Obligation of auditor while conducting audit of loan given to related party at zero percent interest rate

As per section 186(7) of the Companies Act, a company cannot lend at a rate of interest lower than the prevailing yield of 1-, 3-, 5- or 10-year government security closest to the tenure of the loan. However, section 186(11)(a) provides that nothing contained in Section 186 except sub- Section (1), shall apply to any loan made, guarantee given or any security provided or any investment made by a Company established with the object of providing infrastructural facilities.

Practical problem which may arise during the audit of financials

Suppose PQR Ltd., a JV engaged in the infrastructure business in which S Ltd. has 45% stake, has been reporting increasing negative net worth. The company had extended loan to PQR Ltd. (“Joint ventures” and “not fully-owned subsidiaries”) at zero percent interest rate. Although, company continuously reporting negative net worth, the auditor of S Ltd. did not question the management on their decision to extend loans at zero percent rate of interest.

Further, The Auditor in his opinion stated that the loan given to PQR Ltd. was not prejudicial to the interest of the company. The auditor’s opinion was based on the opinion obtained by the Management from an external expert and the auditor did not verify the source data provided to expert by conducting any independent verification of information provided by S Ltd.

Furthermore, the external expert clearly stated in his report that his opinion was restricted to the facts provided by S Ltd. and the Expert has not independently examined any facts in relation to the issues raised.

Whether the audit opinion made by the auditor merely on the reliance of external expert is correct? If not, what are the responsibilities that an auditor lacks while performing an audit?

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