Author: CA. Anandaramakrishnan Lokeshwaran

1. MEANING OF INTERNAL FINANCIAL CONTROL:

As per section 134 of The Companies Act, 2013, the term “Internal Financial Control” means the policies and procedure adopted by the company to ensure:

• Orderly and efficient conduct of business, including adherence to company’s policies,
• Safeguarding of its assets,
• Prevention and detection of frauds and errors,
• Timely preparation of reliable financial information.

The Act has set increased responsibility and accountability on Board of Directors, Audit committee, Senior Management and Independent Auditors. The approach that should be adopted by companies should be that of a comprehensive risk management program – Enterprise Risk Management (ERM).

2. APPLICABILITY OF INTERNAL FINANCIAL CONTROL:

RELEVANT PROVISIONS	APPLICABILITY	STATUTORY REQUIREMENT
Section 134 of companies Act 2013	All listed entities	The director’s responsibility statement shall state the director had laid down internal financial controls to be followed by the company and such that internal financial control is adequate and operating effectively.
Section 143 of companies Act 2013	All entities (listed/unlisted)	The auditor’s report shall state whether the company has adequate internal financial controls with reference to financial statements in place and the operating effectiveness of such IFC.
Section 177 of companies Act 2013	All entities having an audit committee	The audit committee shall evaluate internal financial controls and risk management system. The audit committee may call for comments of auditors about internal control systems before their submission to the board.
Schedule IV	All entities having independent directors	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.
Rule 8 (5) of Companies Accounts rule	All entities (listed/unlisted)	The board report shall state the details in respect of adequacy of internal financial controls with reference to the financial statement.

 

Exemption from IFC for specified Private limited companies

• One- person company (OPC)
• A private limited company having a turnover of less than Rs. 50 Crores as per latest audited financial statement or having aggregate borrowings from bank or financial institutions or body corporate at any point of time during the financial year less than Rs. 25 Crores.

3. OBJECTIVE OF IFC:

Primary objective of IFC is to identify opportunities for improvement and to draw up recommendations & good practices that can be used as a benchmark to develop or strengthen their internal control systems and enhance the reliability of their financial statements. Other Objectives include:

• Efficiency and effectiveness in operations.
• Prevention and detection of fraud and error.
• Safeguarding of its assets.
• Accuracy and completeness of accounting records.
• Reliability of Financial Reporting.

4. TERM INTERNAL CONTROL:

Internal Control = Internal control over financial reporting + Operational control reporting + Fraud prevention reporting.

5. ROADMAP TO IMPLEMENT INTERNAL FINANCIAL CONTROL:

1. Assess the current state of internal controls
2. Embrace a widely acceptable framework or guidelines
3. Set the right tone at the top i.e., those charged with governance
4. Ascertain organizational risks which have financial impact
5. Define the control objectives and control Activities to mitigate the risk
6. Ongoing continuous monitoring of the functioning of control
7. Obtain independent assurance on the effectiveness of the internal controls i.e., Independent Auditors

6. ADVANTAGES OF A ROBUST INTERNAL FINANCIAL CONTROL SYSTEM:

By placing more accountability and responsibility on the Board and Audit committee with respect to internal financial controls, the Companies Act 2013 is attempting to align the corporate governance and financial reporting standards with global best practices. With adequate and effective internal financial controls, some of the benefits that the companies would experience include:

• Senior Management Accountability
• Improved Controls over financial reporting process
• Improved investor confidence in entity operations and financial reporting process
• Promotes culture of openness and transparency within the entity
• Trickling down of accountability to operational management
• Improvements in Board, Audit Committee and senior management engagement in financial reporting and financial controls.
• More accurate, reliable financial statements
• Making audits more comprehensive

7. WHY INTERNAL FINANCIAL CONTROL IS IMPORTANT?

Internal financial controls also become important as they help derive values in the form of

• Fresh Independent look at key business processes
• Identification of potential operating process opportunities
• Updated formal, centralized, and managed internal financial controls documentation for the company
• Enhanced support to CEO/CFO certifications
• Enhanced control environment, thereby mitigating risk
• Better understanding of inherent and residual control risks in internal controls
• Helps in business process redesigning to plug revenue leakage & cost
• Containment opportunities
• Helps in rationalizing the number of controls across organization – moving to smart and automated controls
• Helps in standardizing policies and procedures for multi-location / multi- business companies
• Fosters a control conscious work culture for people behind controls
• Provides assurance to the CEO/CFO as well as improves business performance
• In some instances, also serves as a base for blue print of optimal procedures while thinking about ERP.

8. GUIDANCE NOTE ISSUED BY ICAI ON INTERNAL FINANCIAL CONTROLS OVER FINANCIAL REPORTING:

Under section 143(3)(i) of the Act, an auditor of a company is required to state in his/her audit report whether the company has an adequate Internal Financial Controls (IFC) system in place and the operating effectiveness of such controls. Explanation to Section 134(5)(e) of the Act defines IFC to include policies and procedures adopted by the company for ensuring orderly and efficient conduct of its business, accuracy and completeness of the accounting records, and timely preparation of reliable financial information.

As per the Guidance Note “Internal Financial Controls Over Financial Reporting” (ICFR) 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.

Pertain to the maintenance of the records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company.

Provides reasonable assurance that transactions are recorded as necessary to permit preparation of financial statement in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and director of the company.

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect of the financial statement.

9. REPORTING RESPONSIBILITY OF THE MANAGEMENT:

Section 134(5)(e) of the Act (which deals with the directors’ responsibility statement) requires directors of listed companies to state whether they had laid down IFC to be followed by the company and that such IFC are adequate and were operating effectively.

Section 133 of the Act, read with Rule 7 of the Companies (Accounts) Rules, 2014.

This responsibility also includes Maintenance of adequate accounting records in accordance with the provisions of the Act, for safeguarding of the assets of the Company, for preventing and detecting frauds and other irregularities, Selection and application of appropriate accounting policies, Making judgments and estimates that are reasonable and prudent  and design, implementation and maintenance of adequate internal financial controls, that were operating effectively for ensuring the accuracy and completeness of the accounting records, relevant to the preparation and presentation of the financial statements that give a true and fair view and are free from material misstatement, whether due to fraud or error.

10.REPORTING RESPONSIBILITY OF AUDITOR:

The auditor’s objective in an audit of IFC – Financial Reporting (which is generally carried out along with an audit of financial statements) is to express an opinion on the adequacy and operating effectiveness of the company’s IFC – Financial Reporting. A company’s internal financial control cannot be considered effective if one or more material weakness exists.

Globally also, auditor’s 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.

APPLICABILTY:

As per Sec 135(1), Every company having net worth of rupees five hundred crore or more, or turnover of rupees one thousand crore or more or net profit of rupees five crore or more during the immediately preceding finnacial year fall under the ambit of CSR Provisions.

AMOUNT TO BE SPENT:

Atleast 2% of average net profits of the company made during the immediately preceding three financial years.

Also, as per Sec 135(6) any amount remaining unspent under section (5), pursuant to any ongoing project, undertaken by a company shall be within a period of thirty days from the end of the financial year transferred to a special account opened by the company for that financial year in any scheduled bank named “Unspent CSR account” and such amount to be spent by the company within the period of 3 years from the date on which it has been transferred.

SET-OFF OF EXCESS AMOUNT SPENT:

The excess amount spent in the earlier years can be set off against the required 2% CSR expenditure up to immediately succeeding three financial years subject to complaince with the conditions stipulted under rule 7(3) of the companies rules,2014. This position is applicable from 22^nd  January,2021 and has a prospective effect. Thus, no carry forward shall be allowed for the excess amount spent, if any , in financial year prior to FY 20-21.

NET PROFIT FOR THE PURPOSE CSR:

Net profit for the purpose of calculation for the amount to be spent on CSR activities is as per Sec 198 of the Companies Act, 2013 which is primarily PROFIT BEFORE TAX with other adjustment as refered in rule 2(h) of CSR rules.

Other Adjustment:

Net Profit before Tax should not include:

1) capital payments and reciepts.

2)Income tax.

3)Set off of past losses.

CSR COMMITTEE APPLICABILITY:

Sec 135(9) where the amount to be spent by a company under sub section (5) does not exceed fifty lakh rupees the requirement under sub section (1) for constituion of the CSR committee shall not be applicable and the functions of such committee provided under this section shall, in such cases be discharged by the board of directors of such company.

CSR COMMITTEE COMPOSTION
Listed companies	Three or more directors out of which atleast one shall be Independent Director
Unlisted public companies	Three or more directors out of which atleast one shall be Independent Director. However if there is no requirement of having an independent director in the company, two or more directors
Private Companies	Two or more directors. No independent directors are required as mentioned in the proviso under section 135(1).

Functions CSR Committee:

The Corporate Social Responsibility Committee shall —

• formulate and recommend the CSR policy to the Board;
• recommend the amount of expenditure to be incurred on CSR activities;
• monitor the CSR policy of the company from time to time; and
• formulate and recommend to the Board, an annual action plan in pursuance of its CSR policy, which shall include the items as mentioned in rule 5(2) of the Companies (CSR Policy) Rules, 2014. For companies covered under Section 135(9) of the Act and not required to have CSR Committee, these functions shall be carried out by the Board itself.

CSR Committee shall meet atleast twice a year.

Rule 5(2) of the Companies (CSR Policy) Rules,2014

a) the list of CSR projects or programmes that are approved to be undertaken in areas or subjects specified in Schedule VII of the Act;

b) the manner of execution of such projects or programmes as specified in sub-rule (1) of rule 4;

c) the modalities of utilisation of funds and implementation schedules for the projects or programmes;

d) monitoring and reporting mechanism for the projects or programmes;

CSR EXPENDITURE:

1)ADMINISTRATIVE OVERHEADS:

Administrative overheads are the expenses incurred by the company for ‘general management and administration of CSR functions. However, the expenses which are directly incurred for the designing, implementation, monitoring, and evaluation of a particular CSR Project or Programme shall not be included in administrative.

Administrative expenses generally comprises of items such as employee cost, Utilities, office Supplies, legal expenses etc. However expenses which are attributable to project implementation shall be included in project cost only.

Example: Salary and training for the employees workings in the CSR division of a company, Stationary Cost, travelling expenses etc. may be included in administrative overheads. However, salary of school teachers or other staff, etc. for education-related CSR projects shall be covered under education project cost.

The maximum permissible limit for administrative overheads is 5% of Total CSR Expenditure of the company for the Financial Year.

2)CSR EXPENDITURE AS MENTIONED IN SCHEDULE VII:

Company which are required to Contribute to CSR activites can contribute according to the List given in Schedule VII of section 135 of companies act, 2013 -mentioned in Annexure-A

3)ANY OTHER  PROJECT:

MEANING OF ONGOING PROJECT:

On going project has been defined under rule 2(1)(i) of the companies rule,2014 as a –

1. A multi- year project, stretching over more than one financial year.
2. Having a timeline not exceeding three year excluding the year of commencement.
3. Includes such project that was initially not approved as multi year project but whose duration has been extended beyond one year by the board based on reasonable justification.

MAXIMUM PERMISSABLE TIME LIMIT FOR ANY ONGOING PROJECT:

As per the definition of ongoing project, maximum permissible time limit for any project shall be three Financial year excluding the financial year in which project has been commenced. i.e., (1+3) financial years.

4) NON-PERMITTED CSR ACTIVIES:

• Activities are undertaken in pursuance of normal course of business of the company.
• Any activity undertaken by the company outside India except for training of Indian sports personnel representing any State or Union territory at national level or India at international level,
• Contribution of any amount directly or indirectly to any political party under section 182 of the Act;
• Activities benefitting employees of the company as defined in clause (k) of section 2 of the Code on Wages, 2019 (29 of 2019);
• Activities supported by the companies on sponsorship basis for deriving marketing benefits for its products or services;
• Activities carried out for fulfilment of any other statutory obligations under any law in force in India.

TREATMENT OF UNSPENT ACCOUNT:

If the company spends less than the amount required to be spent under the CSR Obligation, the board shall specify the reason for not spending in the Board’s report and shall deal with the unspent amount in the following manner:

NATURE OF UNSPENT ACCOUNT	ACTION REQUIRED	TIMELINES
Unspent Account pertains to ‘Ongoing Projects’	Transfer such unspent amount to separarte bank of the company to be called ‘Unspent bank account’	Within 30days from the end of financial year.
Unspent Account pertains to ‘Other than Ongoing Projects’	Transfer unspent amount  to any fund included in schedule VII of the Act.	Within 6Months  from the end of financial year.

PENAL PROVISIONS FOR NON- COMPLIANCE WITH PROVISIONS REGARDING TRANSFER OF UNSPENT AMOUNT:

The said non-compliance is a civil wrong and shall attract the following penalties:

COMPANY	Twice the unspent amount required to be transferred to any fund included in Schedule VII of the Act or Unspent CSR Account, as the case may be or one crore rupees which ever in higher.
EVERY OFFICER IN DEFAULT	1/10th of the Unspent Account required to be transferred to any Fund included in Schedule VII of the Act or Unspent CSR Account or Two lakh whichever is higher.

The penalty does not relieve the company from the obligations under the law, and the penalty is over and above the obligated amount required to be transferred under section 135(5) or 135(6). The penalty is the consequence of abiding the law, and not an alternative for the same.

CSR IMPLEMENTATION:

MODES OF IMPLEMENTATION OF CSR:

Company can undertake CSR activities throughthe following three modes of Implementation,

1)Implementation by Company itself,

2)Implementation through eligible implementing agencies as per sub rule (1) of rule 4.

3)Implementation in collabration through one or more companies as prescribed in sub rule (4) of  rule 4.

Rule 4(1) of the Companies (CSR Policy) Rules, 2014 provides the eligible entities which can act as an implementing agency for undertaking CSR activities.

These are:

• Entity established by the company itself or along with any other company – a company established under section 8 of the Act, or a registered public trust or a registered society, registered under section 12A and 80G of the Income Tax Act, 1961.
• Entity established by the Central Government or State Government – a company established under section 8 of the Act, or a registered trust or a registered society.
• Statutory bodies – any entity established under an Act of Parliament or a State legislature.
• Other bodies – a company established under section 8 of the Act, or a registered public trust or a registered society, registered under section 12A and 80G of the Income Tax Act, 1961, and having an established track record of at least three years in undertaking similar activities.

CSR REPORTING & OBLIGATIONS:

i) REPORTING OF CSR IN BOARD’S REPORT:

As per rule 8(1) of the companies (CSR Policy) Rule,2014, the Board’s Report pertaining to any financial year, for a CSR eligible company, shall include an annual report on CSR containing particulars specified in Annexure  I or Annexure II.

ii) REPORTING IN CSR2 FORM:

Every Company which is required to comply with CSR policies must file the Form CSR2 with Ministry of Corporate affairs within 31^st March every year.

iii) WEBSITE

As per rule 9, the Board of Directors of the company shall mandatorily disclose the following on their website if any, for Public access,

1) Composition of the CSR Committee,

2) CSR Policy,

3) Projects approved by the Board.

ANNEXURE – A

• Eradicating hunger, poverty and malnutrition, 2 [promoting health care including preventive health] and sanitation 3 [Including contribution to the Swatch Bharat Kosh set-up by the Central Government for the promotion of sanitation] and making available safe drinking water;
• Promoting education, including special education and employment enhancing vocation skills especially among children, women, elderly, and the differently abled and livelihood enhancement projects;
• Promoting gender equality, empowering women, setting up homes and hostels for women and orphans; setting up old age homes, day care centers and such other facilities for senior citizens and measures for reducing inequalities faced by socially and economically backward groups;
• Ensuring environmental sustainability, ecological balance, protection of flora and fauna, animal welfare, agroforestry, conservation of natural resources and maintaining quality of soil, air and water 4 [including contribution to the Clean Ganga Fund set-up by the Central Government for rejuvenation of river Ganga];
• Protection of national heritage, art and culture including restoration of buildings and sites of historical importance and works of art; setting up public libraries; promotion and development of traditional arts and handicrafts;
• Measures for the benefit of armed forces veterans, war widows and their dependents, 5 [Central Armed Police Forces (CAPE) and Central Para Military Forces (CPMF) veterans, and their dependents including windows];
• Training to promote rural sports, nationally recognized sports, Paralympic sports and Olympic sports;
• Contribution to the Prime Minister’s National Relief Fund or 6 [Prime Minister’s Citizen Assistance and Relief in Emergency Situations Fund (PM CARES Fund) or] any other fund set up by the Central Government for socio-economic development and relief and welfare of the Scheduled Castes, the Scheduled Tribes, other backward classes, minorities and women; 7
• A)Contribution to incubators or research and development projects in the field of science, technology, engineering and medicine, funded by Central Government or State Government or Public Sector Undertaking or any agency of the Central Government or State Government; and
  B)Contributions to public funded Universities; Indian Institute of Technology (IITs); National Laboratories and autonomous bodies established under Department of Atomic Energy (DAE); Department of Biotechnology (DBT); Department of Science and Technology (DST); Department of Pharmaceuticals; Ministry of Ayurveda, Yoga and Naturopathy, Unani, Siddha and Homoeopathy (AYUSH); Ministry of Electronics and Information Technology and other bodies, namely Defense Research and Development Organization (DRDO); Indian Council of Agricultural Research (ICAR); Indian Council of Medical Research (ICMR) and Council of Scientific and Industrial Research (CSIR), engaged in conducting research in science, technology, engineering and medicine aimed at promoting Sustainable Development Goals (SDGs)].