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

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

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

Clause 4(xii)

whether adequate documents and records are maintained in cases where the company has granted loans and advances on the basis of security by way of pledge of shares, debentures and other securities; If not, the deficiencies to be pointed out.

1) The clause requires the auditor to comment on the adequacy of documents and records maintained in cases where the company has granted loans and advances on the basis of security by way of pledge of shares, debentures and other securities. If the auditor is not satisfied about the adequacy of documents and records, he has to report the inadequacies and point out deficiencies in maintenance of records.

2) This requirement is confined to loans and advances which are secured by way of pledge of shares, debentures and other securities, and does not extend to other forms of security, e.g., hypothecation, guarantee, etc.

3) Pledge implies that the physical possession of the security must be transferred to the company along with a power to sale of the security in the case of default. This transfer can be actual or constructive. For example, the share or debenture may be physically in the custody of the company or it may be with a person like a bank which holds it on behalf of the company.

4) A question may arise as to the exact meaning of the term “other securities”. The term, ‘other securities’ may be construed to mean bonds or promissory notes issued by a government or semi-government authority. In a broader
sense, it can include any other asset which is given as security for repayment of a loan or fulfillment of an obligation. However, the term ‘other securities’ is used along with shares and debentures and, therefore, for the purpose of this clause, consideration will have to be confined to securities which are similar to shares or debentures.

5) The auditor has to report whether adequate documents and records have been maintained. What records would be considered adequate depends upon the nature of the security and the party to whom the loan or advance is granted. But the records should generally include the following particulars:
(i) the full name and address of the borrower;
(ii) the amount of the loan or advance;
(iii) stipulations regarding period of repayment, the rate of interest, the security to be pledged and all other terms of the loan or advance;
(iv) the record of the disbursements, repayments towards the loan or advance and recovery of the interest;
(v) full particulars of the security pledged, for example, if the security consists of shares, the particulars would include the names of the companies, number of shares, class of shares, distinctive numbers of the shares, particulars of the parties in whose names the shares stand, etc.;
(vi) the documents needed to transfer the ownership of the security in case of need;
(vii) periodical acknowledgements from the parties confirming the balances due;
(viii) proof that the party has power to borrow, e.g., in case the borrower is a company, its memorandum of association, board resolution or shareholders’ resolution; etc.
6) The clause does not cast a duty upon the auditor to examine the adequacy of the security on the basis of which loans have been granted. This may be due to the fact that an inquiry in this regard has to be made by the auditor in terms of section 227 (1A) of the Act. In any event, it remains the duty of the auditor to ensure by physical verification that, where a loan or advance is given on the basis of a pledge of shares, debentures or other securities, the securities are in the custody of the company and that the market value of the securities is adequate to cover the outstanding amount of the loan and interest. The auditor should also physically verify the securities pledged by reference to either the physical securities or statements from depository participants. In the case of securities in dematerialized form, the auditor should also obtain sufficient appropriate audit evidence that the company has a valid right to sell the shares kept as security in the case of a default from the borrower. There may be several ways with which the auditor can verify the said right of the company, for example, the auditor may obtain a certificate to this effect from the depository participant.

7) The auditor, apart from reviewing and examining regular books of account, has to examine various documents and records as referred above and list out the deficiencies, if any. The deficiencies could be absence of noting of lien, insufficient margins, registers not being updated, absence of data relating to market value of securities, etc. The auditor should also report the deficiencies so found.
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