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Internal Financial Controls: Confusion Prevails

Published on Thu, Mar 05,2015 | 16:51, Updated at Thu, Mar 05 at 16:51Source : 

By: Jamil Khatri, Global Head – Accounting Advisory Services, KPMG

The Companies Act requires the Board of Directors of listed companies to comment in the board’s report on the adequacy and effectiveness of Internal Financial Controls (IFC) of the company.  Additionally, the Companies Act Rules require all companies to report on the adequacy of IFC with reference to the financial statements.  Auditors are required to certify that the IFC are designed and operate effectively. Since the notification of the Act and thereafter the Rules, there has been significant confusion and debate on the scope of this certification. Should the certification be limited to IFC over financial reporting or cover operational areas for listed companies? Does the certification extend to overseas subsidiaries and consolidated financial statements?

The Institute of Chartered Accountants of India (ICAI) sought to address this debate by issuing a detailed Guidance Note in this area.  The Guidance Note addressed several contentious issues in the context of auditor responsibilities (the certification should be limited to IFC over financial reporting; and should not extend to overseas subsidiaries/consolidated financial statements) and provided guidance on the framework to be used for the certification (largely based on the COSO 2013 principles).  Even as companies and auditors were digesting the requirements of the Guidance Note, the confusion was accentuated by the withdrawal of the Guidance Note by the ICAI.  While no official reasons have been sighted for the withdrawal, several participants have attributed the withdrawal to additional work that may be required, to seek alignment with the views of the Ministry of Corporate Affairs (MCA). To add to the uncertainty, auditor certification of IFC has now been deferred to the year ending 31 March 2016, even though, no such relief has been prescribed for certification by the Board of Directors.

To address the above uncertainties, several industry associations have sought a deferral of board certification of IFC for the year ending 31 March 2015.  While such a deferral is possible, till that comes through, companies and boards are grappling with one of the best ways to address the certification requirements.  In practice, we are seeing a few different approaches:
Several companies are mapping their current controls with the requirements of recognised IFC frameworks such as COSO 2013 and then seeking to address the gaps arising prior to 31 March 2015.  Several of these companies may realise that they are unable to address all gaps prior to 31 March 2015 and are, therefore, seeking to provide a comfort to their board with an action plan to address the gaps in a timely manner.  

Several other companies are reviewing their current controls (without necessarily using a framework such as COSO) and increasing the testing of these controls by their internal audit departments to provide a basis for certification to the Board.

Lastly, some other companies are taking an approach that their previous control review and testing is sufficient to enable the Board to certify IFC even under the new Act.

Further, most listed companies are reading requirements related to IFC as those referring to IFC for financial reporting along with limited focus on the operational controls aspect.

In an ideal world, the MCA should provide guidance on the expectations from companies for the FY 14-15 board certification (assuming there is no deferral).  In the interim, as a minimum, company management should firm up their approach and obtain the concurrence of their board/audit committee on the action plan.  We have seen differing views in this area amongst independent directors, and companies would be well served to help ensure that their approach is aligned to the expectations of the board/audit committee.  This would avoid last minute surprises.


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