The Hindu Business Line : A few scary things in CARO

RECENTLY, the Institute of Chartered Accountants of India (ICAI) published a Statement on the Companies (Auditor's Report) Order, 2003 (CARO). The Statement is intended as a roadmap for auditors to clear the mist created by the Order after introduction.

In spite of all the initial sniggering, the Company Law Board (CLB) was quick to clarify that CARO is here to stay and no leeway would be given to auditors after January 1, 2004. Furthering their dilemma, Para 42 of the Statement reminds auditors to make their reports honestly and fearlessly and to bring to bear on their work the professional qualities of independence, balance of judgment and fair-play which they possess as a result of their education, training and experience. A tall order indeed.

The Statement at the outset tackles the conundrum posed when companies maintain records improperly for a part of the year but reform themselves and make the same records as pure as snow later during the same year. It advises auditors to report on the state of affairs during the accounting year and compliance with the requirements of the Order should be judged with reference to the whole accounting year and not merely with reference to the balance sheet date.

A word of caution is thrown in to auditors by asking them to consider the detrimental effect, if any, caused by the failure to comply with the requirements of the Order. Illustrating this, the Statement clarifies that if fixed assets records were not maintained properly in April 2004 but were spick and span in March 2005, the auditor can give the company a clean chit.

However, if the company was made poorer by a few lakhs by an act of deceit in a particular month, it would be an internal control lapse and would have to find its way into the report. This requirement would increase the judgmental decisions to be made by auditors — even if a company pays interest due in June in July or August, all the shareholders would come to know of it.

It would also increase auditor-auditee wrangles since companies would insist that a few slips here and there should be taken as normal. Auditors, on the other hand, given the heavy baggage of responsibility thrust on them and their recent rise to the front pages of any business daily worth its name, would love to disclose all.

The Statement encourages auditors to adopt a general approach while discharging their function and should observe the requirements of the Order in its spirit and not merely by its letter. It goes on to say that the mere fact that the Order is confined to certain specific matters should not be interpreted to imply that the auditors' duties in respect of other matters normally covered in the course of an audit are in any way limited or abridged by the Order.

At the same time, it should be recognised that the reporting obligations under the Order are confined to the specific items stated in the Order. The contents of this para could have been worded a bit more happily — it appears now that auditors have to probe into all areas but, at the same time, they do not have to.

Unlike the previous avatar of the report, MAOCARO, CARO requires the auditor to comment on all the clauses irrespective of the nature of the company's business. It is only in respect of nidhi/mutual benefit fund/societies four additional sub-clauses are to be commented on and there is a special clause for companies dealing in shares, securities, and so on.

Two clauses that would prove nightmarish for auditors are the ones on using short-term funds for long-term uses and whether term loans have been used as per the intent at the time of using the loan. The number, variety and complexity of funding mechanisms today would make it a near impossible task for any auditor to check the utilisation of funds in a company. The auditor would have to wade through all the fine print in all loan agreements to get a hang of the complexities of the loan.

Even if they do, if the proceeds of the loan/funding are put into the business bank account of the company along with the other receipts, complying with this requirement would be more difficult than finding a needle in a haystack. In the case of term loans, normally the cheque is paid directly to the supplier of the equipment, and so on. However, there is a margin to be put in by the borrower. Finding out from which source he has funded the margin would prove to be another hurdle.

The auditor is also required to state whether the management has disclosed on the end use of money raised by public issues and the same has been verified. What is not clear is whether the disclosure has to be verified or the end use has to be verified. If the need is to check the end use of funds, another leather hunt is on the cards for auditors. What would make their task doubly difficult is that there is no other regulation to enable them crosscheck the veracity of the information.

For many clauses, the Statement suggests that auditors obtain a representation from the management. Worldwide, legislation is being contemplated to make auditors responsible and also accountable for what they say in their report. With our penchant to ape global practices, we could end up having a similar diktat here. Then, using the representation letter from the management as a protective umbrella would not stand.

Even now, courts ask for proof that the representation letter was given by the management recklessly. There could also be a spot of bother for auditors if the company gives a representation that they have abided by the law as far as utilisation of funds. But the auditor knows for a fact that it is not so. In such a case, what should the auditor do — stay quiet because of the letter or report because of what he knows?

The ICAI has to take up some of the clauses in CARO with the CLB and ensure that only clauses that can be reported on without any fear or favour are included.