COMPANY (AUDITOR'S REPORT) ORDER, (CARO 2020)

The format of auditor's report is governed by Company (Auditor's Report) Order. The
Company (Auditor's Report) Order, 2016 (CARO 2016) was notified on 29 March 2016.

The past few years have witnessed significant negative impact on the financial services
sector e.g. bank frauds, the collapse of IL&FS, the extreme stress suffered by housing
finance and non-banking financial services sector.

At the same time, the trust of the investors, regulators and auditors in India Inc has also eroded.
The investigations in these matters and analysis by the Central Vigilance Commission of Top
100 Bank Frauds led to the identification of many disturbing patterns such as siphoning off,
large scale diversion of funds, lack of diligence in lending transactions, round-tripping, ever-
greening of loans and non-compliance of prudential accounting and provisioning norms, lack
of scrutiny of whistle-blower complaints and poor quality of auditing in some cases, etc. Most
of these lapses have necessitated systemic improvements.

The notification of Companies (Auditor Report) Order, 2020 (CARO 2020) is a major
initiative taken by the Ministry of Corporate Affairs, Government of India in
consultation with National Financial Regulatory Authority (NFRA), the ultimate watchdog
for audit compliances with the objective of restoring the trust of the various stakeholders in the
financial statements of India Inc. Its scope of applicability remains the same as CARO 2016. It
shall be applicable for auditor's reports issued in the financial year 2019-20 onwards.

Major Inclusions:

a. Unrecorded income:

 Disclosure has to be made with respect to transactions not recorded in the books of
accounts, but otherwise surrendered or disclosed as income in income tax proceedings.

 This seems to be an attempt to streamline the ascertainment of total income of the

company. It may be an addition to the tax amnesty Vivaad se Vishwas in the hope of
reconciling income statements.
b. Internal audit

 Opinion of auditor whether the internal audit in place is commensurate with the size
and nature of the business of the company and whether the internal audit reports were
considered while preparing the financial statements.

 This adds a layer to the existing responsibility of the statutory auditor, whose
prerogative is auditing of financial statements. Additionally, to be able to reflect on the
reports of the internal auditors may require the auditors to employ technical and
specialised skills.

c. Cash losses:

 Cash losses, if any, incurred during the financial year and one immediately preceding
it, with specific amount, need explicit reporting.

 Cash loss is indicative of negative cash flow (i.e. when cash outflow exceeds cash
inflow) in contradistinction to revenue loss. It is almost an indicator for detecting cash
waste, fraud, embezzlement and other issues which may be affecting the financials of
the company.

 Its addition in the formal audit report is likely to nudge the company to align its budget
and put in place a budget control mechanism.

d. Resignation of statutory auditor:

 The Auditor's Report should disclose details on resignation of statutory auditors during
the financial year, and whether the auditor signing the Report has considered the issues,
objections or concerns raised by the outgoing auditors.

 The scope of confirmation and disclosure with respect to outgoing auditors is limited
to instances of resignation of auditor and not termination or the auditor expressing
unwillingness to be reappointed.
 e. Opinion on credit worthiness to satisfy short term liability:

 The Auditor's Report should contain the auditor's opinion on material uncertainty as
regards the capability of the company to meet its liabilities existing as at the date of the
balance sheet, being due within a year therefrom, basis financial ratios, ageing and
expected dates of realisation of financial assets and payment of financial liabilities due
within a year, other information accompanying the financial statement, auditor's
knowledge of board and management plans.

 This is an interesting addition, since it requires the auditor's statement on the financial
capacity of the company for short term liabilities. Such auditor's statements are likely
to draw caution to issues like going concern, bankruptcy, insolvency and classification
as NPAs. This could assist in providing early warning for the banking distress.
However, such opinions will largely depend on the amount of disclosure the
auditor receives from the management.

f. Unspent CSR fund:

 Disclosure has to be made on the unspent CSR fund associated with an identified
ongoing project and its transfer to special account under Section 135(6). While CARO
2020 is already notified, the amendments brought about by the Companies
(Amendment) Act, 2019 are yet to be notified. This is a clear attempt to the strengthen
the compliance regime for CSR.

g. Qualification / adverse remark in CFS:

The CARO 2020 Report now requires all qualifications or adverse remarks with respect to
companies included in the consolidated financial statement of the company. This would
eliminate subjectivity in CFS reporting and bring much needed uniformity in reporting.
Advantages

1. CARO 2020 will usher in a new standard of transparency in reporting the health
of the company. Some of the new items included in the Auditor's Report will also
facilitate identification of early warning signals and early reporting of frauds to
the Reserve Bank of India.
2. The new CARO will also require better implementation of the whistle-blower
policy in letter and spirit by auditee companies. Auditors are now mandated to
review the records of the whistle-blower complaints and the extent of fact finding
conducted by the Audit Committees. Companies will have to gear up to improve
their procedures even to deal with anonymous complaints which in many cases
were ignored by companies.
3. The new CARO Report will also be a single integrated document for all
stakeholders and in particular, regulators for timely identification of
misadventures, defaults and deficiencies in compliance expectations.
4. From a global perspective, the changes, as a whole, can also be viewed as a nudge
to streamline presentation of the financial affairs in a company to regain the
confidence and trust of the investors and regulators. CARO 2020 significantly
increases the responsibilities and onus of the auditor and the auditee companies.