Internal Financial Controls – An Insight

The Companies act, 2013 has ushered in the new era of Corporate Governance and transparency and is set to have far reaching implications. This new regime is expected to turnaround the governance of corporate sector in India.

• The recent corporate frauds (Satyam, Enron, etc.) have created an atmosphere of mistrust in the governance of corporate.
• USA has already adopted Sarbanes Oxley Act in 2002, which contains regulations on the internal controls expected from the Companies.
• Thus, it was imperative for the government to come up with the regulations to re-install the trust in the corporate sector.

A process designed to provide reasonable assurance regarding the reliability of the financial reporting and preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

• Orderly and efficient conduct of its business
• Adherence to company’s policies
• Safeguarding of assets
• Prevention and detection of frauds and errors
• Financial Information based on GAAP

• Companies Act, 1956:
• Reporting to be done only in CARO, 2003
  • Purchase of Fixed Assets and Inventory
  • Sale of Goods

• Companies Act, 2013
• Reporting to be done in the following ways:
  1. Under CARO, 2016
     1. Sale of Goods and Services
     2. Purchase of Fixed Assets and Inventory
  2. Under Internal Financial Controls
     1. Entire Financial Reporting

Management’s Responsibility
The Companies Act, 2013 requires the Directors’ Responsibility Statement to state that the directors had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively.

Terms of Reference to include Evaluation of Internal Financial Controls and Risk Management Systems

The auditor needs to:

• Obtain reasonable assurance to state whether an adequate internal financial controls system was maintained and
• Whether such Internal Financial Controls system operated effectively in the company in all material respects with respect to financial reporting only

Applicability	All Companies	All Companies	Listed and Specified Public Companies
Reporting	Separate Audit Report on IFC	Director’s Report (Director’s Responsibility Statement)	Audit Committee Report
Legal Provisions	S. 143(3)(i), Cos. Act, 2013	R. 8(5)(viii), Cos. (Accounts), Rules, 2014	S. 177(4)(vii), Cos. Act, 2013
Objective	Adequacy and operating effectiveness of IFC	Adequacy of Internal Financial Controls	Evaluation of Internal Financial Controls

1. Qualified / Adverse / Reservation of opinion by Auditor
2. Inquiry and Inspection by ROC (S. 206)
3. Report to the Central Government (S. 208)
4. Investigation of the affairs of the Company by Central Government (S. 210)
5. Inspector’s report on Investigation (S. 223)
6. Actions on Inspector’s report – Prosecution / Winding up (S. 224)

1. Control environment
   1. Integrity and Ethics
   2. Work Culture
   3. Organization Structure
   4. Authority and Responsibility Assignment
   5. HR Policies and Practices
2. Risk Assessment
   1. Identification
   2. Impact Assessment
   3. Mitigation
3. Control Activities
   1. Performance reviews
   2. Information Processing
   3. Physical Controls
   4. Segregation of Duties
4. Information System
   1. Classification
   2. Accuracy and Completeness
   3. Cut-off
   4. Presentation and Disclosure
5. Communications
   1. Policies
   2. Procedures
   3. Codes
   4. Manuals
6. Monitoring
   1. Check on operations for effective and timely performance
   2. Maintenance
   3. Review of processes and internal and external reports

Step 1:
Examine the financial statements to identify the significant accounting balances and disclosures from the viewpoint of IFC

Step 2:
Review the existing structure of the business operations and processes from the perspective of financial reporting

Step 3:
GAP analysis of IFC Components and existing business processes.

Step 4:
Identify the deviations from the existing processes

Step 5:
Back end support for realigning existing business processes with the ideal IFC components.

Step 6:
Back end support in documenting the Internal Financial Controls