The Union Ministry of Corporate Affairs
announced last week the notification of the Companies (Auditor’s Report) Order, 2020 (CARO 2020). The order has introduced several changes to the rules governing audit
reports of companies, with a view to increasing transparency. This follows a consultation paper that the ministry had put out last month, with several proposals for enhancing the role of auditors and bringing their incentives into more clear alignment. For example, the consultation paper proposed that non-audit
services not be provided to audit
clients, to prevent revenue from such services impinging upon the decisions taken by the auditor when writing its report. Already two of the big four companies have said they will no longer offer non-audit services to audit clients.
One of the issues that emerged in the consultations that the ministry has been having with audit firms is the fact that auditors can only provide reports that are as factual and as complete as the information they are provided by the company in question. There have been some recent high-profile examples of companies that have knowingly deceived their auditors. Yet a regular audit is not a forensic exercise, and instead relies on the companies to turn over information in a timely and accurate fashion. If they do not do so, the entire process is naturally called into question. The CARO has sought now to transfer greater responsibility for providing complete information to its auditors. Auditors have essentially been forced to demand more information, in what will be a net positive for shareholders and other stakeholders such as financial institutions.
It is true that the paperwork burden will significantly increase. The 2020 CARO, according to a report in this newspaper, requires auditors to comment on 50 matters, including sub-clauses, where the 2016 iteration of the CARO required comment on only 21 matters. This is a significant expansion in scope and it remains to be seen how much it adds to transaction cost and delays in practice.
However, many of the new pieces of information appear to be well worth making a requirement for audit reports. For example, auditors are now required to report on how the company is using its connections with subsidiaries and joint ventures — are loans being raised to finance them? Or are loans being taken out against them? The auditor will also have to examine what the auditors of the subsidiary have said in their annual reports, and report them in the holding company’s report if they find “adverse” remarks.
Several requirements seem designed to ease the load on banks, such as the requirement to specify the amount of loans that do not have terms for repayment, and whether the company has itself loaned money to related parties. Some provisions may simply go too far — for example, the auditor has been directed to provide an opinion
on the main financial ratios of the firm. Yet where the 2020 CARO restricts itself to enhancing the information available to both investors and to financial institutions, it should be considered to be a major step forward for transparency in accounts. It is important that audit companies implement the rules in both letter and spirit.