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2021

Statutory Requirements and Importance of Internal Audit

Statutory Requirements and Importance of Internal Audit

As per the standard laid down by The Institute of Chartered Accountants of India (ICAI), Internal Audit is broadly defined as a Risk Management Function independently carried out to assist the Management of an organization. It is carried out internally at the behest of the Management and different from External or Statutory Audit.

An independent management function, which involves a continuous and critical appraisal of the functioning of an entity with a view to suggest improvements thereto and add value to and strengthen the overall governance mechanism of the entity, including the entity's strategic risk management and internal control system- or in simple terms - It was, and is, a way of ensuring businesses and public sector organizations use resources efficiently and apply process consistently

Internal auditors assist management with this task by providing a focus on risk management and the implementation of more stringent internal controls to manage prospective risks and vulnerabilities. Internal Control - As per Explanation to clause [e] of sub-section (5) of section 134 - Financial statement, Board's report, etc. of Companies Act, 2013 - 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 frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information; As of today, internal audit undeniably is the backbone of a sound corporate governance system.

Internal Audit helps in identifying gaps and loopholes in implementation of policies and procedures laid down by the organization in various day to day functions like Finance, Risk, HR, Statutory compliances etc. It also does critical appraisal of internal controls and helps in implementing the best industry practices to meet corporate objectives.

Statutory Requirement for Internal Audit:

As per section 138 of Indian Companies Act 2013 read with Rule 13 Of Companies (Accounts) Rules, 2014, certain classes of companies are required to appoint Internal Auditors.

Applicable Provisions

Coverage

Section 138 of the Companies Act, 2013

Internal Audit

Rule 13 of Companies (Accounts) Rule, 2014

Companies required to appoint internal auditors. The section provides, in brief, the threshold limits for applicability.

Rule 8 of the Companies (Meetings of Board and its Powers) Rules, 2014

Power of the Board.


Such a resolution is to be passed by the Board of Directors and needs to be filed with the concerned Registrar of Companies

 

Section 138 of the Companies Act, 2013:

Such class or classes of companies as may be prescribed shall be required to appoint an internal auditor, who shall either be a chartered accountant or a cost accountant, or such other professional as may be decided by the Board to conduct internal audit of the functions and activities of the company.
The Central Government may, by rules, prescribe the manner and the intervals in which the internal audit shall be conducted and reported to the Board.]

Rule 13 of Companies (Accounts) Rules, 2014 – Companies required to appoint internal auditor:

The following class of companies shall be required to appoint an internal auditor or a firm of internal auditors:

  1. Every Listed Company;
  2. Unlisted Company having:
    1. Paid up share capital of 50 crore rupees or more during the preceding financial year; or
    2. Turnover(income) of 200 crore rupees or more during the preceding financial year; or
    3. Outstanding loans or borrowings from banks or public financial institutions exceeding 100 crore rupees or more at any point of time during the preceding financial year; or
    4. Outstanding deposits of 25 crore rupees or more at any point of time during the preceding financial year; and
  3. Private Company:
  4. Turnover of 200 crore rupees or more during the preceding financial year; or
  5. Outstanding loans or borrowings from banks or public financial institutions exceeding 100 crore rupees or more at any point of time during the preceding financial year:

Note: Provided that an existing company covered under any of the above criteria shall comply with the requirements of section 138 and this rule within six months of commencement of such section.

Explanation:

  • The internal auditor may or may not be an employee of the company; 
  • The Internal auditor may be a CA/CWA or any other professional;
  • The Audit Committee of the company or the Board shall, in consultation with the Internal Auditor;
  • Formulate the scope, functioning, periodicity and methodology for conducting the internal audit.

Rule 8 of The Companies (Meeting Of The Board And Its Power), Rules 2014:

  • Section 117 of the Companies Act, 2013 requires certain resolutions to be filed with the concerned Registrar of Companies within 30 days from the passing of the said resolution. Section 117 links to section 179 which is the parent section Rule 8 of the Companies (Meeting if the Board and its Power), Rules 2014 wherein sub-rule 4 states “to appoint internal auditors or secretarial auditor.”
  • Hence it could be very well interpreted that whenever an internal auditor is appointed in a company then the resolution should be filed with the concerned Registrar of Companies in Form MGT-14 within 30 days from the date of passing of the said resolution.

Clause 49 of the Listing Agreement As per Securities and Exchange Board of India (SEBI):

As per Securities and Exchange Board of India (SEBI), there is a statutory clause 49 of the Listing agreement which requires any listed entity to ensure that

  • Internal audit function is being made functional.
  • Weaknesses found in internal controls are reported.
  • Finding and reporting of suspected frauds or irregularity as a result of failure of internal control mechanism.
  • Certification and taking of responsibility by the CEO and the CFO to the Board of Directors for the effectiveness of internal controls, and steps taken by them to improve upon the deficiencies in internal control to the auditors and the audit committee.

Other Regulations:

  • IRDA (Investment) (Fourth Amendment) Regulations, 2008 has introduced requirements of quarterly internal audit for insurers.
  • Requirements of Sections 302 and 404 of the Sarbanes Oxley Act of 2002, for companies seeking listing in US stock exchanges, NASDAQ, NYSE, etc.

Need for Internal Audit for Organizations:

Following factors necessitate Internal Audit in an organization:

  • Increased size and complexity of business.
  • Compliance of Statutory requirement.
  • Use of Information technology on large scale.
  • Risk Management - understand risk exposure and manage such risks.
  • Establish sound corporate governance and use of best industry practices.
  • Need to create greater transparency.

Benefits of Internal Audit:

  • Accomplishment of objectives and goals of the organization through ethical and effective governance
  • Independent, impartial and unbiased opinion regarding the proper conduct of the affairs of the organization.
  • Constitution of a separate component of internal control with the objective of determining whether other internal controls are well designed and properly operated.
  • Improvement in the internal control structure.
  • Better Corporate Governance.
  • Effective Risk management.
  • Identification of threats and opportunities, and controls are designed to effectively counter threats and take advantage of opportunities.

Functions of Internal Auditor:

  • Review operations, policies, and procedures and assist management in establishing better policies and procedures
  • Certify risks being managed within acceptable limits as laid down by the Board of Directors.
  • Examining and evaluating continuous effectiveness of the internal control system and making recommendations, if any, for improving internal control mechanism.
  • Help the management in identifying frauds and preventing them.

Process of Appointment of Internal Auditor:

  1. Obtain consent Letter/Engagement Letter.
  2. Call Board Meeting.
  3. Pass Resolution & File MGT-14.
  4. Send Intimation to appoint Internal Auditor.

Penalty Provisions:

  • As per Section 450, Company and every officer of the company who is in default or such other person shall be punishable with
  • Fine which may extend to ₹ 10,000/- and
  • Where the contravention is continuing one with a further fine which may extend to ₹ 1,000/– for every day after the first during which the contravention continues.

 

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