Internal Financial Controls

Indian regulations on financial reporting are being aligned to international practices and the introduction of Internal Financial Controls (IFC) in the Companies Act 2013 is reflective of this trend. The trend underscores two important evolutions in globalised business; Governance and Technology. As technology adoption in businesses is growing rapidly, businesses have to rely on controls more and more while boards have to ensure that a robust control environment is designed and deployed to achieve business objectives. To this effect, the Companies Act, 2013 has imposed specific responsibilities on the Board of Directors towards the company’s internal financial controls and requires the board to state that they have laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively. While similar reporting requirements have existed elsewhere in the world (in USA it’s the Section 404 under Sarbanes Oxley Act, the Turnbull Guidance on Internal Control with the London Stock Exchange for listed companies and Japan’s Financial Instruments and Exchange Law (J-SOX) are similar rules for public companies), in India there was no such requirement until the new act came into force.

As part of Internal Financial Controls, Indian public and private companies are expected to establish frameworks that provide assurances about the soundness of governance and internal controls, elaborated as follows-

• For listed companies, the management would have to identify and document financial and non-financial controls (referred to in the act as policies and procedures for orderly and efficient conduct of business), assure the boards of the adequacy of such controls and also demonstrate results of testing operating effectiveness of such controls.
• For unlisted companies, the Directors’ Report for FY 2014-15 would have to disclose adequacy of controls related to financial statements.

Annual reports for the year FY 14-15 will be required to have Director Responsibility Statement carrying disclosure on what steps companies have taken to implement Internal Financial Controls.

Additionally, for both listed and private companies, it is mandated that from FY 2015-16, statutory auditors would be expected to make opine on operating effectiveness of controls related to financial reporting.

As with many other important provisions of the new Act, Internal financial control has been made a board and individual director’s responsibility. This means enhanced level of engagement and scrutiny by the board and directors into IFC framework of a company and whether such frameworks are “adequate” and “effective”. Currently, many companies are assessing the impact these new requirements will have on the operations and processes of the company, including the financial reporting process.