Internal Financial Controls – The Internal Control revolution in India



In the early years of the 21st century, a new legislation introduced in the United States brought about radical reforms in the area of corporate compliance. The Sarbanes-Oxley Act (popularly known as SOX), signed on July 30, 2002, was designed primarily to safeguard investors by improving the accuracy and reliability of corporate disclosures. The Act was enacted as a reaction to a number of major corporate and accounting scandals in the US, including Enron and WorldCom. Arguably, over the last 14 years, this legislation has made immense contributions in generating greater focus on improved corporate governance and stronger ethics programs in the United States.

Inspired by what US regulators have achieved in the past and concerned with weaknesses in the existing Corporate Governance structure in India, Indian legislators instituted several new measures through the Companies Act 2013. One such landmark initiative was the requirement of Internal Financial Controls (IFC) for all Indian companies. Under Section 143(3)(i) of the Companies Act 2013, Statutory Auditors are required to make a statement in their Auditors Report, whether the company has adequate IFC system in place and whether such controls are operating effectively.

Applicability and Responsibilities

Initially there was some ambiguity on the applicability and reporting of Internal Financial Controls. To provide more operational clarity on this new regulation, the Institute of Chartered Accountants of India (ICAI), in September 2015, issued a detailed guidance note on Audit of Internal Financial Controls over Financial Reporting. As per ICAI, Internal Financial Controls shall mean:

“the policies and procedures adopted by the company for ensuring the orderly and efficient conduct of its business, including adherence to company’s policies, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.”

Internal financial controls over financial reporting is mandatory for both public as well as private companies in India. This broadens the gamut of organizations that will be required to be compliant under this new regulation.

The responsibilities of the key stakeholders in the IFC compliance process are now clearly laid out:

Directors: Ensure adequacy and operating effectiveness of IFC

Audit Committee: Evaluate adequacy and operating effectiveness of IFC

Auditor: To comment on adequacy and operating effectiveness of IFC

Operating Effectiveness

Performing operating effectiveness testing is critical in identifying potential deficiencies in the internal control framework and developing appropriate remediation measures. From the United States experience we have learned that ensuring operating effectiveness of internal controls is a gradual process rather a one-time phenomenon. It will take concerted planning effort on behalf of the management and other stakeholders to ensure effective implementation of IFC going forward.

A good automation solution could be a boon in operating effectiveness testing, especially with the volume of documentation, coordination and reporting involved in the process. Quikprocess aims to be a trusted partner to companies looking to automate their operating effectiveness testing for IFC. Our deep domain expertise and cutting-edge technology will ensure that the company saves time and costs in IFC compliance.