Is Fraud Reporting applicable to all types of Companies?

Reply: Yes, the Reporting Requirements as above is applicable to all kinds of Companies incorporated under the Act or under any previous Company Law.

Are both material & immaterial frauds to be reported?

Reply: The Draft Rules had distinguished between Material & Immaterial Frauds but the Companies (Audit & Auditors) Rules, 2014 does not make any such distinction & hence all frauds irrespective of materiality need to be reported at present. For changes proposed in the Companies Amendment Bill, 2014 refer to the reply to the last query in this Article.

Is the Auditor required to report in ADT-4 even when he is satisfied with the reply of the Management that there is no Fraud?

Reply: According to Clause 12 of Form ADT-4 the Auditor is required to state whether he is satisfied with the reply of Board or Audit Committee. Hence, in my view ADT 4 needs to be completed & sent even when the Auditor is satisfied with the reply of the Management.

For which year is this provision relating to Fraud Reporting applicable?

Reply: According to Circular No. 1/19/2013-CL-V dated 04-04-2014 issued by MCA the Financial Statements, Auditor’s Report and Boards’ Report in respect of Financial Years that commenced earlier than 1st April 2014 shall be governed by the relevant provisions/schedules/ Rules of the Companies Act, 1956 and that in respect of Financial Years commencing on or after 1st April 2014 the provisions of the new Act shall apply. Hence the Fraud Reporting provisions need to be complied with in respect of Audit relating to Financial years commencing on or after 1st April, 2014.

SA-240 (The Auditors’ Responsibilities Relating to Fraud in an Audit of Financial Statements) issued by The Institute of Chartered Accountants of India (ICAI) defines Fraud as ‘an intentional act by one or more individuals among management, those charged with governance, employees or third parties involving the use of deception to obtain an unjust or illegal advantage’. But the definition contained in Section 447 is different. How does the Statutory Auditor reconcile.

Reply: An Auditor carrying out Audit under the Act cannot turn a blind eye to the definition of fraud provided in the Act. This definition will have primacy. But reference to SA-240 and other applicable Auditing & Assurance Standards is a must.

Even under Companies (Auditor’s Report) Order, 2003 (CARO,2003) the Statutory Auditor was required to Report Fraud. How does the situation change post Companies Act, 2013 ?

Reply: Para. XXI of the aforesaid Order requires an Auditor to Report the amount of fraud in the event fraud on or by the company has been noticed or reported during the year. ICAI in its Statement on CARO,2003 had clearly stated that the clause does not require the auditor to discover the frauds on the Company & by the Company. The scope of Auditor’s Enquiry under this clause is restricted to frauds noticed or reported during the year. The use of the words noticed or reported indicates that the management of the Company should have the knowledge about the frauds that have occurred during the period covered by the Auditor’s Report.
In the case of Fraud Reporting under section 143(12) of the Act, the Auditor in the course of the performance of his duty as auditor should have reason to believe that an offence involving fraud is being or has been committed against the company by officer or employees of the Company.
It will be evident from above, that words ‘noticed or reported’ as used under CARO, 2003 are missing from section 143(12). Here the stress is on the Auditor having a reason to believe that a fraud is being or has been committed.
It should also be noted that unlike in the case of CARO,2003 where fraud on or by the Company is required to be reported, in the case of section 143(12) of the Act only frauds committed or being committed against the company by officers or employees of the company need to be reported.

With such stringent penal consequences, does it mean that test checking is now no longer possible.

Reply: In my view the Act does not mandate that one hundred percent checking be done in the case of Statutory Financial Audit. But if Test checking is adopted then compliance with the Auditing & Assurance standards is a must. While selecting the Audit sample the Auditor must specially refer to SA 530 (Revised) - Audit Sampling in addition to applicable AAS.

Are the reporting Requirements expected to change consequent to the Companies Amendment Bill, 2014?

Reply: In the aforesaid Bill, an amendment has been proposed in section 143 (12) of the Act. According to the proposed amendment in the case of a fraud lesser than the specified amount, the auditor shall report the matter to the Audit Committee constituted under section 177 or to the Board in other cases within such time & in such manner as may be prescribed.
In the case of Companies, where the frauds are not required to be reported to the Central Government, the details regarding fraud are required to be disclosed in the Board’s Report. Consequent changes have been proposed in section 134 (3) of the Act relating to Board Report.
Hence once the aforesaid Bill is enacted only frauds above a threshold limit are required to be reported to the Central Government. The Threshold limit is yet to be notified.

According to the Companies (Corporate Social Responsibility Policy) Rules, 2014 ( hereinafter referred to as the Rules.) Net profit for the purpose of calculating 2% not to include
Profit arising from any overseas branch or branches of the Company whether operated as a separate Company or otherwise.
Any Dividend received from other Companies in India covered & complying with the Provisions of section 135. – Rule 2 (f)

Registered Trust, Registered Society or a Company Registered u/s. 8 of the Act established by the company either singly or with its holding or subsidiary or associate etc. can carry out C.S.R. Activities. – Rule 4(2)

Trusts etc not established by the Company or its holding, subsidiary or associate should have an established track record of at least 3 years in undertaking similar programmes or projects specified by the Company. The modalities of utilisation of funds monitoring & reporting mechanism to be specified by the Company. - Rule 4(2)

Collaboration with other Companies by a Company for CSR permitted. - Rule 4(3)

CSR expenditure to be incurred in India only. - Rule 4(4)

CSR programme benefitting only the employees and their families shall not be considered as C.S.R activity under the Act. - Rule 4(5)

Political contribution not to be considered as C.S.R. Expenditure. - Rule 4(7)

C.S.R. policy to include
a) List of CSR projects or programmes which a company plans to undertake falling within the purview of Schedule VII specifying modalities of execution & implementation Schedules.
b) Monitoring progress of such projects or programmes.- Rule 6

Board’s Report relating to F.Y. commencing on or after 01-04-2014 shall include an Annual Report on C.S.R. containing particulars specified in the Annexure. - Rule 8(1)

According to Section 135, companies to whom C.S.R. provisions are applicable need to form C.S.R. Committee of the Board consisting of three or more directors out of which at least one director shall be an Independent Director in the case of companies where independent directors are required to be appointed . Private companies having only 2 directors shall constitute CSR Committee with two such directors. In case of a covered foreign company the C.S.R committee shall comprise of at least two persons out of which one person shall be as specified under section 380 (1) (d) another person to be nominated by the foreign company. The Board’s Report is required to disclose the Composition of the aforesaid Committee. The C.S.R. Committee shall
a) Formulate and Recommend to the Board a C.S.R. Policy
b) Recommend the amount of Expenditure to be incurred on C.S.R.
C) Monitor the C.S.R. Policy

According to Section 135, companies to whom C.S.R. provisions are applicable need to form C.S.R. Committee of the Board consisting of three or more directors out of which at least one director shall be an Independent Director in the case of companies where independent directors are required to be appointed . Private companies having only 2 directors shall constitute CSR Committee with two such directors. In case of a covered foreign company the C.S.R committee shall comprise of at least two persons out of which one person shall be as specified under section 380 (1) (d) another person to be nominated by the foreign company. The Board’s Report is required to disclose the Composition of the aforesaid Committee. The C.S.R. Committee shall
a) Formulate and Recommend to the Board a C.S.R. Policy
b) Recommend the amount of Expenditure to be incurred on C.S.R.
C) Monitor the C.S.R. Policy

The Boards of the aforesaid companies are required to
a) Approve the C.S.R. Policy of the Company
b) Disclose such Policy in the Director’s Report & also place the same on the Website, if any, in such manner as may be prescribed
c) Ensure that the activities as laid down in the C.S.R. Policy are actually undertaken.

What is the meaning of the words ‘During any Financial Year’ as contained in section 135?

Reply:
Vide Circular No: 21/2014 dated 18-06-2014 MCA has clarified that ‘Any Financial Year’ referred under section 135(1) of the Act read with Rule 3(2) of the Rules means any of the three preceding financial years. Hence if a company does not meet the financial criteria in any of three years viz 2011-12, 2012-13, 2013-14 then C.S.R. provisions are not applicable to it for financial year 2014-15.

How to Account for C.S.R. Expenditure in the Accounts?

According to the Guidance Note on Accounting for Corporate Social Responsibility Activities issued by ICAI in case contribution made to a fund specified in Schedule VII to the Act the same should be charged to the statement of Profit & Loss. Similar will be the Treatment if C.S.R. Expenditure is made through Registered Trust, Society or Section 8 company. C.S.R. Expenditure of Revenue nature incurred on any activity as contained in Schedule VII by a company on its own needs to be charged as an expense in the Statement of Profit & Loss. In case of C.S.R. Expenditure, incurred by a company which gives rise to an ‘asset’ which is transferred by the company to the beneficiary, the same should not be recognized in the books of the company as an asset but instead should be charged to the Statement of Profit & Loss.

Whether Income Earned from C.S.R. Projects/ Programmes from C.S.R. Activities needs to be recognised.

Reply:
According to the aforesaid Guidance Note, since surplus arising from CSR activities is not arising from a transaction with the owner it would be considered as income for accounting purposes but since the surplus cannot be a part of business profits of the company, the same should immediately be recognized as liability for C.S.R. Expenses in the Balance Sheet by way of a charge to the Statement of Profit & Loss. Such surplus will not from part of the minimum 2% of the average net profits made during the three immediately preceding financial years.

Whether Provision for Unspent Amount can be created?

Reply:
The aforesaid Guidance Note lays down that no provision for amount which is not spent i.e. any shortfall vis–a-vis 2 % can be made in the Accounts. But if the Company has already undertaken a C.S.R. activity for which a liability has been incurred then a provision for the amount representing the extent to which the C.S.R. Activity was completed during the year needs to be recognized.

Is it mandatory to spend 2% of average net profits on C.S.R. activity considering the fact the words used in section 135 (5) are ‘shall ensure’.

Reply
Second proviso to section 135 (5) lays down that if a company fails to spend the prescribed amount the Board shall in its Report under clause (o) of sub-section (3) of section 134 specify the reasons for not spending the amount Neither the Act nor the Rules prescribes any penal provision if a company fails to spend the amount. Also there is no explicit legal provisions which requires a company to make good short spend of one year in the subsequent years. Hence if a company fails to spend the prescribed amount of 2 % the reasons are to be stated in the Board’s Report.

Whether C.S.R. contribution to a Trust controlled by a Company is possible.

Reply
There is no bar to such contribution as per the provisions of the Act & the Rules thereunder. But disclosures are required as per Accounting Standard AS 18 – Related Party Disclosures.

Please note that definitions of Related Party & Related Party Transactions differ between Accounting Standard 18 and the Act, hence disclosure under AS-18 is required.

Whether C.S.R. Expenditure is Tax Deductible.

Reply
According to Explanation 2 to section 37(1) of the Income Tax Act, 1961, any expenditure incurred by an assessee on the activities relating to Corporate Social Responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession thus the expenditure on C.S.R. activities is non-deductable unless falling within section 30 to 36 of the Income Tax Act, 1961. Primarily the allowable expenditure relate to section 35 of the Income-tax Act, 1961.