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Companies Act, 2013: Concerning Cost Of Compliance

Published on Tue, May 06,2014 | 21:13, Updated at Tue, May 06 at 21:13Source : 


By: Sriraman Parthasarathy, Partner, Deloitte Haskins & Sells

Globally, compliance requirements for corporates have increased manifold these days thanks to the increasing Stakeholders expectations, large number of scandals/frauds, enhanced public appetite for having more and more information and the compelling need for protecting the interest of the society. In the case of a corporate, need for having a greater monitoring is inevitable due to its legal status and the fundamental difference in the ownership and the management structure. Whilst, corporates are making every effort to ensure such compliances, being a regulatory requirement, anything which is thrust on them where the real benefit is not convincingly demonstrated and felt by them, will become a procedural burden rather than achieving the intended objectives. In addition, excessive compliance requirements would also dilute the effectiveness and this should not result in missing the woods for the trees. This brings up the core issue that there should be a proper balance between such compliance requirements vis-à-vis the benefits arising out of the same. The recently passed new Indian Companies Act, 2013 (“the Act”) is path breaking and has several provisions, inter alia, for increasing the standards of governance, transparency, investor protection and enforcement.  However, the implementation of various measures for various types of entities, including for unlisted / medium and small entities, is going to significantly increase their compliance costs.

Under the new Act, the Board of Directors is vested with the responsibility of ensuring, inter alia, a robust regulatory and compliance framework, whistle blower mechanism, fraud detection and prevention mechanism, etc.  Further, the Board Report is also to include a statement indicating the manner in which formal annual evaluation has been made by the Board of its own performance and that of its committees and individual directors. In addition, various Board committees have to be mandatorily created and are expected to assume various responsibilities. Whilst there is an expectation of enhancing the role and the responsibilities of the Board and its committees, all these new requirements would imply additional efforts and additional costs for corporates!

As regards financial reporting, corporates have the additional responsibility of providing consolidated audited financial statements in addition to the stand alone financials wherever they have subsidiaries. This is going to enhance the work involved for unlisted entities where there was no such requirement under the old regime.  Similarly, the requirement of evaluating the effectiveness of the Internal control financial reporting, which is expected to be on the similar lines of the Sarbanes Oxley requirements of the United States, is an onerous responsibility on the part of corporates which would lead to increased costs for compliance and reporting and finally for obtaining the assurance from the statutory auditors. Additional and enhanced reporting requirements on the part of the auditors including on aspects such as frauds, propriety, internal controls, etc. would naturally increase the audit effort and would also push up the audit costs.  Further, the new Act also mandates change in the method of dealing with various items for accounting purposes such as consolidation, change in depreciation rates, componentisation etc. that could necessitate change in the IT systems resulting in additional expenditure.

Audit rotation is another aspect introduced under the new Companies Act which is going to fuel the cost of audits in the long run. The time to be spent in understanding various processes/ internal control frameworks for having an institutional knowledge required for carrying out the audits would get multiplied with rotation of auditors and this is going to result in higher administration/ audit costs. Whilst such a requirement would have suited the large listed entities from a governance angle, extending this to private companies would imply using a sledge hammer to kill a fly!

Above all, with the introduction of class action suits and various other penal provisions, the cost of insurance is bound to increase for corporates in providing the required indemnity which would push the compliance costs up!

Whilst there are various simplification measures that are included in the new Companies Act, the ones listed above are some of the additional compliance requirements where the applicability of these provisions could have been limited to large/listed entities considering the cost of compliance and the resultant benefits. There is no doubt that all these are measures taken to raise the bar on governance and transparency but application of the same for unlisted and medium/small entities needs to be re-evaluated in the light of the corresponding Costs and the underlying benefits. Hopefully, in future based on the experience gained, the Regulators will relook at many of these provisions and would direct them only against large corporates rather than covering all entities with everything at one go to make sure that at least the medium/small corporates are not burdened with higher compliance costs!


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