The following amendments have taken place in Advanced Auditing since the last attempt in November 2008:
1. Code of Ethics
2. Audit of NBFC
3. Clause 49
4. Clause 41
5. AAS (Auditing and Assurance Standards)
6. Insurance Companies
7. Tax Audit (in relation to New Rule 8D)
8. Bank Audit
SEBI has on April 8, 2008 issued a press release and circular amending certain provisions of Clause 49 relating to corporate governance, and can be viewed here: https://www.sebi.gov.in/Index.jsp?contentDisp=WhatsNewScroll&FilePath=/press/2008/200895.html
The composition of board of directors has been required to be as under:
(a) where chairman is an executive chairman, atleast half the board has to comprise of independent directors
(b) where the chairman is a non-executive chairman, then one-third of the board has to comprise of independent directors
The primary amendment brings item (b) on par with item (a) above in certain specific situations.
1. If the non-executive Chairman is a promoter or is related to promoters or persons occupying management positions at the board level or at one level below the board, at least one-half of the board of the company should consist of independent directors.
– having a non-executive Chairman who is a promoter or related to promoters &
– Having a non-executive Chairman related to persons occupying management positions at the board level or at one level below the Board.
Such companies will need to ensure that one-half of the board consists of independent directors.
This changeover is from a situation where if a company had a non-executive Chairman, then only one-third of the board needed to consist of independent directors.
Given that a large part of Corporate India comprises business houses / promoter driven enterprises, the impact can be quite a very high magnitude.
2. Disclosure of relationships between directors inter-se shall be made in the Annual Report, notice of appointment of a director, prospectus and letter of offer for issuances and any related filings made to the stock exchanges where the company is listed.
An ambiguity which is created is whether the inter-se relationship amongst directors that needs to be disclosed in specified documents/filings is with reference to:
3. The gap between resignation/removal of an independent director and appointment of another independent director in his place shall not exceed 180 days. However, this provision would not apply in case a company fulfils the minimum requirement of independent directors in its Board, i.e., one-third or one-half as the case may be, even without filling the vacancy created by such resignation/removal.
– essentially, if an independent director has retired/resigned/been removed, then his replacement should be found within 180 days.
- no impact where minimum requirement of independent directors is satisfied without filing up the vacancy.
4. The minimum age for independent directors shall be 21 years.
Companies will need to ensure incoming directors are of this age.
An ambiguity – what about companies who already have directors below this age OR does the capacity to contract as per Indian Contract Act anyway rules out those below 21 years of age from being a director, and hence this modification was not really required?
- The Board - A non-executive Chairman may be entitled to maintain a Chairman’s office at the company’s expense and also allowed reimbursement of expenses incurred in performance of his duties.
- Independent Directors may have a tenure not exceeding, in the aggregate, a period of nine years, on the Board of a company.
Some ambiguities which arise due to this requirement:
- Does the tenure already served require being reckoned for directors on board a listed company?
- Does the tenure served by a director prior to listing of a company which lists hereafter require being reckoned
Whilst the provision is itself non-mandatory – but in case of non-adoption, a specific disclosure in the annual report needs to be made and companies wanting to ensure good governance will be faced with the above ambiguities whilst complying.
Some segments will be able to ensure immediate compliance. for example in case of banking companies, the Banking Regulation Act already has a mandatory requirement limiting an independent director’s term to 8 years – itself a stricter standard than SEBI’s non-mandatory requirement limiting the term to 9 years.
- The company may ensure that the person who is being appointed as an independent director has the requisite qualifications and experience which would be of use to the company and which, in the opinion of the company, would enable him to contribute effectively to the company in his capacity as an independent director.
As mentioned though these three requirements are non-mandatory, in case of non-adoption, a specific disclosure in the annual report needs to be made.
These modifications to clause 49 reflect a continuing eye being kept by SEBI on Corporate India and prevailing Corporate governance standards - which is quite comforting! Clarifying the ambiguities will pave way for smooth adoption of these changes.
One aspect which may be challenging for Corporate India is the timing of these modifications - with financial years largely ending in March, with adoption of annual accounts within the quarter ending June, followed by circulation of annual report, may mean disclosures having to be made as on the date of the Annual report on the compliance with clause 49, and therefore compel steps to ensure compliance starting very quickly
Sebi has recently revised Clause 41 of the Equity Listing Agreement, which governs the submission of quarterly results to stock exchanges. The revision aims to rationalise formats and the submission process. The revised Clause 41 is applicable in respect of accounting periods commencing on or after July 1, 2007.
First, the revised Clause 41 requires that while placing the financial results before the board, the CEO and the CFO shall certify that the financial results do not contain any false or misleading statements or figures and do not omit any material fact which may make the statements or figures misleading. This requirement is similar to that in Clause 49, which embodies the corporate governance code. The revised Clause 41 further requires that the financial reports should be approved by the board or a committee (other than the audit committee) of the board, which shall consist of at least one-third of directors and shall include the managing director and at least one independent director.
When the quarterly financial results are approved by the committee, they shall be placed before the board at the next meeting. These modifications will enhance the accountability of the CEO, the CFO and the audit committee. They also reinforce the underlying principles that approval of the financial results, based on the recommendation of the audit committee, is a routine activity of the board.
Many board members feel that way. In fact, the board is required to apply its collective wisdom in approving financial results or in considering the accounting policy or the audit report. The practice of working through committees aims to improve the effectiveness of the functioning of the board and not to absolve the board of its responsibilities.
Another important revision is regarding explanation as to variations in unaudited and audited results. The revised Clause 41 requires that where there is a variation between the unaudited quarterly or year-to-date financial results and the results amended pursuant to limited review for the same period and the variation in net profit or net loss after tax is in excess of 10 per cent or Rs 10 lakh or higher, the company shall explain the reasons for variations.
Similarly, a company has to explain a variation of more than 10 per cent or Rs 10 lakh, which ever is higher, in exceptional or extraordinary items. Revised Clause 41 requires disclosure of exceptional and extraordinary items. Earlier, a company was required to explain variation of 20 per cent or more in respect of any item given in the format prescribed by Sebi for the presentation of quarterly results. The revision is sensible. But the limit of Rs 10 lakh may create hardship for big companies. Materiality should be the governing principle. Therefore, the limit of Rs 10 lakh may not be warranted. Perhaps, we are yet to recognise that many of our listed companies have grown in size and the rate of growth is faster than earlier.
The revised Clause 41 specifically stipulates that the quarterly and year-to-date results are to be prepared and presented in accordance with the recognition and measurement principles laid down in Accounting Standard (AS)-25, Interim financial Reporting. AS-25 stipulates the accounting principles and methods for the preparation and presentation of interim financial reports. AS-25 requires the preparation and presentation of an interim financial report containing at least a set of condensed financial statements. Therefore, a quarterly financial report that a company presents in accordance with the requirements of Clause 41 is not an interim financial report. Therefore, only that part of AS-25 which deals with recognition and measurement principles is applicable.
Preparation and presentation of interim financial reports has certain inherent difficulties. Revenues of some businesses fluctuate widely among interim periods because of seasonal factors; in some businesses, heavy fixed costs incurred in one interim period benefit more than one interim period; costs and expenses related to a full year’s activities are incurred at infrequent intervals during the year; and the limited time available to develop complete information required to estimate assets, liabilities, income and expenses.
There are two distinct views of interim reporting: “integral� and “discrete�. According to the integral view, each interim period is primarily an integral part of the annual period. Under this view, deferrals, accruals and estimations at the end of each interim period are affected by judgments made at the interim date with reference to the results of operations for the remainder of the annual period.
According to the discrete view, each interim period is a basic accounting period. Under this view, the results of operations for each interim period should be determined in essentially the same manner as if the interim period were an annual accounting period. Accounting Standard (AS)-25 has adopted the discrete view.
An enterprise estimates the amount at which an asset, liability, income or expense is to be recognised in financial statements based on information available, until the financial statements are approved by the Board of Directors. The same principle is applied in the preparation and presentation of interim financial reports. Estimates might change in the subsequent periods based on new information. Amounts of income and expenses reported in the current interim period reflect any changes in amounts reported in prior interim periods of the financial year. The amount and nature of any significant change in estimates should be disclosed.
Revenues that are received seasonally or occasionally within a financial year should not be anticipated or deferred as of an interim date if anticipation or deferral would not be appropriate at the end of the enterprise’s financial year.
Costs that are incurred unevenly during an enterprise’s financial year should be anticipated or deferred for interim reporting purposes only if it is also appropriate to anticipate or defer that type of cost at the end of the financial year. A company should estimate provisions in respect of gratuity and other defined benefit schemes for an interim period on a year-to-date basis by using the actuarially determined rates at the end of the prior financial year.
However, it should not anticipate major planned periodic maintenance and overhaul for interim reporting purposes unless an event has caused the enterprise to have a present obligation.
Interim period income-tax expense is accrued using the tax rate that would be applicable to expected total annual earnings, that is, the average annual effective income-tax rate applied to the pre-tax income of the interim period.
The estimated average annual income-tax rate would reflect the tax rate structure expected to be applicable to the full year’s earnings including fully or substantively enacted changes in the income-tax rates scheduled to take effect later in the financial year. The estimated average income-tax rate is re-estimated on a year-to-date basis.
A company considers the effect of the tax loss carry forward to determine the estimated average annual effective tax rate if the criteria for recognition of a deferred tax asset are met at the end of the interim reporting period.
A company applies the same impairment tests, recognition, and reversal criteria at an interim date as it would at the end of its financial year. An enterprise assesses the indications of significant impairment since the end of the most recent financial year to determine whether a detailed impairment calculation is needed.
The revision of Clause 41 is definitely a step forward. Let us hope that some companies take it further and present a set of condensed financial statements at least on a half-yearly basis.
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