Audit Report and CARO, 2020 - Test 5: answer key

Question 1 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. M/s Sharma & Associates are the statutory auditors of Alpha Engineering Ltd., a manufacturing company engaged in producing industrial machinery. During the audit of FY 2025-26, the team examined the company's property, plant and equipment, inventory and loans granted to business associates. The company disclosed a factory building in its balance sheet, but the registered title deed was still in the name of a promoter who had contributed the property during the company's initial years. No registered conveyance in favour of the company had been executed. Management maintained that the property belonged economically to the company and therefore no separate reporting was necessary. The company also revalued its machinery during the year. The revaluation was performed by an independent engineering consultant who was not registered as a Registered Valuer under the applicable provisions. The aggregate change in the net carrying value of the machinery class was 11.5%. Management argued that the revaluation was reasonable and therefore the identity and registration status of the valuer were immaterial. During physical verification, the auditors found discrepancies amounting to 12.2% of the aggregate value of raw materials in that class. Management had recorded the physical count but had not adjusted the resulting difference in the books. Separately, the company had aggregate sanctioned working-capital limits of ₹5.35 crore from two banks, secured against current assets. Quarterly stock statements submitted to the lenders did not agree with the accounting records. Management attributed the differences to different reporting dates. The team further examined a ₹1.8 crore loan granted to an associate enterprise. An instalment had remained overdue for 108 days, and no documented recovery action had been initiated. The engagement partner must identify the relevant CARO reporting obligations and distinguish the applicable thresholds from management's explanations.

The building disclosed in the financial statements is held under a registered title deed in the promoter's name rather than the company's name. Management argues that the building is economically owned by Alpha Engineering Ltd. What is the appropriate CARO reporting treatment?

1. No reporting is necessary because the company has recorded the building as its own asset and management has confirmed ownership.
2. Report only when the building is physically occupied by the promoter and not used in the company's manufacturing operations.
3. Disclose the prescribed details of the property, including carrying value, person in whose name held, relationship, period and reason for not holding it in the company's name. (correct answer)
4. Report the matter only when the promoter has legally disputed the company's possession or use of the building.

Answer: C — Disclose the prescribed details of the property, including carrying value, person in whose name held, relationship, period and reason for not holding it in the company's name.

Explanation. Clause 3(i)(c) of CARO, 2020 requires the auditor to report whether title deeds of all immovable properties disclosed in the financial statements are held in the company's name, except qualifying lessee-held properties with duly executed lease agreements. Where they are not, prescribed particulars must be disclosed, including gross carrying value, registered holder, relationship, period held and reasons. Management's economic-ownership assertion does not remove this reporting obligation.

Where it goes wrong. Confusing accounting recognition or economic ownership with the requirement that the registered title deed should be held in the company's name.

Authority. CARO; CARO, 2020

Question 2 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Which statement correctly describes the reporting requirement regarding the revaluation of machinery undertaken by Alpha Engineering Ltd.?

1. The auditor must report the revaluation, whether it was based on a Registered Valuer's valuation and the amount of change because the change is at least 10% of the class's net carrying value. (correct answer)
2. The auditor need not report because an independent engineering consultant has performed the valuation and management has accepted the revised values.
3. The auditor must report only where the revaluation increases the value of all classes of PPE by more than 20% in aggregate.
4. The auditor must report only if the valuation was performed by a director or employee rather than an external consultant.

Answer: A — The auditor must report the revaluation, whether it was based on a Registered Valuer's valuation and the amount of change because the change is at least 10% of the class's net carrying value.

Explanation. Clause 3(i)(d) of CARO, 2020 requires reporting whether PPE, including Right-of-Use assets, or intangible assets have been revalued during the year and whether the revaluation is based on a valuation by a Registered Valuer. The auditor specifies the amount of change if it is 10% or more in the aggregate net carrying value of each class. An independent consultant's involvement does not automatically satisfy the Registered Valuer requirement.

Where it goes wrong. Confusing an independent valuation professional with a Registered Valuer and applying the 10% threshold to the entire asset base instead of each class.

Authority. CARO, 2020

Question 3 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Considering the inventory discrepancy and sanctioned working-capital facilities, which combination of reporting requirements applies to Alpha Engineering Ltd.?

1. Report the inventory discrepancy only if it exceeds 15% of total inventory and examine lender statements only if the limits exceed ₹10 crore.
2. Report the stock discrepancy only if the auditor discovers fraud and compare bank statements only when the facilities are fully utilised.
3. Report only the mismatch in quarterly statements because the inventory discrepancy is below the threshold applicable to total inventory.
4. Report the discrepancy of 10% or more for each class and examine agreement of quarterly lender statements where aggregate sanctioned limits exceed ₹5 crore. (correct answer)

Answer: D — Report the discrepancy of 10% or more for each class and examine agreement of quarterly lender statements where aggregate sanctioned limits exceed ₹5 crore.

Explanation. Clause 3(ii)(a) requires reporting discrepancies of 10% or more in the aggregate for each class of inventory and whether they were properly dealt with in the books. Clause 3(ii)(b) applies when aggregate working-capital limits in excess of ₹5 crore are sanctioned at any point during the year against current assets. The auditor must compare the quarterly returns or statements submitted to lenders with the books and report differences. The two tests operate independently.

Where it goes wrong. Applying the inventory threshold to total inventory and treating full utilisation of the working-capital facility as a condition for clause 3(ii)(b).

Authority. SA 700; SA 701

Question 4 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

The instalment of the loan granted to the associate enterprise has remained overdue for 108 days. Which specific reporting obligation arises under CARO, 2020?

1. Report the overdue amount only after 180 days and disclose whether legal recovery proceedings have commenced.
2. Report the total amount overdue for more than 90 days and whether reasonable steps have been taken by the company for recovery of principal and interest. (correct answer)
3. Report the instalment as a borrowing default by Alpha Engineering Ltd. under clause 3(ix)(a), even though the company is the lender.
4. Report only the original loan amount granted and omit overdue details because the borrower is an associate enterprise.

Answer: B — Report the total amount overdue for more than 90 days and whether reasonable steps have been taken by the company for recovery of principal and interest.

Explanation. Clause 3(iii)(d) of CARO, 2020 requires reporting the total amount overdue for more than 90 days in respect of loans and advances in the nature of loans granted by the company, together with whether reasonable steps have been taken for recovery of principal and interest. The clause concerns amounts lent by the company. Clause 3(ix)(a), by contrast, concerns the company's own repayment defaults to lenders.

Where it goes wrong. Confusing an amount lent by the company that is overdue with the company's own borrowing default.

Authority. CARO, 2020

Question 5 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. M/s K. Mehta & Co. are the statutory auditors of Zenith Chemicals Ltd., a manufacturer of specialised industrial chemicals. During the audit, the team examined the company's deposits, cost records, statutory dues and income-related disclosures. The company had accepted ₹4.2 crore from individuals and classified part of the receipts as customer advances, although the underlying arrangements indicated that some amounts could constitute deposits or deemed deposits. The auditors also discovered that an order passed by the National Company Law Tribunal concerning repayment of certain deposits had not been fully complied with. Management stated that the affected depositors had verbally agreed to an extension. The Central Government had specified maintenance of cost records for the company's product category under section 148(1) of the Companies Act, 2013. The company had maintained financial accounting records but had not prepared the prescribed cost accounts and supporting records for a substantial part of production. At year-end, undisputed GST dues of ₹32 lakh had remained unpaid for eight months after becoming payable. An additional income-tax demand of ₹48 lakh was under appeal before the Commissioner of Income-tax (Appeals). A separate representation against another demand had merely been submitted to the tax department without any formal pending proceeding. The finance director wanted both amounts described simply as disputed liabilities. During an income-tax assessment completed during the financial year, the company had surrendered previously unrecorded sales income of ₹62 lakh. The amount had not subsequently been recorded in the books of account. The statutory auditors must determine the separate reporting requirements for deposits, cost records, statutory dues and transactions disclosed as income during tax assessments.

Zenith Chemicals Ltd. has accepted amounts classified partly as customer advances, but some arrangements may constitute deposits or deemed deposits. An NCLT order concerning deposit repayment has also not been complied with. What should the auditor report?

1. Report only the total deposits accepted during the year because deemed deposits and tribunal orders are outside CARO.
2. Report only deposits accepted from directors because all other receipts are automatically treated as trade advances.
3. Report compliance with applicable RBI directives and sections 73 to 76 and whether the relevant NCLT order has been complied with, stating contraventions where applicable. (correct answer)
4. Report the amount only if the company has defaulted in repaying every depositor and the RBI has initiated proceedings.

Answer: C — Report compliance with applicable RBI directives and sections 73 to 76 and whether the relevant NCLT order has been complied with, stating contraventions where applicable.

Explanation. Clause 3(v) of CARO, 2020 covers deposits accepted by the company and amounts that are deemed to be deposits. It requires reporting compliance with applicable RBI directives, sections 73 to 76 and relevant rules, along with the nature of contraventions. Where an order has been passed by the CLB, NCLT, RBI, court or another tribunal, the auditor must also report whether it has been complied with. Verbal extensions do not establish compliance.

Where it goes wrong. Assuming that the accounting label of customer advance determines whether a receipt is a deposit or that tribunal-order compliance is outside clause 3(v).

Authority. CARO, 2020

Question 6 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

The Central Government has specified the maintenance of cost records for Zenith Chemicals Ltd.'s product category under section 148(1). The company maintains only financial accounting records. What should the auditor report under CARO?

1. No reporting is necessary because the company prepares examined financial statements and publishes its annual report.
2. Report only if the company is required to appoint a separate cost auditor under section 148(2).
3. Report whether the company's statutory financial statements have been prepared using the absorption-costing method.
4. Report whether cost records have been specified and whether the prescribed cost accounts and records have actually been made and maintained. (correct answer)

Answer: D — Report whether cost records have been specified and whether the prescribed cost accounts and records have actually been made and maintained.

Explanation. Clause 3(vi) of CARO, 2020 requires the auditor to report whether maintenance of cost records has been specified by the Central Government under section 148(1) of the Companies Act, 2013 and whether such accounts and records have been made and maintained. The requirement is not limited to whether a separate cost auditor has been appointed. Financial accounting records do not automatically satisfy the prescribed cost-record requirements.

Where it goes wrong. Confusing the requirement to maintain cost records with the separate appointment or conduct of a cost audit.

Authority. CARO; CARO, 2020; section 148

Question 7 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Which treatment should the auditor adopt for the undisputed GST arrears, the income-tax appeal and the mere departmental representation?

1. Disclose undisputed arrears outstanding for more than six months; state the amount and forum for the pending appeal, but do not treat a mere representation as a dispute. (correct answer)
2. Disclose only amounts outstanding for more than twelve months and classify every written representation as a disputed statutory demand.
3. Disclose the entire GST balance as disputed because the company has a separate appeal pending before the income-tax authority.
4. Disclose only disputed dues before a court and omit unpaid GST because no recovery notice has been issued.

Answer: A — Disclose undisputed arrears outstanding for more than six months; state the amount and forum for the pending appeal, but do not treat a mere representation as a dispute.

Explanation. Clause 3(vii)(a) of CARO, 2020 requires reporting undisputed statutory dues outstanding at the end of the financial year for more than six months from their becoming payable. Under clause 3(vii)(b), disputed dues must be reported with the amount and forum where the dispute is pending. A mere representation to the concerned department is expressly not treated as a dispute. The GST arrears and formal income-tax appeal therefore require different treatments.

Where it goes wrong. Treating every representation as a pending statutory dispute or overlooking the six-month threshold for undisputed dues.

Authority. CARO, 2020

Question 8 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

The company surrendered previously unrecorded sales income during an income-tax assessment but did not record the amount in its books during the year. Which reporting obligation applies?

1. The auditor reports only if the tax authority has imposed a penalty for concealment of income.
2. The auditor reports the unrecorded transaction and whether the previously unrecorded income surrendered or disclosed in the tax assessment has been properly recorded in the books during the year. (correct answer)
3. The auditor reports only the tax demand outstanding at year-end and not the underlying income recognised during the assessment.
4. The auditor need not report because the income was disclosed to the tax authority even though it remains absent from the books.

Answer: B — The auditor reports the unrecorded transaction and whether the previously unrecorded income surrendered or disclosed in the tax assessment has been properly recorded in the books during the year.

Explanation. Clause 3(viii) of CARO, 2020 requires reporting whether transactions not recorded in the books have been surrendered or disclosed as income during the year in tax assessments under the Income-tax Act, 1961. It also requires reporting whether such previously unrecorded income has been properly recorded in the books during the year. Disclosure to the tax authority does not itself correct the accounting records.

Where it goes wrong. Assuming that surrender of income during assessment automatically constitutes proper recording of that income in the company's books.

Authority. CARO, 2020

Question 9 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. M/s V. Raman & Associates are the statutory auditors of Suryodaya Infrastructure Ltd., a public company undertaking major renewable-energy projects. During FY 2025-26, the company raised ₹32 crore through an initial public offering specifically for developing a solar facility. The auditors discovered that ₹7 crore had been temporarily diverted towards repayment of existing borrowings. Management claimed that the money would be restored after receiving the next customer instalment. The company had also utilised a portion of its short-term working-capital borrowings for constructing a long-term generation facility. During the audit, a whistle-blower complaint alleged that procurement employees had diverted company funds through fictitious supplier invoices. The audit team independently identified transactions indicating a fraud of ₹76 lakh by employees. The Audit Committee was informed and the matter was examined under the applicable fraud-reporting requirements. No Form ADT-4 had been filed because the amount involved was below ₹1 crore. The previous statutory auditor had resigned during the year after raising concerns about borrowing utilisation and the reliability of project expenditure records. The incoming auditor obtained the resignation communication. Separately, the company's liquidity position deteriorated significantly. Its financial ratios, ageing of receivables and expected repayment dates indicated possible difficulty in meeting liabilities falling due during the twelve months following the balance-sheet date. Management relied on an anticipated refinancing arrangement that had not been formally approved by the lender. The directors requested the auditor to issue a standard CARO report without adverse observations, arguing that all the issues were temporary and would be resolved in the next financial year. The engagement partner must evaluate the reporting obligations under the relevant CARO clauses using evidence available up to the date of the audit report.

The company has used short-term working-capital borrowings for constructing a long-term generation facility. Which CARO reporting requirement is directly attracted?

1. Clause 3(iii)(e), because every amount used for capital expenditure represents renewal of an existing loan.
2. Clause 3(x)(a), because utilisation of any borrowing for fixed assets is automatically treated as IPO fund diversion.
3. Clause 3(ix)(d), requiring the nature and amount of funds raised on a short-term basis but utilised for long-term purposes to be reported. (correct answer)
4. Clause 3(ix)(a), because the difference between short-term borrowing and long-term expenditure automatically constitutes a repayment default.

Answer: C — Clause 3(ix)(d), requiring the nature and amount of funds raised on a short-term basis but utilised for long-term purposes to be reported.

Explanation. Clause 3(ix)(d) of CARO, 2020 specifically requires the auditor to report whether funds raised on a short-term basis have been utilised for long-term purposes and, if so, to indicate the nature and amount. The classification depends on the nature of the funds raised and their actual utilisation. It is distinct from repayment default under clause 3(ix)(a) and IPO/FPO fund utilisation under clause 3(x).

Where it goes wrong. Confusing mismatched borrowing duration with an actual repayment default or diversion of funds raised through a public issue.

Authority. CARO; CARO, 2020

Question 10 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

What should the auditor report regarding the ₹32 crore raised through the initial public offering for the solar facility?

1. No reporting is required if management promises to restore diverted funds before the next financial year.
2. Report only the total amount raised, without examining whether the funds were applied for the purposes stated at the time of raising them.
3. Report only when the entire ₹32 crore has been used for an unrelated purpose and no subsequent rectification is possible.
4. Report whether the funds were applied for their stated purpose and provide details of diversion, delay or default and subsequent rectification, if any. (correct answer)

Answer: D — Report whether the funds were applied for their stated purpose and provide details of diversion, delay or default and subsequent rectification, if any.

Explanation. Clause 3(x)(a) of CARO, 2020 requires reporting whether money raised through an initial or further public offer, including debt instruments, was applied for the purposes for which it was raised. Where it was not, details including delays or default and subsequent rectification, if any, must be reported. Management's future intention to restore the funds does not remove the auditor's obligation to report the actual utilisation.

Where it goes wrong. Assuming that temporary diversion or a promise of subsequent restoration removes the requirement to report IPO/FPO fund utilisation.

Authority. CARO, 2020

Question 11 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

The auditor has identified an employee fraud of ₹76 lakh and no Form ADT-4 has been filed. Which statement correctly distinguishes the applicable reporting obligations?

1. Report the fraud under CARO clause 3(xi), including its nature and amount; the section 143(12) reporting route for fraud below ₹1 crore is to the Audit Committee or Board, as applicable. (correct answer)
2. No CARO reporting is required because fraud involving less than ₹1 crore is automatically excluded from paragraph 3(xi).
3. File Form ADT-4 with the Central Government in every case of employee fraud, irrespective of the amount involved.
4. Report only fraud committed by directors because employee fraud is outside the scope of the auditor's reporting responsibility.

Answer: A — Report the fraud under CARO clause 3(xi), including its nature and amount; the section 143(12) reporting route for fraud below ₹1 crore is to the Audit Committee or Board, as applicable.

Explanation. Clause 3(xi) of CARO, 2020 requires reporting whether fraud by or on the company has been noticed or reported, its nature and amount, whether a report under section 143(12) was filed in Form ADT-4, and whether whistle-blower complaints were considered. Under section 143(12) read with Rule 13, fraud below ₹1 crore is reported to the Audit Committee or Board, as applicable. The ₹1 crore threshold does not exempt fraud from CARO reporting.

Where it goes wrong. Importing the ₹1 crore threshold into CARO clause 3(xi), thereby incorrectly excluding smaller frauds from the CARO report.

Authority. CARO; CARO, 2020; section 143

Question 12 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Which basis should the auditor use when evaluating the company's ability to meet liabilities under clause 3(xix) of CARO, 2020?

1. Determine whether the company is profitable on the date of the audit report and whether it expects to obtain new business orders after that date.
2. Evaluate financial ratios, ageing and expected realisation/payment dates, other information, Board and management plans, and whether no material uncertainty exists regarding liabilities due within one year from the balance-sheet date. (correct answer)
3. Consider only management's cash-flow forecast and treat an anticipated refinancing arrangement as committed finance without further evaluation.
4. Examine only liabilities falling due within one year from the audit-report date, without considering the balance-sheet date or expected realisation of assets.

Answer: B — Evaluate financial ratios, ageing and expected realisation/payment dates, other information, Board and management plans, and whether no material uncertainty exists regarding liabilities due within one year from the balance-sheet date.

Explanation. Clause 3(xix) of CARO, 2020 requires the auditor to consider financial ratios, ageing and expected dates of realisation of financial assets and payment of financial liabilities, other information accompanying the financial statements, knowledge of the Board and management plans. The assessment concerns whether, as at the report date, no material uncertainty exists that the company can meet liabilities existing at the balance-sheet date when due within one year from that balance-sheet date. Uncommitted refinancing should not be treated as certain.

Where it goes wrong. Calculating the one-year period from the audit-report date rather than the balance-sheet date, or relying solely on an uncommitted management forecast.

Authority. CARO, 2020

Question 13 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. Which of the following private companies qualifies for the specific private-company exemption under CARO, 2020, assuming all other relevant facts remain unchanged?

Which of the following private companies qualifies for the specific private-company exemption under CARO, 2020, assuming all other relevant facts remain unchanged?

1. A private company with capital and reserves of ₹95 lakh, borrowings of ₹1.20 crore at one point during the year and revenue of ₹8 crore, not linked to a public company.
2. A private company with capital and reserves of ₹90 lakh, borrowings of ₹80 lakh and revenue of ₹9 crore, which is a subsidiary of a public company.
3. A private company not being a subsidiary or holding company of a public company, with capital and reserves of ₹1 crore, borrowings not exceeding ₹1 crore throughout the year and revenue of ₹10 crore. (correct answer)
4. A private company not linked to a public company, with capital and reserves of ₹1.20 crore, borrowings of ₹70 lakh and revenue of ₹8 crore.

Answer: C — A private company not being a subsidiary or holding company of a public company, with capital and reserves of ₹1 crore, borrowings not exceeding ₹1 crore throughout the year and revenue of ₹10 crore.

Explanation. The application provision of CARO, 2020 exempts a private limited company only when it is not a holding or subsidiary company of a public company and all three financial conditions are satisfied: paid-up capital and reserves and surplus not exceeding ₹1 crore at the balance-sheet date, total borrowings from banks or financial institutions not exceeding ₹1 crore at any point during the year, and total revenue, including revenue from discontinuing operations, not exceeding ₹10 crore. Each condition must be satisfied simultaneously.

Where it goes wrong. Treating the private-company exemption as available even when one financial limit is breached or the company is a subsidiary or holding company of a public company.

Authority. CARO, 2020

Question 14 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. A company grants several loans during the year without stipulating any repayment period. A portion is granted to promoters and related parties. Which reporting details are specifically required under CARO, 2020?

A company grants several loans during the year without stipulating any repayment period. A portion is granted to promoters and related parties. Which reporting details are specifically required under CARO, 2020?

1. Only disclose the year-end balance of such loans, irrespective of the aggregate amount advanced during the year.
2. Report only loans granted to directors and exclude amounts advanced to promoters and related parties.
3. Report whether individual borrowers have defaulted and whether the loans have been classified as non-performing assets.
4. Specify the aggregate amount, its percentage of total loans granted, and the aggregate amount granted to promoters and related parties. (correct answer)

Answer: D — Specify the aggregate amount, its percentage of total loans granted, and the aggregate amount granted to promoters and related parties.

Explanation. Clause 3(iii)(f) of CARO, 2020 covers loans or advances in the nature of loans repayable on demand or without specifying repayment terms or periods. The auditor must specify the aggregate amount, its percentage to the total loans granted, and the aggregate amount of loans granted to promoters and related parties as defined in section 2(76). The reporting is not restricted to year-end balances or loans to directors alone.

Where it goes wrong. Confusing reporting on loans without repayment terms with reporting only on the year-end outstanding balance or loans specifically to directors.

Authority. CARO, 2020; section 2

Question 15 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. A company provides a guarantee and grants a loan to an entity connected with one of its directors. The auditor finds that the applicable requirements of sections 185 and 186 have not been complied with. Which CARO treatment is appropriate?

A company provides a guarantee and grants a loan to an entity connected with one of its directors. The auditor finds that the applicable requirements of sections 185 and 186 have not been complied with. Which CARO treatment is appropriate?

1. Report the non-compliance with sections 185 and 186 and provide details relating to the loans, investments, guarantees or security involved. (correct answer)
2. Ignore the matter because a guarantee is not treated as a loan or financial transaction for CARO purposes.
3. Report only the interest income lost by the company, without referring to the Companies Act provisions.
4. Report only when the guarantee is actually invoked by the beneficiary and the company incurs a financial loss.

Answer: A — Report the non-compliance with sections 185 and 186 and provide details relating to the loans, investments, guarantees or security involved.

Explanation. Clause 3(iv) of CARO, 2020 requires the auditor to report, in respect of loans, investments, guarantees and security, whether the provisions of sections 185 and 186 of the Companies Act, 2013 have been complied with. If not, the details of non-compliance must be provided. The requirement is not dependent on a guarantee being invoked or an actual monetary loss having arisen.

Where it goes wrong. Assuming that reporting under sections 185 and 186 is necessary only when the company actually suffers a loss from the transaction.

Authority. CARO; CARO, 2020

Question 16 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. Which combination correctly identifies the borrowing-related matters that the auditor must evaluate under clause 3(ix) of CARO, 2020?

Which combination correctly identifies the borrowing-related matters that the auditor must evaluate under clause 3(ix) of CARO, 2020?

1. Only repayment defaults and interest defaults; utilisation of term loans and funds raised for group entities are outside the clause.
2. Defaults and wilful-defaulter status, end-use of term loans, short-term funds used long-term, funds for obligations of group entities and loans raised by pledging group-company securities. (correct answer)
3. Only non-current borrowings and defaults to scheduled commercial banks; other lenders and debt securities are excluded.
4. Only borrowing balances outstanding at year-end, without examining their utilisation or whether the company is a wilful defaulter.

Answer: B — Defaults and wilful-defaulter status, end-use of term loans, short-term funds used long-term, funds for obligations of group entities and loans raised by pledging group-company securities.

Explanation. Clause 3(ix) of CARO, 2020 covers repayment and interest defaults, declared wilful-defaulter status, utilisation of term loans for their intended purposes, short-term funds used for long-term purposes, funds taken to meet obligations of subsidiaries, associates or joint ventures, and loans raised by pledging securities held in such entities. The clause is wider than repayment default alone and requires the auditor to evaluate the different borrowing circumstances separately.

Where it goes wrong. Limiting clause 3(ix) to the ordinary repayment-default test and overlooking its separate end-use and group-financing disclosures.

Authority. CARO, 2020

Question 17 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. A company registered as a Nidhi Company has Net Owned Funds of ₹80 lakh against deposits of ₹18 crore. It maintains unencumbered term deposits equal to only 8% of its outstanding deposits. What should the auditor examine under CARO, 2020?

A company registered as a Nidhi Company has Net Owned Funds of ₹80 lakh against deposits of ₹18 crore. It maintains unencumbered term deposits equal to only 8% of its outstanding deposits. What should the auditor examine under CARO, 2020?

1. Only whether total deposits exceed ₹10 crore because the Net Owned Funds requirement is applicable only to listed Nidhi companies.
2. Whether the company maintains a Net Owned Funds-to-Deposits ratio of 1:10 and unencumbered deposits of at least 5%.
3. Compliance with the Net Owned Funds-to-Deposits ratio of 1:20 and maintenance of 10% unencumbered term deposits, besides defaults in deposit interest or repayment. (correct answer)
4. Only repayment defaults exceeding 90 days because Nidhi companies are exempt from maintaining unencumbered term deposits.

Answer: C — Compliance with the Net Owned Funds-to-Deposits ratio of 1:20 and maintenance of 10% unencumbered term deposits, besides defaults in deposit interest or repayment.

Explanation. Clause 3(xii) of CARO, 2020 requires reporting whether a Nidhi company complies with the Net Owned Funds-to-Deposits ratio of 1:20 and maintains 10% unencumbered term deposits as specified under the Nidhi Rules, 2014. It also requires reporting any default in payment of deposit interest or repayment for any period. The stated 8% maintenance is below the specified 10% requirement.

Where it goes wrong. Confusing the prescribed 1:20 ratio and 10% unencumbered deposit requirement with different prudential thresholds.

Authority. CARO, 2020

Question 18 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. During the audit, the company enters into a material transaction with a related party. The transaction is disclosed in the notes but prior Audit Committee approval under the applicable provisions has not been obtained. Which reporting consideration is most appropriate?

During the audit, the company enters into a material transaction with a related party. The transaction is disclosed in the notes but prior Audit Committee approval under the applicable provisions has not been obtained. Which reporting consideration is most appropriate?

1. No CARO reporting is necessary because disclosure in the notes automatically cures non-compliance with the statutory approval requirements.
2. Report only whether the transaction has been recorded at arm's-length value, without considering statutory approvals.
3. Report only the amount of the related-party transaction and omit compliance with sections 177 and 188.
4. Report whether related-party transactions comply with sections 177 and 188, where applicable, and whether disclosures comply with applicable accounting standards. (correct answer)

Answer: D — Report whether related-party transactions comply with sections 177 and 188, where applicable, and whether disclosures comply with applicable accounting standards.

Explanation. Clause 3(xiii) of CARO, 2020 requires reporting whether transactions with related parties comply with sections 177 and 188 of the Companies Act, 2013, where applicable, and whether the details have been disclosed in the financial statements in accordance with the applicable accounting standards. Accounting disclosure does not independently cure a failure to obtain required statutory approval. Both compliance and disclosure must be examined.

Where it goes wrong. Treating financial statement disclosure as a substitute for compliance with the statutory approval requirements governing related-party transactions.

Authority. CARO, 2020

Question 19 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. A large listed manufacturing company has appointed an internal auditor, but the statutory audit team did not obtain or consider the internal auditor's reports for the period under audit. Which statement correctly identifies the CARO requirement?

A large listed manufacturing company has appointed an internal auditor, but the statutory audit team did not obtain or consider the internal auditor's reports for the period under audit. Which statement correctly identifies the CARO requirement?

1. The auditor should report whether the internal audit system is commensurate with the company's size and nature of business and whether internal audit reports were considered. (correct answer)
2. No reporting is required because appointment of an internal auditor automatically establishes that the system is adequate and effective.
3. The auditor must report only whether internal audit findings were communicated to the Board, irrespective of the adequacy of the system.
4. The auditor should report only the qualifications of the internal auditor and whether the internal auditor is independent of management.

Answer: A — The auditor should report whether the internal audit system is commensurate with the company's size and nature of business and whether internal audit reports were considered.

Explanation. Clause 3(xiv) of CARO, 2020 contains two distinct requirements. The auditor reports whether the company has an internal audit system commensurate with the size and nature of its business and whether the reports of internal auditors for the period under audit were considered by the statutory auditor. Appointment alone does not establish that the internal audit system is commensurate or that its reports were considered.

Where it goes wrong. Assuming that the existence or appointment of an internal auditor automatically satisfies both reporting requirements.

Authority. CARO; CARO, 2020

Question 20 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. A company acquires an immovable property from a director through a non-cash arrangement involving the transfer of shares held by the company. The transaction is not settled through cash. Which CARO reporting requirement is relevant?

A company acquires an immovable property from a director through a non-cash arrangement involving the transfer of shares held by the company. The transaction is not settled through cash. Which CARO reporting requirement is relevant?

1. Clause 3(xiii), because every transaction involving a director is automatically classified as a related-party transaction for this reporting purpose.
2. Clause 3(xv), requiring reporting of non-cash transactions with directors or persons connected with them and compliance with section 192. (correct answer)
3. Clause 3(xi), because every non-cash transaction involving a director necessarily represents fraud by the company.
4. Clause 3(i)(c), because every non-cash property acquisition is exempt from title-deed reporting requirements.

Answer: B — Clause 3(xv), requiring reporting of non-cash transactions with directors or persons connected with them and compliance with section 192.

Explanation. Clause 3(xv) of CARO, 2020 requires reporting whether the company has entered into non-cash transactions with directors or persons connected with them and, if so, whether section 192 of the Companies Act, 2013 has been complied with. The non-cash nature of the arrangement makes the clause relevant. Other CARO clauses may independently apply to related-party compliance or property title deeds, but do not replace this specific reporting requirement.

Where it goes wrong. Confusing the reporting of non-cash transactions under section 192 with the broader reporting requirements for related-party transactions under sections 177 and 188.

Authority. CARO; CARO, 2020; section 192

Question 21 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. A company has started providing housing finance activities and holds investments in several companies. The auditor finds that it may be required to register as an NBFC under the RBI Act and that it also claims to be a Core Investment Company. Which CARO reporting area should be examined?

A company has started providing housing finance activities and holds investments in several companies. The auditor finds that it may be required to register as an NBFC under the RBI Act and that it also claims to be a Core Investment Company. Which CARO reporting area should be examined?

1. Clause 3(v), because every activity involving financial investments is treated as acceptance of deposits.
2. Clause 3(iii), because all investments made by a company automatically establish that RBI registration is compulsory.
3. Clause 3(xvi), including the requirement of registration under section 45-IA, validity of the CoR for NBFC/HFC activity, CIC criteria and the number of CICs in the group. (correct answer)
4. Clause 3(ix), because RBI registration is relevant only where the company has defaulted in repayment of financial borrowings.

Answer: C — Clause 3(xvi), including the requirement of registration under section 45-IA, validity of the CoR for NBFC/HFC activity, CIC criteria and the number of CICs in the group.

Explanation. Clause 3(xvi) of CARO, 2020 requires the auditor to report whether the company is required to be registered under section 45-IA of the RBI Act and whether it has obtained registration, whether NBFC or Housing Finance activities were conducted without a valid Certificate of Registration, whether it continues to fulfil CIC criteria, and whether the group has more than one CIC. It is not merely a test of investment activity or borrowing defaults.

Where it goes wrong. Assuming that any investment-holding company automatically requires RBI registration without examining the applicable NBFC or CIC requirements.

Authority. CARO; CARO, 2020; section 45

Question 22 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. A company incurred cash losses of ₹85 lakh in FY 2025-26 but earned a small cash profit in FY 2024-25. Its statutory auditor also resigned during FY 2025-26 after raising accounting concerns. Which reporting combination is appropriate?

A company incurred cash losses of ₹85 lakh in FY 2025-26 but earned a small cash profit in FY 2024-25. Its statutory auditor also resigned during FY 2025-26 after raising accounting concerns. Which reporting combination is appropriate?

1. Report the cash loss only if it continues for three consecutive financial years and disclose only resignations after an adverse report.
2. Report both matters only when the company is also unable to meet its liabilities within one year of the balance-sheet date.
3. Report the cash losses together for both years and automatically adopt the outgoing auditor's objections as qualifications.
4. Report the cash loss for the current year; separately state that an auditor resignation occurred and whether the outgoing auditor's concerns were considered. (correct answer)

Answer: D — Report the cash loss for the current year; separately state that an auditor resignation occurred and whether the outgoing auditor's concerns were considered.

Explanation. Clause 3(xvii) of CARO, 2020 requires reporting whether the company incurred cash losses during the current and immediately preceding financial years and stating the amount where applicable. Clause 3(xviii) separately requires reporting any resignation of statutory auditors during the year and whether issues, objections or concerns raised by outgoing auditors were considered. The previous year's profit does not remove the current-year cash-loss disclosure.

Where it goes wrong. Assuming that cash losses must occur in both years before reporting or that the incoming auditor must automatically adopt every objection of the outgoing auditor.

Authority. CARO, 2020

Question 23 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. A company has unspent CSR money relating to a project that is not an ongoing project. It also has unspent CSR money relating to a qualifying ongoing project. Which statement correctly applies clause 3(xx)?

A company has unspent CSR money relating to a project that is not an ongoing project. It also has unspent CSR money relating to a qualifying ongoing project. Which statement correctly applies clause 3(xx)?

1. Transfer the non-ongoing-project amount to a Schedule VII Fund within six months of expiry of the financial year and the ongoing-project amount to the special account as required under section 135(6). (correct answer)
2. Transfer both amounts to the Schedule VII Fund within three months of year-end because ongoing and non-ongoing projects receive identical treatment.
3. Transfer the non-ongoing-project amount to a special account and the ongoing-project amount to a Schedule VII Fund within six months.
4. Retain both amounts in the company's general bank account until management decides which projects will receive funding.

Answer: A — Transfer the non-ongoing-project amount to a Schedule VII Fund within six months of expiry of the financial year and the ongoing-project amount to the special account as required under section 135(6).

Explanation. Clause 3(xx) of CARO, 2020 distinguishes unspent CSR amounts relating to ongoing and other projects. Under clause 3(xx)(a), the non-ongoing-project amount is transferred to a Fund specified in Schedule VII within six months of expiry of the financial year under the second proviso to section 135(5). Under clause 3(xx)(b), the amount relating to an ongoing project is transferred to the special account required by section 135(6).

Where it goes wrong. Reversing the destination of the two unspent CSR amounts or applying the same transfer deadline to both categories.

Authority. CARO, 2020; section 135

Question 24 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. A holding company prepares consolidated financial statements incorporating two subsidiaries. One subsidiary's CARO report contains a qualification regarding inventory records, while the other contains an adverse remark regarding statutory dues. What must the auditor of the consolidated financial statements do?

A holding company prepares consolidated financial statements incorporating two subsidiaries. One subsidiary's CARO report contains a qualification regarding inventory records, while the other contains an adverse remark regarding statutory dues. What must the auditor of the consolidated financial statements do?

1. Apply all 21 CARO clauses afresh to the consolidated financial statements and reproduce every subsidiary's complete CARO report.
2. Report the qualifications or adverse remarks contained in the CARO reports of the companies included in the consolidated financial statements, identifying the companies and relevant paragraph numbers. (correct answer)
3. Ignore both matters because CARO, 2020 does not apply to consolidated financial statements under any circumstances.
4. Report only the qualification affecting the subsidiary with the largest assets and omit the adverse remark in the other subsidiary.

Answer: B — Report the qualifications or adverse remarks contained in the CARO reports of the companies included in the consolidated financial statements, identifying the companies and relevant paragraph numbers.

Explanation. The application provision of CARO, 2020 excludes the auditor's report on consolidated financial statements from the Order except for clause 3(xxi). Under that clause, the auditor reports whether qualifications or adverse remarks exist in the respective CARO reports of companies included in the consolidated financial statements. Where applicable, the auditor must identify the companies and paragraph numbers containing those qualifications or adverse remarks.

Where it goes wrong. Remembering the general exclusion of consolidated financial statements but overlooking the express exception under paragraph 3(xxi).

Authority. CARO; CARO, 2020

Question 25 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. During an audit, the company has failed to maintain adequate records showing full particulars and quantitative details of machinery. It also has not physically substantiated its PPE at reasonable intervals. Separately, proceedings have been initiated against the company for holding benami property. Which reporting approach is correct?

During an audit, the company has failed to maintain adequate records showing full particulars and quantitative details of machinery. It also has not physically substantiated its PPE at reasonable intervals. Separately, proceedings have been initiated against the company for holding benami property. Which reporting approach is correct?

1. Report only the absence of PPE records because physical verification and benami proceedings fall outside the scope of clause 3(i).
2. Report the benami proceedings only if the property has already been confiscated by the competent authority.
3. Report the adequacy of PPE and intangible asset records, physical verification and related discrepancies, and whether benami-property proceedings and their details have been appropriately disclosed. (correct answer)
4. Report only the carrying value of machinery and omit the remaining matters if management has provided a written representation.

Answer: C — Report the adequacy of PPE and intangible asset records, physical verification and related discrepancies, and whether benami-property proceedings and their details have been appropriately disclosed.

Explanation. Clause 3(i)(a) of CARO, 2020 covers proper records of PPE, including quantitative details and location, and records of intangible assets. Clause 3(i)(b) requires reporting on physical verification of PPE at reasonable intervals and treatment of material discrepancies. Clause 3(i)(e) covers benami-property proceedings initiated or pending against the company and appropriate disclosure of their details in the financial statements. Management representations cannot replace these reporting procedures.

Where it goes wrong. Treating the PPE-record requirement as the entire scope of clause 3(i) and overlooking separate requirements for verification and benami-property proceedings.

Authority. CARO, 2020