All you need to know about internal Audit of the company

The concept of internal audit was not expressly provided in the 1956 Act, and it did not make it compulsory for any company or type of companies to have an internal audit system. However, the importance of internal audit had been well acknowledgement in Companies (Audit Report) order, 2003, by requiring the auditor of certain classes of companies to comment on this area. According to the order, the statutory auditor of a listed company and any other company having annual turnover exceeding five crore rupees or paid up capital and reserves exceeding fifty lakh rupees, is required under section 227 (4-A) of the 1956 Act, to report on adequacy of internal audit system giving consideration to size and nature of its business.

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Internal audit requirements under the Listing Agreement

The Securities and exchange Board of India (SEBI) has introduced certain mandatory as well as certain recommendatory corporate governance provisions in Clause 49 of the Listing Agreement applicable to listed entities. Some of the important requirements of clause 49 pertaining to internal audit are as follows: The finance director, head of internal audit and a representation of statutory auditors may be present as invitee for the meetings of audit committee. The Audit committee is required to review:

  • Reviewing, with the management, performance of statutory and internal auditors, adequacy of internal control system,
  • The adequacy of the internal audit function, if any, including the structure of internal audit department, staffing and seniority of the official heading the department, reporting structure coverage and frequency of internal audit,
  • Discussion with internal auditors of any significant findings and follow up thereon,
  • Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularly or a failure of internal control systems of a material nature and reporting the matter to the board.
  • Internal audit reports relating to internal control weaknesses,
  • The appointment, removal and terms of remuneration of the chief internal auditor shall be subject to review by the audit committee.

Internal auditors may report directly to the Audit committee. The CEO or the Managing Director or manager or in their absence, a whole time director appointed in terms of Companies Act, 2013 and the CFO shall certify to the Board that:

  • They accept responsibility for establishing and maintaining the internal controls for financial reporting and that they have evaluated the effectiveness of internal control system of the company pertaining to financial reporting and they have disclosed to the auditors and the Audit Committee, deficiencies in the design or operation of such internal controls, if any, of which they are aware and the steps they have taken or propose to take to rectify these deficiencies,
  • They have indicated to the auditors and the audit committee, significant changes in internal control over financial reporting during the year,
  • Significant changes in accounting policies during the year and that the same have been disclosed in the notes on the financial statements; and
  • Instances of significant fraud of which they have become aware and involvement therein, if any, of the management or an employee having a significant role in the company’s internal control system over financial reporting.

Companies act, 2013: Section 138

Section 138 of Companies Act, 2013 has an express provision about internal audit recognizing the utility of such an audit in terms of better internal control and corporate governance. The 21st report on the Companies Bill, 2009 submitted by the Chairman of the Standing Committee on Finance, Mr. Yashwant Sinha, to the Honorable Speaker of the Lok Sabha on 31 August 2010 states that, At the behest of the Committee, with a view to strengthening the compliance systems in companies, the Ministry of corporate affairs have agreed to incorporate a new clause, wherein Internal Audit has been made mandatory for bigger companies. In the notes on clauses forming part of the Companies Bill 2011, it is stated that the new clause seek to provide that prescribed companies shall be required to conduct internal audit of functions and activities of the company by internal auditor appointed by the company, in a manner prescribed by the Central Government. Rule 13 of the Companies (Accounts) Rules  2014 requires all listed companies to appoint an internal auditor. In addition, unlisted public companies and private companies are also required to appoint an internal auditor if certain criteria related to share capital, turnover and outstanding borrowings are met. As per requirement of clause 41 of Listing agreement, listing companies already maintained internal audit departments, the Rule 13 of Companies (Accounts) Rules, 2014 has extended the coverage to unlisted public companies and private companies meeting specified criteria.

Definition of Internal Audit

The term “internal auditing’ has not been defined in Companies Act, 2013. This term has been described in the preface to the standards on Internal Audit, issued by the institute of Chartered Accountants of India, as below : Internal auditing is an independent, objective, assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes. The scope of internal auditing within an organization is broad and may involve topics such as an organization’s governance, risk management and managements controls over efficiency and effectiveness of operations (including safeguarding of assets), the reliability of financial and management reporting and compliance with laws and regulations. Internal auditing may also involve conducting proactive fraud related assessments to identify potentially fraudulent acts; participating in fraud investigations under the direction of fraud investigation professionals , and conducting post fraud investigation audits to identify control break downs and establish financial loss.

Functions of internal auditor

The overall objectives of an internal auditing, as defined in the preface to the standards on Internal audit are:

  • To suggest improvements to the functioning of the entity; and
  • To strengthen the overall governance mechanism of the entity, including its strategic risk management as well as internal control system.
  • The other functions of internal auditor are: understanding and assessing the risks and evaluate the inadequacies of the prevalent internal controls.
  • Identifying areas for systems improvement and strengthening control
  • Ensuring optimum utilization of the resources of the entity, for example, human resources physical resources etc.,
  • Ensuring proper and timely identification of liabilities, including contingent liabilities of entities
    ensuring compliances with internal and external guidelines and policies of the entity as well as the applicable statutory and regulatory requirements.
  • Safeguarding the assets of the entity
  • Reviewing and ensuring adequacy of information system security and control.
  • Reviewing and ensuring adequacy, relevance, reliability and timeliness of management information system.

Role of Internal Audit Standards Board

Internal auditing related activities have been prima facie for the Institute of Chartered Accounts of India. Accordingly, the institute had constituted a Non-standing committee, committee on the internal audit on 5th February 2004. Considering the important role brings played by the committee on Internal Audit in growth and development of the internal audit profession in India, the committee had been converted into “internal auditing standards board” in November 2008. It has been established with a mission to reinforce the primacy of the institute of Chartered Accountants of India as a promoter, source and purveyor of knowledge relating to internal audit and other aspects related to it in the society so as to enable its members to provide more effective and efficient value added services related to this field to the industry and others and help the latter to systematize and strengthen their governance process by systematizing and strengthening their control and risk management process.

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