Presented By
CA Swatantra Singh,
B.Com , FCA, MBA
Email ID: singh.swatantra@gmail.com
New Delhi , 9811322785,
www.caindelhiindia.com,
www.carajput.com
1
Section I
The Need for Corporate Governance

Responsibility to Stakeholders
Predictability
Transparency
Accountability

Easier access to capital (FII, VCF)

Efficiency (at the firm level) and Global
Competitiveness (IPRs)
2
Section II
Conceptualizing Corporate Governance

Narrow Definition
- A set of relationships between the company and
shareholders, directors and management.

Broad Definition
- Going beyond and looking to the implicit and explicit
relationships of the company with employees,
creditors,
consumers,
distributors,
local
communities.
3
Conceptualizing Corporate Governance
(Contd.)

OECD Definition
– System by which corporations are directed and controlled.
– Spells out the rules / procedures for making decisions on
corporate affairs.
– Provide the structure through which the company objectives
are set, and the means of attaining those objectives and
monitoring performance
– Specifies the distribution of rights and responsibilities
among different participants in the corporation, such as, the
board, managers, shareholders and other stakeholders

World Bank Definition
– Corporate governance is about promoting corporate
fairness, transparency and accountability
4
Conceptualizing Corporate Governance
(Contd.)


What constitutes shareholders’
profitability versus profitability
Need for external regulation
interest?
sustainable
– FOR:
» Conflict of interest b/w Management/Promoters and other
constituencies
» To protect small investors
» To account for Externalities
– AGAINST:
» Risk of excessive policing (time & cost of compliance)
» Increase costs
» Check the box approach
5
Section III
Evolution of Systems of Accountability:
Indian Initiatives





In December 1995, CII set up a task force to
design a
voluntary code of corporate governance
In April 1998, the Desirable Corporate Governance: A Code,
was released
SEBI set up the Kumar Mangalam Birla Committee in 1999 to
design a mandatory-cum-recommendatory code for listed
companies (Clause 49)
DCA set up the Naresh Chandra Committee Report in 2002.
The key recommendation related to financial and non-financial
disclosures and independent auditing and board oversight of
management (Draft Companies Bill)
The Narayana Murthy Committee was set up by SEBI in 2002
to review clause 49 and suggest measures to improve corporate
governance standards (Proposed Clause 49)
6
Developments in the U.S

ENRON
– Bankruptcy filing in 2001 (largest in US history)
– Accounting
techniques
involving
unconsolidated
partnerships and “special purpose entities” to hide losses
from financial statements & conceal indebtedness.
– Issues regarding independence of auditors, provision of
non audit services & conflict of interest
– Independence of directors

SARBANES OXLEY ACT, 2002 (SOX)
– Signed into law July 30, 2002
– Enhances reporting obligations of public companies to
prevent securities fraud & other abuses
7
SOX

Applicable to:
– Companies listed or traded in the U.S (including non U.S
Companies)
– Subsidiaries of U.S Companies in India (provided they
have a business connection in the U.S)
– Foreign accounting firms that prepare or furnish audit
report for an issuer
– Sometimes compliance expected by U.S Companies
from business partners in India (implications for BPO
sector)
8
SOX-Brief Overview




CEO & CFO certification in SEC Reports (Ss 302 & 906)
– Compliance with Securities Exchange Act, 1934
– Financial statements represent the true financial
condition of the Company operations
– Financial results contain no untrue statement /omission
of material fact
– Company has complied with Disclosure norms
– Management have disclosed significant deficiencies,
changes, fraud to auditors & audit committee
Ban on loans to executive officers and directors
Accelerated filings of periodic reports
Filing of change of beneficial ownership within 2 days
9
SOX-Brief Overview (Contd.)

Reimbursement by CEO/CFO upon
restatement of financial statements due to
misconduct
– Bonus/other incentive based compensation
– Profits from sale of securities
Independence of Board of Directors/
Committees
 Enhanced Criminal Penalties (upto $5
million fine for individuals, $25 million for
entities, prison terms upto 20 years)


Strict Reporting of illegal or unethical behavior
10
SOX-Brief Overview (Contd.)

Audit Committee
–
–
–
–
Independent
Financial Literacy of members
At least one financial expert
Responsible for appointment, compensation &
oversight of auditor & approval of audit/non
audit services
– Create compliant mechanism regarding
accounting and auditing
– Approve all related party transactions
 Implementation of a ‘Whistleblower’ policy
11
SOX-Brief Overview (Contd.)

Additional Disclosures
– Off Balance Sheet Items & transactions that may
have material current/future effect on financial
condition/results of operations
– Pro forma Information must conform to financials
prepared under GAAP - No untruth/omission
– All fees billed by auditors in annual report
– Audit Partner Rotation
– Registration with Public Company Accounting
Oversight Board (including foreign audit firms that
audit Issuers)
12
Major Areas of Debate

Directors

Independent Directors

Audit Committees

Auditors
13
Section IV
Director: The Fiduciary
“If directors act within their powers, if
they act with such care as is reasonably
to be expected from them, having
regard to their knowledge and
experience, and if they act honestly for
the benefit of the company they
represent, they discharge both their
equitable as well as their legal duty to
the company”
14
WHO DO DIRECTORS OWE A DUTY
TO?
SHAREHOLDERS
COMPANY
EMPLOYEES
PUBLIC
CREDITORS
15
General Duties of Directors
Duty of care and skill
 Duty of loyalty & disclosure
 Duty of disgorging profit in relation to
corporate opportunity

16
Duty of Care and Skill
A director or officer has a duty to the
corporation to perform his functions in
good faith, and in a manner that he
reasonably believes to be in the best
interest of the corporation, and with a
care that an ordinary prudent person
would reasonably be expected to
exercise in a like position and under
similar circumstances
17
Duty of Care and Skill (Contd.)
Courts in UK and USA have held that directors in banks
and financial institutions owe a higher degree of care
– The banking industry is involved in regular receipt of public cash
and property and is thus more vulnerable than other businesses and
therefore a greater care is required;
– A director of a company (a bank) that has a large amount of liquid
assets carries with him higher risks and temptation to which such
assets give rise;
– There are more legislative and regulatory monitoring and liability
provisions pertaining to banking companies than any other
company and such provisions may also extend to the director of
the bank or financial institution.
18
Duty of Care and Skill (Contd.)
Exercise reasonable care, skill and
diligence
 Continuing knowledge of company’s
business
 Reliance on Co-directors and Power to
delegate with supervision
 Bona fide and good faith intention

19
Duty of Loyalty & Disclosure





Section 299, Companies Act, 1956
principal is based on the rudiments of law that the
same person cannot act for himself/herself and at the
same time, with respect to the same matter, act with
another whose interests are conflicting
Effect of disclosure
Disclosure to whom
How extensive should the disclosure be
20
Duty in Relation to Corporate Opportunity

By occupying a position of trust, a director
must not make a profit which he can acquire
only by use of his position and, if he does, he
must account for the profit so made.
21
Corporate Opportunity

Any profit made by a Director through holding the
office of such director must be accounted for.
Therefore, a Director would be held accountable
for personal profits made from:
– The sale of goods, materials or services earlier dealt with by
Company for its business
– Forestalling the company’s business opportunity unless the
company has rejected such opportunity
– Requesting the customer to place orders for goods, materials
and services with another company in which he has some
interest
– Receiving Commission from another company, which
has sold goods to the company
22
Liabilities of Directors

Derivative Action

Statutory Liability

Contractual Liability

Tortuous Liability
23
Derivative Action



Resolutions by directors for transferring the
controlling interest of the company wherein there is a
complete changeover of the structure to the detriment
of the company
Sale of land to oneself at a discounted value
Directors passing an ordinary resolution where the
act in question would require a special resolution
24
Statutory Liability
Companies Act, 1956: Officers in default
 Banking Regulation Act, 1949
 Insurance Act, 1948
 Pollution Laws
 Income Tax Act, 1961

25
Director:Legal Provisions

Restrictions on loans to directors or other specified entities (s. 295)
– Interest rate shall not be less than 4% above prevailing bank rate
– Quantum of loan to not exceed 25 times the gross salary
– No default on public deposit by the company

Boards sanction for contracts in which directors are interested (s.
297)
–
–
–
–
Consent by way of board resolution
Prior to the contract or within three months
Except contract between two public companies
Prior approval of the central government for a contract where the
company has paid up share capital of not less than Rs 1 crore
26
Director: Legal Provisions (Contd.)

Disclosure of interest by directors (s. 299)
– Default ground for vacation under s. 283.

Interested directors not to participate or vote in board
proceedings (s. 300)
– Applicable only to public companies

Maintenance of records of contracts, companies, firms in which
directors are interested (s. 301)
– to be signed by all the directors present in the next board meeting
– kept at registered office and available for inspection

Restriction on directors from holding office of profit (s. 314)
– Company can give consent by special resolution
– Does not apply to managing directors
27
Issues for Consideration

Should the directors be educated on the risk
profile of the company and their duties as a
director?
– Narayana Murthy Committee Report


Should
there
be codified
duties
and
responsibilities?
Should the liability of the non-executive directors
mirror the liability of the executive directors?
28
Independent Directors


No mention in the Companies Act
Clause 49
- Optimum combination of executive and non-executive directors
- Not less that fifty per cent being non-executive
- If non executive chairman, at least one third of the board should
comprise of independent directors
- If executive chairman, at least half of the board should comprise of
independent directors

Clause 63, Draft Companies Bill
– Every public company of prescribed paid up capital or turnover to
have at least seven directors of which at least three or fifty percent,
whichever is higher, to be independent directors
» Would include unlisted public companies also
29
Who is an Independent Director?
 Independence
of judgement
 No
material relationship
 No
pecuniary relationship
30
What is Independence?

The Cadbury Report defines independence as:
Apart from their directors’ fees and shareholdings, they
should be independent of management and free from any
business or other relationship which could materially
interfere with the exercise of their independent judgement.

Clause 49
‘Independent’ defined as those directors who, apart from
receiving director’s remuneration do not have any other
material pecuniary relationship or transactions with the
company, its promoters, management or subsidiaries,
which in the view of the board may affect independence of
judgment
31
What is Independence? (Contd.)

Clause 2(45), Draft Companies Bill
“Independent Director” means a non-executive director of
a company who apart from receiving director’s
remuneration, does not have any material pecuniary
relationship or transactions of such amount as may be
prescribed, with the company , its promoters, managing
director, whole time director, other directors, manager or
its holding company and its subsidiaries apart from
possessing such attributes for being treated as Independent
director as may be prescribed by the Central Government
from time to time.
 Excessively restrictive?
32
Independent Directors

External expert

Independent director: watchdog?
33
Audit Committee

Clause 49, Listing Agreement
– Minimum three members, all non-executive directors
– Majority independent, chairman independent
– At least one director having financial and accounting
knowledge
– Must have at least three meetings per year
34
Audit Committee (Contd.)

Section 292A, Companies Act
– public companies
– minimum three directors
– two thirds other than managing or whole time directors
» no other qualifications prescribed
– recommendations relating to financial management binding
» reasons for not accepting any recommendation
– Auditors required to attend the meetings

Clause 62, Draft Companies Bill
– not less than two independent directors
» no other qualifications prescribed
35
Audit Committee (Contd.)

Proposed Clause 49 (pursuant to N.M. Report)
– At least one member having financial and accounting
expertise
– All members to be financially literate
– Expanded role- independent judgment
– Focusing on
» Quality of accounting policies
» Alternate accounting policies
» Internal control deficiencies
– Implementation of ‘whistleblower’ policy
36
Audit Committee (Contd.)

Audit committees- Efficacy?
– Chairman of Enron’s audit committee was a Stanford
professor with 30 years experience in auditing and
accounts
– Should the members of audit committee be financially
literate?
– Should the scope of audit committee be decided by the
Board of Directors?
– Is remuneration of members an issue?
37
Section V
Auditors: The Watchful Eye

Appointment regulated by the Companies Act
(s.224)
– Maximum number of companies prescribed (20)

Qualifications & Disqualifications (s. 226)
– Person holding any security of that company (2000
Amendment)


Requirement to report on specific matters (s. 227)
ICAI Code of Conduct
38
Section V
Auditors: The Watchful Eye

Duties of Auditor
– Duty of Care (Re Kingston Cotton Mills Co.)
» Reasonable care and skill
– Auditor is the servant of the shareholder and
whose duty is to examine the affairs of the
company on their behalf at the end of a year
and to report to them what he has found.
– The auditor is like a trustee for shareholders.
– Watchdog and not a bloodhound
39
Auditor’s Liability

Basis of Liability
– Contractual and Fiduciary
» Company
» Shareholders as a body
– Tortuous
» “Holding out”
40
Auditor’s Liability (Contd.)

Stage I (Upto 1963)
– Candler v. Crane
» Privity doctrine: a third party not in privity with the auditor cannot recover
damages for negligence
» Justice Denning gave a dissenting judgment



it must be known to the advise41r that the advice would be communicated to the
plaintiff in order to induce him to adopt a particular course of action
the advice must be relied upon for the purpose of the particular transaction for
which it was known to the advisers that the advice was required.
Stage II (1964-1990)
– Hedley Byrne & Co. v. Heller & Partners
» Liability for a negligent misstatement made by one person to another, even
in the absence of any contractual or fiduciary relationship causing financial
loss
41
Caparo Industries Plc v. Dickman

Stage III (Post 1990)
– Watered down in Caparo Industries case
» The three criteria for the imposition of a duty of care are
 foreseeability of damage
 proximity of relationship
 the reasonableness or otherwise of imposing a duty
» The auditor of a public company's accounts owed no duty
of care to a member of the public at large, who relied on
the accounts to buy shares in the company.
 An auditor owed no duty of care to an individual shareholder in the company
who wished to buy more shares in the company
 The purpose for which accounts are prepared and audited is to enable the
shareholders as a body to exercise informed control of the company
42
Caparo Industries Plc v. Dickman

Cadbury Committee on Caparo Industries
– the case exposed two widely held misconceptions:
» audit report is a guarantee to the accuracy of the accounts,
and perhaps even as to the soundness of the company
» that anyone (including investors and creditors) can rely on
the audit, not only in a general sense but also very
specifically by being able to sue the auditors if they are
negligent

In light of Enron is there a need to re-examine the issue
of auditor’s liability as set out in the Caparo Industries
case?
43
Issues for Consideration

Should statute set out the liability?
– Should ‘breach of care’ be extended to any other
group?

Whether rules for auditors liability need to be
codified and made stricter?
– Recommendations of Naresh Chandra Committee Report

Should Audit committees evaluate independence
of auditors?
44
Similarities between US position & Indian
Proposals
SOX






CEO/CFO Certification
Reimbursement for
misstatement
Ban on loans to directors
Code of Conduct/Ethics
Independent Board/
Committee
Disclosure of Off Balance
Sheet/transactions that may
have future impact
Narayana Murthy Committee
 CEO/CFO Certification
 Reimbursement for
misstatement
 Restriction on loan to
directors
 Written/Public Code of
Conduct
 Independent Board of
Directors
 More limited disclosuresbut left open for
consideration
45
Comparison between US & Indian Position
SOX
Audit Partner Rotation
Audit Committee
•
•
•
•
Financial Literacy
One financial expert
Oversee auditor
Approve related party
transactions
• Whistleblowers policy
Narayana Murthy Committee
Audit Partner Rotation
Audit Committee
•
•
•
•
Financial Literacy
One financial expert
Oversee auditor
Approve related party
transactions
• Whistleblowers policy
46
Proposed Amendments

Proposed amendments to clause 49 and Draft
Companies Bill address major issues
– Appointment of a Chief Accounting Officer by a
Company
– Definition of related party transactions expanded and
specific approval requirements introduced
– Disclosure of all contingent liabilities
– Timely communication of Risk Management activities
– CEO/ CFO certification requirements
47
Section VI
Reinventing Corporate Governance in
India

Super regulator v. Multiple regulators?
- Efficiency
- Cost of Compliance

Transparency by the regulators?
- Late trading and market timing investigations

Enforcement by stock exchanges?
48
Reinventing Corporate Governance in
India (Contd.)

Disclosure of voting agreements which impact
governance of companies?

Pro-active role by institutional investors?

Mandatory Corporate Governance Ratings?
- Will it lead to better corporate governance?
49
Reinventing Corporate Governance in
India (Contd.)

How can whistle blowers be encouraged?
- Narayana Murthy Report
- Immunity for whistleblowers?

Directors & officers liability insurance?
50
Conclusion
 Good

corporate governance – means to the end of
sustainable wealth creation
The positive side of adherence to most rigorous standards
in governance for corporations:
-
Increased importance of corporate governance as an investment
criteria among large investors
- Improved Equity Price Performance
- Higher Valuations
- Access to global markets
- Increased investor goodwill & confidence
 Balance between ‘enterprise’ and ‘constraints’
51
Internal Audit
•
•
•
•
CARO Requirement
As per Sarbanes Oxley Act, 2002
Clause 49 of Listing Agreement
SAS 70 Report
52
Internal Audit
• CARO Requirement
Requirement of CARO – Auditor’s comment on
internal audit
• Clause 49 of Listing Agreement
- Applicable to listed companies in Indian Stock
Exchange.
• SAS 70 Report
- Use of Service Organizations like payroll - Hewitt,
MF accounting – Syntel Outsourcing, etc
53
Internal Audit
Sarbanes Oxley Act, 2002
• Applies to all companies listed in SEC
• US based company and its subsidiaries, foreign
companies like Patni, TATA Motors ADR
listed in NYSC.
• Sec 404 – Internal control on Financial
Reporting
• Certification by CEO/CFO on quarterly basis.
54
Internal Audit
Sarbanes Oxley Act, 2002
Senator Paul Sarbanes
Mike Oxley
55
End in Mind…





a statement acknowledging your responsibility for establishing and maintaining
adequate “internal control over financial reporting“
a statement identifying the internal control framework you used to conduct your
evaluation of the effectiveness of internal control over financial reporting
an assessment of the effectiveness of your company's internal control over financial
reporting as of the end of your most recent fiscal year.
– Assertion: a statement as to whether or not your company's internal control over
financial reporting is effective
disclosure of any “material weaknesses“ in your company's internal control over
financial reporting.
– If there are any disclosed material weaknesses, then you are not permitted to
conclude that your internal control over financial reporting is effective
a statement that your independent auditors have issued a report on your assessment of
internal control over financial reporting
56
How to be there..,
Financial Controls must be suitably designed using established criteria
(COSO)
· Control objectives and related financial controls are appropriately
documented
· Documentation is auditable
· Key financial controls are identified (Assertions)
· Management perform the own tests of:
•
the design of controls over financial reporting
•
the effectiveness based on key financial controls
· Deficiencies are documented, disclosed and addressed.
57
Applying the COSO
Framework
Information &
Communication
 Pertinent information
identified, captured
and communicated
in a timely manner.
 Access to internal and
externally generated
information.
 Flow of information that
allows for successful control
actions from instructions on
responsibilities to summary
of findings for management
action.
Monitoring
 Assessment of a control
system’s performance
over time.
 Combination of ongoing
and separate evaluation.
 Management and
supervisory activities.
 Internal audit activities.
Control Activities
 Policies/procedures that
ensure management
directives are carried out.
 Range of activities including
approvals, authorizations,
verifications,
recommendations,
performance reviews, asset
security and segregation
of duties.
Control Environment
 Sets tone of organizationinfluencing control
consciousness of its people.
 Factors include integrity,
ethical values, competence,
authority, responsibility.
 Foundation for all other
components of control.
58
Risk Assessment
 Risk assessment is the
identification and analysis of
relevant risks to achieving
the entity’s objectives –
forming the basis for
determining control activities.
Controls

Preventative and Detective Controls

Manual and Automated Controls

Business Performance Review / Monitoring Controls

General Computer Controls (IT Level Controls)

Application Controls (Transaction Level Controls in
Computer System)
59
Control objectives for Transaction
Processing




Completeness of records (C) - controls over completeness are designed to ensure
that:
– All transactions are recorded once and only once.
– All transactions are recorded in the correct period and in the correct legal entity.
Accuracy of records (A) - controls over accuracy are designed to ensure that:
– All transactions are accurately recorded in the general ledger, including correct
classification to ensure compliance with disclosure requirements.
– Assets and liabilities are recorded at an appropriate value.
– Changes to standing data are accurately input.
Validity of records (V) - controls over validity are designed to ensure that:
– Transactions are authorized.
– Transactions are genuine and they relate to Company.
– Changes to standing data are authorized.
Restricted access to assets and records (R) - controls to restricted access are
designed to ensure that:
– There is appropriate segregation of duties with respect to key controls.
– Physical assets (e.g. gold bullion) are
appropriately safeguarded.
60
Financial Reporting - Assertions

Existence or Occurrence
– Assets or liability exist at a given date (FG)
– Transaction occurred during a given period (Sales)

Completeness
– All financial transactions are included for reporting (Purchases)

Valuation or Allocation
– All amounts represented at appropriate amount (Accounts receivable)

Rights and Obligations
– Assets and Liabilities represents rights and obligations (Lease
capitalized)

Presentation & Disclosure
– Properly classified and disclosed
61 (Long term liabilities)
Documentation standards




Management must document the design of controls related to all
relevant assertions for all significant financial statement accounts
Documentation must encompass the entire process of:
– initiating
– authorising
– recording
– processing
– reporting individual transactions
The required documentation might take various forms: flowcharts,
policy manuals, accounting manuals, narrative memoranda, decision
tables, procedural write-ups or completed questionnaires
Flowcharts, supplemented by narrative descriptions, are frequently the
most effective form of control documentation
62
Objectives of a walkthrough



Confirms that the documentation prepared by the company
reflects its actual processes
Confirm that controls described in the documentation are
actually those applied “in the field”
Confirm that, at least, all key controls have been
documented appropriately (completeness of the process
documented)
Walkthroughs should confirm that the documentation is appropriate
to develop the testing plan
63
Gaps in Controls

Processes not adequately documented (scope and quality)

Controls not implemented

Controls poorly designed

Controls not working effectively

Control-related roles not assigned

Non-existence of policies

Gaps identified during documentation process – Will be shared on
confirmation during walk-through process
64
Scope
Process identified for documentation







Purchase of Materials and Accounts Payable
Production Accounting
Stock Accounting
Sales Accounting and Accounts Receivables
Treasury and Banking Transactions
General Accounting
Fixed Assets
65
Purchase of Materials and Accounts
Payable






Master maintenance – BOM & Suppliers
Issue of purchase orders Receivables
GAR and Inventory Verification
Raising debit notes on creditors
Accounting for creditors
Payment processing
66
Production Accounting



Material Issues
Production accounting – back flashing
Costing and standard updation
67
Stock Accounting



Physical Verification
Stock valuation
3P Management
68
Sales Accounting to Receivables





Master maintenance
Receiving and accepting sales orders
Dispatching
Accounting sales and debtors
Provision for debtors
69
Treasury and banking transactions






Payment and receipt of money
Schedule of authority
Banking of receipts
Accounting for FOREX conversion and forward covers
Export Packing credit management
Bank Recos.
70
General Accounting




IUT’s
Cut offs and period end/ consolidation
Journal entries
Restructuring provisions
71
Fixed Assets






Capital Proposal approval and capital advances accounting
Receiving and accounting for capital WIP
Additions to FA and deletion from FA
Depreciation Accounting
Impairment provisions
Physical verification
72
Presented By
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CA Swatantra Singh, B.Com , FCA, MBA
Email ID: singh.swatantra@gmail.com
New Delhi , 9811322785,
www.caindelhiindia.com,
www.carajput.com
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