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:
- Assess the current state of internal controls
- Embrace a widely acceptable framework or guidelines
- Set the right tone at the top i.e., those charged with governance
- Ascertain organizational risks which have financial impact
- Define the control objectives and control Activities to mitigate the risk
- Ongoing continuous monitoring of the functioning of control
- 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.