Companies (Auditor's Report) Order, 2016: Applicability of The Order Companies Covered by The Order

Chapter 10
Audit Reports & CARO
5. Companies (Auditor’s Report) Order, 2016

Applicability of the Order
The Order shall NOT apply to the auditor’s report on Consolidated FS.

Companies covered by the Order

Foreign Company It shall apply to every company including a foreign company as defined in Section
2(42) of the Companies Act, 2O13.

Branch Audit (ICAI The Order is also applicable to the audits of branches of a company since a branch
Guidance Note) auditor has the same duties in respect of audit as the company’s auditor. It is,
therefore, necessary that the report submitted by the branch auditor contains a
statement on all the matters specified in the Order to enable the company’s auditor
to consider the same while complying with the provisions of the Order.

Companies not covered by the Order
The Order provides that it shall not apply to:
(a) Banking company as defined in Section 5(c) of the Banking Regulation Act, 1949.
(b) Insurance company as defined under the Insurance Act,1938.
(c) Not for Profit Company licensed to operate under section 8 of the Companies Act 2013.
(d) One Person Company as defined in Section 2(62) of the Companies Act 2013 and Small company as
defined in Section 2(85) of the Companies Act 2013.
(e) Private limited company (not being a subsidiary or holding company of a public company) with a paid up
capital and reserves and surplus not more than ` 1 crore as on the balance sheet date and which does not
have total borrowings exceeding ` 1 crore from any bank or financial institution at any point of time during
the financial year and which does not have a total revenue as disclosed in Scheduled III to the Companies
Act, 2013 (including revenue from discontinuing operations) exceeding ` 10 crores during the financial
year as per the FS.

The Order exempts from its application a private limited company which fulfils ALL the following conditions:
(Cumulative Conditions)
It is not a subsidiary or holding company of a PUBLIC company.
Its paid‐up capital and reserves and surplus ≤ ` 1 crore as on the balance sheet date.
Its Total borrowings from any bank or financial ≤ ` 1 crore at any point of time during the financial
institution year.
Its Total revenue as disclosed in Scheduled III to the ≤ ` 10 crores during the financial year as per the FS.
Companies Act, 2013 (including revenue from
discontinuing operations)
(1) Paid‐Up Share Capital = Equity Share Capital + Preference Share Capital.
(2) Reserves = All Capital Reserves + All Revenue Reserves + Revaluation Reserve – P & L (Dr) Balance

© Siddharth Agarwal. All Rights Reserved.
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Siddharth Agarwal Classes

Definition of Small Company under the Companies Act, 2013

Sec 2(85) of the Companies Act, 2013 defines a small company. As present, it is a private company which
satisfies bot the following thresholds:
1. Paid Up Share Capital ≤ ` 50 lacs AND
2. Turnover ≤ ` 2 crores.

The following 3 categories of Companies shall NOT be regarded as SMALL Companies:
1. A HOLDING company or a SUBSIDIARY company. (Here the word PUBLIC is not mentioned)
2. A company registered under SECTION 8. or
3. A company or body corporate governed by any SPECIAL ACT.

Master Illustration on Combined Application of “Small
Company Exemption” and QUADRO
Threshold Items Case 1 Case 2 Case 3 Case 4 Case 5

1. PUSC (S) 40 Lacs 40 Lacs 40 Lacs 40 Lacs 40 Lacs
2. Reserves 30 Lacs 30 Lacs 30 Lacs 30 Lacs 30 Lacs
3. P & L A/c 10 Lacs 10 Lacs 40 Lacs 40 Lacs 10 Lacs
80 lacs 80 lacs 110 lacs 110 lacs 80 lacs
4. Borrowings from Banks/FI 70 Lacs 2 Crores 70 Lacs 80 Lacs 90 Lacs
70 Lacs 2 Crores 70 Lacs 80 Lacs 90 Lacs
5. Turnover (S) 1.8 Crore 1.8 Crore 3.8 Crore 1.75 Crore 2.5 Crore
6. Other Income 30 Lacs 30 Lacs 10 Lacs 25 Lacs 50 Lacs
2.1 Crore 2.1 Crore 3.9 Crore 2 Crore 3 Crore

A. Whether it is a Small Company?     

B. Whether it satisfies QUADRO?     

Whether CARO is Exempted Exempted Applicable Exempted Exempted

Applicable/Exempted?

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Matters to be included in the Auditor’s Report (Contained in

Para 3)

Memory Aid:
1. Filled CS (FILLD CS – First 7 clauses)
2. Deafman (DEFMN – Next 5 clauses)
3. Republican (RPBN – Next 4 clauses)

Clause No. Details of the clause
3 (i) (a) Whether the company is maintaining proper records showing full particulars,
Fixed Assets including quantitative details and situation of fixed assets.
(b) Whether these fixed assets have been physically verified by the management at
reasonable intervals; whether any material discrepancies were noticed on such
verification and if so, whether the same have been properly dealt with in the books
of accounts.
(c) Whether the title deeds of immovable properties are held in the name of the
company. If not, provide the details thereof.

3 (ii) Whether physical verification of inventory has been conducted at reasonable intervals
Inventory by the management and whether any material discrepancies were noticed and if so,
whether they have been properly dealt with in the books of accounts.

3 (iii) (a) Whether the company has granted any loans, secured or unsecured to companies,

Loan to Parties firms, Limited Liability Partnerships or other parties covered in the register
covered u/s 189. maintained under section 189 of the Companies Act, 2013. If so,
(b) Whether the terms and conditions of the grant of such loans are not prejudicial to
the company’s interest.
(c) Whether the schedule of repayment of principal and payment of interest has been
stipulated and whether the repayments or receipts are regular.
(d) If the amount is overdue, state the total amount overdue for > 90 days, and
whether reasonable steps have been taken by the company for recovery of the
principal and interest.

3 (iv) In respect of loans, investments, guarantees, and security whether provisions of
Loans & Section 185 and 186 of the Companies Act, 2013 have been complied with. If not,
Investments. provide the details thereof.

3 (v) In case, the company has accepted deposits, whether the directives issued by the
Deposits Reserve Bank of India and the provisions of Sections 73 to 76 or any other relevant
provisions of the Companies Act, 2013 and the Rules framed thereunder, where
applicable, have been complied with? If not, the nature of such contraventions be
stated.
If an order has been passed by Company Law Board or National Company Law Tribunal
or Reserve Bank of India or any court or any other tribunal, whether the order has been
complied with or not.

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3 (vi) Whether maintenance of cost records has been specified by the Central Government
Cost Accounting under section 148 (1) of the Companies Act, 2013 and whether such accounts and
Records records have been so made and maintained.

3 (vii) (a) Whether the company is regular in depositing undisputed statutory dues including

Statutory Dues provident fund, employees' state insurance, income‐tax, sales‐tax, service tax, duty
of customs, duty of excise, value added tax, cess and any other statutory dues to
the appropriate authorities and if not, the extent of the arrears of outstanding
statutory dues as on the last day of the financial year concerned for a period of > 6
months from the date they became payable, shall be indicated.

(b) Where dues of income tax or sales tax or service tax or duty of customs or duty of
excise or value added tax have not been deposited on account of any dispute, then
the amounts involved and the forum where dispute is pending shall be mentioned.
(a mere representation to the concerned department shall not be treated as a
dispute).

3 (viii) Whether the company has defaulted in repayment of loans or borrowing to a financial
Defaulter institution, bank, government or dues to debenture holders? If yes, the PERIOD and
Company the AMOUNT of default to be reported (in case of defaults to banks, financial
institutions, and government, lender wise details to be provided).

3 (ix) Whether moneys raised by way of Initial Public Offer or Further Public Offer (including
End use of debt instruments) and Term Loans were applied for the purposes for which those are
Money raised raised. If not, the details together with DELAYS or DEFAULT and subsequent
RECTIFICATION, if any, as may be applicable, be reported.

3 (x) Whether any fraud by the company or any fraud on the Company by its officers or
Fraud employees has been noticed or reported during the year; If yes, the NATURE and the
AMOUNT involved is to be indicated.

3 (xi) Whether managerial remuneration has been paid or provided in accordance with the
Managerial requisite approvals mandated by the provisions of Section 197 read with Schedule V
Remuneration to the Companies Act? If not, state the AMOUNT involved and STEPS taken by the
company for securing refund of the same.

3 (xii) Whether the Nidhi Company has complied with the Net Owned Funds to Deposits in
Nidhi Company the ratio of 1: 20 to meet out the liability and whether the Nidhi Company is
maintaining 10% unencumbered term deposits as specified in the Nidhi Rules, 2014 to
meet out the liability.

3 (xiii) Whether all transactions with the related parties are in compliance with section 177
RPT disclosure and 188 of Companies Act, 2013 where applicable and the details have been disclosed
in the FS etc., as required by the applicable accounting standards.

3 (xiv) Whether the company has made any preferential allotment or private placement of
Preferential shares or fully or partly convertible debentures during the year under review and if so,
Allotment as to whether the requirement of section 42 of the Companies Act, 2013 have been
complied with and the amount raised have been used for the purposes for which the
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funds were raised. If not, provide the details in respect of the AMOUNT involved and
NATURE of non‐compliance.

3 (xv) Whether the company has entered into any non‐cash transactions with directors or
Barter persons connected with him and if so, whether the provisions of section 192 of
Transactions with Companies Act, 2013 have been complied with.

Directors

3 (xvi) Whether the company is required to be registered under Section 45‐IA of the Reserve
NBFC Bank of India Act, 1934 and if so, whether the registration has been obtained.

Reasons to be stated for Unfavourable or Qualified Answers
(Contained in Para 4)

(1) Qualified/Adverse Remark ‐ Where, in the auditor's report, the answer to any of the questions referred
to in paragraph 3 is unfavourable or qualified, the auditor's report shall also state the reasons for such
unfavourable or qualified answer, as the case may be.

(2) Disclaimer ‐ Where the auditor is unable to express any opinion in answer to a particular question, his
report shall indicate such fact together with the reasons why it is not possible for him to give an answer
to such question.

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Questions & Answers

Question 1 ‐ CARO 2016 Para 3(i)(b) – Fixed Assets
X Ltd closed its manufacturing operations and sold all its manufacturing fixed assets during the financial
year ended 31st March 2019. However, it intends to continue its operations as a trading company. In respect
of other fixed assets, the company carried out a physical verification as at the end of 31st March 2019 and
found a material discrepancy to the tune of ` 1 lac, which was written off and is disclosed separately in the
Statement of Profit and Loss. Kindly incorporate the above in your audit report.

Answer
Sale of manufacturing assets do not cast a doubt over entity’s going concern assumption under SA 570 if it
intends to continue its operations as a trading company.

According to Para 3(i)(b) of CARO 2016, the auditor has to comment whether the fixed assets have been
physically verified by the management at reasonable intervals; whether any material discrepancies were
noticed on such verification and if so, whether the same have been properly dealt with in the books of
account.

Reporting in CARO 2016: ‐ “While carrying out physical verification of fixed assets, a material discrepancy to
the tune of ` 1 lac was found, which was written off and disclosed separately in the Statement of Profit and
Loss.”

Questions 2 ‐ CARO 2016 Para 3(vii)(b) – Statutory Dues
XYZ Pvt. Ltd. has submitted the FS for the year ended 31‐3‐19 for audit. The audit assistant observes and
brings to your notice that the company's records show following dues:
1) Income Tax relating to Assessment Year 2016‐17 ` 125 lacs ‐ Appeal is pending before Hon'ble ITAT since
30‐9‐18.
2) Customs duty ` 85 lakhs ‐ Demand notice received on 15‐9‐18 but no action has been taken to pay or
appeal.
As an auditor, how would you bring this fact to the members?

Answer
CARO 2016 Para 3(vii)(b) – Statutory Dues
As per Para 3 (vii)(b) of CARO, 2016, in case dues of income tax or sales tax or service tax or duty of customs
or duty of excise or value added tax have not been deposited on account of any dispute, then the amounts
involved and the forum where dispute is pending shall be mentioned.

In the present case, there is Income Tax demand of ` 125 Lacs and the company has gone for an appeal, it
needs considerations as to whether the entire demand is disputed, because it is difficult to presume that the
demand by Income Tax authority is without any basis. Additionally, the demand notice has been received for
Customs duty of ` 85 lakhs and is outstanding on the closure of financial year, for which no action has been
taken by the management. Therefore, it should also be brought to notice of the members by reporting.

Question 3 ‐ CARO 2016 Para 3(viii) ‐ Defaulter Company
OK Ltd. has taken a term loan from a nationalized bank in 2011 for ` 200 lakhs repayable in five equal
instalments of ` 40 lakhs from 31st March 2012 onwards. It had repaid the loans due in 2012 & 2013, but
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defaulted in 2014, 2015 & 2016. As the auditor of OK Ltd. what is your responsibility assuming that company
has sought reschedulement of loan?

Answer
CARO 2016 Para 3(viii) ‐ Defaulter Company
Reporting for Default in Repayment of Dues: As per Para 3(viii) of CARO, 2016, the auditor has to report:
Whether the company has defaulted in repayment of loans or borrowing to a financial institution, bank,
government or dues to debenture holders? If yes, the period and the amount of default to be reported (in case
of defaults to banks, financial institutions, and government, lender wise details to be provided).

In this case, OK Ltd. has defaulted in repayment of dues for three years. Application for rescheduling will not
change the default position. Hence the auditor has to report in his audit report that the Company has
defaulted in its repayment of dues to the bank to the extent of ` 120 lakhs.

Question 4 ‐ CARO 2016 Para 3(ix) – End use of Money raised
Under CARO, 2016, as a statutory auditor, how would you report on the following:
A Term Loan was obtained from a bank for ` 80 lakh for acquiring R&D equipment, out of which ` 15 lakh
was used to buy a car for use of the concerned director who was overlooking the R&D activities.

Answer
Utilisation of Term Loans: According to Para 3 (ix) of CARO, 2016, the auditor is required to comment
Whether moneys raised by way of initial public offer or further public offer (including debt instruments) and term
loans were applied for the purposes for which those are raised. If not, the details together with delays or default
and subsequent rectification, if any, as may be applicable, be reported.

If the auditor finds that the fund has not been utilized for the purpose for which they were obtained, the report
should state the fact. In the instant case, term loan taken for the purpose of R&D equipment has been utilized
for the purchase of car which has no relation with R&D equipment.

Car though used for R&D Director cannot be considered as R&D equipment. The auditor should state the
fact in his report that out of the term loan taken for R&D equipment, ` 15 lakh was not utilised for the
purpose of acquiring R&D equipment.

Question 5 ‐ CARO 2016 Para 3(ii) – Inventory
Under CARO, 2016, as a statutory auditor, how would you report on the following:
Physical verification of only 50% of items of inventory has been conducted by the company. The balance
50% will be conducted in next year due to lack of time and resources.

Answer
CARO 2016 Para 3(ii) – Inventory
Physical Verification of Inventory: Para 3 (ii) of CARO, 2016 requires the auditor to report on whether physical
verification of inventory has been conducted at reasonable intervals by the management. Physical verification
of inventory is the responsibility of the management which should verify all material items at least once in a
year and more often in appropriate cases. The auditor in order to satisfy himself about verification at
reasonable intervals should examine the adequacy of evidence and record of verification.
In the given case, the above requirement of CARO, 2016 has not been fulfilled as such and the auditor should
point out the specific areas where he believes the procedure of inventory verification is not reasonable. He
may consider the impact on financial statement and report accordingly.

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Question 6 ‐ Applicability of CARO, 2016
Wipron Private Limited reports the following position as on 31st March 2016:
Paid up capital 80 lacs
Revaluation reserve 10 lacs
Capital reserve 11 lacs
P & L A/c [Dr. Balance] (2 lacs)
The Management of the Company contends that CARO 2016 is not applicable to it. Comment.

Answer
As per the Statement on CARO, 2016 issued by ICAI, for determining the applicability of the CARO, 2016 to a
private limited company, both capital as well as the revenue reserves shall be taken into consideration while
computing the limit of `1 crore prescribed for paid up capital and reserves and surplus.

Revaluation reserve, if any, should also be taken into consideration while determining the figure of reserves
for the limited purpose of determining the applicability of the Order. The credit balance in the profit and loss
account should also be considered as apart of reserve since the balance in the profit and loss account is
available for general purposes like declaration of dividend.

Accordingly, the profit and loss account (Dr Balance) of ` 2 lacs shall be deducted.

Accordingly, the aggregate of PUSC + R + S stands at ` 99 lacs which is less than the limit of `1 crore prescribed.

Hence the contention of the management is correct and CARO, 2016 is NOT applicable to the Company.

Question 7 – Other Matter Paragraph
C Ltd. is holding 55% shares of D Ltd. M/s AB & Associates are statutory auditors of C Ltd. whereas for D Ltd.
there is another firm appointed as statutory auditors. What are the reporting responsibilities of M/s. AB &
Associates for audit of consolidated financial statements? (5 Marks) (May 2017)

Answer
When the Parent’s Auditor is not the Auditor of all its Components: In a case where the parent’s auditor is
not the auditor of all the components included in the consolidated financial statements, the auditor of the
consolidated financial statements should also consider the requirement of SA 600 “Using the Work of another
Auditor”.

As per SA 706, when the parent’s auditor decides that he will make reference to the audit of the other auditors,
the auditor’s report on consolidated financial statements should disclose clearly the magnitude of the portion
of the financial statements audited by the other auditor(s) by putting an OMP paragraph after the Auditor’
responsibility section in the Auditor’s report. This may be done by stating aggregate rupee amounts or
percentages of total assets and total revenues and cash flows of subsidiary(s) included in consolidated financial
statements not audited by the parent’s auditor.

However, reference in the report of the auditor of consolidated financial statements to the fact that part of
the audit of the group was made by other auditor(s) is not to be construed as a qualification of the opinion
but rather as an indication of the divided responsibility between the auditors of the parent and its
subsidiaries.

Question 8 ‐ Auditors' Responsibility
What is included in an Auditors' Responsibility paragraph? (5 Marks) (May 2017)

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Answer
Please refer Theory given in this chapter under Revised SA 700.

Question 9 ‐ CARO 2016 Para 3(i)(c) – Fixed Assets
ABC Ltd. owns a piece of Land and Building situated at IP road, Mumbai which was purchased before 30
years. The title deeds for the same are deposited with State Bank of India for obtaining credit facilities by
the company.
As the statutory auditor of the company for the year ended 31st March 2017, what are the audit procedures
to be followed and what is the reporting under CARO 2016? (4 Marks) (May 2017)

Answer
Title deeds of Immovable Property in the name of Bank:
(1) Audit Procedures:‐
(a) Verify the title deeds available and RECONCILE the same with the fixed assets register. The scrutiny of
the title deeds of the immovable property may reveal a number of discrepancies between the details
in the Fixed Assets register and the details available in the title deeds.
(b) Where the title deeds of the immovable property have been mortgaged with the Banks/ Financial
Institutions, etc., for securing the borrowings and loan raised by the company, a CONFIRMATION
about the same should be sought from the respective institution to this effect.
(c) The auditor may also consider verifying this information from the ONLINE RECORDS, if available, of
the relevant State.

(2) Requirements under CARO, 2016:‐ As per Clause (i) (c) of Paragraph 3 of the CARO, 2016, the auditor is
required to report on whether the title deeds of immovable properties are held in the name of the
company. If not, company is required to provide the details thereof.

Question 10 ‐ CARO 2016 Para 3(i)(a,b) – Fixed Assets
The Property, Plant and Equipment of ABC Ltd. included ` 25.75 crores of earth removing machines of
outdated technology which had been retired from active use and had been kept for disposal after
knockdown. These assets appeared at residual value and had been last inspected 10 years back. As an
Auditor, what may be your reporting concern as regards matters specified above? (5 Marks) (May 2018 –
NS)

Answer
According to clause (i) (a) of Para 3 of CARO, 2016 the auditor has to comment whether the company is
maintaining proper records showing full particulars, including quantitative details and situation of fixed assets;
and as per clause (i) (b) whether these fixed assets have been physically verified by the management at
reasonable intervals; whether any material discrepancies were noticed on such verification and if so, whether
the same have been properly dealt with in the books of account;

In the given case, ABC Ltd. has intention to sale its earth removing machines of outdated technology which
had been retired from active use and had been kept for disposal after knockdown and these assets are
appearing at residual value. Further, inspection of such machines (though it is a retired machine, however
value is ` 25.75 crores which is material amount) was done 10 years back, is not in compliance with CARO,
2016.

Hence, this fact needs to be disclosed in the Audit Report as per clause (i) (a) and (b) of Paragraph 3 of CARO
2016.

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Question 11 – CARO various Clauses
Whilst the Audit team has identified various matters, they need your advice to include the same in your
audit report in view of CARO 2016:‐
(a) The long term borrowings from the parent has no agreed terms and neither the interest nor the
principal has been repaid so far.
(b) The Company is in the process of selling its office along with the freehold land available at Chandigarh
and is actively on the lookout for potential buyers. Whilst the same was purchased at ` 25 Lakhs in
2008, the current market value is ` 250 Lakhs,
This property is pending to be registered in the name of the Company, due to certain procedural issues
associated with the Registration though the Company is having a valid possession and has paid its
purchase cost in full. The Company has disclosed this amount under Fixed Assets though no disclosure
of non‐registration is made in the notes forming part of the accounts.
(c) An amount of ` 3.25 Lakhs per month is paid to M/s. WE CARE Associates, a partnership firm, which is
a 'related party' in accordance with the provisions of the Companies Act, 2013 for the marketing
services rendered by them. Based on an independent assessment, the consideration paid is higher than
the arm's length pricing by ` 0.25 Lakhs per month. Whilst the transaction was accounted in the
financial statements based on the amounts' paid, no separate disclosure has been made in the notes
forming part of the accounts highlighting the same as a 'related party' transaction.
(d) The Internal Auditor of the Company has identified a fraud in the recruitment of employees by the HR
department wherein certain sums were alleged to have been taken as kick‐back from the employees
for taking them on board with the Company. After due investigation, the concerned HR Manager was
sacked. The amount of such kickbacks is expected to be in the range of `12 Lakhs.

Answer
(a) As per clause (xiii) of para 3 of CARO 2016 the auditor is required to report, “whether all transactions with
the related parties are in compliance with sections 177 and 188 of Companies Act, 2013 where applicable
and the details have been disclosed in the Financial Statements etc., as required by the applicable
accounting standards”.

In the present case, the auditor is required to report as per clause xiii of para 3 of CARO 2016 regarding
receipt of long term borrowing from Parent Company which qualifies as a transaction with the related
party.

(b) As per clause (i) (c) of para 3 of CARO 2016 the auditor is required to report, “whether the title deeds of
immovable properties are held in the name of the company. If not, provide the details thereof.”

In the present case, the Company has office along with freehold land in Chandigarh. Though company has
paid its purchase cost in full however, this property is pending to be registered in the name of the
company i.e. title deed is not in the name of Company since 2008. Therefore, the auditor is required to
report the same in accordance with clause (i)(c) of para 3 of CARO 2016.

The reporting under this clause, where the title deeds of the immovable property are not held in the
name of the Company, may be made incorporating following details, in the form of a table or otherwise
in case of land:‐
• total number of cases,
• whether leasehold / freehold,
• gross block and net block, (as at Balance Sheet date), and
• remarks, if any.

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(c) As per clause (xiii) of para 3 of CARO 2016, the auditor is required to report, “whether all transactions
with the related parties are in compliance with sections 177 and 188 of Companies Act, 2013 where
applicable and the details have been disclosed in the Financial Statements etc., as required by the
applicable accounting standards;”

Therefore, the duty of the auditor, under this clause is to report (i)Whether all transactions with the
related parties are in compliance with section 177 and 188 of the Companies Act, 2013 (“Act”); (ii)
Whether related party disclosures as required by relevant Accounting Standards (AS 18, as may be
applicable) are disclosed in the financial statements.

In the present case, the auditor is required to report as per clause xiii of para 3 of CARO 2016, as one
of related party transaction amounting 3.25 lakhs per month i.e. in lieu of marketing services has been
noticed of which amount ` 0.25 lakh per month is exceeding the arm’s length price has not been
disclosed highlighting the same as related party transactions as per AS 18. Thus, the auditor is required
to report accordingly.

(d) As per clause Clause (x) of para 3 of CARO 2016 the auditor is required to report, “whether any fraud by
the company or any fraud on the Company by its officers or employees has been noticed or reported
during the year; If yes, the nature and the amount involved is to be indicated.”

In the instant case, a fraud has been identified in recruitment of employees by the HR Department

wherein certain sums were alleged to have been taken as kickback from the company of amounting
approx. ` 12 lakhs. The auditor is required to report on the same in accordance with clause (x) of para
3 of CARO 2016.

Question 12
There are certain circumstances in which Emphasis of Matter in Auditor's Report is mandated to be included.
Explain this statement in the light of mandatory requirements of matters that are to be emphasised in
Auditor's Report when the Audit Report is on Financial Statements prepared in accordance with Special
Purpose Framework. (5 Marks) (Nov 2018 ‐ NS)

Answer
Circumstances in which Emphasis of Matter Paragraph in Auditor’s Report is mandated in case of Financial
Statements prepared in accordance with a Special Purpose Framework:
As per SA 706, “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s
Report” and/or SA 800, “Special Considerations—Audits of Financial Statements Prepared in Accordance with
Special Purpose Frameworks”, the auditor’s report on special purpose financial statements shall include an
Emphasis of Matter paragraph alerting users of the auditor’s report that the financial statements are prepared
in accordance with a special purpose frame work and that, as a result, the financial statements may not be
suitable for another purpose. The auditor shall include this paragraph under an appropriate heading.

The special purpose financial statements may be used for purposes other than those for which they were

intended. For example, a regulator may require certain entities to place the special purpose financial
statements on public record. To avoid mis under standings, the auditor alerts users of the auditor’s report that
the financial statements are prepared in accordance with a special purpose frame work and, therefore, may
not be suitable for another purpose.

Restriction on Distribution or Use: In addition to the alert required above, the auditor may consider it
appropriate to indicate that he auditor’s report is intended solely for the specific users. Depending on the law
or regulation of the particular jurisdiction, this may be achieved by restricting the distribution or use of the
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auditor’s report. In these circumstances, the emphasis of matter paragraph given above maybe expanded to
include these other matters, and the heading may be modified accordingly.

Question 13 – Applicability of CARO & Para 3(ix) of CARO
During the financial year ended on 31/03/2018, LM Private Limited had borrowed from a Nationalized Bank,
a term loan of ` 120 lakhs consisting of ` 100 lakhs for purchase of a machinery for the new plant and ` 20
lakhs for erection expenses. As on the date of 31st March, 2018, the total of capital and free reserves of the
Company was ` 50 lakhs and turnover for the year 2017‐18 was ` 750 lakhs. The Bank paid ` 100 lakhs to
the vendor of the Company for the supply of machinery on 31/12/2017. The machinery had reached the
yard of the Company. On 28/02/2018, the Company had drawn the balance of loan viz. ` 20 lakhs to the
credit of its current account maintained with the Bank and utilized the full amount for renovating its
administrative office building. The machinery had been kept as capital stock under construction. Comment
as to reporting issues, if any, that the Auditor should be concerned with for the financial year ended on
31/03/2018, in this respect. (5 Marks) (Nov 2018 ‐ NS)

Answer
Applicability of CARO , 2016 and Utilisation of Term Loan: CARO ,2016 specifically exempts a private limited
company, not being a subsidiary company of a public company, having a paid up capital , reserves & surplus
not more than ` 1 Crore as on balance sheet date and which does not have total borrowing exceeding ` 1
Crore from any bank or financial institution at any point of time during the year and which does not have a
total revenue as disclosed in Schedule III to the companies Act 2013 exceeding ` 10 Crores during the financial
year as per financial statements.

In the case of LM Pvt. Ltd, it has paid up capital of ` 50 Lacs which is below the specified limit of ` 1 Crore

and turnover is ` 7.5 crores which is also less than specified ` 10 Crores. However, there is total borrowing
of ` 1.20 Crores which is more than ` 1 Crore and exceeding the specified limits of ` 1 Crore. Hence CARO,
2016 will be applicable to LM Pvt. Ltd.

As per clause (ix) of Para 3 of CARO, 2016, an auditor need to state in his report that whether the term loans
were applied for the purpose for which the loans were obtained. If not, the details together with delays or
default and subsequent rectification, if any, as may be applicable, be reported.

The auditor should examine the terms and conditions subject to which the company has obtained the term
loans. The auditor may also examine the proposal for grant of loan made to the bank. As mentioned above,
normally, the end use of the funds raised by term loans is mentioned in the sanction letter or documents
containing the terms and conditions of the loan. The auditor should ascertain the purpose for which term
loans were sanctioned. The auditor should also compare the purpose for which term loans were sanctioned
with the actual utilization of the loans. The auditor should obtain sufficient appropriate audit evidence
regarding the utilization of the amounts raised. If the auditor finds that the funds have not been utilized for
the purpose for which they were obtained, the auditor’s report should state the fact.

In the present case, the term loan obtained by LM Private Ltd. amounting ` 20 Lacs have not been utilized for
erection expenses instead its utilized for renovating its administrative office building. Further, assuming that
erection work has not been done and machinery is not being installed, disclosure of the same as Capital Stock
under construction is in order.

Here, the auditor should report the fact in his report that pending utilization of the term loan for erection
expenses, the funds were temporarily used for the purpose other than the purpose for which the loan was
sanctioned as per clause (ix) of Para 3 of CARO, 2016.
2.32

Chapter 10
Question 14 – Section 143(12) and Para 3(x) of CARO, 2016
What are the reporting requirements in the audit report under the Companies Act, 2013 / CARO, 2016 for
the following situations?
(i) A fraud has been committed against the company by an officer of the company.
(ii) A fraud has been committed against the company by a vendor of the company.
(iii) The company has committed a major fraud on its customer and the case is pending in the court.
(iv) A fraud has been reported in the cost audit report but not noticed by statutory auditor in his audit.
(Nov 2018 ‐ OS) ‐ 4 Marks

Answer
Reporting Requirements in the Audit Report under the Companies Act, 2013 / CARO 2016: According to
Clause (x) of Para 3 of CARO 2016, the auditor is required to report whether any fraud by the company or any
fraud on the company by its officers or employees has been noticed or reported during the year. If yes, the
auditor is required to state the amount involved and the nature of fraud.

Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the course of the
performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been
committed against the company by officers or employees of the company, he shall immediately report the
matter to the Central Government (in case amount of fraud is ` 1 crore or above) or Audit Committee or Board
in other cases (in case the amount of fraud involved is less than ` 1 crore) within such time and in such manner
as may be prescribed.
(i) Fraud Committed against the Company by an Officer of the Company: Fraud committed against the
company by an officer of the company has to be reported in accordance with Clause (x) of Para 3 of CARO
2016, and as per section 143(12) of the Companies Act, 2013.
(ii) Fraud committed against the company by a vendor of the Company: In case employees or management
are involved in fraud committed by vendor, reporting has to be done in accordance with CARO 2016 and
as per section 143 (12) of the Companies Act, 2013. Suspected fraud by vendors, customers and other
third parties should be dealt with in accordance with SA 240. Therefore, reporting has to be done in
accordance with SA 240, “The Auditor’s Responsibilities relating to Fraud in an audit of Financial
Statements”.
(iii) Company has committed major fraud on its customer of which case is pending in the court: Major fraud
committed by the company on its customer has to be reported in accordance with Clause (x) of Para 3 of
CARO 2016.
(iv) Fraud reported in Cost Audit Report but not noticed by Statutory Auditor: As per Clause (x) of Para 3 of
CARO 2016, all frauds noticed or reported during the year shall be reported indicating the nature and
amount involved as specified the fraud by the company or on the company by its officers or employees
are only covered. Here in the given scenario, a fraud has been reported in the cost audit report but not
noticed by Statutory Auditor in his audit. Hence the statutory auditor has to report the nature and amount
involved in the audit report as per section 143 of the Companies Act, 2013.

2.33


Question 15 – Para 3(iv) of CARO, 2016
As a Company auditor you notice that there is an inter‐corporate loan granted by the company. What are
the reporting requirements as regards the matters concerning terms of interest on the intercorporate loan?
(4 Marks) (Nov 2018 ‐ OS)

Answer
Reporting Requirements for terms of Interest on the Intercorporate loan: As per clause (iv) of Para 3 of CARO,
2016, the auditor is required to report in respect of loans, investments, guarantees, and security whether
provisions of section 185 and 186 of the Companies Act, 2013 have been complied with. If not, provide the
details thereof.

For this purpose, the auditor should obtain the details of, loans given to any person or other body corporate,
guarantee given or security provided in connection with a loan to any other body corporate or person and
securities acquired of any other body corporate by way of subscription, purchase or otherwise, made during
the year as well as the outstanding balances as at the beginning of the year in accordance with section 186.

As per Clause (iv) of CARO, 2016, with respect to matters concerning terms of interest on the intercorporate
loan the auditor is required to:
(i) Check whether rate of interest is not lower than the prevailing yield of 1 year, 3 years, 5 years or 10 years
government security closest to the tenor of the loan granted.
(ii) Check if the company is in default in the repayment of any deposits accepted or in payment of interest
thereon, then the company is not allowed to give any loan or guarantee or any security or an acquisition

till such default is subsisting.
Non‐compliance with respect to interest on the intercorporate loan may be reported incorporating following
details:‐
Sl. Non‐compliance of Name of Amount Balance as at Remarks,
No. Section 186 Company / Involved Balance Sheet Date if any
Party
1 Loan given at rate of
interest lower than
prescribed
2 Any other default

Question 16 – SA 701 ‐ KAM
CA. Amar has come across certain key matters while auditing the accounts of PR Ltd. for the financial year
2017‐18. He, being the associate of your firm, seeks your advice on "Communicating Key Audit Matters" in
the Auditor's Report. Guide him. (5 Marks) (Nov 2018 ‐ OS)

Answer
Refer Theory given in this chapter under SA 701 under the heading ‘Communicating Key Audit Matters’.

2.34

Chapter 10
Multiple Choice Questions

Question 1
Your firm has been appointed as the auditors of Stuart Limited, a well‐established consumer goods
manufacturing company. During the audit you were provided with various oral representation during
meetings and discussions. While finalizing the audit you requested the management to provide such
representations in writing. The management has however informed you that they are not accustomed to
providing any representations to the external auditor in writing. The management is of the view that it has
provided full access to whatever records, documents and evidences were available with it without any
exception and that now it is the auditor’s responsibility to correlate the same with the oral representations.

What would be your response to the above?
(a) Agree with management since you have been provided full access to whatever records, documents and
evidences were available with management without any exception
(b) Document that management gave oral representation in audit working paper and issue unmodified
opinion.
(c) After corroborating the audit evidences, consider this as a scope limitation and then consider to express
a qualified opinion or disclaimer of opinion or re‐assess the continuation of engagement with the audit
client if integrity of the management is in question.
(d) Give unmodified opinion and include the observation in “other matter” paragraph, stating that the
written representations of the concerned matters could not be obtained.

Question 2
The auditor shall express _________ opinion when the auditor, having obtained sufficient appropriate audit
evidence, concludes that misstatements, individually or in the aggregate, are both material and pervasive
to the financial statements
(a) Adverse
(b) Qualified
(c) Disclaimer of opinion
(d) Clean

Question 3
Which of the following company is not exempted from reporting under CARO, 2016?
(a) Banking company.
(b) Insurance company.
(c) Company licensed to operate under section 8 of the Companies Act, 2013.
(d) Private limited company having paid up capital of Rs. 5 crore.

Question 4
When does an auditor shall modify the opinion in the auditor’s report?
(a) When, based on the audit evidence obtained, the financial statements as a whole are not free from
material misstatement.
(b) When, unable to obtain sufficient appropriate audit evidence to conclude that the financial statements
as a whole are free from material misstatement.
(c) Either (a) or (b)
(d) Both (a) and (b).
Question 5
2.35


As per CARO, 2016, the auditor is required to report whether the company is required to be registered under
section 45‐IA of the Reserve Bank of India Act, 1934. If so, whether the registration has been obtained.
(a) Under Clause (xi) of paragraph 3 of the CARO, 2016,
(b) Under Clause (xvi) of paragraph 3 of the CARO, 2016,
(c) Under Clause (xv) of paragraph 3 of the CARO, 2016,
(d) Under Clause (xiv) of paragraph 3 of the CARO, 2016.

Question 6
As per Clause (i)(c) of Paragraph 3 of the CARO, 2016, the auditor is required to report on :
(a) whether the title deeds of immovable properties are held in the name of the company. If not, provide
the details thereof.
(b) whether the company has entered into any non‐cash transactions with directors or persons connected
with him
(c) whether any fraud by the company or any fraud on the Company by its officers or employees has been
noticed or reported during the year; If yes, the nature and the amount involved is to be indicated;
(d) whether the company is maintaining proper records showing full particulars, including quantitative
details and situation of fixed assets.

Question 7
LM Ltd. had obtained a Term Loan of rupees 300 lakhs from a bank for the construction of a factory. Since
there was a delay in the construction activities, the said funds were temporarily invested in short term
deposits. Under which clause of CARO 2016 the auditor is required to report
(a) Under Clause (viii) of paragraph 3 of the CARO, 2016,
(b) Under Clause (xi) of paragraph 3 of the CARO, 2016,
(c) Under Clause (x) of paragraph 3 of the CARO, 2016,
(d) Under Clause (ix) of paragraph 3 of the CARO, 2016.

Question 8
Medivision Industries designs and manufactures spectacles. Medivision’s year end was 31 March 2018 and
its draft financial statements show a profit before tax of Rs.60 lakh. The fieldwork stage for this audit has
largely been completed but there are few outstanding issues.
On 1 January 2018, Medivision began the commercial production of a new range of lightweight frames
which have been proven to keep their shape regardless as to how roughly they are treated. Up to 31
December 2017, the company had correctly capitalised development costs of Rs.45 lakh relating to this
project. The directors believe that the new frames will have a product life of three years. The financial
statements show development costs at a carrying amount of Rs.45 lakh. Medivision's accounting policy
states that it amortises intangible assets on a straight‐line basis.
The auditor's report for Medivision is due to be signed in the next week or so, and you have been unable to
resolve a disagreement with the directors concerning the amortisation of the development costs. The
directors have refused to include any amortisation on the basis that sales of the product have not yet
commenced.
Which of the following options correctly summarises the impact on the auditor's report if the issue remains
unresolved?
(a) The auditor to provide an ‘Unmodified opinion’, since the directors are correct not to include any
amortisation on the basis that sales of the product have not yet commenced.
(b) The auditor to provide an ‘Unmodified opinion’ with emphasis of matter paragraph about the
amortisation charge on the capitalised development costs.
2.36

Chapter 10
(c) The auditor to provide a Modified opinion ‐ Adverse opinion since having obtained sufficient
appropriate evidence, concludes that the misstatement is both material and pervasive.
(d) The auditor to provide a Modified opinion – Qualified opinion due to material misstatement of not
recording the amortization charge on the capitalised development costs, which is material but not
pervasive.

Question 9
Best Manufacturers Limited is a manufacturing company and has entered into an agreement In February
2017 with CISCA Brothers for buying land in order to set up their new manufacturing unit. As per the
agreement, Best Manufacturers were required to pay Rs. 20 Lakhs as signing amount and the balance
amount was required to be paid in three instalments of Rs. 25 lakhs each in the month of May, July and
September 2017. The title deed for the land was to be transferred after the payment of second instalment
in July 2017, so in the accounts for the year 2016‐17 of the Best Manufacturers the payment of signing
amount was booked as an expense. Your firm have been appointed as auditor of financial statements of
Best Manufacturers Limited for the year 2016 –17. There is conflict between Financial Reporting Framework
and Legal requirement, so what will be the duty of your firm in such case?
(a) Incorporate the changes in financial statements as per the legal requirement.
(b) As the title deed has not been transferred in favour of the company in the year 2016‐17, there is no
need to review the payment in terms of Accounting Standard or any other legal requirement.
(c) Take management representation on the same.
(d) Discuss the matter with management and ensure disclosure of the same in notes to accounts. In the
absence of same, the auditor may consider issuing modified opinion.

Question 10
DSP Chartered Accountants have been appointed statutory auditors of Flakes Private Limited for the year
2016‐17. The company’s net profit has declined by 5% as compared to previous year in spite of increase in
sales. On verification of company’s profit & loss account it is noticed that in the current year a huge amount
is debited as loss on sale of fixed assets due to which the profits has reduced. The auditor discussed the
matter with management and was told that since the lot of fixed assets were lying idle due to their non‐
working condition, they have been sold at less than their written down value. As an auditor do you think
that the fact regarding disposal of assets should be disclosed in auditor’s report/ notes to accounts?
(a) If the assets has been sold as per company’s policy and under applicable Financial Reporting
framework, then separate disclosure is not required in auditor’s report/ notes to accounts.
(b) As the sale of assets has an impact on profit for the current year, it should be disclosed in the notes to
account of the Financial Statements.
(c) Even if the assets has been sold as per company’s policy and under applicable Financial Reporting
framework, the auditor should disclose the facts in Emphasis of Matter Paragraph of Audit Report as
the loss booked in Profit & Loss account has a material impact on the net profit of the company.
(d) As the loss on sale of fixed assets is debited in Profit & Loss Account as per Accounting Standard, there
is no requirement of disclosure of the same in any report.

2.37


Question 11
Auditor's report on prior period i.e. year ended 31 March 2017 included a modified opinion on an
unresolved matter. If such matter is not relevant/ immaterial to the current period figures in the financial
statements for the year ended 31 March 2018, how should the auditors deal with this matter in his
auditors report for the year ended 31 March 2018?
(a) Since the matter is not relevant/ material to current period figures, no reporting in respect of this
matter would be required in the auditor’s report for the year ended 31 March 2018.
(b) Modify opinion on current period's financial statements because of the effects or possible effects of
the unresolved matter on the comparability of the current period and corresponding figures in the
auditor’s report for the year ended 31 March 2018.
(c) Considering the matter is not relevant/ material to current period figures, the management may
include a note in the financial statements and basis that no reporting in respect of this matter would
be required in the auditor’s report for the year ended 31 March 2018.
(d) Include an emphasis of matter because of the effects or possible effects of the unresolved matter on
the comparability of the current period and corresponding figures in the auditor’s report for the year
ended 31 March 2018.

Question 12
A Ltd. is a company in the business of buying and selling modern and contemporary Indian arts.
Following are the assets (in millions) of the Company on 31 March 2017:
• Fixed assets: INR 10
• Investments: INR 20
• Loans and advances: INR 40
• Inventories: INR 400
• Trade receivables: INR 10
• Cash and cash equivalents: INR 20
The management has not obtained valuation of inventories as at 31 March 2017 from a valuation expert in
art forms. The auditors could not perform alternate procedures for valuation of inventories. Therefore,
auditors were not able to comment on the carrying value of inventories. However, the auditors were
able to obtain sufficient appropriate audit evidence in respect of all other captions of financial
statements. The auditors qualified their opinion in the auditor's report. What are your views on
auditors qualifying their report?
(a) The auditors were able to obtain sufficient appropriate audit evidence in respect of all captions of
financial statements other than inventories. The auditors may qualify their opinion in the auditor's
report considering only one caption of the financial statements could be misstated.
(b) Total assets amount to Rs. 500 million, out of which, Rs. 400 million pertaining to inventories comprises
of 80% of total assets. This signifies that the auditors are not able to obtain sufficient appropriate
audit evidence on 80% of the assets. Hence, possible misstatement, if any, could be pervasive.
Therefore, the auditors should issue adverse opinion.
(c) Total assets amount to Rs. 500 million, out of which, Rs. 400 million pertaining to inventories
comprises of 80% of total assets. This signifies that the auditors are not able to obtain sufficient
appropriate audit evidence on 80% of the assets. Hence, possible misstatement, if any, could be
pervasive. Therefore, the auditors should disclaim their opinion.
(d) Inventory is considered to be an important component of the financial statements. This is one of the
items wherein significant risk may exist from the audit’s perspective. Auditor should take cognizance
of this fact and accordingly decide his opinion – qualified/ adverse/ disclaimer.

2.38

Chapter 10
Question 13
X Ltd is in the business of trading of industrial equipments. The Company’s operations are based out of India
and Germany. For the purpose of hedge, the company has taken forward contracts. The Company is Phase
1 company as per the requirements of Ind AS and hence forward contracts have been fair valued for the
purpose of preparation of financial statements. The Company also got its property, plant and equipment
fair valued. The Company has shown its fair valuation reports in respect of above items to the auditors.
What should be the responsibility of the auditors in this case?
(a) The auditor may refer to the work of the valuer in his report containing an unmodified opinion and
accordingly reduce the his responsibility for the audit opinion.
(b) The auditor may refer to the work of the valuer in his report for forward contracts but not for
property, plant and equipment, containing an unmodified opinion and accordingly reduce the his
responsibility for the audit opinion.
(c) The auditor may refer to the work of the valuer in his report for property, plant and equipment but
not for forward contracts, containing an unmodified opinion and accordingly reduce the his
responsibility for the audit opinion.
(d) The auditor may involve his own expert for the purpose of audit of fair valuation of forward contracts
and property, plant and equipment. But in any case he cannot reduce his responsibility for the audit
opinion by referring to the work of the valuer in his report.

Question 14
DCHI Ltd is in the business of optics and imaging products. It is a wholly owned subsidiary of Japanese
company, DCHJ Ltd. DCHI Ltd has many expatriates (Expats) working in the company whose tenure range
from 2 to 5 years. During the course of audit of financial statements of the company, the statutory auditors
observed that the company has not been deducting and depositing the TDS (tax deducted at source) on
salaries of expats. The auditors assessed that the impact of this can be significant as the company has many
expats and salary amount is significant. Management explained that TDS on salary of expats would lead to
unnecessary hassles to the expats and they serve the company only for a short period. How should the
auditors of DCHI Ltd deal with this matter?
(a) Considering this as a statutory non‐compliance, the auditor should look at the significance of the matter
and accordingly should report the same in CARO.
(b) Considering this as a statutory non‐compliance, the auditor should look at the significance of the matter
and accordingly should consider reporting this in the main report along with CARO.
(c) The auditor should agree to the management’s view as the expats are temporary workers and this may
not be convenient for the management.
(d) Since the matter relates to statutory liability only, the reporting requirements do not arise till the time
this becomes disputed.

2.39

Companies (Auditor's Report) Order, 2016: Applicability of The Order Companies Covered by The Order

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5. Companies (Auditor’s Report) Order, 2016

Siddharth Agarwal Classes

Definition of Small Company under the Companies Act, 2013

Threshold Items Case 1 Case 2 Case 3 Case 4 Case 5

Whether CARO is Exempted Exempted Applicable Exempted Exempted

Matters to be included in the Auditor’s Report (Contained in

3 (iii) (a) Whether the company has granted any loans, secured or unsecured to companies,

Siddharth Agarwal Classes

3 (vii) (a) Whether the company is regular in depositing undisputed statutory dues including

Siddharth Agarwal Classes

Questions & Answers

Siddharth Agarwal Classes

Siddharth Agarwal Classes

In the instant case, a fraud has been identified in recruitment of employees by the HR Department

The special purpose financial statements may be used for purposes other than those for which they were

Siddharth Agarwal Classes

In the case of LM Pvt. Ltd, it has paid up capital of ` 50 Lacs which is below the specified limit of ` 1 Crore

Siddharth Agarwal Classes

Multiple Choice Questions

Siddharth Agarwal Classes

Siddharth Agarwal Classes

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