The Companies Act, 2013, requires auditors to frame an opinion on whether a company has “an adequate Internal Financial Controls (IFC) system in place and the effectiveness of such controls. It means apart from Normal Audit Report and CARO, auditor is also required to comment on Internal Financial Controls however applicability of Internal Financial Controls is restricted to only certain class of company like Small Company etc.
The purpose behind the implementation of IFC is to shifting of responsibility on auditor to assess the effectiveness of IFC:
What is Internal Financial Control:
As its name suggest “Internal Financial Control” it is refer to control implemented in Financial Environment by management of an organisation. Internal Financial Controls are systematic implementation and review of controls relating to financial transactions of company.
Internal financial control is a risk management framework that manages the risk to the organization from error or fraud and therefore assists in the achievement of a Company’s objectives.
As per Section 134 of the Companies Act, 2013 (the Act), the term “Internal Financial Controls” means the policies and procedures adopted by the company for ensuring:
- orderly and efficient conduct of business, including adherence to company’s policies,
- safeguarding of its assets,
- prevention and detection of frauds and errors,
- accuracy and completeness of the accounting records, and
- timely preparation of reliable financial information.
Considering the definition prescribed under companies act, Internal Financial Control put an additional burden on management of company to frame policy and procedure which will ensure that financial transactions are not manipulated by employees, roles and responsibility has been fixed between group of employees and manner has been prescribed for accurate financial reporting.
Internal financial controls are designed to assist the organization in highlighting risk of “fraud and error“ and improving reliability of financial reporting & compliance with laws, regulations and policies.
What was the need of Internal Financial Control:
With an objective of enhancing the robustness of the corporate governance structure, companies act has prescribed mandatory implementation of Internal financial control for certain class of company. Previously auditor was not able to detect financial frauds through his statutory audit whereas post implementation of IFC auditor are specifically asked to test effectiveness and responsible to comment in his report of IFC. Because of the implementation of internal financial control management are bound to ensure accuracy of financial transactions. Let’s have a look on objective of internal financial control:
- To mitigate risks and provide reasonable assurance that operations are efficient and effective, assets are safeguarded.
- Financial reporting is accurate and reliable.
- To ensure Company’s resources are used prudently and in an efficient, effective and economical manner.
- Resources of the Company are adequately managed through effective internal controls.
- A framework for an effective internal control system which conveys to managers that they are responsible for ensuring that internal controls.
- To adhered across the Company’s and to all Employees that they are responsible for adhering to those internal controls.
- To ensure the propriety of transactions, information integrity, compliance with regulations and achievement of Company’s objectives through operational efficiency
Applicability for Internal Financial Control:
Companies Act 2013, Auditor of every company has to provide comment in his audit report whether the company has adequate internal financial controls. Further auditor also comment on operating effectiveness of such controls. However ministry of corporate affairs have provided some relaxation for specified category of company which are as follows:
- Small Company
- One Person Company
- Company whose turnover of recent audited financials does not exceeds 50 Crore or
- Company who’s borrowing does not exceeds 25 Crore
Key advantages of Internal Financial Control:
A well implemented Internal Financial Control support the reliability of financial reporting and Ensure compliance with applicable laws and regulations. Following are the main advantage of IFC:
- Reduce the risk of direct and indirect fraud like cash theft by employee
- Promotes culture of openness and transparency within the entity
- Improved investor confidence in entity’s operations and financial reporting process
- More accurate, reliable financial statements and Integrity & reliability of reporting
- Effective and efficient use of resources
- Improvements in Board, Audit Committee and Senior Management engagements in financial reporting and financial controls