MCA Notifies Amendments to Companies’ Accounting and Auditing Disclosures

In the last few years, India has been on a bid to reduce compliance burdens and ease doing business for companies working in India. In this vein, several amendments of the Companies Act, 2013 (‘Companies Act’) relaxing compliance burdens such as reducing requirements for incorporation of small companies, decriminalisation of offences under the Companies Act, extension of exemptions for foreign companies under the Companies Act, etc. were all introduced this past year.

Subsequently, the Ministry of Corporate Affairs (‘MCA’) has released amendments pertaining to accounting rules and auditing disclosure requirements, and it will be effective for the financial year of 2021-22. The main highlights of the amendment and its effects on companies in India are summarised below.

Amendments to Accounting Rules:

The MCA released the amendment to the Companies (Accounts) Amendment Rules, 2014 (‘accounting rules’) on 24th March 2021, and they have come into force as on 1st April 2021. The amendment inserts the following provisio to sub rule (1) of rule 3 of the accounting rules:

“That for the financial year commencing on or after the 1st day of April, 2021, every company which uses accounting software for maintaining its books of account, shall use only such accounting software which has a feature of recording audit trail of each and every transaction, creating an edit log of each change made in books of account along with the date when such changes were made and ensuring that the audit trail cannot be disabled.”

Rule 3 of the accounting rules lay down how the books of accounts are to be maintained in electronic form by all companies. Rule 3 requires that all relevant books and papers relating to accounts be maintained in electronic form and continue to remain accessible in India. Further, they have to be maintained in the following ways:

• The books have to be retained completely in the format that it was originally generated, sent or received, or in a format that accurately represents the information as it was generated, sent or received. The information should also remain complete and not altered.
• Information received from branch offices should not be altered.
• Information should be displayed in a legible form.
• There should be a system for the storage, display, retrieval, disposal or printout of the records/books and such records should not be rendered unusable. A backup of the records has to be maintained in electronic form.
• The company also has to periodically intimate the Registrar of companies of the following details:
  1. Name of the internet service provider.
  2. The IP address of the service provider.
  3. Location of the service provider.

The amendment means that the accounting software being used by companies for maintaining the electronic record, in the manner elaborated above, must be capable of creating audit trails for every transaction. I.e., for each transaction, the software should be able to track or create an edit log for the changes made in the books of accounts and detail the dates for when such changes were made. The audit trail also should also not be capable of being disabled.

The measure is meant to improve the transparency of the books of accounts being maintained and will help auditors of small, medium, and large enterprises to keep track of the changes, thereby easing the auditing process. This will also help companies as a more transparent system that keeps check of all changes (both minor and major) will lead to lesser disputes. The measure may also not affect medium or large enterprises as most high-end auditing software may already be tracking such changes, however smaller enterprises that rely on lower-end software might require further up-gradation of their technology. The amendment to the accounting rules has also introduced a disclosure requirement in the auditor’s report, in regard to the use of this audit trail software.

Amendment to the Auditing Rules:

The MCA released a notification amending the Companies (Audit and Auditors) Rules, 2014 (‘auditor rules’). The amendment made changes to Rule 11 of the auditor rules, which details the matters to be included in the auditor’s reports. The following changes have been made:

• Clause (d) of Rule 11 has now been omitted. This clause had  required that the report should state whether the company had provided the requisite disclosures in their statements as to their holdings and dealings in Specified Bank Notes for the periods of 8th November 2016 to 30th December 2016. 
• A clause (e) has been added, which details that the following requirements are mandated as disclosures in the auditor’s report:
  1. Whether the management has represented that other than the specified disclosures, no funds are advanced, invested, or loaned by the company to any persons or entities (including foreign entities), with the intention that the entity will invest or lend or provide guarantee or security to any entity by or on behalf of the company.
  2. Whether the management has represented, other than the specified disclosures, that no funds have been received by the company from any persons or entities (including foreign entities) with the consideration that the company shall invest or lend in the parties identified by such entities.
  3. That the auditor has not found any relevant circumstances that may act in contrary to the above causes, from the audit procedures.
  4. Whether the dividend declared is in compliance with the Companies Act, 2013.
  5. Whether the company has used such audit trail software for maintaining electronic records of the books of accounts as required based on the amendment to the Accounting rules.

The amendment has removed the reporting requirements for holdings and dealings in regard to Specified Bank Notes (for the demonetisation period in 2018) but has added new disclosures meant to hit at transactions that relate to camouflaged lending or investments, discrepancies in payment of dividend; and reporting related to the audit trail software that is now mandated under the accounting rules.

Effect of these amendments:

The changes to the auditing rules are meant to target camouflaged investments i.e. transactions where the lending or investment funds are routed through channel companies and not directly, with the intention of masking the real beneficiary. These changes have been made to target instances of money laundering and other suspicious activities. Similarly, the change to the auditing rules is meant to prevent instances of fabrication or window dressing of books of account, and to create a transparent auditing process.