CARO, 2003 and Loan Requirements

There are seven clauses under paragraph 4(iii) of the Order. It is clarified that the auditor’s comments on all the seven clauses are to be made with reference to the companies, firms or other parties covered in the register maintained under section 301 of the Act.

1. Has the company granted any loans, secured or unsecured to companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and amount involved in the transactions; and [Paragraph 4 (iii)(a)]. The duty of the auditor, under this clause, is to determine whether the company has granted any loans, secured or unsecured to companies, firms or other parties covered in the register maintained under section 301 of the Act. If the company has done so, the clause requires that the auditor’s report should disclose the “number of parties” and “amount involved” in such cases. The auditor is required to disclose the requisite information in his report in respect of all parties covered in the register maintained under section 301 of the Act irrespective of the period to which such loan relates. The clause covers not only the loan granted during the year but covers all loans including opening balances. Further, there is no stipulation regarding the loan being given in cash or in kind. In the absence of such stipulation, the auditor is required to disclose the requisite information in his report in respect of all kind of loans whether given in cash or in kind to the parties covered in the register maintained under section 301 of the Act. Under section 301 of the Act, every company is required to maintain one or more registers which contain the particulars of all contracts or arrangements to which section 297 or section 299 of the Act applies. The particulars of contracts and arrangements required to be entered in the register maintained under section 301 include, among other things, names of the parties to the contract or arrangement. The auditor should obtain a list of companies, firms or other parties covered in the register maintained under section 301 of the Act from the management. The auditor should examine all loans (secured or unsecured) granted the company to identify those loans granted to companies, firms or other parties covered in the register maintained under section 301 of the Act. It may so happen that a party listed in the register maintained under section 301 of the Act might take a loan from the company and repays it to the company during the financial year concerned. Therefore, while examining the loans, the auditor should also take into consideration the loan transactions that have been squared-up during the year and report such transactions under the clause. For example, the company has, during the financial year, granted a loan of Rs. 1,00,000/-to a firm in which one of the directors of the company is interested and the firm repays the loan during the financial year concerned. The auditor is also required to consider such transaction while commenting upon this clause of the Order. Apart from reporting the number of parties, the auditor is also required to disclose the “amounts involved”. Since the Order does not clarify what constitutes “amounts involved” it would be proper if the auditor discloses the maximum amount involved during the year in the transactions covered this clause. While commenting upon this clause, the auditor may also consider whether the year-end balance should also be disclosed in his audit report.

2. Whether the rate of interest and other terms and conditions of loans given the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and [Paragraph 4 (iii)(b)]. This clause, read with Paragraph 4(iii)(a) of the Order, requires the auditor to examine and comment whether the rate of interest and other terms and conditions of loans given the company (whether secured or unsecured) to companies, firms or other parties covered in the register maintained under section 301 of the Act are prima facie prejudicial to the interest of the company. The auditor should examine agreements entered into the company with the parties covered in the register maintained under section 301 of the Act or any other supportive documents available for ascertaining the rate of interest and other terms and conditions of all loans granted the company to such companies, firms or other parties. The auditor’s duty is to determine whether, in his opinion, the rate of interest and other terms and conditions of the loans given are prima facie prejudicial to the interest of the company. The “other terms” would primarily include security, terms and period of repayment and restrictive covenants, if any. In determining whether the terms of the loans are “prima facie” prejudicial, the auditor would have to give due consideration to a number of factors connected with the loan, including its ability to lend, borrower’s financial standing, the nature of the security, prevailing market rate of interest and so on. It may be mentioned that clause (a) of sub-section (1A) of section 227 of the Act also requires the auditor to inquire whether loans and advances made the company on the basis of security have been properly secured and whether the terms on which they have been made are not prejudicial to the interests of the company or its members. The auditor’s inquiry under the aforesaid clause may also be useful for the purposes of reporting under this clause. Further, the auditor may also come across a situation where the company has a policy of providing loans at concessional rates of interest to its employees and such a loan has been given to a relative of the director who is also an employee of the company. In such a case also, the auditor would be required to examine and comment whether loan is prejudicial to the interests of the company. It may, however, be noted that normally such rate of interest as per the policy followed the company cannot be said to be prejudicial to the interest of the company if other employees of the company also receive the loan at the same rate of interest.

3. Whether receipt of the principal amount and interest are also regular; and [Paragraph 4 (iii)(c)]. This part of the clause requires the auditor to report upon the regularity of receipt of principal amount of loans and interest thereon. Again, read with paragraphs 4(iii)(a) and (b) of the Order, the scope of auditor’s inquiry under this clause shall be restricted in respect of companies, firms or other parties covered in the register maintained under section 301 of the Act. The auditor is required to comment on this clause in regard to receipt of principal amount of loans “granted” the company to companies, firms or other parties covered in the register maintained under section 301 of the Act. The auditor has to examine whether the receipt of principal amount and interest is regular. The word ‘regular’ should be taken to mean that the principal and interest should normally be received whenever they fall due, respectively. If a due date for receipt of interest is not specified, it would be reasonable to assume that it falls due annually. A loan repayable on demand falls due as and when the lender calls back the loan. The auditor can make an assessment of the regularity only if the loan is demanded the company since the question of regularity would be judged consequent action of the company (payment or non- payment). If the lending company has not called back the loan, the auditor cannot comment under this sub-clause. The following are some of the procedures that the auditor may apply to report on the clause:

  •  the auditor, while obtaining an understanding of the terms and conditions for reporting under paragraph 4(iii)(b) of the Order, should also take note of repayment schedule;
  •  if loan agreements are not executed, any other equivalent documents may be referred to arrive at the terms of receipt of interest, for example, letters of understanding, acknowledgement the party of the terms and conditions communicated the company, etc.;
  •  the dates of receipt of principal amount and payment of interest needs to be verified with reference to the books of accounts of the company to come to the conclusion whether such receipts are regular; and
  •  if the results of the procedures mentioned above indicate any irregularity in receipt of principal and/or interest, the auditor should mention the fact in his report.

4. If overdue amount is more than rupees one lakh, whether reasonable steps have been taken the company for recovery of the principal and interest. [Paragraph 4(iii)(d)]. This clause requires the auditor to state whether reasonable steps have been taken the company for recovery of the principal and interest, wherever the overdue amount is more than rupees one lakh. A loan is considered to be overdue when the payment has not been received on the due date as per the lending arrangements. In such cases, the auditor has to examine the steps, if any, taken for recovery of this amount. It may, however, be noted that the scope of the auditor’s inquiry under this clause is restricted to loans given the company to parties covered in the register maintained under section 301 of the Act. In making this examination, the auditor would have to consider the facts and circumstances of each case, including the amounts involved. It is not necessary that steps to be taken must necessarily be legal steps. Depending upon the circumstances, the degree of delay in recovery and other similar factors, issue of reminders or the sending of an advocate’s or solicitor’s notice, may amount to “reasonable steps” even though no legal action is taken. The auditor is not, therefore, required to comment adversely on the mere absence of legal steps if he is otherwise satisfied that reasonable steps have been taken the company. The auditor should ask the management to give in writing, the steps which have been taken. The auditor should arrive at his opinion only after consideration of the management’s representations. The auditor should obtain sufficient appropriate audit evidence to support the fact that reasonable steps have been taken for recovery of the principal and interest of loans taken/granted the company.

5. Has the company taken any loans, secured or unsecured from companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and the amount involved in the transactions; and [Paragraph 4(iii)(e)].
6.Whether the rate of interest and other terms and conditions of loans taken the company, secured or unsecured; are prima facie prejudicial to the interest of the company; and [Paragraph 4(iii)(f)]. The auditor should examine agreements entered into the company with the parties covered in the register maintained under section 301 of the Act or any other supportive documents available for ascertaining the rate of interest and other terms and conditions of all loans taken the company from companies, firms or other parties covered in the register maintained under section 301 of the Act. The auditor’s duty is to determine whether, in his opinion, the rate of interest and other terms and conditions of the loans taken are prima facie prejudicial to the interest of the company. The “other terms” would primarily include security, terms and period of repayment and restrictive covenants, if any. In determining whether the terms of the loans are “prima facie” prejudicial, the auditor would have to give due consideration to a number of factors connected with the loan, including the company’s financial standing, financial position, availability of alternative sources of finance, urgency of borrowing, ability to borrow, the nature of the security given, prevailing market rate of interest and so on.
7. Whether payment of the principal amount and the interest are also regular. [Paragraph (4)(iii)(g)]. The following are some of the procedures that the auditor may apply to report on the clause:

  •  the auditor, while obtaining an understanding of the terms and conditions for reporting under paragraph 4(iii)(g) of the Order, should also take note of repayment schedule;
  •  if loan agreements are not executed, any other equivalent documents may be referred to arrive at the terms of repayment and payment of interest, for example, letters of understanding, acknowledgement the party of the terms and conditions communicated the company, etc.;
  •  the dates of repayment of principal and payment of interest needs to be verified with reference to the books of account of the company to come to the conclusion whether the repayments of principal and payment of interest are regular; and
  •  if the results of the procedures mentioned above indicate any irregularity in payment of principal and/or interest, the auditor should mention the fact in his report.
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