business in which it
the Directors Reports and Management Discussion and operates and other publicly available information.
Analysis Report, wherever required to be prepared. As per
SA-720 – The Auditor’s Responsibility in Relation to • Auditors will also have to ensure that approved plans
Other Financial Information, the auditors are expected are in line with industries / peer group estimates.
only to review the said information included as a part of
the Annual Report accompanying the audited financial (v) Audit Documentation: While taking the above
statement for any material factual inconsistencies and judgements, auditors would have to ensure adequate
also include the same in the audit report. Further, in documentation of the audit procedures performed as
many cases there are practical challenges in getting this above to arrive at appropriate conclusion(s). In addition,
data before finalising the accounts and issuing the audit they should also obtain Management Representation
report. However the auditor should ensure that at least on specific aspects as deemed necessary. However,
draft versions of these documents are made available the Management Representation Letter shall not be a
by the Management. Finally, he should not only read substitute for audit procedures to be performed but would
the same for inconsistencies but also perform certain serve as additional evidence.
procedures as outlined below.
CONCLUSION
(iv) Review of the Board of Directors and Management The additional reporting responsibilities have placed very
Plans: specific responsibilities on the auditors to provide early
• Since the plans are forward-looking, the auditors warning signals on the financial health of an entity. As
would not be in a position to confirm the correctness is the case with most of the other clauses, where
thereof. However, while reviewing these plans, they will the auditors are expected to be playing varied and
have to look into the historical performance and review versatile roles, this clause is no exception since they
various assumptions considered for the preparation of are expected to play the role of a soothsayer!.
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BCAJ
CARO 2020 SERIES:

RESIGNATION OF STATUTORY AUDITORS AND CSR

ZUBIN BILLIMORIA
(This is the eighth and last article in the CARO 2020 series that started in June, 2021)
PART A - RESIGNATION OF STATUTORY AUDITORS
BACKGROUND appointing/re-appointing an auditor:

There have been several instances of resignations by
statutory auditors mid-way through their tenures in the • If the auditor resigns within 45 days from the end of a
recent past. Whilst that may be legally permissible, what quarter of a financial year, then the auditor shall, before
is more important is whether there is anything which is such resignation, issue the limited review/ audit report for
more than what meets the eye in the resignation that the such quarter.
incoming auditor needs to know. Also, resignation of an
auditor of a listed entity/its material subsidiary before • If the auditor resigns after 45 days from the end of a
completion of the review/audit of the financial results/ quarter of a financial year, then the auditor shall, before
statements for the year due to frivolous reasons such as such resignation, issue the limited review/ audit report for
pre-occupation may seriously hamper investor confidence such quarter as well as the next quarter.
and deny them access to reliable information for taking
timely investment decisions. • Notwithstanding the above, if the auditor has signed the
limited review/ audit report for the first three quarters
SCOPE OF REPORTING of a financial year, then the auditor shall, before such
The scope of reporting pertaining to the aforesaid clause resignation, issue the limited review/ audit report for the
is as under: last quarter of such financial year as well as the audit
report for such financial year.
Whether there has been any resignation of the
statutory auditors during the year, if so, whether the b) The auditor proposing to resign shall bring to the notice
auditor has taken into consideration the issues, of the Audit Committee the reasons for his resignation
objections or concerns raised by the outgoing auditors. including but not limited to areas where he has not been
[Clause 3(xviii)] provided the necessary information / documents and
explanations to matters raised during and in connections
PRACTICAL CONSIDERATIONS IN with the audit.
REPORTING
Before proceeding further it would be pertinent to c) The above information has to be provided to the
note certain statutory requirements and professional company in the format specified in Annexure A of the
pronouncements. Circular, as under:
Sr. No. Particulars
SEBI Circular [CIR/CFD/CMD1/114/2019 dated
18th October, 2019] 1 Name of the listed entity/ material subsidiary:
The key requirements in respect thereof are summarised 2 Details of the statutory auditor:
hereunder: a. Name:
b. Address:
c. Phone number:
a) All listed entities/material subsidiaries shall ensure d. Email:
compliance with the following conditions while

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Duty of Outgoing Auditor [Section 140(2) of

Sr. No. Particulars
Companies Act, 2013]
3 Details of association with the listed entity/ material
subsidiary:
a. Date on which the statutory auditor was appointed: The auditor who has resigned from a company shall file
b. Date on which the term of the statutory auditor was within a period of 30 days from the date of resignation
scheduled to expire: a statement in Form ADT-3 with the company and the
c. Prior to resignation, the latest audit report/limited
Registrar of Companies. In the case of a government
review report submitted by the auditor and date of its
submission. company or any other company-owned or controlled by
any of the governments, the auditor shall also file such a
4 Detailed reasons for resignation:
statement with the Comptroller and Auditor-General of
5 In case of any concerns, efforts made by the auditor prior India.
to resignation (including approaching the Audit Committee/
Board of Directors along with the date of communication
Clause 8 of Part I of First Schedule of the Chartered
made to the Audit Committee/Board of Directors)
Accountants Act, 1949
6 In case the information requested by the auditor was not
provided, then following shall be disclosed:
a. Whether the inability to obtain sufficient appropriate audit A Chartered Accountant in practice shall be deemed
evidence was due to a management-imposed limitation or to be guilty of professional misconduct, if he accepts a
circumstances beyond the control of the management. position as auditor previously held by another chartered
accountant without first communicating with him in writing;
b. Whether the lack of information would have significant
impact on the financial statements/results.
The underlying objective is that the member may have an
c. Whether the auditor has performed alternative procedures opportunity to know the reasons for the change in order
to obtain appropriate evidence for the purposes of audit/
limited review as laid down in SA 705 (Revised). to be able to safeguard his own interest, the legitimate
interest of the public and the independence of the existing
d. Whether the lack of information was prevalent in the accountant. It is not intended, in any way, to prevent or
previous reported financial statements/results. If yes, on
what basis the previous audit/limited review reports were obstruct the change. When making the enquiry from the
issued. outgoing auditor, the one proposed to be appointed or
already appointed should primarily find out whether there
7 Any other facts relevant to the resignation:
are any professional or other reasons why he should not
accept the appointment.
Declaration
I/ We hereby confirm that the information given in this The existence of a dispute as regards the fees would not
letter and its attachments is correct and complete. constitute valid professional reasons on account of which
an audit should not be accepted by the member to whom
I/ We hereby confirm that there is no other material reason it is offered. However, in the case of an undisputed
other than those provided above for my resignation/ audit fees for carrying out the statutory audit under
resignation of my firm. the Companies Act, 2013 or various other statutes
having not been paid, the incoming auditor should
Signature of the authorized signatory not accept the appointment unless such fees are paid.
Date: Implementation Guide on Resignation/ Withdrawal

Place: from an Engagement to Perform Audit of Financial
Enclosures: Statements Issued by ICAI (the “Implementation
Guide”)
d) The listed entity / material subsidiary should cooperate
in providing all the information and documents as In view of the increasing instances of withdrawal from
requested by the auditor. audit engagements mid-way through the tenure, the ICAI
has issued the above Implementation Guide that the
e) Disclosure should be made by the company as soon as outgoing and incoming auditors need to be aware. The
possible but not later than twenty four hours of the Audit Implementation Guide identifies various reasons for the
Committees’ views. resignation of auditors as under:

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• SA 210 “Agreeing to the Terms of Audit Engagements” Keeping in mind the above reporting requirements,
- If the auditor is unable to agree to a change in the terms the following are some of the practical considerations
of the audit engagement and is not permitted by the that could arise whilst reporting under this clause:
management to continue the original audit engagement,
the auditor shall withdraw from the audit engagement. a) Modified Report issued by the outgoing auditor:-
The nature and extent of the modification should be
• SA 220 “Quality Control for an Audit of Financial critically evaluated by the incoming auditor both from a
Statements” - If the engagement partner is unable qualitative and quantitative perspective. In doing so he
to resolve the threat to independence with reference may have to generally rely on oral discussions with the
to the policies and procedures that apply to the audit outgoing auditor since he may not be willing to part with
engagement, if considered appropriate, the auditor can the internal documentation and working papers, especially
withdraw from the audit engagement. if it is an unlisted / non-public interest entity to which the
SEBI circular mentioned earlier would not apply. In such
• SA 240, “The Auditor’s Responsibilities relating to circumstances he should advise the outgoing auditor
Fraud in an Audit of Financial Statements” - If, as a to communicate in writing the specific reasons for
result of a misstatement resulting from fraud or suspected withdrawal as per the Implementation Guide mentioned
fraud, the auditor encounters exceptional circumstances above to the appropriate level of management and those
that bring into question the auditor’s ability to perform charged with governance and insist on a copy thereof,
the audit, the Standard suggests the withdrawal from the especially if the minutes do not reveal much. In such
engagement as one of the options, subject to following cases, there is no rule, written or unwritten, which would
certain procedures and measures. prevent an auditor from accepting the appointment in
these circumstances once he has conducted proper due
• SA 315, “Identifying and Assessing the Risks of diligence before accepting the audit. He may also consider
Material Misstatements Through Understanding the attitude of the outgoing auditor and whether it was
the Entity and its Environment” - Concerns about proper and justified.
the competence, integrity, ethical values or diligence of
management, or about its commitment to or enforcement b) Performing appropriate due diligence before
of these, may cause the auditor to conclude that the risk of stepping into the Outgoing Auditors shoes:- It is
management misrepresentation in the financial statements imperative that the incoming auditor undertakes appropriate
is such that an audit cannot be conducted. In such a case, inquiries and performs due diligence procedures as under
the auditor may consider, where possible, withdrawing from before stepping into the shoes of the outgoing auditor who
the engagement, unless those charged with governance has withdrawn from the engagement:
put in place appropriate corrective measures.
(i) Evaluate diligently about the entity, the scope of the
• SA 580, “Written Representations”- If the auditor is mandate, the resources (time, manpower and competence)
unable to obtain sufficient appropriate audit evidence, available to execute the audit and then take a conscious
then the auditor is expected to determine the implications call to accept or not to accept the engagement.
thereof to decide whether to qualify the opinion or to
resign. (ii) Have auditors frequently resigned from the entity in
the past.
• Non-payment of auditor’s remuneration.
(iii) Evaluate the reasons for issuance of qualified,
• Issuance of a Qualified report. disclaimer opinion by the outgoing auditor.
The Implementation Guide emphasises that the (iv) Whether entity is regular in payment of statutory dues.
auditor is expected to describe the above specific
circumstances, amongst others, while giving the (v) Review the financial statements to ascertain any
reasons for resignation, instead of mentioning indication that the going concern basis may not be
ambiguous reasons such as other preoccupation or appropriate.
personal reasons or administrative reasons or health
reasons or mutual consent or unavoidable reasons. (vi) Check and understand accounting policies or

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treatment of specific transactions that cast doubt on the public domain.

integrity of the financial information.
CONCLUSION
(vii) Are there issues arising from communication with The regulators have tightened the rules for withdrawal by
the outgoing auditors, professional or otherwise, which statutory auditors from the engagement midway through
suggest that the incoming auditor should decline the their tenure to ensure that companies do not go scot-
appointment. free and brush under the carpet any irregularities and
misappropriations. The reporting responsibilities under
(viii) Check whether the entity is involved in any long this clause would ensure that there is a proper channel
drawn litigation with the regulatory authorities. of communication between the incoming and outgoing
auditors regarding any adverse matters concerning the
(ix) Consider any other information available in the entity.
PART B - CORPORATE SOCIAL RESPONSIBILITY (CSR)
BACKGROUND Additional Disclosures under amended Schedule III

The provisions dealing with CSR have been in force While reporting under this Clause, the auditor will have to
for a few years and many companies have now ingrained keep in the mind the amended Schedule III disclosures
it as part of their DNA. Earlier, the approach of the which are as under:
regulators was more in the nature of ‘comply or report ’.
However, the emphasis is now on ensuring that Where the company covered under section 135 of the
companies take their CSR obligations more seriously. companies act, the following shall be disclosed with
Earlier, there was no responsibility on auditors to regard to CSR activities in the financial statements;
comment on CSR compliance separately, and only the
Board of Directors were required to report on the same. 1 amount required to be spent by the company during the year,
However, reporting under CARO 2020 would ensure
greater accountability on companies who were not taking 2 amount of expenditure incurred,
CSR seriously. 3 shortfall at the end of the year,
4 total of previous years shortfall,
SCOPE OF REPORTING
The scope of reporting pertaining to the aforesaid clause 5 reason for shortfall,
is as under: 6 nature of CSR activities,
7 details of related party transactions, e.g., contribution to a
a) Whether, in respect of other than ongoing projects, trust controlled by the company in relation to CSR expenditure
the company has transferred unspent amount to a Fund as per relevant Accounting Standard/ Indian Accounting
specified in Schedule VII to the Companies Act within a Standard,
period of six months of the expiry of the financial year 8 where a provision is made with respect to a liability incurred
in compliance with second proviso to sub-section (5) of by entering into a contractual obligation, the movements in the
section 135 of the said Act. [Clause 3(xx)(a)] provision during the year should be shown separately.
b) Whether any amount remaining unspent under
sub-section (5) of section 135 of the Companies Whilst reporting, the auditor should make a cross
Act, pursuant to any ongoing project, has been reference to the above disclosures made in the financial
transferred to special account in compliance with the statements to ensure that there are no inconsistencies.
provision of sub-section (6) of section 135 of the said
Act. [Clause 3(xx)(b)] Other Relevant Statutory Provisions
PRACTICAL CONSIDERATIONS AND Section 135(5) and (6) of the Companies Act, 2013
CHALLENGES IN REPORTING
Before proceeding further it would be pertinent to note Section 135(5):
certain statutory requirements: The Board of Directors of every eligible company shall

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ensure that the Company spends in every financial year,

Sub Broad Area Projects or Programmes related to
at least 2% of the average net profits of the company Clause Activities in the following areas
during the 3 immediately preceding financial years, in
i)@ (continued) • Disaster relief in the form of medical
pursuance of the CSR policy. The net profit shall be as aid, supply of clean drinking water and
computed in terms of section 198. food supply*
• Trauma care around highways in case
The expression “three immediately preceding financial of accidents*
• Supplementing of Government
years” in sub-section (5) shall be read as number of years Schemes like mid-day meal by
completed by a newly incorporated company. corporates through additional nutrition*
• Enabling access to or improving
delivery of public health systems (also
“Unspent amount” as referred to in sub-section covered under Clause iv below)*
(5) unless relates to an “ongoing project” shall be • Social Business Projects involving
transferred to a fund specified in Schedule VII within giving medical and legal aid to road
accident victims* (also under Clause ii
6 months of the end of the financial year. below)
Section 135(6): ii)@ Education and • Promotion of education including

vocational special education and employment
Any amount remaining unspent under sub-section (5), skills enhancing vocational skills amongst:
pursuant to any ongoing project, fulfilling such conditions (i) children,
as may be prescribed, undertaken by a company in (ii) women,
(iii) elderly, and
pursuance of its Corporate Social Responsibility Policy, (iv) differently abled.
shall be transferred by the company within a period • Road safety awareness programmes
of thirty days from the end of the financial year to including drivers training, training
a special account to be opened by the company in to enforcement personnel, traffic
safety*
that behalf for that financial year in any scheduled bank • Awareness of the above aspects
to be called the Unspent Corporate Social through print, audio and visual media*
Responsibility Account, and such amount shall be spent • Setting up of Research Training and
Innovation Centres for the benefit of
by the company in pursuance of its obligation towards the predominantly the rural community
Corporate Social Responsibility Policy within a period of covering the following aspects:
three financial years from the date of such transfer, (i) Capacity building for farmers
covering best sustainable farm
failing which, the company shall transfer the same to management practices*
a Fund specified in Schedule VII, within a period of (ii) Training agricultural labour on skill
thirty days from the date of completion of the third development*
financial year. • Providing Consumer Protection
Services covering the following
aspects:
Permissible CSR Activities [Schedule VII read with (i) Providing effective consumer
the Rules]: grievance redressal mechanism*
(ii) Protecting consumer’s health and
safety, sustainable consumption,
Schedule VII prescribes the following broad heads of consumer service, support and
activities on which the prescribed classes of Companies complaint resolution*
(iii) Consumer rights to be mandated*
need to spend to fulfil their CSR obligations: (iv) All other consumer protection
programmes and activities*
• Donations to IIMs for conservation of
Sub Broad Area Projects or Programmes related to
buildings and renovation of classrooms
Clause Activities in the following areas
(also covered under clause v below)*
i)@ Hunger, • Eradicating extreme hunger, poverty • Donations to Non Academic
Healthcare, and malnutrition Technopark not located within an
Sanitation etc. • Promoting health care including academic institution but supported
preventive health care and sanitation by the Department of Science and
• Contribution to the Swatch Bharat Technology*
Kosh. • Research and case studies in
• Provision for aids and appliances to the areas specified in Schedule VII
differently abled persons * (normally under the respective areas
and, if not, under this clause)*

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Sub Broad Area Projects or Programmes related to Sub Broad Area Projects or Programmes related to
Clause Activities in the following areas Clause Activities in the following areas
iii) Gender • Promoting gender equality, viii) (continued) (ii) Scheduled Tribes
equality • Empowering women, (iii) other backward classes and
and • Setting up of hostels, old age homes (iv) women
empowerment and hostels for women and orphans,
of day care centres and such other ix) Technology Contributions or funds provided to
disadvantaged facilities for senior citizens, and Incubators technology incubators located within
sections • Measures for reducing inequalities academic institutions approved by the
faced by socially and economically Central Government.
backward groups.
x) Rural Any project meant for development of
• Slum Rehabilitation Projects and
Development rural India will be covered*
EWS Housing*
Projects
iv) Environmental • Maintaining ecological balance,
xi) Slum Any project for development of slums
and ecological • Protection of flora and fauna,
Development would be covered
sustainability • Maintaining quality of air and water
Projects
and • Contribution to the Clean Ganga
conservation Fund xii) COVID -19 Funds may be spent for COVID-19
of • Setting up of Research Training and Related Areas purposes under the following activities/
natural Innovation Centres for the benefit of Funds:
resources predominantly the rural community
covering the following aspects: • Eradicating hunger, poverty and
(i) Doing own research on the field malnutrition $
for individual crops to find out the • Disaster Management, including
most cost optimal and agri-ecological relief, rehabilitation and
sustainable farm practices with a reconstruction activities $
focus on water management*. • Contribution to PM Cares Fund $
(ii) To do Product Life Cycle Analysis • Contribution to State Disaster
from the solid conservation point of Management Authority $
view* • Ex-gratia payment to temporary/
• Renewable energy projects* casual/daily wage workers for the
purpose of fighting COVID-19 $
v) Heritage, Art • Protection of natural heritage, • Spending for setting up makeshift
and • Protection of art and culture, hospitals and temporary COVID
Culture • Restoration and maintenance of care facilities will be eligible under
related buildings and sites of historical items (i) and (xii) of Schedule VII. #
importance and works of art, • Companies engaged in R & D
• Setting up public libraries, activities for new vaccines, drugs
• Promotion and development of and medical devices in the normal
traditional arts and handicrafts course of business may undertake
similar new activities for COVID-19
vi) Armed Forces Measures for the benefit of: related matters for FYs 2020-21,
(i) armed forces, 2021-22 and 2022-23 subject to
(ii) veterans, and the following conditions:
(iii) war widows. a) Such activities are carried out
in collaboration with institutes or
vii) Sports • Training to promote: organisations mentioned in item
(i) rural sports, ix of Schedule VII
(ii) nationally recognised sports, b) Details thereof are disclosed
(iii) paralympic sports, and in the Annual Report on CSR
(iv) Olympic sports Activities
• Any training provided outside India [Inserted in the CSR
to sports personnel representing Amendment Rules vide
any State or Union Territory at notification dated
National or International level. 24th August, 2020]
viii) Political • Contributions to Prime Ministers
Contributions National Relief fund or *As per the MCA Circular dated 18th June, 2014
• Contributions to other funds set up by
providing clarifications on various aspects related to CSR
the Central
Government for socio economic activities.
development and relief and for the
welfare of: @ The above referred circular provides that the items
(i) Scheduled Castes,
included under sub clauses (i) and (ii) above, should

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be interpreted liberally so as to capture their essence. can be set off against the spending requirements in the
The above circular has also clarified on certain related immediately succeeding three financial years subject to
aspects as under: the following conditions:
• One off events like marathons, awards, charitable a) The excess amount available for set-off shall not
concerts, sponsorship programmes etc. would not include any surplus arising out of the CSR activities.
qualify as CSR expenditure.
• Only activities undertaken in project / programme b) The Board of Directors shall pass a resolution
mode are permissible. specifically permitting the same.
• Expenses incurred in pursuance of legal obligations
under Land, Labour or other laws would not quality as The aforesaid carry forward shall not be allowed for
CSR expenditure. excess amounts spent during any financial year ended
before 22nd January, 2021.
$ As per MCA Circular dated 23rd March, 2020.
# As per MCA Circular dated 22nd April, 2021. Creation and Acquisition of Capital Assets:
As per the amended Rules, any CSR amounts may be
Monitoring Unspent Funds: utilised by a Company towards creation or acquisition of
The provisions dealing with tracking and treatment of capital assets, only if the assets are held by any of the
unspent funds, excess amounts spent and capital assets following:
created or acquired as per the recent amendments which
are crucial to reporting under this clause are tabulated a) A company registered under Section 8 of the Act, or
and summarised hereunder: a Registered Public Trust or Society having charitable
objects and a CSR Registration Number; or
Unspent CSR b) Beneficiaries of the said CSR project in the form of

Liability
Self-Help Groups or Collective Entities; or
c) A public authority.
Ongoing project
(having timelines of
exceeding three years Non Ongoing Project In case of any such assets existing prior to the
excluding year of
commencement) amendment i.e. 22nd January, 2021, the same shall be
transferred within 180 days from the commencement
date.
Failure to spend will
Deposit amount in
result in transfer to Transfer to a fund
Special Bank Account
a Fund specified in specified in Keeping in mind the above reporting as well as
within 30 days from
schedule VII (see Note schedule VII
the end of the FY for
spending within 3 FYs
below) within 30 days (See note below) requirements, the following are some of the practical
from end of the 3rd FY
challenges that could arise in reporting under these
clauses:
Note:
a) Reporting Issues and Challenges in the Initial
The Funds specified under Schedule VII are as under: Period of Applicability:- The amendments are
• PM National Relief Fund prospective from 22nd January, 2021. Accordingly only
• Swach Bharat Kosh the unspent amount for F.Y. 2020-21 in respect of other
• Clean Ganga Fund than ongoing projects needs to be transferred to the fund
• PM CARES Fund specified in Schedule VII within six months from the end
• State Disaster Management Authority of the financial year. This is the case even if the Company
• Skill Development Fund has unspent amounts in earlier years. However, if the
Company has made provisions for unspent amounts
Excess Amounts Spent: of the earlier years, which remains outstanding as on
As per the amended Rules, notified on 22nd January, 31st March, 2021 the same should be transferred to the
2021, any excess amount beyond the prescribed limit separate bank account or Schedule VII fund as the case

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may be within the prescribed periods as indicated earlier. multiple projects, both ongoing and others, a robust
The auditors should ensure that appropriate factual internal control mechanism would have to be implemented
disclosures are made where deemed necessary. Further, to monitor project-wise utilisation to ensure that unspent
there could be several other practical issues which could amounts are transferred on a timely basis and their
be encountered in the first year of reporting, few of which subsequent utilisation in case of ongoing projects, which
are discussed hereunder together with their possible needs to be verified by the auditors to enable them to
resolution by the auditors, coupled with appropriate report compliance under Clause 3(xx)(b). Whilst there
reporting of all relevant facts as deemed necessary based is no requirement to maintain separate special bank
on their best judgement: accounts for each project it is desirable to ensure proper
monitoring and greater transparency. The Board may
Issues Possible Resolution consider laying an appropriate policy in this regard.
A Company has a Subject to the definition of ongoing c) Funds Utilised towards acquisition of Capital
running project that was project in terms of the timeline, the
commenced few years Board of Directors can henceforth Assets in earlier periods:- For companies that have
back and is expected to consider and approve this current utilised funds in earlier periods and shown them as capital
continue for next 2 years. running project as an Ongoing Project assets, it is mandatory to transfer the same within 180
Can this be considered with reasonable justification.
as an Ongoing project? days from 22nd January, 2021 to the prescribed authorities
/entities as indicated earlier. Though no specific reporting
A CSR project was Subject to the definition of ongoing
is required under these clauses, it would be incumbent on
undertaken and project in terms of the time line, the
subsequently abandoned Board of Directors can henceforth the auditors to verify the same as part of their audit and in
by Implementing Agency consider and approve the aforesaid case the report is dated after the expiry of the said period,
due to lack of additional project as an Ongoing Project with he may consider drawing attention to the same since it is
funds. Can this be reasonable justification.
considered as an a statutory requirement. Similar factual disclosure could
Ongoing project? be considered in the case where the period of 180 days
has not elapsed on the date of signing, and the same are
A Company contributed If the Company has already paid the
a certain amount to the whole amount of its CSR obligations not transferred.
Implementing Agency during F.Y. 2020-21, then it is not
for the construction of a required to consider it as Ongoing d) Transactions with Related Parties:- In many
hospital. It paid the full Project. However, it is the duty of the
amount in F.Y. 2020-21, Board as per Rule 4 (5) to satisfy itself companies, CSR obligations are fulfilled by transferring
whereas the hospital is that the funds so disbursed have been the funds to group entities registered as NPOs under
expected to be completed utilized for the purpose and in the Section 8/25 of the Companies Act, 2013 / 1956. In such
in F.Y. 2022-23. Can this manner as approved by it and the CFO
be considered as an or the person responsible for financial cases, care should be taken to ensure that the same are
Ongoing project? management need to certify to that towards approved projects. The monitoring of the same
effect. Hence the Company needs to is done in accordance with the revised guidelines on
have a report from the Implementation
monitoring and impact assessment, including the need
Agency for the spends and utilization
of funds and report it in the Board for involving an external agency, if required, as discussed
Report for F.Y. 2020-21 with facts and earlier. In case of any lapses or deficiencies noticed the
details. Further, a mandatory impact same should be factually reported under Clause 3(xx)(b)
assessment needs to be done by
a Monitoring Agency in case of based on materiality and use of judgement.
companies with mandatory spending
of Rs. 10 crores or more in the three CONCLUSION
immediately preceding financial
years and for individual project The additional reporting requirements have placed very
outlays in excess of Rs.1 crores as specific responsibilities on the auditors to supplement the
per the amended Rules. revised regulatory landscape of CSR of “comply or pay
up”, which views CSR spending more as a tax then a
b) Monitoring in case of Multiple Projects:- In case social obligation. As is always the case, it is the auditors
of companies having huge CSR budgets and financing who have to bell the cat!
Use money to gain control over your time.

— The Psychology of Money

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A BCAJ ‘CARO 2020’ Compilation

BCAJ VOL. 53 ISSUE 10 | JANUARY 2022

SEBI TIGHTENS REGULATIONS FOR

October, 2021 January, 2022

CARO 2020 SERIES: ANTI-TAX AVOIDANCE

UNFAIRNESS AND THE AUDIT: BUILDING

5 CARO 2020 Series: Frauds and Unrecorded Transactions |

6 CARO 2020 Series: Non-Banking Finance Companies (NBFCs) [Including Core

7 CARO 2020 Series: Reporting on Financial Position |

8 CARO 2020 Series: Resignation of Statutory Auditors and CSR |

READERS, AUTHORS AND CONTRIBUTORS

ROLLING OUT CARO 2020 SERIES: ANTI-TAX AVOIDANCE

AUGUST 2021 SEPTEMBER 2021

THE BOMBAY CHARTERED ACCOUNTANT JOURNAL T H E B O M B AY C H A R T E R E D A C C O U N TA N T J O U R N A L

DIGITAL WORKPLACE – MLI SERIES: ANALYSIS OF

BCAJ VOL. 53-A PART 6 | SEPTEMBER 2021

CARO 2020 SERIES: INVENTORIES

SHOULD CHARITY SUFFER THE

You are the

VO L. 53 I S S U E 7 | O CTO B E R 2021 | PAG E S 13 6 | P R I C E : R 100

LAWS AND BUSINESS:

CARO 2020 SERIES:

CARO 2020 SERIES:

AUDIT QUALITY MATURITY MODEL

WE THANK ALL OF YOU FOR THE SUCCESS OF VOLUME 53

CARO 2020 SERIES : NEW CLAUSES AND MODIFICATIONS

PROPERTY, PLANT AND

MODIFICATIONS / ADDITIONAL Additional reporting

BOMBAY CHARTERED ACCOUNTANT JOURNAL 5

6 BOMBAY CHARTERED ACCOUNTANT JOURNAL

ii. Identifying the list of promoters of the company and

iii. Ascertaining whether the requirements under the Trade

BOMBAY CHARTERED ACCOUNTANT JOURNAL 7

FROM UNPUBLISHED ACCOUNTS

8 BOMBAY CHARTERED ACCOUNTANT JOURNAL

CARO 2020 SERIES: NEW CLAUSES

INVENTORIES AND OTHER CURRENT ASSETS

PRACTICAL CHALLENGES IN REPORTING • Management does not conduct an inventory count

BOMBAY CHARTERED ACCOUNTANT JOURNAL 9

10 BOMBAY CHARTERED ACCOUNTANT JOURNAL

BOMBAY CHARTERED ACCOUNTANT JOURNAL 11

c. This clause is not applicable to unsecured sanctions or

d. Considering the discussion in paragraphs (b) and

The auditor will have to consider materiality of

e. Each bank and financial institution may have its

12 BOMBAY CHARTERED ACCOUNTANT JOURNAL

We become what we think about.

Life is 10% what happens to me and 90% of how I react to it.

The mind is everything. What you think you become.

BOMBAY CHARTERED ACCOUNTANT JOURNAL 13

CARO 2020 SERIES:

LOANS & ADVANCES, GUARANTEES & INVESTMENTS

BACKGROUND Clause Particulars Nature of

14 BOMBAY CHARTERED ACCOUNTANT JOURNAL

practical challenges, which are discussed below, in

BOMBAY CHARTERED ACCOUNTANT JOURNAL 15

b. Tracking of transactions entered into and settled (c) discussed later.

16 BOMBAY CHARTERED ACCOUNTANT JOURNAL