Normally, laws in India are passed and amendments are made to take care of changed scenarios and to alter provisions that defy logic. The Companies Act, 2013 has bucked this trend. The Government has promised some relaxation for private companies and has promised that they will relook into other provisions. We’ve been used to amendments to the Companies Act and the latest in this postponement trend is the requirement for auditors to comment on the effectiveness of internal controls.

Internal controls If we look at the provisions holistically, the main theme that comes across is to ensure that companies do not get away with murder and the auditors do not defend the murder.

Towards this end, Clause 143 (3) (i) of the Act required the auditor to state in his report, inter-alia , whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls. When Enron electrified the world in 2002 with the omissions in their books of account, the US reacted with the Sarbanes Oxley Act (SOX).

The only Section of SOX that was most used was Section 404 which required all entities to take a relook at their internal controls and all auditors to test the effectiveness of those controls. The strategy was to perform “walk-throughs” of all major processes in the company.

This requirement seemed simple and basic but it did have some impact — a software company in India realised after a walk-through that their asset capitalisation and commencement of depreciation charge was being delayed by a week.

Through a notification dated 14th October, 2014 the Ministry of Corporate Affairs ( MCA) has postponed the requirement of the auditors to comment on the effectiveness of internal controls to periods beginning from April 1, 2015. As an afterthought, the notification says that the auditor may voluntarily do this test of internal control for the year ending March 31, 2014. Of all regulators, the MCA should know that voluntary compliance is not a very popular concept with companies.

Clause 134(5)(e) of the Act mandates the directors to state in their report that the internal financial controls of the company are adequate and effective. This provision has not been deferred.

Thus, we have a situation in which companies are doing their internal controls this year and auditors are testing their effectiveness next year. Ideally, this should have been a one-time joint effort. Now companies will have to incur a cost to do their internal controls and an additional cost for auditors to test them.

Conflicting provisions The Act requires auditors to report their observations or comments on financial transactions or matters which have any adverse effect on the functioning of the company. It will be impossible for auditors to comply with this reporting requirement without testing the adequacy of internal controls.

In another clause, the Companies Act makes a blanket statement that an auditor shall comply with all auditing standards. The Institute of Chartered Accountants of India has issued Auditing Standard SA 265, which talks about communicating deficiencies in internal control to the management. The hapless auditor is in the quixotic situation of having respite from the MCA but none from the alma mater .

Instead of amending, relaxing and postponing provisions of the Companies Act, 2013 in bits and pieces, the Government would do well to take time out and pass a single amendment Act which will stand the test of time.

The writer is a chartered accountant

Related Topics
comment COMMENT NOW