Companies Act, 2013 on financial reporting is being aligned to international practices and the introduction of Internal Financial Controls (IFC) in the Act is reflective of this trend. The Act has imposed specific responsibilities on the Board of Directors/ Audit Committee as well as on Independent Directors towards the company’s internal financial controls.
The purpose of the IFC in laconic includes achieving the following objectives:
Reporting & Responsibilities of the Board of Directors:
Rule 8(5)(viii) of Companies (Accounts) Rules, 2014: prescribed that the report of the Board shall contain the details in respect of adequacy of internal financial controls (“IFC”) with reference to the Financial Statements.
Section 134(5)(e) of the Companies Act, 2013: It requires, in case of listed Company, to state in the Directors’ Responsibility Statement, that the Company had followed their internal financial controls and such IFC are adequate and were operating effectively.
Schedule IV(II)(4) of the Companies Act, 2013: The independent directors should satisfy themselves on the integrity of financial information and ensure that financial controls and systems of risk management are robust and defensible.
In case of listed Company the Company has to follow both the disclosures as mentioned in the Rule 8(5)(viii) of Companies (Accounts) Rules, 2014 and Section 134(5)(e) of the Companies Act, 2013.
However, unlisted company has to follow the disclosure as mentioned in Rule 8(5)(viii) of Companies (Accounts) Rules, 2014 i.e. the Board Report of the unlisted company shall state the adequacy of IFC with respect to Financial Statement only.
Responsibilities of the Audit Committee:
Section 177 of the Companies Act, 2013: The Audit Committee shall evaluate the Internal Financial Controls System of the Company.
The Audit Committee to express that it has taken necessary steps to evaluate IFC system as implemented by Company. It may call for comments of statutory auditors as well as Internal Auditors about internal control systems and its audit scope & criteria. The audit Committee may also seek external help or expertise views, guidance for the evaluation of IFC. The Audit Committee may draft/approve necessary SOPs, policies, procedures/ framework in line with IFC system.
Reporting & Responsibilities of Statutory Auditor:
Section 143 of the Companies Act, 2013: The auditor’s report should state that whether the company has adequate IFC system in place and the operating effectiveness of such controls.
For the purpose of section 134(5)(e) The term “internal financial controls” means the policies and procedures adopted by the company for ensuring the orderly and efficient conduct of its business, including adherence to company’s policies, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.
Unlike in section 134(5)(e), where IFC is clearly explained for the purpose of this section, there is no such explanation provided in section 143(3)(i). Therefore, by reading the words “for the purpose of this clause” as written in explanation of 135(5)(e), it may be interpreted that the aforesaid meaning of IFC may not be applicable for the auditor reporting on internal financial control u/s 143(3)(i) as well as for the Rule 8(5)(viii) of Companies (Accounts) Rules, 2014.
Hence, it is appeared that Statutory Auditors’ responsibility with respect to reporting on the adequacy and effectiveness operating of internal financial control system is only limited to those pertaining to financial statement reporting only. The same shall also apply to the unlisted company i.e. contents of the Board Report of the unlisted company in respect of IFC will be limited to the statement of adequacy of IFC with respect to Financial Statement.
(Author: Aman Mourya, CS, LLB, B.Com(H) is associated with Newgen Software Technologies Limited)