Two distinct sub-clauses — one on physical verification, one on working capital loans.
### (a) Physical Verification of Inventory
Management must conduct physical verification at regular intervals (not just year-end).
Auditor checks:
Whether verification was conducted and whether coverage and procedure are appropriate
If any discrepancy ≥ 10% in aggregate for each class of inventory — must be properly dealt with in books of accounts
### (b) Working Capital Loans — Quarterly Returns
If the company has sanctioned working capital limits from banks/FIs aggregating > ₹5 crore:
Whether quarterly statements/returns are filed with lenders
Whether these statements agree with books of accounts
If not in agreement → details must be provided
### Why (b) Matters
Companies sometimes inflate inventory/debtors in statements submitted to banks to obtain higher credit limits. This clause enables auditors to flag misrepresentation.
Worked example
### Example 1
10% Discrepancy [Clause ii(a)]:
PQR Ltd conducts annual physical verification of raw materials (book value ₹40 lakh) and finds actual stock worth ₹35 lakh — a 12.5% shortage. Management treats it as normal wastage and makes no entry.
Answer: Discrepancy of 12.5% exceeds the 10% threshold for the class. Auditor must report under Clause 3(ii)(a) that a discrepancy of ≥10% was found in aggregate and has NOT been properly dealt with in the books of accounts.
### Example 2
Working Capital Mismatch [Clause ii(b)]:
MNO Ltd has a ₹8 crore cash credit facility from a bank. The quarterly stock statement submitted to the bank shows inventory of ₹6 crore, but the books show only ₹4.5 crore.
Answer: The quarterly returns do not agree with books of accounts. The auditor must report this discrepancy under Clause 3(ii)(b) and provide details of the mismatch (₹1.5 crore difference in inventory).
⚠️ Common exam mistakes
Forgetting the ₹5 crore threshold for working capital loans — the quarterly returns requirement applies only if aggregate sanctioned limit exceeds ₹5 crore.
Applying Clause (ii)(a) to work-in-progress without checking whether WIP is included in 'inventory' per the company's accounting policy.
Treating a 9% discrepancy as reportable — the threshold is 10% OR MORE in aggregate per class; below 10% need not be specifically flagged under CARO.
Confusing 'regular intervals' with 'annual' — management should verify inventory more than once a year if the business warrants it.
Bare-Act text Clause 3(ii) · Companies (Auditor's Report) Order, 2020 (CARO 2020) · click to expand
3(ii)(a) whether physical verification of inventory has been conducted at reasonable intervals by the management and whether, in the opinion of the auditor, the coverage and procedure of such verification by the management is appropriate; whether any discrepancies of 10% or more in the aggregate for each class of inventory were noticed and if so, whether these have been properly dealt with in the books of account; (b) whether the company has sanctioned working capital limits in excess of five crore rupees, in aggregate, at any point of time during the year, from banks or financial institutions on the basis of security of current assets; whether the quarterly returns or statements filed by the company with such banks or financial institutions are in agreement with the books of account of the company, if not, indicate the details thereof.