CARO 2020: New Audit Disclosures Aim To Prevent IL&FS-Like Situation

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

To curb corporate scams, the Ministry of Corporate Affairs has specified 21 items that an auditor must include in its report, as per the government’s recent notification on Companies Auditors Report Order 2020 or CARO. It applies to all companies in India, except banks and insurers or firms below a specified threshold.

Here are the key disclosures that auditors would have to make in their report:

Ownership Of Company’s Assets And Property

Recent investigations by regulators unearthed instances where promoters of a listed entity misused immovable property by offering it as collateral or transferring it to a related entity without the approval of the company. That led to deterioration of investor confidence in the company’s financials.

For instance, in case of CG Power and Industrial Solutions Ltd., the Securities and Exchange Board of India passed strictures against its erstwhile promoters and directors. Former officials indulged in misrepresentation of company’s funds and were involved in structuring of transactions relating to the transfer of company’s properties, the market regulator said in its interim order.

To ensure accuracy in representation of assets and immovable property, CARO 2020 widened the scope of statements in an auditor’s report about property, plants and equipment. Accordingly, an audit report must also state:

• Whether all immovable properties are held in the company’s name and proper records of its intangible assets are maintained.
• Details of those properties which are disclosed in financial statements but not held in company’s name and the reason for doing so.
• Additional details like value of the property and whether the beneficiary is a promoter, director or relative of the company will need disclosures as well.

A clearer picture on title deeds and ownership of assets would prevent mismanagement in companies having significant promoter control, experts said.

Authorities can also rely on such disclosures and recover stamp duty when a change in title appears between two balance sheets, Chopra added.

Company’s Ability To Discharge Liabilities

The auditors’ report of IL& FS Financial Services Ltd. for 2017-18 indicated that the non-bank lender was a going concern. Yet, within a span of few months, the infrastructure conglomerate collapsed and defaulted on its debt obligations.

In its audit quality review of IFIN, the National Financial Regulatory Authority noted that the auditor— Deloitte Haskins and Sells—did not make relevant inquiries and instead relied on past trends of the company to certify its going concern status.

CARO 2020 aims to address this by introducing a slew of disclosures to certify a company’s ability to discharge liabilities reflected in the balance sheet if they fall due within a span of 12 months. While doing so, an auditor must consider factors like expected ageing of assets, plans of the board of directors and information in the financial statements.

Chopra explained that an auditor’s comment on the going concern status would indicate the ability of a company to sustain its business and remain stable in the immediate next year. He pointed out that the scope of going concern under CARO is wider than that under auditing standards, as it requires an auditor to make an opinion rather than merely relying on the management’s representation.

CARO 2016 was silent about specific comment by an auditor relating to discharging of current liabilities. And Auditing Standards only partially deal with such disclosures. Now, a specific comment is mandatory for all companies, which will benefit investors, Milan Mody, partner at NA Shah Associates, told BloombergQuint.

This will enrich the qualitative nature of an auditors report, Chopra said.

Financial ratios can help any well-informed investor to make a better assessment of a company, Chopra added.

Disclosures On Loans And Guarantees

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

For insolvent Videocon Industries Ltd., Reliance Communications Ltd. and Aircel Ltd., financial and performance guarantees among group companies has been a point of contention for financial lenders. Reliance Infratel Ltd. overseas lenders too had raised questions about inter-corporate guarantees.

To address this, the ministry has now revamped disclosures relating to loans, guarantees, investments and securities in the auditor’s report. Now, an audit report must comment on:

• Nature and quantum of loans, investments, securities or guarantees given by a company to a third parties, including a statement to indicate whether such transactions are in the company’s interest.
• Instances of evergreening of loans and company’s compliance with end-use obligations
• Balance outstanding at the end of a financial year under any loan, advance or guarantees extended towards a subsidiary company or joint venture.
• Default in repayment of loans or borrowings by the company.

According to Chopra, liquidity crises in companies is mainly attributable to violation of the end-use terms under which banks grant loans. In many instances, companies have diverted working capital loans for other purposes, strangulating liquidity and causing solvency concerns, he said, adding that disclosures in CARO on end-use of loans would address such issues.

The disclosures also aim to minimise financial wheeling and dealing prevalent in group company structures, as auditors would be required to comment on the fairness of all the loans granted, Mody pointed out.

Proper reporting would also prevent misutilisation of group company structure for unscrupulous activities, he added.

Auditors will have to start making these disclosures in the audit statements for the year ending March 2020.