Audit Report 2015 - is it a nightmare or a labor-pain?

The auditing community had really gone through a rough and tough time in the form of ‘labor pain’ in drafting the audit report under section 143 (3) of the Companies Act 2013 for the financial year ended march 2015 due to last minute rush of MCA orders/clarifications and on some issues/ guidelines that were still awaited at the time of finalizing the audit report as on that date. No doubt, it is appreciated that MCA has issued prescribed Rules under various Chapters well in time in spite of the fact that Rules constitute 74% of the total sections under the new Act as against 16% under the departed Act as detailed hereunder. It is hats off.

Nonetheless, owing to the various new obligations, responsibilities and commitments, the new Act had thrown some unexpected and surprising twists and turns with regard to drafting of audit reports under Sec. 143 of the Act on account of still awaiting instructions/ guidance on specific issues and as a result best judgmental approach was called for and relied upon. It was a real labor pain since the persons who had gone through only will feel the pinch. It is appropriate to apply the phrase ‘labor pain’, since it precedes the delivery to stake holders. The issues of delivery that bothered are very many. But, in this delivery of audit report, there is no short cut to save the pains by or through caesarian. It is why this article to understand the depth of problems that are faced on certain issues for which no precedents to follow or fall back up on.

Under section 143 (2) of the Companies Act 2013, ‘The auditor shall make a report to the members of the company on the accounts examined by him and on every financial statements which are required by or under this Act to be laid before the company in general meeting..’ 

Again, under Sec.137 (1), ‘A copy of the financial statements, including consolidated financial statement, if any, along with all the documents which are required to be or attached to such financial statements under this Act, duly adopted at the annual general meeting of the company, shall be filed with the Registrar within thirty days of the date of annual general meeting in such manner, with such fees or additional fees as may be prescribed within the time specified under section 403’. Therefore, it is clear that even consolidated financial statements are also to be adopted at AGM.

Under Section.129 (3), ‘Where a company has one or more subsidiaries, it shall, in addition to financial statements provided under sub-section (2), prepare a consolidated financial statement of the company and of all the subsidiaries in the same form and manner as that of its own which also be laid before the annual general meeting of the company along with the laying ofits financial statement under sub-section (2)’

Now, two questions arise.

The first is to whom the auditor’s report is to be addressed?

In the light of the said sections quoted above wherein the emphasis is that CFSs are to be prepared in the same form and manner as that of its own and are to be adopted in General Meeting. It appears appropriate that auditor’s report on consolidated financial statements is addressed to the Members.  But, in earlier dispensation, the report was addressed to The Board of Directors, since consolidation was not mandatory under the previous act. But, as on date, it was a bone of contention and hence there was a divided view. But, the ICAI has come forward, though a little late, with a clear stand on addressing to the members taking into view of the mandatory requirement of consolidation and its adoption in the general body meeting.

The second question relates to preparation of consolidated accounts.

Whether is it required to ‘Report on other Legal and Regulatory Requirements?

The proviso to Section 143 (1) (f) runs as follows;

‘Provided that the auditor of a company which is a holding company shall also have the right of access to the records of all its subsidiaries in so far as it relates to the consolidation of its financial statements with that of its subsidiaries’.

 Again, Section 129(3) as dealt with above deals with preparation of a consolidated financial statement of the company and of all the subsidiaries in the same form and manner as that of its own. It does not deal with audit report per say.  Guidance Note –already prevailing on consolidated financial statements to be read with As 21 gives illustrative audit reports that naturally do not report on other legal and regulatory requirements, the explanation that may be given will naturally be it is for dispensation under companies’ act 1956.There has been one strong view floating among audit community, it may not be relevant for including regulatory requirements in consolidation since indented for standalones since it is entity specific though the requirements for the preparation of consolidation is mentioned under section 129(3). The ground reality has not changed except that it is made mandatory for companies dealt with in the section.  Here again, audit community has been in quandary for reason a clarification is long overdue.

The auditor’s report shall also state among other things under ASs 700/705/706, a ‘Report on Other Legal and Regulatory Requirements as required by Section 143 (3) of the Act’ So far so good. AASB has issued six Illustrative Auditor’s Report Formats under Companies Act, 2013. - (16-12-2014). But, all relate to stand alone financial statements. ICAI has once again come forward, though a bit late, with two Illustrative Auditors Report Formats, that settles the whole issue. Now that ‘Report on other Legal and Regulatory Requirements are also to be part and parcel of consolidated audit reports, the confusion surrounding the issue is settled once for all, for which once again a great Salute.

Suspense on the new CARO:

The next issue that caused a little breathless condition is as regards the new Companies (Auditor’s Report) Order, 2015 under Section 143(11) of the Companies Act 2013. This order 0rder was issued by MCI as late as on10th April 2015, again with a caveat that it is effective from the date it is published in gazette-that it is yet to see the light of the day. Though the delay in the issue of new CARO is understandable for reason a lot of issues are to be addressed in the changed environment thanks to the demands and calls of the new act, the audit community is at a loss to understand the delay in getting it in gazette   But, one saving feature is that the matters to be included in the CARO is sizably reduced.

Fraud Reporting under Section 143 (12):

The ICAI Guidance Note on Fraud reporting is copiously dealing with various issues in dealing with fraud with special focus on limitations on auditors in dealing with fraud. The author’s article on fraud reporting in the May 2015 issue of CA Journal has to the extent possible handled the various concerns on fraud mainly based on the GN which runs more than 150 pages. But, the unresolved point is as regards the absence of materiality concept in Section 143 (12) for the purpose of reporting fraud to central government. Though Lok-Sabha has passed an amendment to keep fraud involving a lesser than a specified amount outside the purview of the act so that the Bill concentrates on big fishes, it was pending in Rajya-Sabha for quite some time. Until then when the audit report was finalized, it was anybody’s judgment/ guess.  Though the upper house has cleared the amendment since then, the specified amount spelt out in the amendment, it is not yet prescribed. Again, is it not a point of worry?

IFCI under Section 143 3(i):

Under the above section, the auditor has to report whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls. The Institute has already issued a GN that’s running more than 350 pages that’s under revision. Knowing the enormity of work involved, this obligation was made optional for 2014-15 but is obligatory thereafter. In fact, GN suggests a separate report as an addendum to the main audit report taking into consideration the areas to be covered. Because of the heavily loaded responsibility, the audit community shall gear up for this challenge to squarely meet this responsibility arising of the new obligation. We will cross the bridge when it comes. In fact, this demands a separate article to cover up comprehensively.

Clauses (f) and (h) of Section 143 (3) of the Act:

Again, under clause (f) of sub section 3 of Section 143,‘the observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company;’ further, under clause (h)‘any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith;’ are to be stated.

What’s the difference between ‘adverse effect on the functioning of the company’ under sub clause (f) and ‘adverse remark relating to the maintenance of accounts and other matters connected therewith’ dealt with in clause (h) of the sub section?

ICAI has clarified the difference between the inner intents of both the clauses clearly and in compact, though both the clauses appear to travel on same territory on certain issues. Since clause (h) of section 143(3) requires the auditor to report under this clause only if the auditor has “any qualification, reservation or adverse remark”, it is appropriate to conclude that a matter reported under emphasis of matter paragraph in the audit report need not be considered for reporting under this clause as an emphasis of matter is not in the nature of a qualification, reservation (disclaimer) or adverse remark.

Ordinarily matters that are pervasive in nature such as going concern or matters that will significantly impact the operations of the company due to its size and nature will need to be reported under clause (f) of sub-section (3) of section 143 of the Act. Examples of emphasis of matter which may have an adverse effect on the functioning of the company are also highlighted in the GN. Again this is another cap on the feather to ICAI to come out with a GN on the clauses to bring precision without which the audit community will be loitering in wilderness in the eleventh hour of audit.

How many GNs on various sub sections of Section 143 of the Act? Really mind boggling since at short span of time?

Conclusion:

The above are the short list of various tests and trials; tasks and challenges that are confronted, being the first operational year of drafting audit reports. Besides, under various sections certain hard decisions based on judgmental calls are to be taken. Take, for example, trade advances lying for more than 365 days that are deposits under the new act—whether to be reported under relevant clause of the CARO even when the Company has not gone for public deposits is a million dollar question and if so, how to be reported. Schedule III on Financial Statements since primarily based on Revised schedule VI of the earlier year, the passage was smooth and easier. Schedule II on Depreciation is based on useful life, a prelude to IFRS regime, though fraught with initial hiccups, nearly made easy, thanks to the GN on Depreciation from ICAI. Regarding Exceptional items, clarity is required neither since not defined in Schedule III nor in AS 5 on Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies, though GN on Revised Schedule VI touch upon Para 12 to 14 of the above standard for deciphering exceptional items. Since those Para do not specifically mention about exceptional items but material items, clarity here will help diverse approach by various entities. Therefore, it is high time the ICAI stepped in to design to follow similar/same approach across the table.