Gearing Up For Reporting On Internal Financial Controls, Section 143(3)(i) of The Companies Act, 2013 (‘2013 Act’) requires an auditor to comment on the adequacy of internal financial controls (‘IFC’) system in place and the operating effectiveness of such controls. IFC as defined under Section 134(5)(e) of the 2013 Act includes both business and financial controls and thus, raised concerns for the auditors with regard to their reporting responsibilities. In order to address these concerns, The Institute of Chartered Accountants of India (ICAI) on 14th September 2015 has issued Guidance Note on Audit of Internal Financial Controls over Financial Reporting (‘Guidance Note’). The Guidance Note covers aspects such as scope of reporting on IFC, essential components of internal controls, technical and implementation guidance on audit of IFC, illustrative reports on IFC, etc. Now you can scroll down below n check more details regarding Gearing Up For Reporting On Internal Financial Controls
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Framework for Internal Financial Controls
The Guidance Note does not prescribe a particular framework for IFC but states that a benchmark system of internal control, based on suitable criteria, is essential to enable the management and auditors to assess and state the adequacy and compliance of the system of internal controls. For example, in the Indian context, Appendix I ‘Internal Control Components’ of Standard on Auditing (SA) 315-Identifying and Assessing the Risk of Material Misstatement Through Understanding An Entity and Its Environment, provides the necessary criteria for IFC over financial reporting (IFC–FR) for companies.
Scope of Reporting
The Guidance Note states that the auditors’ reporting on IFC is only in the context of audit of financial statements. Globally, auditors’ reporting on internal controls is together with the reporting on financial statements and such internal controls reported upon relate only to internal controls over financial reporting. Accordingly, the Guidance Note clarifies that the term IFC wherever used in the context of the responsibility of the auditor for reporting on such controls under Section 143(3)(i) of the 2013 Act per se implies and relates to IFC – FR
As regards the company, the Board report of all companies will need to comment on adequacy of IFC with respect to financial statements with the directors’ responsibility statement of listed companies to additionally state whether IFC (as per the wider definition in Section 134(5)(e)) are adequate and operating effectively.
The Guidance Note states that though the SAs do not address the auditing requirements for reporting on IFC, certain portions of the SAs may still be relevant. The procedures prescribed in the Guidance Note are supplementary that the auditor would need to consider for planning, performing and reporting in an audit of IFC–FR under Section 143(3)(i) of 2013 Act.
The Guidance Note specifically states that since the audit of IFC is in connection with financial reporting, the concept of materiality will be applicable even in such audits. The audit procedures would typically involve following steps:
Step–1 Planning: This stage includes identification of significant account balances/disclosure items, identification and understanding significant flow of transactions, identification of risk of material misstatements (RoMM), and identification of controls which will address RoMM.
Step–2 Design and Implementation: The auditor should test the design effectiveness of controls by determining whether the company’s controls, if they are operated as prescribed by persons possessing the necessary authority and competence to perform the control effectively, satisfy the company’s control objectives and can effectively prevent or detect errors or fraud that could result in material misstatements in the financial statements.
Step–3 Operating Effectiveness: Operating effectiveness of a control is tested by determining whether the control is operating as designed and whether the person performing the control possesses the necessary authority and competence to perform the control effectively.
Step–4 Reporting: Where there are deficiencies that, individually or in combination, result in one or more material weaknesses, the auditor must evaluate the need to express a modified opinion i.e. qualified or adverse on the company’s IFC–FR. Additionally, the auditor should disclose whether his opinion on the financial statements was affected by the modified opinion on IFC–FR.
IFC Reporting On Consolidated Financial Statements (CFS)
A strict reading of Section 129(4) of the 2013 Act indicates that the auditor will be required to report under Section 143(3)(i) of the 2013 Act on the adequacy and operating effectiveness of the IFC–FR even in the case of CFS. The Guidance Note has clarified this by stating that reporting on the adequacy and operating effectiveness of IFC–FR would apply even in the case of CFS for the components which are a ‘company’ under the 2013 Act.
Accordingly, in line with the approach adopted in case of reporting on the CFS under Section 143(3) of 2013 Act and the Companies (Auditor’s Report) Order, 2015 notified under Section 143(11) of the 2013 Act, the reporting on adequacy of IFC would also be on the basis of the reports under Section 143(3)(i) of 2013 Act as submitted by the statutory auditors of the components that are Indian companies under the 2013 Act.
Specified Date for Reporting On the Adequacy and Operating Effectiveness of IFC–FR
Section 143(3)(i) of the 2013 Act does not specify whether the auditor’s report should state if IFC existed and operated effectively during the period under reporting of the financial statements or at the balance sheet date. Paragraph 57(k) of the Statement on the Companies (Auditor’s Report) Order, 2003 issued by the ICAI inter alia states that an auditor is required to assess whether the major weaknesses noted by him have been corrected by the management at the balance sheet date.
Accordingly, the auditor should report if the company has adequate internal control systems in place and whether they were operating effectively at the balance sheet date.
IFC Reporting On Interim Financial Statements
It may also be noted that an auditor’s reporting on IFC is a requirement specified in the 2013 Act, and therefore, reporting on IFC will not be applicable with respect to interim financial statements, such as quarterly or halfyearly financial statements, unless such reporting is required under any other law or regulation.
Due to enhanced reporting responsibilities, companies should immediately start evaluating their present components of internal controls and ensure compliance.