Understanding PP&E Clauses in the CARO Audit Report

The Companies (Auditor’s Report) Order (CARO) was introduced by the Ministry of Corporate Affairs (MCA) to enhance the quality of financial reporting and ensure transparency in company disclosures. Specifically, it applies to audits of financial years starting from April 1, 2021, under CARO 2020, which includes expanded reporting requirements for Property, Plant, and Equipment (PP&E).

The purpose of these reporting requirements is to ensure that companies maintain accurate and reliable records of their physical assets, which is critical for assessing a company’s financial health.

Let’s look at these clauses in detail. 

High-Level Overview of Key Provisions for PP&E Audit

The Companies (Auditor’s Report) Order (CARO) 2020 outlines specific clauses to ensure the accurate management, verification, and compliance of Property, Plant, and Equipment (PP&E) within a company’s financial reporting. The following are the critical areas auditors must address:

1. Maintenance of Proper Records (Paragraphs 3(i)(a)(A) and 3(i)(a)(B)):
   • Auditors must verify whether the company is maintaining detailed records for PP&E, including:
     • Full particulars such as asset description, identification, and categorization.
     • Quantitative details and their physical location.

2. Physical Verification of Assets (Paragraph 3(i)(b)):
   
   Auditors need to check if PP&E has been physically verified by the company at reasonable intervals. Any material discrepancies identified during verification must be:
   • Clearly disclosed.
   • Properly adjusted in the books of account.

3. Title Deeds of Immovable Properties (Paragraph 3(i)(c)):
   • This clause requires the auditor to examine whether the title deeds for all disclosed immovable properties (excluding leased properties) are in the company’s name.

   • If not, detailed disclosure is required, including:
     • The name in which the property is held.
     • Its relationship to the company (e.g., promoter, director, relative, or employee).
     • The reason for not being in the company’s name and whether the property is in dispute.

4. Revaluation of Assets (Paragraph 3(i)(d)):
   • Auditors must verify whether the company has revalued its PP&E or intangible assets during the year.
   • If revaluations result in a 10% or more change in the net carrying value of a class of assets, the details must be disclosed.
   • The revaluation must be conducted by a registered valuer to ensure accuracy and compliance.

5. Benami Property Proceedings (Paragraph 3(i)(e)):
   • Auditors need to verify if any proceedings have been initiated or are pending against the company under the Prohibition of Benami Property Transactions Act, 1988.
   • If so, the financial statements must disclose:
     • Details of the proceedings, including the nature and status.
     • The company’s view on the matter.

Audit Procedures and Reporting for Property, Plant, and Equipment (PPE)

Acceptance of Electronic PPE Registers:

The auditor may accept an electronic PPE register if the following two conditions are satisfied:

1. Controls and Security: The register cannot be altered without proper authorization and maintains an audit trail.
2. Retrievability: It must be retrievable in a legible form, either on-screen or as a hard copy.

If these conditions are unmet, the auditor should obtain an authenticated printout. For reliance on electronic registers, auditors must document evaluations of controls ensuring completeness, accuracy, and security of the register. This aligns with SA 315 and the Guidance Note on Audit of Internal Financial Controls Over Financial Reporting issued by ICAI.

Verification and Custody:

• Asset Location Records: Where assets such as construction equipment have movable locations, records of movement or custody must be maintained. For furniture and similar items located at employees’ residences, the PPE register should note the responsible individual.
• Grouping Assets: Low-value assets, such as chairs and tables, can be grouped in the register. For assets with the same useful life, group-level depreciation reporting is acceptable.

Classification and Quantitative Details:

• Land: Identified by survey numbers or deeds.
• Leaseholds: Classified by individual leases.
• Buildings: Sub-divided into types such as factory, office, or service buildings, and further by location, construction type, and year.
• Plant and Machinery: Categorized as movable or immovable, with further sub-division by process or operational independence.
• Furniture, Appliances, and Fittings: Identified individually for high-value items; others may be grouped.
• Vehicles: Referenced by registration books.
• Development Work: Classified by project type or associated buildings/plants.

Allocation of Costs:

• Cost allocation may involve analysis of past purchases and disposals, factoring in missing or incomplete records. Approximations are permissible, such as assuming oldest assets were sold first.

Initial Asset Identification:

• Assets should initially be identified by knowledgeable personnel (e.g., maintenance staff) and coded for future reference. Discrepancies in records and verified assets should be reconciled based on factors like cost, age, and materiality. Adjustments must be documented, with appropriate management action requested.

Reporting Gaps:

• The absence of a PPE register constitutes a significant documentation and control deficiency and must be highlighted in the auditor’s report.

This guidance emphasizes rigorous verification, accurate documentation, and effective controls to ensure reliable PPE reporting in compliance with CARO 2020 and relevant ICAI standards.

 

Physical Verification of Property, Plant, and Equipment (PPE): Audit Considerations

Clause Requirement

This clause under CARO 2020 requires the auditor to report whether the company’s Property, Plant, and Equipment (PPE) have been physically verified by the management at reasonable intervals. The auditor must also confirm whether any material discrepancies observed during the verification process have been appropriately recorded in the books of account.

Key Provisions

1. Scope of PPE:
   • Includes Right-of-Use (ROU) assets under Ind AS 116, where the company has the right to use an asset through a lease.
   • Covers Investment Property under Ind AS 40 and Non-current Assets Held for Sale under Ind AS 105.

2. Management Responsibility:
   • The management is responsible for conducting physical verification. The auditor’s role is to evaluate the adequacy and evidence of such verification.

Audit Procedures and Verification Methods

1. Observing the Process:
   • The auditor may observe the verification if conducted on a single day or over a short period.
   • If the process is continuous or the auditor is not present during verification, they should review:
     • Written instructions issued to the staff.
     • Working papers and records of the personnel involved in the verification.
   • The qualifications and technical knowledge of the individuals performing the verification should also be assessed.

2. External Verification:
   • If an external agency conducts the verification, the auditor must evaluate the competence of the agency and their findings.
3. Verification Approach:
   • The method of verification must be reasonable and context-appropriate.
   • For assets like buildings, measurement is generally unnecessary unless alterations or demolitions are evident.
   • Indirect evidence (e.g., operational output in process industries) may suffice if physical inspection is impractical.
   • Open land should be periodically surveyed to prevent encroachments.
4. Marking Assets:
   • Movable assets should have distinctive identifiers for easy tracking, especially if they are verified at different times.

Reasonable Intervals

What constitutes “reasonable intervals” depends on factors such as:

• Number, nature, and value of assets.
• Geographical spread and operational constraints.

Generally:

• Annual verification is preferred.
• For complex cases, all assets should be verified at least once every three years.

If all assets are not verified during the year, the auditor should disclose this fact but may affirm the appropriateness of the frequency.

Material Discrepancies

1. Auditor’s Responsibility:
   • The auditor must report if any material discrepancies were noticed during the verification process and confirm whether they were properly recorded in the books of account.
2. Judging Materiality:
   • Professional judgment is crucial. Factors to consider include:
     • Cost relationship: The cost of the asset compared to the total asset value.
     • Operational significance: The asset’s role in critical operations or production.
     • Nature of discrepancy: For instance, missing or damaged mission-critical assets warrant higher scrutiny.
     • Industry and business context: Materiality thresholds vary by industry and business size.
3. Reporting Requirements:
   • If discrepancies are material but properly accounted for, the auditor need not provide details. Instead, they should confirm that discrepancies were identified and addressed appropriately.
   • If discrepancies are not properly dealt with, the auditor must disclose this failure.

Factors Affecting Materiality

• The value of the discrepancy in relation to the company’s total assets.
• The importance of the asset in operations (e.g., critical machinery).
• Location and condition of the asset.
• A material discrepancy is one that, if unreported, would misrepresent the company’s financial position regarding PPE.

By addressing these aspects, the auditor ensures that the company maintains accountability and transparency in managing its tangible assets.

Title Deeds of Immovable Properties

Auditors must verify whether the title deeds of all immovable properties disclosed in the financial statements are in the company’s name (excluding leased properties with duly executed lease agreements). If not, the auditor must report details in a prescribed format, including property description, gross carrying value, current holder, and reasons for discrepancies.

Relevant Provisions:

1. Scope of Immovable Property:
   
   Defined under the General Clauses Act, 1897, as land, benefits arising from land, and items permanently attached to the earth. For companies under Ind AS:
   • Right-of-use (ROU) assets (under Ind AS 116) must also be reported.
   • Investment properties (Ind AS 40) and non-current assets held for sale (Ind AS 105) are included.
   • Excludes inventory items like real estate stock or non-PPE properties.
2. Title Deeds Definition:
   
   Refers to legal documents establishing ownership, such as sale deeds, transfer deeds, or government allotments. For leased properties, this includes lease agreements.

Audit Procedures and Reporting Requirements:

1. Verification Process:
   • Auditors review the Property, Plant, and Equipment (PPE) register to identify immovable properties.
   • Verify title deeds and compare with company disclosures.
2. Special Cases:
   • If properties are transferred due to mergers or conversions (e.g., from LLPs), deeds may still be in the prior entity’s name.
   • For properties mortgaged to banks, obtain confirmation from the institution.
3. Lost Title Deeds:
   • Certified copies and an FIR report must be obtained if deeds are lost.
   • Management must provide written representation on these matters.
4. Legal Clarity:
   • Discrepancies, disputes, or pending litigation over ownership must be discussed with management and documented.
   • Auditors may seek advice from legal counsel for complex cases.

Key Disclosures:

If title deeds are not in the company’s name, the auditor must report:

1. Property Description: Include location and relevant identification details.
2. Value: Gross carrying amount in the company’s records.
3. Current Holder: Identify if the property is held by a promoter, director, relative, or employee.
4. Holding Period: Specify how long the property has been held this way.
5. Reason: State why the property is not in the company’s name (e.g., ongoing registration processes).

Auditors are not directly responsible for reporting issues with leased properties unless lease agreements are incomplete or improperly executed. Any irregularities in sub-leases or informal arrangements should also be disclosed.

Additional Considerations:

• Discrepancies: Differences between the PPE register and title deed details (e.g., ownership transfers or errors) must be analyzed and clarified.
• Litigation or Disputes: Cases involving disputes over property titles require detailed investigation and may necessitate collaboration with legal experts.
• Reporting Format: Auditors must ensure their reports include all required details and are supported by sufficient evidence.

Explanation and Summary of Clause 45: Revaluation of Property, Plant, and Equipment (PPE), Right of Use (ROU) Assets, and Intangible Assets

This clause requires auditors to verify whether a company has revalued its PPE (including ROU assets) or intangible assets during the year. It also mandates reporting on whether the revaluation was performed by a registered valuer and specifying the amount of change if it exceeds 10% of the aggregate net carrying value of each asset class.

Key Provisions

1. Definition of Revaluation:
   • Adjusting the carrying value of assets to reflect significant changes in their fair market value.
   • Revaluation may not be required annually but should ensure alignment with fair value.
2. Accounting Standards:
   • AS 10 (Revised) and Ind AS 16 permit two accounting models for PPE:
     • Cost Model: Allows only downward adjustments due to impairment.
     • Revaluation Model: Allows both upward and downward adjustments.
   • Reporting under this clause applies only to the revaluation model.
3. Exclusions:
   • Fair valuation upon first-time adoption of Ind AS.
   • Changes in value due to interest or foreign exchange fluctuations.
   • Modifications to ROU assets under Ind AS 116.

Audit Procedures and Reporting

1. Verification of Revaluation Process:
   • Confirm whether the revaluation is conducted by a registered valuer per Section 247 of the Companies Act.
   • Check disclosures in the financial statements per Schedule III of the Act.
2. Considerations for Revaluation:
   • If one item of a PPE class is revalued, the entire class must be revalued.
   • Cross-check compliance with the Companies (Registered Valuers and Valuation) Rules, 2017, which define asset classes such as land, buildings, and machinery.
3. Information Required for Reporting:
   • Date and details of the revaluation.
   • Name, license, and registration details of the valuer.
   • Methods and assumptions used in the valuation.
   • Review of the valuation report and fair value estimation.
4. Auditor’s Review:
   • Ensure proper accounting treatment of revaluation surplus.
   • Document the valuation report as part of audit records (SA 230, “Audit Documentation”).
   • Specify the change amount if it exceeds 10% of the net carrying value of each asset class.
5. Compliance with Auditing Standards:
   • While the registered valuer’s work is not treated as an auditor’s expert under SA 620, auditors must evaluate the evidence provided using SA 500 (“Audit Evidence”).

Key Takeaways for Auditors

• Ensure revaluations are backed by a registered valuer’s report and comply with the Companies Act and applicable rules.
• Pay attention to the 10% threshold for reporting material changes in the net carrying value of asset classes.
• Maintain detailed documentation of all supporting evidence, including the valuation report, disclosures, and accounting adjustments.
• Apply professional skepticism when using the work of a management expert (e.g., a registered valuer).

This clause emphasizes transparency and accuracy in reporting revalued assets to prevent misrepresentation of the company’s financial position.

Explanation of the Clause on Reporting Benami Property under CARO 2020

This clause mandates auditors to assess whether a company is involved in proceedings under the Prohibition of Benami Property Transactions Act, 1988 (earlier known as the Benami Transactions (Prohibition) Act, 1988). If proceedings have been initiated or are pending, auditors must ensure proper disclosure in the company’s financial statements.

Auditor’s Responsibilities:

1. Scope of Reporting:
   • Check if proceedings under Section 24(1) of the Prohibition of Benami Property Transactions Act, 1988 have been initiated during the reporting period.
   • Verify pending proceedings before authorities like the Initiating Officer (IO), Adjudicating Authority, Appellate Tribunal, High Court, or Supreme Court.
2. Disclosure Requirements:
   • Ensure that disclosures are included in the financial statements, covering:
     • Details of the property (e.g., acquisition year, amount).
     • Beneficiaries.
     • Balance sheet references if the property is recorded in books.
     • Reasons for non-recording if the property is not in the books.
     • Nature, status, and company’s view on ongoing proceedings.
3. Liabilities and Contingencies:
   • Evaluate if liabilities arising from the proceedings are to be reported as contingent liabilities or provisions, based on the case’s merits.
4. Subsequent Events:
   • Consider events post-balance sheet date but before signing the audit report, as per SA 560, Subsequent Events.
5. Audit Procedures:
   • Inquire with management and obtain representation letters.
   • Review legal expenses and board meeting minutes for indications of benami-related proceedings.
   • Adhere to SA 250 (Consideration of Laws and Regulations in an Audit of Financial Statements) and SA 501 (Audit Evidence – Specific Considerations for Selected Items).

Understanding Key Concepts:

1. Benami Property and Transactions (Definitions):
   • Benami Property: Assets held under another person’s name where the consideration was provided by someone else, with the intent of concealing ownership.
   • Benami Transaction: Includes fictitious arrangements or those where the true owner denies ownership or cannot be traced.

2. Initiating Officer (IO):
   • An IO, typically an Assistant/Deputy Commissioner of Income Tax, investigates suspicious transactions, records reasons for suspicion, and issues a show cause notice to the alleged owner (benamidar) under Section 24(1).

Steps for Audit Reporting:

1. Verify if any Section 24(1) notices were issued.
2. Review whether disclosures align with Schedule III requirements:
   • Include the property’s impact on financials and liabilities.
   • Provide sufficient detail to inform stakeholders of risks and outcomes.
3. Report only on cases where the company is identified as a benamidar (not as a beneficial owner).

Auditor’s Limitations:

The reporting obligation is restricted to the adequacy of disclosures in financial statements, and cases involving the company as a benamidar. It does not extend to instances where the company is merely the beneficial owner.

Annexure A – Relevant Legal Definitions:

• Benami Property: Any asset, tangible or intangible, owned or held under another’s name or involving fictitious ownership.
• Benamidar: The individual or fictitious person in whose name the property is held.
• Property: Includes all assets, legal documents, or proceeds derived from properties.

This clause ensures transparency in financial reporting by addressing compliance with laws on benami properties and their implications for stakeholders.

Conclusion

The clauses discussed in this thread, as outlined under CARO 2020 (Revised 2022), are specifically tailored for audits of Property, Plant, and Equipment (PP&E).

These provisions aim to ensure that companies adhere to legal and regulatory standards while maintaining accurate and transparent financial records related to their tangible assets. The following key takeaways summarize the importance of these clauses:

Key Takeaways:

1. PP&E Register Maintenance and Ownership Verification:
   A well-maintained PP&E register is the cornerstone of asset accountability. These clauses emphasize the need for companies to document full particulars of their assets, including quantitative details and locations, ensuring accurate tracking and ownership verification. Auditors also assess issues like benami properties, disputed titles, or encumbrances to validate ownership records.

2. Physical Verification:
   Regular physical verification is crucial to substantiate the records in the PP&E register. The guidance mandates auditors to confirm whether physical checks are conducted at reasonable intervals, and any discrepancies are identified and reconciled in the books of account. This process minimizes the risk of inaccuracies and unaccounted-for assets.

3. Enhanced Disclosures:
   Detailed disclosures in financial statements—covering aspects such as acquisition dates, book values, depreciation, and challenges like legal disputes—foster transparency. These insights reinforce trust among stakeholders and provide a clear picture of the company’s asset management practices.

4. Legal and Regulatory Compliance:
   Provisions addressing compliance with laws, such as the Prohibition of Benami Property Transactions Act, 1988, highlight auditors’ roles in identifying and reporting non-compliance. This ensures companies are safeguarded from legal liabilities and regulatory penalties.

5. Identification of Risks:
   Auditors are tasked with evaluating risks associated with PP&E, including improper valuation, classification errors, impairment, or pending litigations. Identifying these issues ensures the company maintains accurate and risk-free asset reporting.

6. Alignment with Standards:
   Clauses referencing auditing standards like SA 250 (laws and regulations), SA 560 (subsequent events), and SA 501 (specific considerations for selected items) reinforce a robust approach to PP&E audits, ensuring that audit procedures align with regulatory expectations.

7. Stakeholder Protection:
   The provisions ensure that investors, creditors, and regulators can rely on a company’s financial statements to make informed decisions, fostering trust in the organization’s asset management practices.

In conclusion, the CARO 2020 guidance for PP&E audits reinforces the role of auditors as stewards of accountability. By addressing asset ownership, legal compliance, and accurate financial reporting, these clauses contribute to maintaining corporate transparency and safeguarding the integrity of financial statements related to tangible assets.