Rule 11(e) and Rule 11(f) of the Companies (Audit and Auditors) Rules, 2014

?Implementation Guide by ICAI on reporting under Rule 11(e) and Rule 11(f) of the Companies (Audit and Auditors) Rules, 2014

?The Ministry of Corporate Affairs (MCA) issued the Companies (Audit and Auditors) Amendment Rules, 2021 on 24 March 2021 introducing a new Rule 11(e) and a new Rule 11(f) in the Companies (Audit and Auditors) Rules, 2014.

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Rule 11(e) deals with reporting on lending or receiving funds through pass-through entities marked for an ultimate beneficiary and Rule 11(f) deals with reporting on the payment/declaration of dividends.

?The Rules are effective for audits of companies for FY 2021-22 onwards.

The Institute of Chartered Accountants of India (ICAI) on 26 April 2022 has issued an ‘Implementation Guide (IG) on Reporting under Rule 11(e) and Rule 11(f) of the Companies (Audit and Auditors) Rules, 2014’. ?The IG provides the following guidelines with regard to reporting under both, Rules 11(e) and 11(f):

a.????????Applicability to consolidated financial statements: Reporting on compliance with Rules 11(e) and 11(f) for subsidiaries, joint ventures, and associates that are Indian companies (together termed as components) will be on the basis of the reports of their statutory auditors. The auditors of the parent company may request such information from the component auditors as part of group reporting instructions. The auditors of the parent company would need to apply professional judgment and comply with Standards on Auditing (SA) 600, Using the Work of Another Auditor while assessing the matters reported by component auditors.

b.????????Transactions eliminated in consolidation procedures (intra-group transactions) and consequently not forming part of consolidated financial statements: Guidance note on Schedule III indicated that disclosure in consolidated financial statements would be provided after applying the principles of consolidation i.e., only the funds provided or invested outside the group would be required to be disclosed. However, the IG suggests that even if transactions are eliminated on consolidation, such transactions would continue to be covered by an auditor’s reporting obligations.

c.????????Reporting language in the audit reports on standalone and consolidated financial statements: The IG provides illustrative language that can be referred to for reporting under Rule 11 (e) and Rule 11(f) in standalone and consolidated financial statements.

?Key guidelines to consider while reporting under Rule 11(e)

?The IG has provided the following guidelines under Rule 11(e):

???????Scope of reporting: Reporting under Rule 11(e) in substance requires an auditor to report whether the disclosures in the notes to the financial statements (in respect of certain types of funding arrangements as specified in these rules) have been appropriately provided by the management. Auditor also needs to bring out the material misstatements identified.

·????When there are no transactions that require reporting under Rule 11(e): The IG specifies that in a situation wherein there is no transaction that requires reporting, a statement to that effect should be provided in the financial statements.

·????Reporting based on fund and non-fund based transactions: Reporting under Rule 11(e)(i) would be required when the funding party transfers funds to the intermediary (i.e., no reporting would be required under this rule in case of a non-funding arrangement between the funding party and the intermediary). However, reporting under Rule 11(e)(ii) would be required irrespective of whether the intermediary enters into a funding or a non-funding arrangement with the ultimate beneficiary.

·????Importance of determining ‘timing of cash flows: The IG brings out the importance of determining the timing of cash flows from a funding party to the intermediary and from the intermediary to the ultimate beneficiary. It is also important to determine when an understanding for onward lending or investment of funds on behalf of the funding party is reached. This will determine the financial period in which reporting will be done under Schedule III of the Companies Act, 2013 and in the audit report.

·????Sources of funds: For the purpose of reporting under Rule 11(e), a funding party may advance, loan, or invest funds from any source. Therefore, sources of funds for a company may include share capital, securities premium, grants, profits, borrowings, etc.

·????Indirect lending: There may be cases where there is more than one intermediary as a pass-through entity. In such a case, reporting for intermediaries who pass on the funds further to other intermediaries will be under Rule 11(e)(i) (i.e., as a funding party who further advances, loans or invests funds to another intermediary) and under Rule 11(e)(ii) (i.e., as an intermediary who receives funds from the funding party).

·????Management responsibility: The IG states that management should implement internal controls that would ensure all transactions are appropriately captured and reported.

?Further, each transaction of lending or investing should be carefully evaluated and supported by a formal written agreement that includes the nature and purpose of such funding. Management should also obtain end-user certificates from parties that receive the funds.

·??????Auditor’s responsibility: Some of the key audit procedures to be planned and performed by an auditor, as mentioned in the IG, include:

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1. ?Auditors should ensure completeness of reporting of all arrangements covering funding and utilization of funds under Rule 11(e).

?2.?Internal controls implemented by management should be tested for appropriate identification and reporting of transactions.

3. Compare the list of loans and investments made by companies with statutory records maintained by the company as per the requirements of the Companies Act, 2013.

4. Obtain minutes of board meeting where the funding of amounts was approved, and which will enable an auditor to determine whether the company was acting as a funding party or as an intermediary.

o?Key guidelines to consider while reporting under Rule 11(f)

?Action points for auditors

Reporting under Rules 11(e) and 11(f) of the Companies (Audit and Auditors) Rules, 2014 are applicable for audits of companies for financial years 2021-22 and onwards. These rules cast an extensive responsibility on auditors due to wide scope of reporting under these rules.

They should also communicate the areas of responsibilities of the management with those charged with governance, and require adequate documentation in the notes to the financial statements regarding the types of funding arrangements.

The IG discusses scenarios in which auditor reporting is required, considering the date of declaration and payment of interim and/or final dividend. It also provides guidance on auditor responsibility.

Key provisions discussed in the IG are given below:·????

1. Auditors should determine the adequacy of profits, including if management has considered the effect of any audit qualification when determining the adequacy of profits.

2. Certified copy of resolutions declaring dividends by the board of directors should be obtained.

3. Auditors should check whether the dividend has been transferred to a separate bank account within the time prescribed under the Companies Act, 2013.

4. Where the dividend is paid through the Registrar and Transfer Agent (RTA), confirmation regarding payment to registered shareholders can be obtained from the RTA.

5. Investor complaints with regard to dividends should be examined to determine if any of them indicate any non-compliance by the company with the Companies Act, 2013.

6·????A written representation from management regarding compliance with section 123 of the Companies Act, 2013 should be obtained from the management.

7· Auditors should ensure compliance with rules pertaining to dividend declaration and payment as per any other law (i.e. apart from the Companies Act, 2013).