Corporate Governance - Financial Reporting

Question 1

For which eight Stakeholders is Company Financial Reporting significant?

Answer 1

1. Investors re. decision to buy, hold or sell.
2. Creditors re. interest in security of debt.
3. Suppliers re. company’s ability to pay for goods or services.
4. Employees re. employment security.
5. Customers re. company’s ability to provide goods or services.
6. Governments re. company’s tax liability.
7. Regulators re. company compliance with laws and regulations
8. Public re. company ability to participate in local economy.

Question 2

What are the threshold Financial Reporting Requirements?

Answer 2

1. CA ‘06 requires companies to keep adequate accounting records to (i) show/explain company transactions, (ii) disclosure company financial position with reasonable accuracy and (iii) enable directors to ensure accounts comply with applicable statutory and IAS requirements.
2. FCA DTRs include provisions concerning annual report disclosures (Rule 9.8) - AR&A must indicate appropriateness of adopting going concern accounting basis and directors’ assessment of company prospects (via ‘viability statement’).
3. Board should establish formal and transparent policies to ensure independence and effectiveness of external/internal audit functions and satisfy itself on financial statement integry (Principle M, Code).
4. Board should present a fair, balanced and understandable assessment of the company’s position and prospects (Principle N, Code).
5. Board should explain in AR&A that they consider it fair, balanced and understandable, providing necessary information for shareholder assessment of company performance (Provision 27, Code).
6. Within annual/half-yearly statements, board should state whether it is appropriate to adopt a going concern accounting basis and additionally identify any material uncertainties in the company’s ability to continue over a prospective 12-month time horizon (Provision 30, Code).

Question 3

What Risks might threaten Investor Confidence in Financial Reporting?

Answer 3

1. Company adoption of accounting policies that unduly flatter its financial position.
2. Recognition of revenue and profits earlier than appropriate.
3. Inappropriate removal of debts from company balance sheet.
4. Concealment of loans as operating income.
5. Overvaluation of company assets.

Question 4

What is the Requirement for and Role of the Audit Committee?

Answer 4

1. Audit Committee must be empanelled from >=3 independent NEDs (>=2 for smaller companies); of which board Chair cannot be a member, there must be one or more member(s) with recent and relevant financial experience, and entire Committee must have competence relevant to Company’s section (Provision 24, Code).
2. Chief role deliverables comprise:
   - Monitoring financial statement integrity and formal announcements concerning the company’s financial performance.
   - Advising whether the AR&A are fair, balanced and understandable, necessary for shareholders to assess company’s position, performance, business model and strategy.
   - Reviewing company’s internal financial controls, and internal control and risk management systems.
   - Monitoring and reviewing the effectiveness of the internal audit function.
   - Tendering and giving recommendations concerning the (re)appointment or removal of the auditor (including engagement terms and remuneration).
   - Reviewing auditor’s independence and objectivity.
   - Reviewing effectiveness of audit process.
   - Developing policy concerning commissioning non-audit services from auditor.
   - Reporting back to board on discharge of Committee responsibilities.

Question 5

What is the Audit Committee’s Relationship with the Board?

Answer 5

The following should be raised by the Audit Committee with the Board (FRC Guidance on Audit Committees):
1. Significant issues concerning financial statements (and how these were resolved).
2. Audit Committee’s assessment of the effectiveness of the external audit process and recommendations concerning auditor (re)appointment.
3. Audit Committee’s assessment of the effectiveness of the internal audit function.
4. Feedback on the audits performed by the internal audit function.
5. Any other requests raised by the board.

Question 6

What is the Audit Committee’s Relationship with the Company’s Shareholders?

Answer 6

FRC Guidance on Audit Committees:
1. Committee should consider reporting clarity and be prepared to meet investors.
2. Audit Committee report re. Committee’s work should be prepared and signed by Committee chair for inclusion in AR&A.

Question 7

What Matters might an Audit Committee report on?

Answer 7

FRC Guidance on Audit Committees:
1. Role of the Audit Committee.
2. Names and qualifications of Committee members, including how composition requirements have been addressed.
3. Number of Committee meeting.
4. Evaluation of Audit Committee performance.
5. Approach taken external audit evaluations and (re)appointment of current auditor.
6. Current audit partner name and tenure length.
7. Date of last audit tender and notice of any forthcoming plans.
8. Any external audit services provided, together with report on safeguarding of auditor independence and objectivity.
9. Audit fees.
10. Explanation of any internal audit effectiveness reviews.
11. Any significant issues reviewed.

Question 8

What is the Company Secretary’s Role in connection with the Audit Committee?

Answer 8

1. Developing:
   - Audit Committee terms of reference.
   - Appropriate Committee composition.
   - Induction for new Committee members.
   - Annual Committee activities calendar
   - Resource plan.
   - Committee professional development and Current ual evaluation plan.
2. Advising upon/managing:
   - Current and emerging (e.g. from shareholders and regulators).
   - Commissioning required advice.
3. Communicating:
   - Audit Committee report in collaboration with Internal Audit and Committee chair.
   - By acting as Committee secretary (via procedural, governance and logistical support).

Question 9

What is the Role of the external Auditor?

Answer 9

1. Giving an expert and independent opinion on whether the company’s financial statements provide a true and fair view of its financial position.
2. Giving an expert and independent opinion on whether financial statements comply with relevant laws.
3. External auditors of listed companies must also review the company’s compliance with the UK Corporate Governance Code.

Note: External auditors are not responsible for detecting fraud or errors in the company’s financial statements (- board’s responsibility).

Question 10

Who do Auditors owe a Duty of Care to?

Answer 10

Auditors owe a duty of care to their client companies and their shareholders as a whole (Caparo Industries v Dickman) when undertaking audit work and issuing an opinion.

Question 11

What Forms of Opinion may an Auditor issue?

Answer 11

1. Unmodified: Financial statements do present a true and fair view of company’s financial position.
2. Modified: Implies there are grave concerns about the financial statements or the company’s financial condition, or the board and auditor could not agree on the application of accounting policies. Three types of modified audit opinion:
   - Qualified: Statements would give a true and fair picture but-for one particular matter.
   - Adverse: Material misstatements existing that is pervasive and hence seriously incorrect.
   - Disclaimed: Auditor lacks requisite information to give an opinion (hence a risk of material misstatement may exist).

Question 12

What five Threats may exist to Auditor Independence?

Answer 12

1. Self-interest threat: Levied audit fees are so high, the auditor cannot afford to lose the company as a client.
2. Self-review threat: Auditor undertakes audit and non-audit work hence risk non-audit may be audited.
3. Advocacy threat: Similarly, auditor is asked to make statement for company that they are subsequenty asked to audit.
4. Familiarity threat: Auditor has audited company for too long and becomes lax.
5. Intimidation threat: ‘Enron-style’ intimidation risk.

Question 13

What six Measures may be adopted to protect Auditor Independence?

Answer 13

1. Appointment by shareholders (recommended by board; confirmed via AGM).
2. Restriction/prohibition of non-audit services - no more than 70% of average audit fees from past three FYs, subject to not undertaking prohibited activities (e.g. book-keeping, tax advice).
3. Independence assessment of audit firm employees.
4. Audit firm/partner rotation - partner rotation every 5 years; audit tender every 10 years; firm change every 20 years.
5. Provision of reasoned auditor statement confiming independence.
6. Management intimidation.

Question 14

What is the Company Secretary’s Role in relation to the external Auditors?

Answer 14

CoSec typically involved in:
1. Appointment- and remuneration-related discussions.
2. Assessment of auditor’s independence.
3. Ensuring auditor attends AGM and is pre-briefed about likely questions.
4. Advising board/Audit Committee on audit rotation requirements.
5. Ensuring board action plan is developed to address improvement recommendations outlined in the auditor’s ‘management letter’.