CS Urja Mahesh Karia
Audit of ‘Internal Financial controls (hereinafter to be referred as ‘IFC’) over Financial Reporting’ is a reasonably advanced reporting concept for India. In India though there were no such requirements earlier, however, similar reporting requirements existed globally such as section 404 of Sarbanes Oxley Act, 2002 of USA.
Initially when majority of the Sections of the Companies Act, 2013 (hereinafter to be referred as ‘the Act’) were notified along with Section 143(3)(i), there was lot of ambiguity not only on part of the company but also on the part of the auditors regarding the actual reporting.
Later on, MCA has notified the Companies (Audit & Auditors) Amendment Rules, 2014 and introduced new Rule 10A. Further, ICAI has also issued Guidance Notes on 14th September 2015 and both of these steps helped to give more clarity on the said concept.
Introducing this requirement has caused a lot of apprehension and on the other hand it also induced a lot of interest.
A combined study of the concerned provisions Companies Act, 2013 and ICAI Guidance Notes, below given are some points which can be helpful in understanding the said concept and establishing IFC in any Company:
The said Guidance Note applies for reporting on internal financial controls in respect of listed companies, unlisted companies, small companies and also one person companies (as defined in the Companies Act, 2013). It means is applicable to all type of companies incorporated under the Act.
Simple reading of Section 143(3)(i) of the Act and Rule 10 (a) of the Corresponding Rules does not specifically provides that IFC is applicable only in the case of listed companies.
Therefore, it appears that the auditor is required to report on adequacy and operating effectiveness of such internal financial controls even in the case of all companies.
II. Auditor’s Reporting:
Auditors Reporting on internal financial controls is a requirement specified in the Act and, therefore, will apply only in case of reporting on financial statements prepared under the Act and reported under Section 143.
Accordingly, Reporting on internal financial controls will not be applicable with respect to interim financial statements, such as quarterly or half-yearly financial statements, unless such reporting was required under any other law or regulation.
III. Specified Date:
The period of testing should cover the entire period of the financial statements. However, the reporting by the auditor will be based on the situation existing as at the balance sheet date.
IV. Responsibility in IFC:
Board of Directors – Boards’ report of all companies to state the details in respect of adequacy of internal financial controls with reference to the financial statements.
Statutory Auditor- To express an opinion on the effectiveness of the company’s internal financial controls financial reporting and the procedures in respect thereof are carried out along with an audit of the financial statements.
V. Top-Down Approach to Internal Financial Controls Over Financial Reporting as provided by ICAI Guidelines:
VI. Board & Audit Committee oversight: Section 177 provides that the audit committee may call for Reporting on IFC under the Companies Act, 2013, the comments of the auditors about internal control systems including the observations of the auditors and may also discuss any related issues with the internal and auditors and the management of the company.
VII. Some Other Points clarified in the ICAI Guidance Notes on Audit of Internal Financial Controls over Financial Reporting :
♣ Even if a specific statement of responsibility of the directors over internal financial controls is not made in the board’s report to the members of unlisted companies, ensuring adequacy and operating effectiveness of the internal financial controls system still remains with the management and the persons charged with governance in the company.
♣ A company’s internal financial control over financial reporting includes policies and procedures that –
(1) Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
♣ Audit Engagement Letter: It is to be issued by the auditor to the company. The auditor can issue 2 types of Engagement letters viz.
- Either issue combined engagement letter for reporting on financial statement and reporting on Internal Financial Statement; or
- Separate engagement letter for reporting on financial statement and reporting on Internal Financial Statement.
♣ Management Representation Letter: To be issued by the entity to the auditor.
Therefore, the concept of Internal Financial Control is not only process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements but it also leads to good governance and lucidity or better transparency in the company.
Disclaimer: The above views are only a concise over view of corresponding sections of the Companies Act, 2013 and the guidance note issued by ICAI on IFC and is not exhaustive in any manner howsoever.
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