Month: August

This article highlights how Covid might have impacted the internal controls of companies. Needless to say, when the internal controls have been affected by the pandemic, the auditors of such companies need to consider its impact on their reporting on the adequacy and operating effectiveness of internal controls with reference to financial statements as prescribed u/s 143(3)(i) of the Companies Act, 2013.

The pandemic has hit all organisations globally and India is no exception. Considering this, the Securities and Exchange Board of India (SEBI) issued a Circular dated 20th May, 2020 encouraging listed entities to make timely disclosures about the impact of Covid on their companies. One of the items in the list of information that the Circular states listed companies may consider disclosing is internal financial reporting and controls.

The users of the financial statements, various stakeholders, including investors, lenders, suppliers and customers, Government agencies and so on, are keen to know to what extent the company has been affected by the pandemic. As stated in the ‘Guidance Note on Audit of Internal Financial Controls over Financial Reporting’ issued by The Institute of Chartered Accountants of India (GN on IFC) for the purpose of auditor’s reporting u/s 143(3)(i) of the Companies Act, 2013, ‘internal financial controls over financial reporting’ shall mean ‘a process designed to provide a reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.’ Therefore, to prepare reliable financial statements, internal controls over financial reporting are imperative. If such internal controls are affected by Covid and if the company has not taken adequate steps, the financial statements prepared may not be reliable for external purposes and the stakeholders will lose confidence in the entity’s financial reporting. From the governance perspective, it is important for the Audit Committee and management that new processes for financial statements closure and reporting of results and financial / operational controls are appropriately documented.

EXTENDED REPORTING TIMELINES

IMPACT ON FINANCIAL CLOSURES

(A) Performance reviews refer to overall analytical procedures of actual performance with budgets, forecasts, etc. However, it is very likely that the budgets, forecasts, prior period actuals, etc., did not include the impact of Covid at all, or had considered its impact based on information available at that time. In the absence of the robustness of a performance review, what controls does the company need to establish to ensure the reliability of financial information? Let’s understand this by way of an example. A company manufactures white goods such as dishwashers, washing machines, etc. Its volume of production in a given period is predictable as the company had established its plant many years ago. For F.Y. 2019-20, the company was able to run its normal operations throughout the year, except the last week near the year-end due to the lockdown. However, in F.Y. 2020-21, the lockdown was extended and therefore production was completely shut for part of the year. While reviewing the performance of F.Y. 2020-21 and comparing the same with the previous year, the variance can be quantified for that attributable to the period when the plant was shut.

(B) Information processing controls are application controls and general IT controls. Before Covid, these controls were usually based on the assumption that applications were being accessed by users through LAN. This identifies the user and has security firewalls to protect the data in the system to ensure its reliability. In the period of the pandemic, where many organisations had to close their offices and allow employees to work from home, IT systems are being accessed by employees through their home networks. The reduced number of employees may result in reduced controls being adhered to. Vulnerability of security for data protection and its unauthorised access pose a significant threat to the reliability of the financial close process. Further, there is heightened risk of data leakage. For example, a company has IT security through which tenders submitted by potential suppliers can be accessed by the procurement department only through the office LAN. During Covid, when staff is working on their home networks, such control cannot be implemented and needs to be modified without compromising on the security of the data. IT processes or controls that have an increased volume or that need to be performed differently due to changes in work environment or personnel, are likely to have additional risks in areas such as the following:

Access termination – Increased number of access termination requests and fewer people available to process them – this may increase the risk of unauthorised access due to terminated personnel not being removed in time. In many organisations, there is an exit form which the employee fills and after approval from the HR it is handed over to IT to ensure that all access given to that employee is terminated and confirmed by IT by signing the same form showing the date and time of termination. In the Covid scenario, the exiting personnel, HR staff and IT staff are all at different locations. To ensure coordination amongst them for terminating the access immediately when the employee leaves, different controls need to be put in place.

Change management – Verbal approvals may be accepted rather than waiting for approvals to be documented through a ticketing system, and thus there may be increased use of emergency IDs which may not be subject to the same degree or timeliness of monitoring as usually occurs. Whenever any change is required in the IT environment, many companies have a hard copy documentation system showing the requester, the approver and details of the changes made, followed by subsequent testing and implementation. During Covid, such hard copy documentation may not be possible given that the requester, approver, programme writer, testing team and implementation team are at different locations. This may require modification of the existing IT change management controls.

Execution of review controls – The questions to be answered are:
(a) What changes are made to the review process of access control, change management and other IT environment processes?
(b) To what extent are the company’s IT risks affected by the new way of working and what are the mitigating controls introduced to deal with the security threat to the IT systems that process financial data?

Many organisations are changing their strategies to take advantage of digital technology, such as storing data on cloud which can be accessed from anywhere by the authorised personnel. Even if the employee working on such data is not able to access the company’s server from her remote location, such data need not be copied on the workstation of the employee when it is available on cloud. With such changes in strategy, it is obvious that the relevant risk control matrix of the company will undergo a change. The new risks identified will be because the majority of employees are working from different locations. Controls to mitigate such risks, for example, data security risk as discussed above, will be plotted against each of such processes.

(C) Physical controls relate to the existence of assets and authorisations for their access. In the Covid scenario, such authorised person holding custody of the physical assets is away from the office or location of the assets for prolonged periods. How does the company ensure the existence of its assets when the person entrusted with their physical custody no longer has their custody? How has the company changed its internal controls which earlier were physical controls? For example, during partial lockdown, earlier internal controls might have been modified in respect of frequency of physical verification, the authority performing such verification, etc. Such modified controls may also consider any new digital technology implemented by the company or any supplemental controls to the original pre-Covid controls.

Safeguarding inventory
Safeguarding inventories is the responsibility of the management which is required to establish procedures to ensure the existence, condition and support valuation of all inventory. There may be transactions as at the yearend where the company has transferred the control of assets, but where physical possession is with the company such as bill-and-hold arrangements. The internal control framework relating to safeguarding and monitoring of inventories would need to include these considerations, e.g., assessing the inventory shrinkage by location, product type, or other disaggregated basis, comparing the actual inventory value of each location to an expected range, and investigate any individual locations that are outside of the expected range.

Further, with scenarios like localised lockdown, travel restrictions, etc., physical inventory counting would be challenging and in some cases impractical. In certain situations where the conventional method of physical verification is not practicable, management may establish internal controls to undertake physical verification remotely via video calls with the help of technology.

Environmental and safety norms
Companies may be using sensitive chemicals and industrial gases for producing goods. Some of these items are required to be stored in temperature-controlled containers and to be continuously monitored. If there is any leakage of hazardous gases or chemicals, the implications on the company could be very severe and even lead to closure of the factory, thereby affecting the going-concern assessment. Localised lockdowns imposed by various State Governments might induce stress on the monitoring mechanism relating to compliance with environmental and safety norms.

(D) Segregation of duties as a control was put in place by companies to ensure that employees preparing the information, authorising the information, recording the information and holding the custody of the documents are different. In the Covid scenario, the flow of physical documents to different employees performing these different roles is not possible. Further, many organisations had severe staff absences for prolonged periods as even the staff was affected by the pandemic. This requires delegating their responsibility to other staff and modifying internal controls around it. Has the company modified its internal control system and does the revised internal control system ensure effective segregation of duties, this is the question that companies need to answer.

Fraud risks
Fraud risks change in such a time of crisis, as new opportunities are created for internal as well as external parties. Incentives for committing fraud – both misappropriation of assets and financial reporting fraud – may also be heightened, especially if significant terminations are likely or employees suffer significant personal financial stress. As stated in the GN on IFC, ‘When planning and performing the audit of internal financial controls, the auditor should take into account the results of his or her fraud risk assessment.’ In the years when the company is hit by the Covid pandemic, fraud risk assessment of the auditor is expected to be different from the earlier years. The risk of fraud has increased significantly due to changes in the way of working. Such risks can range from the basic documentation process where scanned documents are being relied upon, which can be forged, as against the original signed documents; to frauds in complex transactions where significant estimation is involved such as fair valuation, etc., since these estimates are also significantly impacted by Covid. Some of the areas where fraud risk has increased are:

(i) Physical document approvals are replaced by email approvals in the Covid period. Such approvals carry the risk of emails being compromised.
(ii) Due to the new style of working, the demand for certain goods and services has significantly increased. This has created an opportunity in procurement fraud.
(iii) Owing to lockdown situations, many customers may be facing financial difficulties to pay their dues within the credit period. This increases the risk of financial reporting fraud by resorting to unethical means of recording receipts from debtors which are not genuine.

The auditors, while planning and performing the audit of internal financial control, will need to take into account as well as document how their audit plan is different from the earlier years due to higher risks of fraud, i.e., what is their audit response to such risks.

ASSUMPTIONS FOR THE FUTURE
Ind AS 1 requires the entity to disclose information about the assumptions it makes about the future, at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. In the Covid scenario, the future holds a lot of uncertainty and it will need the company to demonstrate its internal controls for arriving at the estimates, or its estimation process. It may have an impact inter alia on going-concern assessment, impairment of assets, fair valuation, etc., that is, financial statement items that are based on assumptions of the future. Companies faced difficulties in estimating the impact of Covid on their operations beyond the short term. This is an inherent risk because of uncertainty about the future which was never experienced before in history and has resulted from the global pandemic. Due to the disrupted supply chain and distribution models, uncertainty over pricing, etc., projecting future cash flows with acceptable precision is not possible for many companies. Coordination with management experts, such as those heading the strategy department, valuation specialists, etc., when performing impairment tests, assessing fair values of assets such as investment properties, investments, etc., and performing actuarial calculations and analyses, can be more challenging. Many auditors have considered these matters as key audit matters for their audit of the financial year ended 31st March, 2021. The question is do internal controls over the estimation process of the company consider the uncertainty brought by Covid?

Exceptions identified during control testing
It is likely that management will identify exceptions during its testing of controls because controls were designed for a totally different environment. To ensure that sufficient time is available for remediation before the year-end, management will need to modify the design of existing controls and test the operative effectiveness of the new controls during the year. If such remediation does not take place by the year-end, it will have consequences of communication with audit committees and modification in the auditor’s report. Further, in the absence of controls being effective, auditors may need to modify their strategy to evaluate the impact of ineffective controls. Therefore, companies should change their plan of testing controls affected by Covid earlier than usual in the year. If the company has had to incorporate new controls during the year, these controls should be documented in its internal control documentation and appropriately tested.

Planned changes in RCM
Each entity’s internal controls will be uniquely impacted by Covid, e.g., entities with significant dependence on technology will have different challenges to address than those with a more manual control environment. With a majority of staff working from home, manual controls maintained through hard copy documents cannot be adhered to. Technology-dependent controls may need revision with new technology suitable for the new environment. Hence, it is imperative that on a holistic basis the potential changes or shifts in focus, both in terms of scoping and risk assessment, testing approaches, etc., are made and additional controls or control modifications of existing controls are undertaken to address the risks arising from Covid. Based on the experience of Covid, companies will start making changes in their risk control matrix. It will include identification of additional risks posed by Covid, new controls to mitigate those risks, modification to existing controls in view of the ‘new normal’ and removal of some controls which have become redundant. This might include automation of all key manual controls to reduce dependency on people and physical access to the work environment, increased use of continuous monitoring and detection and defining indicators which would suggest that controls may not be operating effectively.

Changes to the design of management’s control may also require the auditor to alter the combination of testing procedures (i.e., inquiry, inspection, observation and re-performance). This includes making inquiries on the changes in the company’s mode of carrying out operations in response to Covid. For example, changes due to people working remotely, and consequently the change in the company’s policies and procedures, including execution of controls, segregation of duties, etc. This would also include evaluating the electronic or digital evidence made available by management, and the controls around the same, specifically with reference to review, reliability, security and storage of such evidence by the management.

Enhancing disclosures
The pandemic would also have wide-ranging implications on the financial statements. Hence, it is crucial that the management adequately presents their ‘side of the story’ in detail. Disclosures might include entity-specific information on the past and expected future impact of Covid on the strategic orientation and targets, operations, performance of the entity as well as any mitigating actions put in place to address the effects of the pandemic. Updating the information included in the latest annual accounts to adequately inform stakeholders of the impact of Covid, in particular in relation to significant uncertainties and risks, going-concern, impairment of non-financial assets and presentation in the statement of profit or loss, have garnered renewed focus.

SNAPSHOT
In short, the way Covid has impacted internal controls over financial reporting of companies is as follows:
a) New normal – The way companies carry out day-to-day transactions from initiation to closure that involves authorisations, recording, cash receipts or payments, etc., has changed. Given that these processes have undergone changes, all pre-Covid controls may not be relevant and new controls may be needed.
b) Risks change due to Covid – Not only are the new processes susceptible to new risks, but existing risks may also be heightened due to the change in the environment. In addition to this, there are certain inherent risks of dealing with the ‘unknown’, i.e., how long the pandemic will continue, what will be its severity and the resulting impact on the organisation, etc.
c) Controls must also change accordingly – Companies will need to thoroughly review their risk control matrix in light of the new risks. It will require addition of new controls (e.g., those relevant to new technology), changes in the existing controls (such as approval process through emails or physical verification of assets through virtual means, etc.), or removal of some of the irrelevant controls (like those related to physical documentation).
d) Audit of internal controls over financial reporting – With the new risk-control matrix, the auditors will need to plan their integrated audits in light of the changed processes of the client, the revised design of controls and testing their operating effectiveness. The auditors will need to evaluate ‘what could go wrong’ with increased audit scepticism considering the high fraud risk in the new reality, the risk of non-compliance with laws and regulations, the impact of uncertainty on the estimation process of the company, and so on.

NEXT STEPS
Companies establish criteria for internal controls over financial reporting. These are dynamic in nature and as the circumstances change, companies need to revisit internal controls on identified risks. The impact of Covid will require them to relook at their existing criteria and identify what changes are required to be carried out to achieve the objective. Many companies have prepared their own checklists to ensure that the internal controls criteria are updated based on the current environment.

At the same time, auditors need to be aware of what changes are being carried out by their clients in their criteria for internal controls and plan their audits accordingly. This may require the auditor to obtain samples of the period when operations were severely affected by Covid (and  therefore have a modified design of internal controls) and when operations were running normally.

A dialogue between the clients and auditors is imperative to discuss the exceptions observed in management testing, changes being made in internal controls, effective date of incorporating the changes, plan of management testing of such controls and ensuring that those are operating effectively.

(The views expressed in this article are the personal views of the author)

NEW CLAUSES AND MODIFICATIONS

Whilst the clause on reporting in respect of inventories has been present in the earlier versions, too, CARO 2020 has modified parts of the first clause and added certain reporting requirements in respect of current assets which are given below.

Modifications
a. Whether in the opinion of the auditor the coverage and procedure for physical verification of inventories is appropriate;
b. Whether any discrepancy in excess of 10% or more in the aggregate for each class of inventory was noticed and the same was properly dealt with in the books of accounts.

Additional Reporting
a. Whether at any point of time during the year the company has been sanctioned working capital limits in excess of Rs. 5 crores in aggregate from banks or financial institutions, on the basis of security of current assets;
b. Whether the quarterly returns or statements filed by the company with such banks or financial institutions are in agreement with the books of accounts and if not, to give details.

PRACTICAL CHALLENGES IN REPORTING
The reporting requirements outlined above entail certain practical challenges which are discussed below:

Verification of inventory:
a. On the appropriateness of coverage and procedure for physical verification of inventory, the auditor will have to observe the performance of the management’s physical count taking procedure, control over movement of inventory, adequacy of design and effective operations of internal controls.

b. Apart from ensuring that proper written instructions are issued, it is also incumbent for the auditor to point out specific areas where the instructions are not clear or other procedural lapses like inadequate segregation of duties, cut-off procedures not adhered to especially for sales and work-in-progress in continuous process industries, as may be observed. It is important for the auditor to comment on the specific areas where he feels that the procedures are not adequate rather than commenting that the ‘procedures are generally adequate’.

c. Covid-19: The onset of Covid-19 has caused significant disruptions in the business operations of companies which could pose challenges in conducting physical verification of inventories. This, in turn, would make it difficult for auditors to ensure compliance with SA 501, Audit Evidence-Specific Considerations for Selected Items, which requires the auditor to obtain sufficient appropriate audit evidence regarding the existence and conditions of inventories. SA 501 requires attendance at location/s of physical inventory count, unless impracticable, and performing audit procedures on inventory records to determine whether the records accurately reflect actual inventory count results. Some of the challenges may be broadly analysed under the following situations:

• Management does not conduct an inventory count (not even any alternative audit procedure) on the balance sheet date:
In such cases, as per Key Audit Considerations amid Covid-19 issued by ICAI on physical inventory (ICAI’s Covid guidance), the management should inform the auditors and those charged with governance about the reasons for the same. However, if carrying out a count is not feasible, the auditor would need to evaluate the reasonableness of the circumstances and the internal controls with respect to the existence and condition of inventory. Depending upon the materiality, the auditor may use his judgement to modify his audit report in accordance with SA 705 (Revised) Modifications to the Opinion in the Independent Auditor’s Report. Further, its impact on auditor’s opinion on internal financial controls u/s 143(3)(i) of the Companies Act, 2013 (‘ICFR’) also needs to be evaluated, in addition to reporting under this clause regarding coverage of physical verification of inventory.

• Physical verification conducted at a date other than the balance sheet date:
In such cases, the design and operating effectiveness of controls over inventory would need to be evaluated before reporting. Further, the following considerations are also relevant:
i.    Whether the inventory records are properly maintained;
ii.    Understanding reasons for differences in the physical verification count and the inventory records;
iii.    Performing roll-backward procedures, if the inventory count is done after the year-end or roll-forward procedures, if inventory count is done during the interim period;
iv.    Evaluating whether any adjustment is required in roll-forward or roll-backward procedures due to differences observed as in (ii) above;
v.    To consider whether the time between inventory count date and balance sheet date reflects appropriate assessment of the physical condition of the inventory.

• Impracticable for auditor to attend the physical count:
This issue is relevant for the auditor to issue an audit opinion on the financial statements and not on CARO 2020. However, in order to have complete discussion on physical verification of inventory, specifically its increased importance during Covid pandemic times, the same is also discussed here.

•  In the event that it is impractical for the auditor to physically attend the inventory count process, the auditor can perform alternative audit procedures to obtain sufficient appropriate audit evidence regarding the existence and condition of the inventory. In addition, to evaluate design and test the operating effectiveness of internal control over physical verification of inventory, the following may be considered:

i. Prepare a document substantiating the impracticality and unreasonableness of observing the count in person, given the Covid-19 situation;
ii. Use of web or mobile-based video-conferencing technologies (i.e., Microsoft Teams, Facetime, WhatsApp). In this case, care should be taken by the auditor that if inventory items cannot be identified with a unique reference number, etc., there is no chance of replacement of inventory during / after the count to avoid double counting. It would be advisable to retain the recording thereof as part of the audit documentation;
iii.    Consider using an external party, e.g., an independent CA firm in that location (ICA) or Internal Auditor (IA), in which case the auditor needs to evaluate
a. Objectivity and independence of ICA / IA;
b. Inquire for any relationships that may create a threat to their objectivity;
c. Evaluate their level of competence;
d. Determine the nature and extent of work to be assigned;
e. Communicate planned use of ICA / CA with those charged with governance;
f. Obtain written agreements from the entity for the use of ICA / IA for providing direct assistance;
g. Direct, supervise and review the work performed by ICA / IA providing direct assistance, including provide instruction / work programme, including sample selection, communicate management’s inventory count instructions, etc., and, if possible, supervise the count while it is in progress.

When inventory is under the custody and control of a third party, e.g., bonded warehouse, job worker / contractor, etc., the auditor shall verify the procedures undertaken by the management to evaluate the existence and condition of that inventory. This could be by way of obtaining confirmation from the third party as to the quantities and condition of inventory held on behalf of the entity and / or perform inspection or other procedures appropriate in the circumstances. The auditor needs to focus on whether inventory with third party is for a longer than normal period and obtain reasons for the same.

In the event the entity has specialised inventory where inventory count is not based on a normal physical verification process but on the confirmation of quantity / quality by an expert, the auditor will review the certification obtained by the entity and compare it with the book records. For example, in the case of coal, tonnage is calculated by considering the height, width, length of the stock yard and the moisture content in the coal to arrive at its tonnage. The entity will normally take the help of engineers in this process who would be internal or external experts.

a. Appropriate coverage: Even if the company has instituted proper procedures for physical verification, it is imperative that the coverage thereof is adequate and appropriate with respect to the nature, size, materiality, location, feasibility of conducting physical verification and risk of material mis-statement involved. This could involve significant judgement and an interplay of several factors, some of which are discussed hereunder:

• Classification of inventory – This is important for assessing the extent of coverage as also for evaluating the impact of discrepancies. Whilst the class of inventory is broadly specified in the Accounting Standards for manufacturing and trading companies, the same is not clear for service companies since all of it may not be amenable for quantification. Further, even if the classification for manufacturing and trading companies is appropriate to determine the adequacy of verification, an A-B-C analysis is desirable for which the basis would need to be evaluated for reasonableness. Further, the auditor also needs to examine whether there is a control system in place to identify and mark slow-moving, obsolete or damaged inventory.

• Periodicity of verification – The auditor would need to verify the periodicity of such verification and whether all the material items of inventory have been covered at least once in a year or as per the systematic plan as designed by the management. This would depend upon the nature of inventory, the A-B-C classification discussed above and the number of locations involved.

b. Dealing with discrepancies: The auditor should, based on his understanding of the business and operating effectiveness of internal controls, verify explanations provided by the management for discrepancies between inventory as per the books and as physically verified and steps taken by them to reconcile. Some of the common causes for discrepancies are:
• Incorrect data entry on receipt
• Issues not recorded
• Misplaced stocks
• Loss due to theft or natural calamity
• Human errors or incorrect unit of measurement used
• Inventory records not updated
• Supplier frauds
• Goods distributed as free samples
• Weight loss / gain due to passage of time

Under the modified (changed) reporting requirement, the auditor will have to report on any discrepancy noticed in excess of 10% or more in the aggregate for each class of inventory. Each class of inventory will have to be identified as per AS 2, ‘Valuation of Inventories’ / Indian Accounting Standard (Ind AS) 2, ‘Inventories’ and the internal policies of the management. The count at the time of physical verification will have to be compared with the book records and discrepancies in excess of 10% or more in the aggregate for each class will have to be reported. It may be worth it to note that the threshold limit of discrepancies of 10% should be applied to the value and not to the quantity. Hence, if the inventory has been valued other than at cost, e.g., net realisable value (NRV), the discrepancy of 10% needs to be compared with NRV.

It is worthwhile to note that this clause deals with discrepancies observed during physical verification only and not with discrepancies observed during audit. Further, even if the management has a valid explanation for the discrepancies, the fact needs to be brought out while reporting under this clause.

Working capital facilities:
a. This is a new reporting requirement wherein the auditor has to review quarterly returns or statements filed by the company with banks and financial institutions in case the sanctioned working capital limits with them are in excess of Rs. 5 crores in aggregate and to report if these are not in agreement with the books of accounts.

b. Collation of all working capital facilities: For calculating the limit of Rs. 5 crores, it is important to note that sanctioned amounts (not disbursed amounts) and both fund and non-fund-based amounts are required to be considered at any point of time during the year (as against only at the year-end) on the basis of security of current assets. This could present challenges in identifying the completeness thereof since sanctioned facilities as well as non-fund-based facilities are not reflected in the books of accounts. Accordingly, the auditor would need to make specific inquiries and obtain a representation and corroborate the same with the requisite documentary evidence like sanctioned letters, confirmations from the lenders, review of the minutes, ROC filings for charge created, etc. The aggregate of the sanctioned limit from all banks and financial institutions is also required to be collated. In case of a company which operates from multiple locations and working capital facilities are negotiated locally, care should be taken to ensure that all such sanctioned facilities are combined for the purpose of reporting under this clause. The auditor will also have to cross-verify the same with the relevant disclosures, if any, in the financial statements.

c. This clause is not applicable to unsecured sanctions or sanctions on the basis of security other than current assets or withdrawals above the sanctioned limit, e.g., in case the company has a combined sanctioned working capital limit of Rs. 4.75 crores but the same is overdrawn by Rs. 0.30 crore. In this case, the total outstanding working capital facility is in excess of Rs. 5 crores, however, since the aggregate sanctioned limit is less than Rs. 5 crores, this clause would not be applicable.

d. Considering the discussion in paragraphs (b) and (c) above, in case the sanctioned working capital limit exceeds Rs. 5 crores, the auditor is required to review quarterly returns and statements filed by the company with such banks / financial institutions and report if they are in agreement with the books of accounts and, if not, give details thereof.

The auditor will have to consider materiality of discrepancies, its relevance to the users of financial statements and their professional judgement while reporting discrepancies.

e. Each bank and financial institution may have its own requirements of submission of statements and returns. These submissions may be monthly, quarterly, yearly or of any other frequency, including event-based. However, for the purpose of reporting under this clause only quarterly statements / returns and that too which have relevance with the books of accounts of the company need to be considered, compared and reported.

Though this clause is applicable only if sanctioned working capital limits are provided based on the security of current assets, however, the responsibility of the auditor is to compare all the information provided in the quarterly statements / returns which can be compared with the books of accounts and is not restricted only to current assets. Such information may include aging of inventory and receivables, trade payable, property plant and equipment, other information, etc. So long as information can be compared with the books of accounts, it will be the responsibility of the auditor to report.

f. Challenges for MSMEs: Reconciliation of the details of statements / returns submitted to the lenders with the books of accounts on a quarterly basis could pose difficulties in case of MSMEs since they may not be regular in updating their accounting records. These MSMEs will have to keep their books of accounts updated based on which statements / returns submitted to banks and financial institutions can be compared, failing which their auditor will issue a disclaimer while reporting under this clause.

g. It is hoped that the introduction of this reporting requirement would lead to better discipline and improvement in internal controls which would result in a win-win situation for companies, lenders and auditors.

IMPACT ON THE AUDIT OPINION

In such cases, it is imperative that the Board’s Report contains explanations / comments on every reservation / adverse comment in the audit report as per section 134(3)(f) of the Companies Act, 2013 and that there will not be any factual inconsistency between the two if, in the auditor’s judgement, the matter / observation may have any adverse effect on the functioning of the company.

CONCLUSION