With the introduction of companies Act 2013, many new reporting requirements are made mandatory for statutory auditors. One of this requirement, under section 143(3)(i), is that the statutory auditor has to state in his report that whether the company has adequate internal financial controls system in place and operating effectiveness of such controls.
The section has cast onerous responsibilities on the auditor. The concept is new in India which has thrown up many challenges to the members.
Meaning
Clause (e) of Sub-section 5 of Section 134 explains the meaning of 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.”
Management Responsibility
Clause (e) of Sub-section 5 of Section 134, makes it mandatory for every listed companies to state in its directors responsibility statement regarding IFC adequacy & operating effectiveness.
Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the board report of all companies to state the details in respect of adequacy of internal financial controls with reference to the financial statements.
Clause (e) of Sub-section 5 of Section 134 to the 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.
Scope
It may be noted that auditor’s 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 is required under any other law or regulation.
Report on Balance Sheet Date
The auditor should report if the company has an adequate internal financial controls system in place and whether the same was operating effectively as at the balance sheet date. It should be noted that when forming the opinion on internal financial controls, the auditor should test the same during the financial year under audit and not just as at the balance sheet date, though the extent of testing at or near the balance sheet date may be higher.
Internal Controls and Internal Financial Controls
Internal controls are much wider term covering all types of controls over all functions of a business.
Fundamental to a system of internal control is that it is integral to the activities of the company, and not something practiced in isolation.
An internal control system:
- Facilitates the effectiveness and efficiency of operations.
- Helps ensure the reliability of internal and external financial reporting.
- Assists compliance with laws and regulations.
- Helps safeguarding the assets of the entity.
In general and as per SA 315, a system of internal control to be considered adequate should include the following five components:
- Control environment
- Risk assessment
- Control activities
- Information system and communication
Internal financial controls system needs to be dynamic to address the changes in entity’s operating environment, including:
- Business developments, including changes in information technology and business processes, changes in key management, and acquisitions, mergers and divestment.
- Legal and regulatory developments such as changes in industry regulations and new regulatory reporting requirements.
- Changes in the financial reporting framework, such as changes in accounting standards.