Companies Act, 2013 mandates that every company should have an effective system of internal financial controls to ensure that its financial statements are accurate and reliable, and to prevent fraud and mismanagement. In this article we will discuss about internal financial controls applicability on Companies along with Management and Auditors responsibility thereon.
Meaning of internal financial controls
Clause (e) of Sub-section 5 of Section 134 of Companies Act, 2013 explains the meaning of the term, “internal financial controls” as “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.”
Benefits of having effective internal financial controls
Beyond compliance, IFC will facilitate in::
- Business process re-designing to plug revenue leakage & cost containment opportunities
- Rationalizing the number of controls across organizations
- Standardizing policies & procedures for multi-location/multi- business companies
- Developing control conscious work culture for people behind controls
- Assurance to Top Management as well as optimizing business performance
Management Responsibility
The Companies Act, 2013 Act has significantly expanded the scope of internal controls to be considered by the management of companies to cover all aspects of the operations of the company. Clause (e) of
Sub-section 5 of Section 134 to the said Act requires the directors’ responsibility statement to state that the directors, in the case of a listed company, had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively.
Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the Board of Directors’ report of all companies to state the details in respect of adequacy of internal financial controls with reference
to the financial statements.
The inclusion of the matters relating to internal financial controls in the directors’ responsibility statement is in addition to the requirement for the directors to state that they have taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of the 2013 Act, for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities.
Auditors’ Responsibility
Companies Act, 2013 specifies the auditor’s reporting on internal financial controls only in the context of audit of financial statements. Consistent with the practice prevailing internationally, the term ‘internal financial controls’ stated in Clause (i) of Sub-section 3 of Section 143 would relate to ‘internal financial controls over financial reporting’ in accordance with the objectives of an audit stated in SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”
Meaning of internal financial control over financial reporting (ICOFR)
As per Guidance Note on IFC issued by ICAI “internal financial controls over financial reporting” shall mean “A process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal financial control over financial reporting includes those policies and procedures that
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(ii) 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 authorisations of management and directors of the company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.”
Difference between internal financial controls and internal financial control over financial reporting
Internal Financial Controls is much wider in scope when compared to ICOFR. Internal financial controls include Internal controls over financial reporting and operational controls and anti-fraud controls
Applicability of reporting on internal financial controls in the case of unlisted companies
Clause (e) of Sub-section 5 of Section 134 of the 2013 Act has prescribed the Directors’ Statement of Responsibility over establishing adequate internal financial controls and asserting operating effectiveness of such controls of the company only in case of listed companies.
It may however be noted that Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the
Board of Directors’ report of all companies to state the details in respect of adequacy of internal financial controls with reference to the “financial statements”. Also, section 143(3) applies to the statutory auditors of all the companies.
Hence, it appears that the auditors of even unlisted companies are required to report on the adequacy and operating effectiveness of the internal financial controls over financial reporting.
However MCA vide its notification dated 13th June 2017 (G.S.R. 583(E)) provided exemption from applicability of Internal Controls over financial reporting (ICFR Applicability) to following private companies:
1. Which is one-person Company (OPC) or a Small Company; or
2. Which has turnover less than Rs. 50 Crores as per latest audited financial statement or which has aggregate borrowings from banks or financial institutions or anybody corporate at any point of time during the financial year less than Rs. 25 Crore.
Additionally, the above-mentioned Companies will be exempted from IFC Applicability only if it has not committed a default in filing its financial statements under section 137 of the Companies Act 2013 or annual return under section 92 of CA 2013 with the Registrar.
Requirement for ICOFR under Clause 49 of Listing Agreement
The requirements mentioned in Clause 49 of Listing Agreement with SEBI related to Internal financial controls over financial reporting (ICOFR) are:
- Responsibility of the CEO/CFO to maintain ICOFR.
- Evaluate the effectiveness of internal control systems pertaining to financial reporting.
- Indicate to the auditors and the audit committee significant changes to accounting policies and ICOFR.
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CA. Mohammad Salim is an ICAI award winning Chartered Accountant having rich experience of more than 20 years in the field of indirect taxes. He is the Member, Indirect Taxes Committee of PHD Chamber of Commerce and Industry. He is author of four successful books on GST published by Taxmann Publication and is also GST expert on taxmann portal.
