Internal Audit for Foreign Companies in India: Frequently Asked Questions
- Listed companies and certain unlisted public companies are mandated to conduct an internal audit.
- Internal audits are used to examine the financial and non-financial activities of the company.
- Through internal audits companies are made aware of their compliance status and prospective risks and can take measures to improve efficiency.
Certain categories of companies in India are required to undergo an internal audit.
Internal audits are conducted in order to check the health of a company’s finances and analyze the organization’s operational efficiency.
The function of an internal audit is to verify the reliability of information included in financial statements. This additionally entails the verification of non-financial information and transactions for accuracy and compliance with an entity’s policies and procedures.
The internal audit is an independent function of management, which entails the continuous and critical appraisal of the functioning of an entity, with a special focus on possible areas for improvement and how to strengthen and add value to an entity’s corporate governance mechanisms.
Like the secretarial audit, tax audit, and the cost audit, internal audit is also governed under the Companies Act, 2013. Under the Act, the government has the jurisdiction to make rules and regulations for the way an internal audit must be conducted.
Who should conduct an internal audit?
An internal audit must be conducted by either a chartered accountant, or a cost accountant.
Not all companies are mandated to conduct an internal audit. Under the Companies Act, 2013, the following classes of companies have to carry out an internal audit:
- Every listed company;
- Every unlisted public company with paid-up capital exceeding INR 500 million (US$7 million) in the previous financial year;
- Every unlisted public company that has a turnover greater than INR 2 billion (US$28 million) in the previous financial year;
- Every unlisted public company with outstanding loans and liabilities exceeding INR 1 billion (US$14 million) at any point during the previous financial year;
- Every unlisted public company with outstanding deposits exceeding INR 250 million (US$3.5 million) in the previous financial year;
- Every private company that has a turnover of more than INR 2 billion (US$28 million) in the previous financial year; or
- Every private company that has had outstanding loans and liabilities exceeding INR 1 billion (US$14 million) at any point.
Is there a penalty for non-compliance?
For non-compliance with an internal audit, no specific penal provisions are mentioned under the Companies Act, 2013.
Since no punishment has been specified, any sort of non-compliance will be prosecuted under Section 450 of the Companies Act, 2013. The section further states that the company and the auditor will be fined up to INR 10,000 (US$140) in case of any non-compliance.
Are there key guidelines that need to be followed while conducting an internal audit?
Keeping the importance of the internal audit function in mind, the Securities and Exchange Board of India (SEBI) introduced mandatory and recommendatory corporate governance provisions in Clause 49 of the Listing Agreement applicable to only listed companies.
As per Clause 49, an audit committee is required to review the following:
- Whether the internal audit is being made functional in proper order by reviewing the structure of the internal audit department, personnel recruited, and seniority of the official who shall be heading the department, frequency of audits, and terms of remuneration of the chief internal auditor;
- Internal audit reports relating to weaknesses found in internal controls;
- The findings of any internal investigation by internal auditors into matters where there is a suspected fraud or irregularity, or a failure of internal control systems of a significant impact; and
- The chief executive officer (CEO) and the chief financial officer (CFO) are required to certify to the board of directors that they accept responsibility for the effectiveness of internal controls, and that they have disclosed to the auditors and the audit committee any deficiencies in the operation of internal controls and steps taken for their rectification.
The above clauses are part of the Listing Agreement, with which every entity listed on India’s stock exchanges must comply.
What is the relevance of an internal audit?
For foreign companies in India, navigating through local compliance rules and regulations can be a challenging task.
Internal auditors assist management with this task by providing a focus on risk management and the implementation of more stringent internal controls.
In this way internal audits can enhance the organization’s capacity to build value by enabling management personnel to take timely financial decisions, make immediate changes to how internal controls are operated – if required, and address any areas of vulnerability.
(This article was originally published on April 14, 2014. It has been updated on January 27, 2020.)