Saturday, April 11, 2015

Internal Financial Controls_Directors' Responsibility Statement_Fabindia

Section 134 of the Companies Act 2013 requires that every  company shall attach to its Board's report a Directors' Responsibility Statement. The Statement, in case of a listed company, shall include, among other things, a statement that "the directors had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively."

Explanation to section 134 (5) defines the term internal financial controls as follows:

"The term 'internal financial controls' means 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 of frauds and errors, the accuracy and completeness of the accounting records and the timely preparation of reliable financial information.'

Section 143 of the Companies Act 2013 requires the auditor to state whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls. This requirement will be applicable from the fiscal year ending on or after March 31, 2016. The Institute of Chartered Accountants of India had issued Guidance for its members. However, it withdrew the same subsequently.  The definition is quite broad and it is difficult for the auditor to comment on the same. Auditors are usually concerned with internal financial controls relating to the preparation of financial statements.

The Board is responsible for the orderly and efficient conduct of business. Therefore, it is responsible for internal financial controls that ensure the company achieving its objectives. The Board develops mechanisms to get the assurance that internal financial controls are adequate and effective. The Board should always be in a position to provide an assurance to shareholders that internal financial controls are adequate and operating effective.

It is reported in Times of india the MD and the CEO told the Crime Branch  officials that they are policy makers and others implement the same. Perhaps that is the correct statement. But that is an incorrect approach. The Board is responsible for ensuring effective implementation of policies. Directors, including independent directors, should not sign on dotted lines under the Directors' Responsibility Statement. They should get the assurance, may be through the internal auditor, that internal controls are adequate and operating effectively. Otherwise they will be held liable for not applying due diligence.

Fabindia is a private limited company. Therefore, its directors' accountability is not as stringent as that of directors of listed companies. Listed companies cannot afford to adopt the Fabindia approach.

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