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Home » » Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(xv)

Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(xv)

Written By Admin on Sunday, 1 April 2012 | Sunday, April 01, 2012

Clause 4(xv)

whether the company has given any guarantee for loans taken by others from bank or financial institutions, the terms and conditions whereof are prejudicial to the interest of the company.

1) The clause requires the auditor to determine whether the company has given any guarantee for loans taken by others from bank or financial institutions and if yes, whether the terms and conditions of the guarantee are prejudicial to the interest of the company. The scope of the auditor’s inquiry under the clause does not extend to the guarantees given by the auditee company for loans taken by “others” from sources “other than bank or financial institutions”.

2) It may be noted that several types of guarantees are in vogue. The type of guarantee within the scope of the clause is the one which the company has provided to a bank or financial institution in respect of loans taken by a third party. In other words, the company has a legal binding to indemnify the bank or financial institution if the third party, on behalf of whom the guarantee has been furnished, fails to fulfill the conditions subject to which the loan was granted by the bank or financial institution. Section 126 of the Indian Contract Act, 1872 defines a contract of guarantee as a contract to perform the promise, or discharge the liability, of a third person in case of his default.

3) Guarantee given by a company is a contingent liability. In respect of contingent liabilities, the auditor is normally concerned with seeking reasonable assurance that all contingent liabilities are identified and properly valued and disclosed as an off-balance sheet item. The auditor should obtain a written representation from the management that:

(i) there are no guarantees issued up to the year-end which are yet to be recorded; and
(ii) all obligations in respect of guarantees have been duly recorded in the register of guarantees and disclosed.
4) The auditor should examine the Memorandum of Association of the company with a view to determine whether the company can give a guarantee. It may be noted that if a company provides any guarantee without having a clause in this regard in the Memorandum of Association, the act of providing guarantee would be ultra vires. The auditor, in such a situation, should make necessary disclosure in the audit report.

5) The auditor should also examine the register of guarantees, if any, maintained by the company. The auditor should also obtain a list of the guarantees issued by the company during the year from the management of the company which should be checked with the register of guarantees. The auditor should perform appropriate procedures and examine records like the minutes book of the board meetings, and general meetings to determine that all the guarantees given by the company have been included in the list. The auditor should also ascertain whether the guarantees have been issued by or under sanction of the competent authority.

6) The auditor should review the issuance of guarantee(s) to establish the reasonableness thereof in the light of previous experience and knowledge of the current year's activities. In determining whether the guarantee is prejudicial to the interest of the company, the auditor would have to give due consideration to a number of factors connected with the guarantee, including the financial standing of the party on whose behalf the company has given the guarantee, party’s ability to borrow, the nature of the security offered by the party, the availability of alternative sources of finance and the urgency of the borrowing, if available, for which the company has given guarantee and so on. The auditor should obtain this information from the management.

7) The auditor should also verify whether the company has complied with the requirements of sections 295 and 372A of the Act. If the company has obtained the previous approval of the Central Government under section 295, it should be construed that the guarantee is not prejudicial to the interest of the company.

8) If the auditor is unable to comment on the clause because of the absence of the necessary board resolution or the register or other relevant records, the auditor should issue a disclaimer with regard to the clause and should also state the reasons for such a disclaimer.
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