Winston Churchill once remarked, ‘“No comment’ is a splendid expression. I am using it again and again.” Auditors’ of companies do not have the liberty of using this term in their audit reports.
Audit Reports in India are guided by the Companies Act, 1956 — as amended — and the pronouncements of the Institute of Chartered Accountants of India, which, inter-alia, include the Companies Audit Report Order (CARO), issued in 2003 and revised in 2005.
CARO is a very comprehensive document that details audit requirements on 21 areas that could be part of an entity’s financial statements ranging from fixed assets to utilisation of IPO proceeds and frauds. CARO also includes thirteen appendixes that extract information from other Acts that need to be reported in CARO.
The UK Act
If one thought that the Companies Act, 1956 was gargantuan, a look at the Companies Act, 2006 in the UK would dwarf the former — it contains 1,300 sections and 16 schedules.
The sections regarding audit are fairly simplistic. The report must state clearly whether, in the auditor’s opinion, the annual accounts give a true and fair view of the state of affairs and the profit/loss of the company. The report needs to certify preparation of the financial statements in accordance with the Companies Act, 2006 as also the relevant financial reporting framework (normally IFRS).
Section 496 of the UK Companies Act asks the auditors to report whether in his opinion the information given in the directors’ report for the financial year for which the accounts are prepared is consistent with those accounts.
As per UK law, a part of the directors’ report is auditable which should form an integral part of the audit report including the directors’ remuneration.
The Act also states that the report of the auditor should be either qualified or unqualified, thereby giving a free reign to auditors to report/qualify on anything they find amiss. There are no CARO-like requirements under the Act. Section 507 of the Act punishes errant auditors with fines in case there are any offences in connection with the audit report.
Although CARO 2005 is comprehensive and gives an excellent checklist for auditors to work with, with the imminent staggered implementation of International Financial Reporting Standards (IFRS), the ICAI could think of including a few more points to complete the report.
On property, plant and equipment (PPE), the auditor needs to look at quantitative records, physical verification and whether sale of a substantial part of the fixed assets threatens the going concern status of the entity.
Accounting Standard 28 issued by the ICAI details requirements regarding ‘Impairment of Assets’. The meltdown has squeezed credit to many entities resulting in under utilisation of PPE — an indicator of impairment.
Although the notes on accounts would state impairment details, they are considered to be the property of the management. CARO could give an opportunity to the auditor to express his view on the impairment.
Similarly, mark-to-market and fair value are bound to form an integral part of the converged accounting standards issued by the ICAI — though these could be tailored to India’s requirements. This method of valuation is subjective and subject to numerous ifs and buts. An insertion in CARO regarding the valuation techniques used could be useful.
Though the principal players in financial instruments — banks and financial institutions — are out of the purview of CARO, valuation rules could apply to derivatives and other financial instruments. The time-lines to adhere to the trilogy of Accounting Standards on Financial Instruments and IFRS are within hand-shaking distance of each other mandating an entry in the report of the auditor.
It would also be worth including a general entry in CARO — “any other matter which, in the opinion of the auditor, needs reporting” — to give the freedom to the auditor to highlight matters which are not specifically specified in CARO and other regulations which warrant mention in the report but do not merit a qualification.