Brief analysis of Internal Audit provisions under the Companies Act 2013 by Mr. ASISH K BHATTACHARYYA .
| Audit committee apathetic towards internal audit? |
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Internal audit's customers are financial auditors ( often referred to as a statutory auditor), the management and the Board. Internal audit provides an assurance to the management and the financial auditor that internal control related to the preparation of financial statements are adequate and operating effectively. The primary objective is to reduce the cost of financial audit and to prevent and detect financial irregularities, frauds and errors. Internal audit also helps in achieving operating objectives. It monitors compliance with standard operating procedures (SOP) and operating policies in conducting business operations. It reviews efficiency in resource allocation and utilisation. Often, the internal auditor acts as an internal consultant to local managers in addressing challenges that they face in complying with SOPs and achieving target efficiency. It suggests modifications in SOPs and company's operating policies that are required for achieving operating objectives in the changed environment, both internal and external. The internal auditor optimises the use of its resources by focusing on financial transactions and operations where the fraud risk or the risk of deviations from SOPs or the probability that wastes might be higher than the standards are high; or where internal controls are under stress due to the external environment, for example, when the demand for the product or service is low, internal controls related to marketing function are under stress. Some refer to this internal audit approach as risk- based internal audit. However, in companies that have robust enterprise risk management (ERM) system, risk- based internal audit refers to internal audit around risks identified under ERM. Although operating objectives are derived from strategic objectives, achieving operating objectives does not necessarily result in achieving strategic objectives. Internal audit helps in achieving strategic objectives and improving Board effectiveness. Two important tools that the Board uses to help the company in achieving strategic objectives are ERM and strategy audit. ERM system minimises future shocks from unfolding of uncertain events and help management in responding to emerging risks and opportunities proactively. The greatest challenge in implementing an ERM system is to establish the right culture – shared understanding about risk, including risk appetite and ethical standard established by the Board. The Board cannot directly monitor the organisation culture and the ERM system. The internal auditor monitors the same on behalf of the Board. The effectiveness of strategy audit, which is a periodical review of the current corporate strategy and business strategies, depends on the timeliness and accuracy of information being made available to the Board. Usually, the management information system (MIS) is oriented towards the management's information needs for performance evaluation, planning and control. A strategy review requires a different set of information — mostly drawn from the external environment (e. g., competitor's analysis, emergence of new opportunities, market performance of the company's products compared with that of competing products and indication of structural changes in economic political, technological and social environment). The internal audit provides an assurance that the information system is adequate and operating effectively. The effectiveness of an internal audit depends on its independence and resources available to it. The law has made the audit committee responsible for protecting the independence of the internal audit and providing adequate resources. The Companies Act requires that the audit committee or the board shall formulate the scope, functioning, periodicity and methodology for conducting the internal audit. Clause 49 of the Listing Agreement requires the audit committee to review the performance of the internal auditor, adequacy of internal audit and the findings of any internal investigation by internal auditors. It requires the audit committee to discuss with the internal auditor significant findings and follow up actions there on. Unfortunately, the audit committee of most companies is apathetic to the internal audit. An internal audit is still perceived as a service to management. In most companies the chief internal auditor ( CIA) reports to the CEO or the CFO. This reporting structure is appropriate when the internal audit serves the management. When an internal audit serves the Board, the CIA should report to the chairperson of the audit committee. The audit committee spends inadequate time in examining internal audit reports. The internal auditor presents its observations through power- point presentations before the audit committee, which allocates about three hours in a year for discussing internal audit findings. The audit committee seldom discusses with the internal auditor the internal audit scope, its performance, and resources available to it. Audit committees, in their own interest, should comply with the law, in spirit. They should have intensive engagement with the internal auditor to understand challenges it faces in achieving excellence. Absence of a robust internal audit is a corporate governance risk. Affiliation: Professor and Head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs; Advisor ( Advanced Studies), Institute of Cost Accountants of India; Chairman, Riverside Management Academy Private Limited E- mail: asish. bhattacharyya@ gmail. com ACCOUNTANCY ASISH K BHATTACHARYYA Intensive engagement with the internal auditor is needed to understand challenges it faces in achieving excellence Effectiveness of an internal audit depends on its independence and resources available to it |
| BRIEF CASE |
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There is a mass of judgments on the question whether a state government can levy tax on works contracts which involve elements of both service and sale of goods. The power to impose service tax belongs to the Centre while the state can demand tax on goods used in the works. But separating the aspects of service and goods has been the intricate task of the Supreme Court for decades. In the latest case last week, the Karnataka government was third time lucky and the court upheld the state levy in its judgment in state of Karnataka vs Pro Lab. The Sales Tax Act imposed a levy on processing and supply of photographs. That was challenged by the firm in the high court, which struck down the provision as it was held to be predominantly a service contract with negligible element of goods. The state amended the law, and even a constitutional amendment had taken place since the question was originally raised. Still the state government was not successful in convincing the courts that it could imposed the levy. This time, the Supreme Court resolved the controversy by ruling that after the 46th amendment to the Constitution in 1982, Article 366 " empowered state legislature to enact a law taxing sale of goods". In this particular case, supply of photo goods could be separated from the rest of the contract and, therefore, the state levy was valid. Cashew unit acquisition quashed The Supreme Court last week set aside the judgment of the Kerala High Court and ordered the state government to hand over 10 cashew factories acquired by it to their owners. The court held that the legal provision in the Kerala Cashew Factories ( Acquisition) Act enabling the take- over was unconstitutional. The judgment in S T Sadiq vs state of Kerala stated that the provision brought by an amendment sought to overcome some of the rulings of the Supreme Court. The legislature can change the basis on which a decision is given by a court and thus change the law in general, which will affect a class of persons and events at large. It cannot, however, set aside an individual decision between two parties which affected their rights and liabilities. The legislature cannot exercise judicial power, the judgment said. Guess work in calculating loss When there is a breach of contract and neither party produces evidence of the actual amount of losses suffered by it, the court has to do some guesswork to arrive at the compensation figure. In the judgment delivered last week, the Supreme Court cut the gordian knot by awarding Delhi Development Authority half the amount it claimed against a contractor, Construction & Design Services. The firm did not complete a public works project on time and therefore the contract was terminated and ₹ 20 lakh in damages was demanded. The firm raised several objections and asserted that DDA did not suffer any loss. DDA contended that it had suffered a loss of over ₹ 20 lakh. However, neither party produced hard evidence to substantiate its claim. The court stated that in such a situation, it has to do " guess work" and awarded half the amount claimed by DDA against its contractor. More compensation than asked for In a motor accident claim, the court can invoke the " fair and just" clause in the Motor Vehicles Act and award compensation higher than asked for, the Supreme Court stated last week in its judgment, Jitendra vs Kasam Daud. A 22- year- old woman, who was maintaining her family with embroidery work, was fatally run over by a tempo. Her husband and relatives sought ₹ 2.96 lakh from the motor vehicle accident tribunal. It granted ₹ 2.24 lakh only. On appeal, the Gujarat High Court reduced the compensation to ₹ 2.09 lakh. On further appeal, the Supreme Court enhanced the amount to ₹ 6.47 lakh. The judgment stated that the courts below had failed to follow the principles laid down by it in computing compensation. Power of attorney in cheque bounce Any employee of a company cannot file a criminal complaint about a cheque that was dishonoured by a bank under the Negotiable Instruments Act. There must be proper authorisation and power of attorney in that behalf, the Supreme Court stated in a batch of appeals titled, A C Narayan vs state of Maharashtra. In one case from Andhra Pradesh, an employee of a company filed the complaint about bounced cheques for recovery of debts. However, according to the company resolution, only the managing director or anyone designated could file complaint. Therefore, the complaint was rejected by the magistrate and it was upheld by the Supreme Court. In another case from Maharashtra, the magistrate started criminal process on the complaint of a person who claimed that she had power of attorney on behalf of several others. The drawer of the cheques challenged the prosecution in the Bombay High Court which dismissed the objection. But on appeal, the Supreme Court found that the courts below had not examined the power of attorney nor its content. Therefore, the prosecution was quashed. When property value zooms If the value of a property involved in a suit goes up, an application can be made to correct the figure according to the current market value. In this case, Mount Mary Enterprises vs Jivratna Medi Treat Ltd, the Bombay High Court did not allow the buyer of the property to change the earlier price of ₹ 14 lakh to ₹ 1.20 crore. On appeal, the Supreme Court set aside the high court judgment and ruled that if the property was undervalued initially, it may be allowed to be corrected if it did not result in injustice to the other party and is done in good faith. Workers win after three- decade wait After three decades of litigation, the Supreme Court last week directed the industrial tribunal in Dhanbad to decide the claims of each of 150 workers for retrenchment compensation. They were employed by public sector Bharat Coking Coal Ltd through a contractor for building awashery in Sudamdih. The work was over in 1980. Their demand to be absorbed in the company was rejected, leading to an industrial dispute. Their pleas were rejected by the tribunal. However, the issue of compensation was not settled all these years. The Supreme Court ended the dispute by asking the tribunal to decide the entitlements within six months make payment accordingly. A weekly selection of key court orders |
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