Internal Financial Controls, as defined in Section 134(5)(e) of the Companies Act, 2013, refers to the policies and procedures implemented by a company to ensure:
- Efficient and orderly conduct of business, including compliance with company policies.
- Protection of company assets.
- Prevention and detection of frauds and errors.
- Accuracy and completeness of accounting records.
- Timely preparation of reliable financial information.
It’s important to note that the applicability of Internal Financial Controls is specified in Section 134(5) of the Companies Act 2013. It applies to listed companies, and Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014, along with Rule 8(4), extends the applicability to listed and unlisted public companies with a paid-up capital of Rs 25 crore or more calculated at the end of the preceding financial year.
Reporting of Internal Financial Controls
Management’s Responsibility:
As per Section 134(5)(e) of the Companies Act, 2013, the directors are responsible for laying down internal financial controls for the company and ensuring their adequacy and effective operation. The Directors’ Responsibility Statement should include this information.
Additionally, Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the Board of Directors’ report to mention the details regarding the adequacy of internal financial controls, specifically with reference to the financial statements.
Auditor’s Responsibility:
According to Section 143(3)(i) of the Companies Act, 2013, the auditor’s report should state whether the company has an adequate internal financial control system in place and whether it is operating effectively in all material aspects related to financial reporting. This applies to both standalone and consolidated financial statements.
The term “Internal financial controls” specifically refers to “Internal financial controls over financial reporting” as per the objectives of an audit stated in SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing.” The Guidance Note issued by ICAI in September 2015 provides a definition of internal financial controls over financial reporting.
In addition, as per the new clause (xiv) in the Companies (Auditor’s Report) Order, 2020, the auditor is required to comment on whether the company has an internal audit system and whether it has considered the reports of the internal auditors, particularly in relation to reporting on internal financial controls in the audit report.
The process of reporting internal financial controls can be outlined as follows:
- Management’s Responsibility: a. Directors lay down internal financial controls for the company. b. Internal financial controls should be adequate and effectively operating. c. Directors’ Responsibility Statement includes the disclosure of internal financial controls.
- Auditor’s Responsibility: a. Auditor’s report states whether the company has an adequate internal financial control system. b. Auditor assesses the operating effectiveness of internal financial controls. c. Reporting covers both standalone and consolidated financial statements.
- Definition of Internal Financial Controls: a. Internal financial controls relate to internal financial controls over financial reporting. b. Internal financial controls aim to provide reasonable assurance regarding the reliability of financial reporting. c. Controls include policies and procedures for accurate record-keeping, compliance with accounting principles, and prevention or timely detection of unauthorized asset transactions.
- Consideration of Internal Audit: a. Auditor comments on whether the company has an internal audit system. b. Reports of the internal auditors are considered, including financial impact observations. c. Internal audit observations related to internal financial controls are taken into account.
The process involves management’s establishment and evaluation of internal financial controls, auditor’s assessment and reporting on adequacy and effectiveness, and consideration of internal audit findings. This ensures transparency and accountability in the reporting of internal financial controls.
Checklist for reporting internal financial controls:
- Management’s Responsibility:
- Directors have laid down internal financial controls.
- Internal financial controls are adequate and operating effectively.
- Directors’ Responsibility Statement includes disclosure of internal financial controls.
- Auditor’s Responsibility:
- Auditor’s report states whether the company has adequate internal financial controls.
- Operating effectiveness of internal financial controls is assessed.
- Reporting covers both standalone and consolidated financial statements.
- Definition of Internal Financial Controls:
- Internal financial controls relate to internal financial controls over financial reporting.
- Controls aim to provide reasonable assurance regarding the reliability of financial reporting.
- Controls include accurate record-keeping, compliance with accounting principles, and prevention/detection of unauthorized asset transactions.
- Consideration of Internal Audit:
- Company has an internal audit system.
- Reports of internal auditors are considered, including financial impact observations.
- Internal audit findings related to internal financial controls are taken into account.
By following this checklist, management and auditors can ensure compliance with reporting requirements and provide transparency regarding the adequacy and effectiveness of internal financial controls.
list of deliverables related to internal financial controls:
- Well-defined Policies and Procedures:
- Develop and implement clear policies and procedures for internal financial controls.
- Ensure that these policies and procedures are documented and communicated to relevant personnel.
- Adherence to Company Policies:
- Establish mechanisms to monitor and ensure the orderly and efficient conduct of business in accordance with company policies.
- Implement controls to promote compliance with policies and mitigate risks associated with non-compliance.
- Safeguarding of Assets:
- Implement measures to safeguard company assets, including physical assets, intellectual property, and sensitive financial information.
- Establish controls to prevent unauthorized access, theft, or misuse of assets.
- Fraud and Error Prevention:
- Design and implement controls to prevent and detect fraud and errors within the organization.
- Conduct regular assessments and monitoring activities to identify potential fraudulent activities and take appropriate actions.
- Accuracy and Completeness of Accounting Records:
- Ensure that accounting records are maintained accurately and completely, reflecting all relevant transactions and events.
- Implement internal controls to validate the accuracy and completeness of financial data, including reconciliations and review procedures.
- Timely Preparation of Reliable Financial Information:
- Establish processes and systems to ensure the timely preparation of financial information.
- Implement controls to ensure the reliability and integrity of financial data, including review and verification procedures.
By focusing on these deliverables, organizations can strengthen their internal financial controls, enhance transparency, and mitigate risks associated with financial reporting and asset management.