New Challenges in Commercial Audit

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Outline of presentation

• Commercial Audit Universe ( CPSEs)

• Challenge I : Companies Act 2013

Brief Background

Government Companies

Additional Responsibilities on/Expectations from

Auditors

• Challenge II : Transition to IND AS regime

• Challenge III : Three Phase Audit

Commercial Audit Universe

•544 CPSEs as on 31 March 2014•377 Government Companies•6 Statutory Corporations•161 deemed Government Companies

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Commercial Audit Universe…contd•Paid up capital Rs 3.30 lakh crore•Net Profit Rs 1.53 lakh crore(202 CPSEs)•Net loss Rs 49612 crore (124 CPSEs)•Dividend declared Rs 66051 crore (111

CPSEs)•Total assets Rs 35 lakh crore (approx)•Value of production Rs 14.14 lakh crore•Net Worth Rs 11.61 lakh crore.•Disinvestment proceeds Rs 15819 crore

( 2013-14).

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Challenge I : New Companies Act

•Changing Economic and Business Environment •Alignment with International requirements•Sophisticated Stakeholders, Higher

expectations•To condense, simplify, rationalize the provisions•Also said that the new regime is based on

“suspicion” and more demanding•Act introduced without effective consultation

leaving many gaps, inconsistencies and ambiguities.

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STRUCTURE OF COMPANIES ACT, 2013

7 Schedules

470 Sections

95 Definitions

29 Chapter

s

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Particulars Under Companies Act,1956 Under Companies Act, 2013

Mandatory rotation of Auditors

• No mandatory rotation. Discretion of the Company

• Mandatory rotation of Individual Auditor after term of 5 yrs & Audit Firm after 10 yrs

Whistleblower mechanism

• No such provision • Immediate reporting by Auditors to Government in case of fraud

Multi-disciplinary concept of firms

• A firm can be appointed as auditor only if all its partners practicing in India are qualified for appointment

• A firm can be appointed as auditor if majority and not all partners are qualified for appointment

Restriction on services

• No such provisions • Prohibition of rendering classified services by Auditors to Co./Holding/Subsidiary

Increased Accountability of Auditors- Penal provisions

• Penalty u/s 232 & 233:No Criminal liability imposed. Penalty imposed for contravention of Section 231

• Criminal liability i.e. imprisonment along with penalty imposed on Auditors. No penalty for contravention of Section 146. Partner & firm Jointly & severally liable.

ACT 1956 VS. ACT, 2013- A COMPARISON

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Particulars Under Companies Act,1956

Under Companies Act, 2013

Reasons for resignation

• No such provision • Statement indicating the reasons for resignation shall be filed within 30 days to Company, Registrar & CAG in case of Government companies

Special resolution on removal of auditor

• No special resolution for removing auditor on expiry of tenure

• Special resolution required for appointment of auditor other than retiring auditor

Change of auditor by Tribunal

• No such provisions • Tribunal can suo moto or on application from Central government/ any person can direct change of Auditor

When no Auditor appointed/re-appointed at AGM

• The CG to appoint Auditor in such situation

• The existing Auditor shall continue to be the Auditor of the Company.

ACT 1956 VS. ACT, 2013- A COMPARISON

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GOVERNMENT COMPANIESA COMPANY IN WHICH NOT LESS THAN 51% OF PAID UP CAPITAL IS HELD BY GOI OR BY ONE OR MORE STATE GOVTS OR PARTLY BY GOI AND PARTLY BY STATE GOVTS.

• Classes of Government Companies covered are as under :-▫ Govt. Co., or▫ Other company owned or controlled, directly or indirectly, by the

Central Government, or by any State Government, or Governments, or partly by the Central Government and partly by one or more State Governments

• The first Auditor shall be appointed by the C&AG within 60 days from the date of registration.

• If no appointment is made by the C&AG, then the appointment shall be made by the Board within next 30 days

• In case the Board also fails to make an appointment then it shall inform the members who shall make the appointment within 60 days by calling an EGM.

• The first Auditor shall hold office till the conclusion of the first AGM.

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GOVERNMENT COMPANIES (Contd…)• In respect of Government Co.’s (other than the first Auditors)

the Auditor shall be appointed within 180 days of the commencement of the FY by the C&AG who shall hold office only till the conclusion of the AGM.

• Any casual vacancy arising in the office of the Auditors (whether due to resignation or otherwise) shall be filled by the C&AG within 30 days.

• In case the vacancy is not filled by the C&AG then the vacancy shall be filled by the Board within next 30 days.

• The C&AG shall have the power to direct the auditor regarding the manner in which the accounts are to be audited.

• The auditor shall submit a copy its report to the C&AG which shall include amongst other things, directions issued by the C&AG, action taken thereon and impact on financial statements.

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GOVERNMENT COMPANIES (Contd…)•The C&AG shall have the right within 60

days of receipt of Audit Report to:▫Conduct supplementary Audit by such

person as it may authorize.▫Comment upon or supplement such report.

•The C&AG shall if considered necessary, by an order, cause test audit to be conducted of the accounts of the Government Companies.

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SOME ISSUES CLARIFIED BY MCA

There is no corresponding section to erstwhile section 619 B. Sections 139(5) and 139(7) of the Companies Act, 2013 (New Act) deal with appointment of auditors by C&AG. No clarity allowing such appointment in respect of erstwhile deemed Govt Companies.

MCA clarified that the new Act does not alter the position with regard to audit of such deemed Government companies through C&AG and thus such companies are covered under subsection (5) and (7) of section 139 of the New Act.

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SOME ISSUES…. Contd.

There was ambiguity in the manner in which the information about incorporation of a company subject to audit by an auditor to be appointed by the C&AG is to be communicated to the C&AG for the purpose of appointment of first auditors.

MCA clarified that it will primarily be the responsibility of the company concerned to intimate the C&AG about its incorporation along with name, location of registered office, capital structure of such a company immediately on its incorporation.

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SOME ISSUES…… Contd (2)• Companies (Amendment) Act 2013, passed in May 2015,

to facilitate the ease of doing business• Key amendments:

• Omitting requirement for minimum paid up share capital, and consequential changes. (For ease of doing business).

• Doing away with the requirement for filing a declaration by a company before commencement of business or exercising its borrowing powers.  (For ease of doing business).

• Prescribing specific punishment for deposits accepted under the new Act. To deal with defaults in repayment of depositor. (For protection of depositors’ interests).

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SOME ISSUES….Contd (3)• Prohibiting public inspection of Board resolutions filed in the

Registry. (To provide for confidentiality of commercial interests discussed in resolutions)

• Including provision for setting off past losses/depreciation before declaring dividend for the year- (Standard prudential clause)

• Rectifying the requirement of transferring equity shares for which unclaimed/ unpaid dividend has been transferred to the Investor Education and Protection Fund (IEPF) even though subsequent dividend(s) has been claimed.

• Enabling provisions to prescribe thresholds beyond which fraud shall be reported to the Central Government (below the threshold, it will be reported to the Audit Committee/ Board). Disclosures for the latter category also to be made in the Board’s Report.

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SOME ISSUES….Contd (4)• Empowering Audit Committee to give omnibus

approvals for related party transactions on annual basis.

• Exemption u/s 185 (Loans to Directors) provided for loans to wholly owned subsidiaries and guarantees/securities on loans taken from banks by subsidiaries.

• Related party transactions between holding companies and wholly owned subsidiaries exempted from the requirement of approval of non-related shareholders

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Consolidated Financial Statements• Prior to April 1 , 2014 • Companies Act 1956 had not mandated the

consolidation of Accounts.• Neither AS 21 mandated consolidation.• Consolidation was required only for listed entities by

SEBI

• Post April 1,2014• Required under Companies Act 2013.• AS 21 still does not mandate. • SEBI guidelines continue to mandate only for listed

companies

Requirement of Consolidation Accounting Standards (AS) :-

AS 21 : Consolidation of Accounts AS 23 : Accounting for Investments in Associates in Consolidated Financial Statements AS 27 : Financial Reporting of Interests in Joint Ventures

Companies Act 2013 (the Act 2013) :-

Requirements of consolidation as per the Act 2013 Section 129(3),

Schedule III of the Act,1956 – Guidance & other requirements.

Consolidation and Listing Requirements –listed companies

Abbreviations : Consolidated Financial Statements – CFS Separate Financial Statements – SFS

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Provision of the Companies Act 2013Section 129(1) :-

Financial Statements to follow the Accounting Standards(AS) notified u/s 133. Items in the Financial Statements in accordance with the AS.

Section 129(2) At every annual general meeting of a company, the Board of Directors of the company shall lay before such meeting financial statements for the financial year.

Section 129(3) Where a company has one or more subsidiaries, it shall, in addition to financial statements provided under sub-section (2), prepare a consolidated financial statement of the company and of all the subsidiaries in the same form and manner as that of its own which shall also be laid before the annual general meeting of the company along with the laying of its financial statement under sub-section (2):

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Section 129…Contd….

Proviso 1 Provided that the company shall also attach along with its financial statement, a separate statement containing the salient features of the financial statement of its subsidiary or subsidiaries in such form as may be prescribed: Rule 5 – AOC 1

Rule 5 :- Form of Statement containing salient features of financial statements of subsidiaries.

The statement containing the salient feature of the financial statement of a company’s subsidiary or subsidiaries, associate company or companies and joint venture or ventures 129 shall be in Form AOC-1.

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Section 129…Contd…. Proviso 2 Provided further that the Central Government may provide for the consolidation of accounts of companies in such manner as may be prescribed. Rule 6 Rule 6. Manner of consolidation of accounts.- The consolidation of financial statements of the company shall be made in accordance with the provisions of Schedule III of the Act and the applicable accounting standards: • Provided that in case of a company covered under sub-section (3) of section

129 which is not required to prepare consolidated financial statements under the Accounting Standards, it shall be sufficient if the company complies with provisions on consolidated financial statements provided in Schedule III of the Act.

ExplanationFor the purposes of this sub-section, the word “subsidiary” shall include associate company and joint venture. ( this is not required as per AS)

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Section 129…Contd. Section 129(4)

The provisions of the Act applicable to mutatis mutandis, apply to the consolidated financial statements.

Section 129(5) - Deviation

Where the financial statements of a company do not comply with the accounting standards the company shall disclose in its financial statements, • the deviation from the accounting standards, • the reasons for such deviation and • the financial effects, if any, arising out of such

deviation.

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Schedule III – Additional requirements

Para 1 :- In addition, the consolidated financial statements shall disclose the following information:

(i) Profit or loss attributable to “minority interest” and to owners of the parent in the statement of profit and loss shall be presented as allocation for the period.

(ii) “Minority interests” in the balance sheet within equity shall be presented separately from the equity of the owners of the parent.

Para 2 :- prescribes the format in which the details to be given Para 3 :- mandates all subsidiaries (AS 21 provides exemption)Para 4 :- requires disclosures of companies not consolidated with reasons

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Consolidation : Requirements of ASA parent which presents consolidated financial statements should consolidate all subsidiaries, domestic as well as foreign, other than when :-

(a) control is intended to be temporary - the subsidiary is acquired and held exclusively with a view to its subsequent disposal in the near future; or

(b) it operates under severe long-term restrictions which significantly impair its ability to transfer funds to the parent.

When a subsidiary is not consolidated – it is accounted for as per AS 13 – at cost , reasons for not consolidating to be given.Commentary : Dissimilar activities not a valid reason for non-inclusion.

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Consolidation : Accounting Policies & Year

Accounting Policies :-

Apply uniform accounting policies for like transactions and other events in similar circumstances.

If it is not practicable to use uniform accounting policies appropriate adjustments are made along with disclosure of facts.

Accounting Year :-

The financial statements used in the consolidation should be drawn up to the same reporting date.

If not adjustments should be made for the effects of significant transactions or other events that occur between those dates and the date of the parent’s Consolidated Financial Statements

The difference between reporting dates should not be more than six months.

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Key Definitions Minority Interest (AS 21) that part of the net results of operations and of the net assets of a subsidiary

attributable to interests which are not owned, directly or indirectly through subsidiary(ies) by the parent

Minority interests shall be aggregate of the following :-(Minority Shareholder’s share):

(a) Share Capital(b) Capital Profits(C) Revenue Profits(d) Proposed Dividend

Minority Interests shall be shown separately in the liabilities side of the Consolidated Balance Sheet

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Key Definitions contd…. Associate :-

• investor must have significant influence;• should not be a subsidiary;• should not be a joint venture of the investor.

Significant influence :-• The power to participate in the financial and/or

•operating policy decisions of the investee;• But not control over those policies.

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Key Definitions contd….Control :-

• the ownership of more than 50% of the voting power of an enterprise; or

• control of the composition of the board of directors in the case of a company or control of the composition of the corresponding governing body in case of any other enterprise.

Key Definitions contd. 29

•A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity, which is subject to joint control.

•Joint control is the contractually agreed sharing of control over an economic activity.

• A venturer is a party to a joint venture and has joint control over that joint venture.

•An investor in a joint venture is a party to a joint venture and does not have joint control over that joint venture.

•Proportionate consolidation is a method of accounting and reporting whereby a venturer's share of each of the assets, liabilities, income and expenses of a jointly controlled entity is reported as separate line items in the venturer's financial statements.

Subsidiary – Full Consolidation

Common balance sheet transactions to be eliminated in full • Loan and advances • Trade receivables and payables

Common income statement transactions to be eliminated in full

• Sales & Purchases • Interest • Dividend

Elimination of unrealized group profit – current as well as non-

current items Account for Non- Controlling Interest separately. • In Profit and Loss • Equity

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Joint Ventures – Proportionate Consolidation & Proportionate Cancellation

Jointly controlled assets;

Jointly controlled operations;

Jointly controlled entities – Proportionate consolidation;

Upstream and Downstream transactions.

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Consolidated financial statementsOverview and key changes

• As per the 2013 Act, preparation of CFS mandatory for all companies having subsidiaries

• Rules clarify that CFS will be made in accordance with Schedule III and AS

• A proviso to rule 6 of Chapter IX states as below

”A company covered under sec 129(3) which is not required to prepare CFS under the accounting standards, it is sufficient compliance, if the company complies with provisions on CFS of schedule III”

• CFS to be prepared in the same form and manner as SFS of the parent

• For preparation of CFS, subsidiary includes associate and joint ventures

• Schedule III lays down general instructions for preparation of CFS

• Separate statement containing financial information of subsidiaries, associates and JVs to be given in prescribed form

Key impact

• Meaning of the proviso in the rules is not clear – Differing views possible

▫ Whether rules can override the Act w.r.t. preparation of CFS?

▫ No separate exemption for non-listed intermediate holding companies

• Impact on companies currently preparing CFS under IFRS

• Whether companies without any subsidiary but having associate/ JV need to prepare CFS!

• Mandatory disclosure of statutory information in CFS – Exemption in AS 21 may not override Schedule III

• Presentation of comparatives in the first set of CFS

• Non-listed and private companies to gear up their financial reporting process.

Investor Protection

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Prevention of Oppression and Mismanagement-Class Action SuitKey provisions• Suit can be initiated by members and/or depositors if they collectively believe

that management or conduct of affairs of company is being conducted in a manner prejudicial to interests of company or its members or depositors

• Application can be filed before Tribunal for seeking following order:

▫ Restrain the company and its directors to act contravention to its articles, memorandum, resolution or provisions of the Act

▫ Initiate action for claiming damages and compensation against the company, its directors (including independent directors), auditors (including audit firm and partners involved), experts/advisor/consultant or any other person for any improper or misleading statement or any fraudulent, unlawful or wrongful act or conduct

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Prevention of Oppression and Mismanagement-Class Action Suit• Eligibility to file (after considering rules):

▫ For Members: a) In case of company having share capital, at least 100 members of company or at least 10% of total number of its members, whichever is less, or any member or members singly or jointly holding at least 10% of issued share capital of company, subject to condition that applicant or applicants have paid all calls and other sums due on his or their shares

b) In case of company not having share capital, at least 1/5th of total number of members

▫ For Depositors:At least 100 depositors or at least 10% of total number of depositors, whichever is less or any depositor or depositors singly or jointly holding at least 10% of total value of outstanding deposits of company

Challenge II : Transition to IND -AS

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IND AS regime• Ministry of Corporate Affairs (MCA) announced Road

Map in March 2010 for application of Indian Accounting Standards (Ind AS) converged with International Financial Reporting Standards (IFRS) to specified class of companies in phases beginning with the financial year 1 April 2011. MCA could not notify the date of implementation of Ind AS as per its notified road-map.

• MCA after consultations with various stakeholders and regulators, issued a press note on 2 January 2015 wherein a revised Road map for implementation of Ind AS converged with IFRS was laid down for companies other than Banking Companies, Insurance Companies and Non- Banking Finance Companies (NBFC).

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Proposed New Roadmap for Implementation of Ind AS• There shall be two separate sets of accounting

Standards notified under the Companies Act 2013.

• The first set would comprise Ind AS converged with IFRSs which will be applicable to financial statements of the specified class of companies.

• The second set would comprise existing notified AS and shall be applicable to financial statements of other companies.

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Contd… Proposed New Roadmap for Implementation of Ind AS• The first set of Accounting Standards i.e. Ind AS

converged with IFRS shall be applicable to the specified class of companies in two phases;

• Phase I: i) On voluntary basis for financial statements for accounting periods beginning on or after April 1, 2015, with the comparatives for the periods ending 31st March, 2015 or thereafter, (ii) on mandatory basis for the accounting periods beginning on or after April 1, 2016, with comparatives for the periods ending 31st March, 2016, or thereafter, for the companies specified below:

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Contd… Proposed New Roadmap for Implementation of Ind AS• a)Companies whose equity and / or debt

securities are listed or are in the process of listing on any stock exchange in India or outside India having net worth of Rs. 500 crore or more.

• b)Companies other than those covered in (a) above, having net worth of Rs. 500 crore or more.

• c)Holding, subsidiary, joint venture or associate companies or companies covered under (a) or (b) above.

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Contd… Proposed New Roadmap for Implementation of Ind AS• Phase II: Listed companies other than those covered in

paragraph (a) of phase I, i.e, listed companies whose net worth is less than Rs. 500 crore for preparation of financial statements for accounting periods beginning on or after April 1, 2017 with the comparatives for the period ending 31st March, 2017 or thereafter.

• MCA vide its notification dated 16 February 2015 notified the Companies (Indian Accounting Standards) Rules 2015 specifying 39 Ind AS to be implemented as per the above road-map. The Ind AS have been formulated by MCA in consultation with National Advisory Committee on Accounting Standards (NACAS).

Key challenges of convergence

Convergence in phases will lead to two sets of companies – one with converged Ind ASs and another with existing ASs. International experience appears to accommodate such a situation.

Cost of transition, compliance and implementation issues need to be tackled with care to ensure smooth transition

Departures from IFRSs or carve-outs based on needs of local business environment may not serve the essential objective of Indian Corporate Accounting becoming fully aligned with IFRS.

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Contd… Key challenges of convergence

The proposed road map does not provide any milestone for adoption of the Ind ASs by unlisted companies having net worth of Rs.500 crore or less. This leaves a gap to be filled so that all companies are covered for adoption of Ind AS.

Fair value measurement of assets /liabilities would result in significant difference from currently presented financial information and increase the volatility in reported earnings and related performance criteria.

Non availability of Tax Accounting Standards under Direct Taxes may result in ambiguity in tax treatment of accounting changes arising from transition to Ind AS. 43

Challenges in Audit of CPSEs Need for special exposure/training to audit personnel

in the nuances of changes and their implications on audit.

Examine the need to issue directions to Statutory Auditors, as required.

We need to be ready to examine IND AS converged accounts well before March 2016.

Assess the implication of transition/convergence on the CPSEs in the first as well as second phase of the road map

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Challenge III : Three Phase Audit System

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Three Phase Audit System :- An intensified, innovative, focused and result oriented approach to

financial audit introduced by CAG to improve the quality of financial statements of CPSEs.

The Three Phase Audit System was introduced in selected CPSEs falling under categories of ‘Listed’, ‘Navratna’, ‘Miniratna’ and ‘Statutory Corporations’ from the FY 2008-09.

Phase-I: Analysis of accounting policies, notes to accounts with reference to the applicable laws and disclosures in conformity with the accounting standards as per last year’s certified accounts;

Phase-II: Examination of Financial Statements, providing an opportunity to the management and issuing directions to statutory auditors to take timely remedial action;

Phase-III: Final examination of Financial statement and auditor’s report after approval of the same by the management.

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Impact of Three phase auditAs a result of Three Phase Audit conducted in 74

CPSEs in 2013-14, a number of quantitative as well as qualitative changes were made by the CPSEs in their financial statements which led to improvement in the quality of their financial statements.

Effect of comments of CAG during supplementary audit

(Rs. In crore)Profitability Assets Liabilities

Overstatement 1861.84 1899.30 55.26

Understatement 1435.63 158.59 4245.68

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The value addition by Three Phase Audit:

on profitibility on Assets/Liabilities Amendments to Accounts / other disclosures

Classification mistakes

4595.82 4349.74

11560.66

3081.6

20225.28

38496.51

5720.42

29504.62

2012-13 2013-14

` in

cro

re

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Three Phase Audit Issues

Limited scope for Phase I audit and no scope for comments in Phase II audit;

Total output in Three Phase audit system is less as compared to earlier system of Accounts audit;

Delayed submission of draft accounts to CAG for IInd Phase audit resulting in limited coverage of audit due to time constraints; and

Delayed submission of uncertified accounts of units to sub auditor.

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Experience/lessons from three phase audit The new audit approach was appreciated by both management of

various CPSEs who opted for it and the statutory auditors concerned.

As a result of Three Phase Audit conducted in CPSEs, a number of quantitative as well as qualitative changes were made by the CPSEs in their financial statements which led to improvement in the quality of their financial statements.

Recently, MsAB offices have raised concern regarding delay in submission of provisional accounts by the management for conducting phase two audit.

Efforts are underway to draw a time schedule in which time line for submission of provisional accounts and completion of audit would be mutually agreed.

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