There was once a boat which was destined to travel distances meant only for a ship. The chief rower of the boat anointed himself as the captain and made everyone believe that they were indeed travelling in a ship and that they were all set to reach the destination safely. The assistant too made unsuspecting travelers believe that they were indeed in a ship. Suddenly the boat hit a rock, broke into pieces and sunk. As for the survivors, it’s anyone’s guess, what happened to them.
The boat here is Enron, key management is the captain, and assistant is the independent auditor. What rocked the boat was perhaps the most shocking and reckless event in America’s corporate history. We had a similar anecdote closer home, albeit with a satirical name, Satyam.
Best phase for Indian economy
The Indian economy is perhaps at its best phase in decades, thanks to a forward thinking government at the centre which is determined to put economic growth on a double digit trajectory. Indian companies are vying for global attention and want to compete with China and other emerging economies. As our promoters look overseas for business opportunities and investments, it would be interesting to perhaps understand the corporate governance situation that currently exists in the country.
The current scenario
Independent auditors report on aspects such as adherence to standards of reporting, compliance with various regulations and to a certain extent, in some rare instances, act as the trusted advisor to the promoter. There is a requirement for internal audit and internal controls for companies with certain minimum threshold. But this is not doing enough. The board of directors has a responsibility to report on the ‘performance’ of the company but is not required to do anything more.
While there are checks and balances in place to ensure adherence to laws, reporting red flags such as cash losses, regulatory defaults, inadequate internal controls, etc., these were never meant to achieve the larger objective of bringing in operational efficiency in the company. The country needs a framework to keep its businesses efficient and de-risk itself at least to the extent of known and controllable ones.
Internal Financial Controls
This is where Internal Financial Controls (IFC) will play a significant role in making Indian companies operate more efficiently. Segregation of duties will ensure companies stay adequately independent of owners’ interference in operational matters. Financial reporting to internal and external stakeholders will take a sharp turn into a track of meaningfulness and better reliability. Board oversight will increase.
All audit reports for the financial year ending March 31, 2016, shall include a separate comment from the statutory auditors on whether or not a company has adequate IFC during the year. Although the industry is waiting for a relief from the ministry of corporate affairs in this matter, it is very unlikely that this relief will come through considering this is a need of the hour for Indian companies to move towards efficiency.
The requirement to have an adequate and effective IFC for Indian Companies is a much appreciated one. Promoters and those at helm should embrace this change constructively as it is going to take a lot of responsibility from their shoulders and place it on other stakeholders, such as the independent auditors, audit committee, process owners, etc. Accountability for operational efficiency and effectiveness will now be evenly spread out.
To conclude, the overall trend in the current legislative environment of India is that of aligning itself to globally acceptable standards. In this direction, the Companies Act of 2013 and the subsequent amendments enacted to the Act ushers in a new era of governance and transparency for the Indian corporate sector. The provisions on IFC have to be seen as an enabler of good corporate governance if nothing else.