CARO 2020 Clause 3(ix) is not only a loan-default check. For a company to which CARO applies, the borrowing clause requires the auditor to look at repayment defaults, declared wilful-defaulter status, the actual end-use of term loans, short-term money used for long-term purposes, funds raised to support subsidiaries or other group entities, and borrowings secured by pledging securities held in subsidiaries, joint ventures or associates. A strong audit file therefore follows the flow of funds and the lender terms, rather than stopping at the closing loan balance.
The main professional reference is ICAI's Guidance Note on the Companies (Auditor's Report) Order, 2020 (Revised 2022 Edition). Where wilful-defaulter status is relevant, the current regulatory framework should also be read with the RBI's Master Direction on Treatment of Wilful Defaulters and Large Defaulters.
What does CARO Clause 3(ix) cover?
Clause 3(ix) can be organised into six separate questions. Keeping them separate prevents a clean repayment history from masking a fund-utilisation problem, or proper end use from masking a lender default.
- 3(ix)(a): repayment defaults. Has the company defaulted in repayment of loans or other borrowings, or in payment of interest, to any lender? If yes, the reporting captures the nature of borrowing, lender, amount, whether principal or interest, and period of delay or non-payment.
- 3(ix)(b): wilful-defaulter status. Has the company been declared a wilful defaulter by a bank, financial institution or other relevant lender or authority?
- 3(ix)(c): term-loan end use. Were term loans applied for the purposes for which they were obtained? If not, the amount diverted and its actual use become reporting matters.
- 3(ix)(d): short-term funds used long term. Were funds raised on a short-term basis used for long-term purposes? If yes, the nature and amount need to be identified.
- 3(ix)(e): group obligations. Did the company take funds from an entity or person on account of, or to meet obligations of, subsidiaries, associates or joint ventures?
- 3(ix)(f): borrowings against group-company securities. Did the company raise loans during the year by pledging securities held in subsidiaries, joint ventures or associates, and was there any repayment default?
Default and wilful default are not the same conclusion
Clause 3(ix)(a) asks about actual repayment or interest defaults. Clause 3(ix)(b) separately asks whether the company has been declared a wilful defaulter. The auditor should establish the factual repayment position and separately verify whether a formal declaration exists.
The RBI directions explain that wilful default involves more than the mere existence of an overdue amount. The framework covers specified situations involving capacity to pay, diversion or siphoning of lender funds, or disposal of secured assets without lender approval, and it prescribes an identification and review mechanism. Management representation alone should therefore not be the only evidence considered for declared status.
How to test term-loan end use under 3(ix)(c)
Start with the sanction letter and loan agreement, because they define the stated purpose. Then trace actual disbursements and utilisation through bank statements, vendor payments, fixed-asset records, project ledgers and supporting invoices. The question is not whether the expenditure was generally useful to the company; it is whether the borrowing was used for the purpose for which the term loan was obtained.
Example: a company obtains a term loan specifically for a new production line. Most of the amount is paid to the machinery supplier, but a portion funds renovation of the head office. Even if the renovation is a legitimate business expense, it differs from the stated loan purpose. The auditor should quantify and document that diversion rather than treating the entire loan as properly utilised.
How to test short-term funds used for long-term purposes
Clause 3(ix)(d) requires a source-and-use analysis. Short-term sources can include working-capital borrowings and other funds with a short maturity profile. Long-term uses can include fixed assets, long-duration investments or other uses whose economic recovery is not aligned with the source's tenor.
The RBI directions provide a related regulatory concept: their definition of diversion of funds includes using short-term working-capital funds for long-term purposes when that use is not in conformity with sanction terms. For CARO work, do not simply compare two year-end balances. Review material fund movements during the year where the facts indicate possible maturity mismatching.
Group-company funding needs a separate trail
For 3(ix)(e), compare funds taken during the year with material loans, advances, investments or payments made for subsidiaries, associates and joint ventures. The analysis should capture funds raised on account of, or to meet obligations of, those entities even when payments are routed through the parent company's bank account.
For 3(ix)(f), inspect loan and security documents to identify whether securities held in a subsidiary, joint venture or associate were pledged for a borrowing. If so, capture the loan details and separately test repayment status.
Practical working-paper checklist
- Prepare a lender-wise borrowing population covering opening balance, additions, repayments, interest, security and closing balance.
- Obtain sanction letters, loan agreements and material amendments.
- Map contractual repayment and interest dates against actual payments, not only year-end balances.
- Investigate delays, rescheduling, waivers and settlements and retain supporting evidence.
- Separately verify whether a formal wilful-defaulter declaration exists; do not infer it merely from an overdue account.
- For every material term loan, document the sanctioned purpose and trace actual utilisation.
- Perform a source-and-use review where short-term borrowings appear to finance fixed assets or other long-term uses.
- Reconcile funds taken with material funding or obligation payments involving subsidiaries, associates and joint ventures.
- Review security documents for pledges of group-company securities and test repayment status of the related loan.
Common mistakes to avoid
- Testing principal defaults but overlooking interest defaults.
- Checking only the balance-sheet date and missing defaults or fund movements during the year.
- Treating a show-cause process as automatically equivalent to a formal wilful-defaulter declaration.
- Assuming a term loan is properly used because the expenditure is business-related without matching it to the sanctioned purpose.
- Looking only at direct transfers to subsidiaries and missing funds raised to meet their obligations through other routes.
Practical takeaway
CARO 2020 Clause 3(ix) is best handled as a borrowing-lifecycle audit: identify material sources of funds, test contractual repayment, verify formal wilful-defaulter status separately, trace term-loan end use, investigate short-term-to-long-term mismatches, and map group-company funding and security pledges. The evidence trail should connect sanction terms, cash movement and final CARO wording. Before signing a live report, recheck the current CARO guidance and RBI directions because regulatory guidance and lender-classification procedures can change.
