Practical Aspects of FS & Audit Reports including IFC

Practical Aspects of Financial Statements & Audit Reports, including IFC

Practical Aspects of Financial Statements & Audit Reports, including CARO & IFC. This covers key areas such as classification of assets and liabilities, disclosures, ICFR reporting, financial statement components, and audit procedures. IFC (Internal Financial Controls), or any other aspect covered in the document. Guidance Note on Audit of Internal Financial Controls Over Financial Reporting issued by the Institute of Chartered Accountants of India (ICAI). It provides detailed guidance on Internal Financial Controls and their audit requirements under Section 143(3)(i) of the Companies Act, 2013.

SCOPE OF REPORTING UNDER ICFR REPORTING :

Auditors must assess and report whether the company has an adequate internal financial controls (IFC) system in place and whether these controls are operating effectively. The scope of IFC reporting is broader than CARO 2015, which only requires reporting on controls over inventory, fixed assets, and sales.

Applicability of Internal Financial Controls

• Mandatory for all companies under the Companies Act, 2013 (except small and one-person companies).
• Applicable to both listed and unlisted companies in financial statement audits.
• Auditors must also report on IFC in consolidated financial statements where applicable.

Legal Requirements for IFC under the Companies Act, 2013:

Mandatory requirements for implementing Internal Financial Controls (IFC) for all companies under the Companies Act, 2013. 

• Section 134(5)(e): The Board of Directors of listed companies must state in the Directors’ Responsibility Statement that IFC exists and is effective.
• Rule 8(5)(viii): All companies, including private limited ones, must disclose IFC adequacy in the Board’s Report.
• Section 143(3)(i): Auditors must confirm the existence and effectiveness of IFC in the audit report.

Key Responsibilities for Implementing IFC

• Management’s Role : Management’s Role is to Establishing Standard Operating Procedures (SOPs) for financial processes. and Ensuring that internal controls operate effectively across all business areas.
• Auditor’s Role : Autitor role in Testing whether material weaknesses exist in IFC. and Reporting on operating effectiveness and adequacy of controls.

Action Plan for Compliance – Steps to Implement IFC

• Prepare SOPs (if not already available).
• Implement IFC processes across departments.
• Test and document the existence and effectiveness of controls.
• Identify material weaknesses and take corrective action.
• Ensure compliance before the audit deadline.

Audit Procedures for Internal Financial Controls

• Risk Assessment: Identify material misstatements due to fraud or error.
• Testing of Controls: Assess design and operational effectiveness of financial controls.
• Evaluation of Deficiencies: Identify material weaknesses and assess their impact on financial statements.
• Reporting & Documentation: Provide an opinion on whether IFC is adequate and effective.

The Internal Financial Controls (IFC) Audit Checklist you’ve provided covers a comprehensive set of processes across various departments. To streamline this checklist for practical application, here’s how organizations typically use it: Suggestions for Enhancing This Checklist:

Key Focus Areas in IFC Audit:

• Standards Compliance: Alignment with applicable laws and accounting standards.
• Operational Effectiveness: Ensuring controls are functioning properly.
• Risk Management: Identifying areas of potential financial misstatements.
• Process Improvement: Addressing weaknesses in financial controls.

Categorized Breakdown of IFC Audit Checklist:

Link to Regulatory Requirements Mention that Section 134(5)(e) of the Companies Act, 2013 requires Directors’ Responsibility Statement on IFC. Under Section 143(3)(i), auditors must report on the adequacy and effectiveness of IFC. IFC Audit Risk-Based Approach Emphasize a risk assessment model to classify financial controls into High, Medium, and Low-risk areas.

Audit Planning & Closure

• Task assignment & engagement
• Documentation of audit process
• Closure of assignments

Accounts & Finance

• Payables & Receivables: Invoice processing, payment & receipt cycles.
• Reconciliations: Bank reconciliations, debtor/creditor reconciliation.
• Fixed Assets: Depreciation, asset disposal & booking.
• Regulatory Compliance: GST, TDS, VAT return filings.
• Financial Closing: General ledger review, financial statement reporting.

Commercial & Treasury Operations

• Credit Management: Credit limit setup, dealer/customer onboarding.
• Export-Import: Licensing, dispatch processing, financing instruments.
• Loan & Working Capital Management: Term loans, bank guarantees, buyer credit.

Internal Controls & Testing

• Control Testing: Test of design and operational effectiveness.
• Depot & Inventory Controls: Physical stock verification, invoicing, dispatch.
• ICOEFR Compliance: Risk control matrices, IT process linkages.

IT & System Controls

• ERP & User Management: User creation, server security, ticketing systems.
• Data Integrity & Access Control: Ensuring financial data security.

• Technology and IT Controls : Incorporate IT General Controls (ITGC) under IFC, including access management, cybersecurity, ERP controls, and automated reconciliations.

Legal & Secretarial Compliance

• Company Law Compliances: AGM, Board meetings, ROC filings.
• Contracts & Legal Cases: Review of agreements & pending litigations.

Logistics & Production

• Stock & Inventory Control: Excise returns, logistics processes.
• Production & Maintenance: Preventive maintenance, work order planning.

HR & Payroll Compliance

• Payroll Processing: Salary computation, leave management.
• Recruitment & Exit Management: Ensuring proper documentation.

Revenue & Reporting

• Revenue Audits: NBFC revenue review, cash flow checks.
• Audit Reporting: IFC compliance documentation & corrective measures.

ICFR REPORTING LESS COMPLEX

• Concentration of ownership & management in a small number of individuals.
• Straightforward or uncomplicated transactions.
• Simple record-keeping/centralized accounting.
• Few lines of business & few products within business lines;
• Few internal controls.
• Few levels of management with responsibility for a broad range of controls.
• Few personnel, many having a wide range of duties.
• Use of less complex IT systems.
• Extensive involvement by owners & senior management in the day-to-day activities of the business.

Details of Point wise : Internal Financial Controls (IFC) Audit Checklist:

BASICS – CURRENT VS. NON-CURRENT

Current Asset – satisfies any of the following criteria.

• In the company’s normal operating cycle, it is;
• Intended for sale; or
• Intended to be consumed; or
• Expected to be realized.
• Held primarily for the purpose of being traded; or
• Expected to be realized within 12 months after reporting date; or
• Cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least 12 months after reporting date.

Current liability if it satisfies any of the following criteria; if it is :

• Expected to be settled in the company’s normal operating cycle; or
• Held primarily for the purpose of being traded; or
• Due to be settled within 12 months after reporting date; or
• The company does not have an unconditional right to defer settlement of liability for at least 12 months after reporting date. Terms of a liability that could, at option of ounterparty, result in its settlement by issue of equity do not affect its classification.

Balance Sheet Title – ‘as at’ or ‘as on’ 31^st March

• PL Title – Statement of Profit & Loss / I & E
• Rounding off based on turnover.
  • < Rs. 100 Crores – To the nearest hundreds, thousands, lakhs or millions or decimal thereof
  • 100 Crores or more – To the nearest lakhs or millions or crores or decimal thereof
• Comparative figures required to be disclosed for the last reporting period

GENERAL

• Linking of notes with B/S & PL
• Name , DIN, designation & address of signatories to any document uploaded / filed with ROC
• B/s & PL on letterhead of Auditors ??
• Date of signing
• Payment to shareholders for 2(22)(e)

SHARE CAPITAL & RESERVES

• Authorized / Paid up Capital – Check with Master Data
• Reconciliation of no of shares outstanding at beginning and at end of reporting period.
• Rights, preference & restrictions attaching to each class of shares etc.
• Is conversion of loans into shares in event of default in repayment – Non-cash?
• Share Premium A/c??

BORROWINGS

• Long Term vs. Short Term
• Directors??
• CC Limits??
• Demand Loans??
• Secured /unsecured – nature of security to be stated & guaranteed by directors to be shown separately.
• Term of repayment of term loans to be given
• Period of maturity with respect to B/S date
• Number of installments due; Amt of installments due
• Applicable rate of interest
• Period & amount of default in payment of principal & interest as on B/S date

OTHER CURRENT LIABILITIES

• The amount shall be classified as:
• Current maturities of long term debts
• Current maturities of finance lease obligations
• Interest accrued but not due on borrowings
• Interest accrued and due on borrowings
• Income received in advance
• Unpaid dividends
• Share Application money due for refund and interest accrued thereon (including advances for allotment of share Capital)
• Unpaid matured deposit and interest thereon
• Unpaid matured debentures and interest thereon
• Other payables

OTHER CURRENT LIABILITIES

• Others payable may include:
• Statutory obligations like, ESI, PF, GST etc.
• Liability for purchase of fixed assets
• Contractually reimbursable expenses
• Interest accrued on trade payables
• Expenses Payable.
• TDS Payable
• Trade / Security Deposit
• Mark-to-market loss on forward and option contracts
• Retention Monies
• Accrued salaries and benefits

FIXED ASSETS

• Fixed Asset on the face of the Balance Sheet has to be classified as follows:
• Tangible Assets
• Intangible Assets
• Software
• Capital work-in-progress
• Intangible assets under development
• Capital advances to be grouped as Capital Work-in-Progress or loans and advances? Long term or short term?

INVENTORIES

• Classification into:
• Raw Materials
• Work-in-progress
• Finished goods
• Stock-in-trade (trading goods)
• Stores and spares
• Loose tools
• Others (specifying nature)
• Finished goods should include all goods except acquired for trading purposes
• Goods-in-transit -disclose under relevant sub-head
• Mode of valuation to be stated

REVENUE FROM OPERATIONS

• For companies other than finance company:
• Sale of Products
• Sale of Services
• Other Operating Revenues
• Less: Excise Duty
• For Finance company:
• Interest
• Other Financial services
• As per AS 9 presentation for excise duty – on face of PL

OTHER INCOME

• To be classified as:
• Interest income (other than for finance company)
• Dividend
• Dividend from subsidiary company
• Net gain / loss on sale of investments
• Other non-operating income
• Interest, dividend, etc. to be disclosed separately for Current as well as Non Current Investments

EXPENSES

Disclosure on face of the PL:

• Cost of material consumed
• Purchase of stock-in-trade
• Changes in inventories of finished goods Work-in-progress and stock in trade
• Employee benefit expenses
• Finance cost
• Depreciation and amortization expenses
• Other expenses.

FINANCE COST

• Interest expense
• Interest on borrowings, debentures, bonds, etc.
• Finance charges on finance lease are in nature of interest
• Other borrowing costs
• Commitment charges
• Loan processing charges
• Guarantee charges
• Loan facilitation charges
• Discounts/ premium on borrowings
• Other ancillary costs
• Applicable net loss on foreign currency transactions to the extent they are regarded as adjust to interest cost
• Interest on Tax???

OTHER EXPENSES

• All other expenses will be grouped here. Following to be disclosed separately:
• Consumption of stores and spares
• Power and fuel
• Rent
• Repairs to buildings
• Repairs to machinery
• Insurance
• Rates and taxes, excluding taxes on income
• Miscellaneous expenses
• Any expenditure which exceeds 1% of revenue from operations or Rs.1 L whichever is higher – separate

Notes to Accounts ; AS DISCLOSURES IN NOTES

• SMC / Non- SMC
• AS 1
• FS to be prepared in compliance of
• AS
• FS has to be AS compliant:
• FS to disclose deviation from AS
• Reason for deviation
• Financial effect arising of deviation

IMPORTANT NOTES

• Contingent Liabilities / Commitments (to the extent not provided for)
• Broad Heads – RM , Income, Purchases
• Value of imports made during the year on CIF basis:-
• Raw Materials
  • Components (intermediaries & components) &
  • Spare Parts (for capital equipment)
  • Capital Goods
• in foreign currency (accrual basis) on:
  • Royalty
  • Know-how
  • Professional & consultation fee
  • Interest
  • Others
  • Dividend if paid in FC (cash Basis):
  • Total amount remitted during the year in FC
  • Total no. of non-resident shareholders
  • of shares held by them on which dividend due
  • Year to which dividend relates
  • Foreign Exchange Earnings (Accrual basis):
  • Export of goods (calculated on F.O.B. basis)
  • Royalty, know how, professional and consultation fees
  • Interest and dividends
  • Other income (indicating the nature thereof)
• OTHER DISCLOSURES IN NOTES
  • To disclose in FS full particulars of:
    • Loan given;
    • Investment made;
    • Guarantee given; or
    • Security Provided.
    • Purpose for which loan or guarantee or security is proposed to be utilised by recipient of loan or guarantee or security [186(4)]
  • Contribution during yr to National Defence Fund Amount contributed to Political Party and name of party [182(3)]
  • Public Companies:
  • Money received from director
  • Private companies
  • Money received from director
  • Money received from relative of director

ICFR REPORTING

• • Take Engagement Letter
  • Perform procedures
  • Take Representation Letter
  • Issue Separate / Combined Report
  • Unmodified
  • Modified
  • Qualified
  • Adverse
  • Disclaimer

Different types of ICFR (Internal Controls over Financial Reporting) Reporting

Different types of ICFR (Internal Controls over Financial Reporting) Reporting opinions, categorized into Qualified, Adverse, and Disclaimer opinions. ICFR Reporting Opinions:

• Unmodified (Clean) Opinion: IFC is adequately designed and effective.
• Qualified Opinion: Deficiencies exist, but they do not materially misstate the financials. → Internal control weaknesses exist but do not materially impact financial statements.
• Adverse Opinion: Severe weaknesses exist that could lead to material misstatements. – Severe control deficiencies exist, materially impacting financial statements.
• Disclaimer of Opinion: Auditor could not obtain sufficient evidence to form an opinion.- Auditor cannot obtain evidence to conclude on ICFR effectiveness.

1. ICFR Reporting – Qualified Opinion : This means that some material weaknesses were found, but overall, financial statements remain fairly presented.

• • Due to adequacy issues (impacting both adequacy and operating effectiveness)
    • Internal control weaknesses in customer acceptance, credit evaluation, and credit limits for sales.
    • Inadequate controls over inventory (receipts, issue for production, physical verification, and overhead allocation).
    • Company has not maintained adequate internal controls over financial reporting.
    • However, these weaknesses do not affect the auditor’s opinion on the financial statements.
  • Due to operating effectiveness issues (affecting only operational effectiveness but not adequacy)
    • Similar control weaknesses as mentioned above.
    • Internal controls exist but are not operating effectively.
    • Despite these issues, financial statements remain fairly stated.

2. ICFR Reporting – Adverse Opinion : This means that serious deficiencies exist in internal financial controls, which significantly impact the audit opinion on financial statements.

• • Due to fundamental deficiencies in control framework
    • Risk assessment was not adequately considered, particularly regarding fraud risks.
    • Lack of proper controls for inventory reconciliation, leading to misstated inventory values.
    • Auditor believes financial statements could be materially misstated due to these weaknesses.
    • As a result, the auditor issues a modified (qualified/adverse) opinion on financial statements.
  • Due to framework deficiencies, but no impact on financial statement opinion
    • Company has not established an ICFR framework as per ICAI’s guidance.
    • Auditor unable to obtain sufficient evidence on ICFR effectiveness.
    • However, this does not affect the auditor’s opinion on financial statements.

3. ICFR Reporting – Disclaimer of Opinion : This occurs when the auditor cannot obtain sufficient audit evidence to form an opinion on ICFR effectiveness.

• • Due to framework deficiencies, but no impact on financial statement opinion
    • No established ICFR framework as per ICAI guidance.
    • Auditor is unable to determine if controls are adequate and effective.
    • Financial statements remain unaffected.
  • Due to auditor’s inability to obtain evidence on ICFR, affecting financial statement opinion
    • Controls at a significant branch were not available for audit.
    • Auditor cannot determine if financial controls exist or are effective.
    • This affects financial statement opinion, leading to a qualified/adverse/disclaimer opinion.

We are assistance in SOP preparation and implementation. Test checking of IFC to ensure compliance.and Audit readiness support.