Internal Financials Control Reporting

As per Section 134(5)(e) of Companies Act, 2013, the term “Internal Financial Controls” means the policies and procedures adopted by the company for ensuring:

1. Orderly and efficient conduct of its business, including adherence to company's policies
2. Safeguarding of its assets
3. Prevention and detection of frauds and errors
4. Accuracy and completeness of the accounting records, and
5. Timely preparation of reliable financial information.

Applicability of Internal Financial Controls

As per Section 134(5) of the Companies Act 2013, Internal Financial Controls is applicable only to listed companies. Whilst the Act specifies on listed companies, Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 read with Rule 8(4) talks about listed and unlisted public companies only with 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 Companies Act 2013, the Directors Responsibility Statement shall state 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.

Further, Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the Board of Directors’ report of all companies to state the details in respect of adequacy of internal financial controls with reference to the financial statements only.

Auditor’s Responsibility

As per Section 143(3)(i) of Companies Act 2013, the auditor's report shall state whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls in the company in all material respects with respect to financial reporting only. Furthermore, it states that auditors will have to report in respect of both stand alone and consolidated financial statements.

The term ‘internal financial controls’ would relate to ‘internal financial controls over financial reporting’ in accordance with 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”. As per Guidance Note issued by ICAI in September 2015, “internal financial controls over financial reporting” 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 that:

1. pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
2. provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorisations of management and directors of the company; and
3. provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.”

Also, as per new clause (xiv) Internal Audit System in CARO, 2020, 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 i.e., all internal audit observations having a financial impact are considered and also taken care for reporting of Internal Financial controls under the Audit report.

***Exemption for Private Companies for Internal Financial Controls Applicability

MCA vide its notification dated 13th June 2017 (G.S.R. 583(E)) provided exemption from Applicability of Internal Controls over financial reporting under Section 143(3)(i) to following private companies:

1. which is a one-person company;
2. which is a small company;
3. which has turnover less than rupees 50 crores as per latest audited financial statement;
4. which has aggregate borrowings from banks or financial institutions or any body corporate at any point of time during the financial year less than rupees 25 crores.

The above-mentioned Companies will be not exempted from IFC Applicability if it has committed a default in filing its financial statements under section 137 of the Companies Act 2013 or annual return under section 92 of Companies Act 2013 with the Registrar.