KCB revision - SLIDE DECK 8 - Financial reporting and audit Flashcards
What stakeholders may have an interest in a companies financial reporting and why?
- Investors - to assist in their decision to hold, buy or sell.
- Creditors – interested in the security of their debt
- Suppliers – to understand the company’s ability to pay for their goods or services
- Employees – to understand the security of their employment
- Customers - to understand the company’s ability to provide their goods or services
- Governments – to assess company’s taxation
- Regulators – to help assess whether company is complying with laws and regulations
- Public – to understand ability to participate in local economy and activities
The requirements for companies to report on their performance is contained within law, regulations, standards and codes in the UK dependent on the type, size and sector within which the company operates.
What law requires every company to keep adequate accounting records?
The Companies Act 2006 (CA2006) requires every company to keep adequate accounting records which are sufficient to:
show and explain the company’s transactions;
disclose with reasonable accuracy, at any time, the financial position of the company at that time; and
enable the directors to ensure that any accounts required to be prepared comply with the requirements of the CA2006 and, where applicable, International Accounting Standards (IAS).
In addition to the CA2006, what other regulations do listed companies need to comply with in terms of financial reporting?
Listed companies also need to adhere to the Listing Disclosure guidance and Transparency rules, the Standards issued by IFRS and IASB and the UK CG Code guidance in respect to financial reporting.
Listing, Disclosure Guidance and Transparency Rules include provisions for annual report disclosures (LR 9.8).
Statement to be included in the annual report on the appropriateness of adopting the ‘going concern’ basis of accounting and on the directors’ assessment of the prospects of the company. (‘viability statement’.)
and
Standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB) to provide a common global language for business affairs so that company accounts are understandable and comparable across international boundaries.
and
The board should establish formal and transparent policies and procedures to ensure the independence and effectiveness of internal and external audit functions and satisfy itself on the integrity of financial and narrative statements. (Principle M)
The board should present a fair, balanced and understandable assessment of the company’s position and prospects. (Principle N)
The directors should explain in the annual report their responsibility for preparing the annual report and accounts, and state that they consider the annual report and accounts, taken as a whole, is fair, balanced and understandable, and provides the information necessary for shareholders to assess the company’s position, performance, business model and strategy. (Provision 27)
In annual and half-yearly financial statements, the board should state whether it considers it appropriate to adopt the going concern basis of accounting in preparing them and identify any material uncertainties to the company’s ability to continue to do so over a period of at least twelve months from the date of approval of the financial statements. (Provision 30)
UKCG Code
List ways how a company may misreport their financial numbers to improve their financial position.
A company can misreport their financial numbers to improve its financial position through:
The adoption of accounting policies that give a more flattering picture of the company’s position.
Claiming that revenue or profits were earned earlier than it should have.
Taking debts off the company’s balance sheet.
Disguising money from loans as operating income.
Over-valuing the company’s assets.
What recommendations were advised following the FRC’s Review of Corporate reporting in November 2020?
Companies should provide CLEAR AND MEANINGFUL EXPLANATIONS as to how they achieve good governance standards in line with the flexibility offered by the Code.
Companies should clearly SHOW THE IMPACT OF ENGAGEMENT with stakeholders, including shareholders, on decision- making, strategy and long-term success.
Companies should better ASSESS AND MONITOR CULTURE, including consideration of methods and metrics used to monitor culture.
Companies should DEMONSTRATE THEIR COMMITMENT TO DIVERSITY AND INCLUSION through actions, such as improved succession planning and recruitment from diverse talent pools.
FRC Review of Corporate Reporting, Nov 2020
The audit committee is key to ensuring that an organisation has robust and effective processes relating to financial reporting, internal controls, risk management and ethics. The committee is also the main oversight body for the internal and external auditors.
What are the requirements to have an audit committee and where are these found?
Listed companies are required to have audit committees as are some financial institutions. For other types of companies, audit committees are optional, and it is up to the board of the company to decide how to manage risk and audit matters.
Disclosure Guidance and Transparency Rules. Listed companies are required under the Disclosure and
Transparency Rules (DTR 7.1) to establish an audit committee.
UK Corporate Governance Code 2018. Principle M of the 2018 Code requires the board of a listed company to
‘establish formal and transparent policies and procedures to ensure the independence and effectiveness of internal and external audit functions and satisfy itself on the integrity of financial and narrative statements.’
What is the role of the audit committee and where would you find this information?
NB - You’ll have access to this via the FRC website but it’s long and hard to summarise.
The FRC in their Guidance on Audit Committees (April 2016) provides information about the role and responsibilities of the audit committee. These include:
- Monitoring the integrity of the financial statements of the company and any formal announcements relating to the company’s financial performance, and reviewing significant financial reporting judgements contained in them
- Providing advice on whether the annual report and accounts, taken as a whole, is fair, balanced and understandable, and provides the information necessary for shareholders to assess the company’s position and performance, business model and strategy
- Reviewing the company’s internal financial controls and internal control and risk management systems, unless expressly addressed by a separate board risk committee
- Monitoring and reviewing the effectiveness of the company’s internal audit function
- Conducting the tender process and making recommendations to the board, about the appointment, reappointment and removal of the external auditor, and approving the remuneration and terms of engagement of the external auditor;
- Reviewing and monitoring the external auditor’s independence and objectivity
- Reviewing the effectiveness of the external audit process, taking into consideration relevant UK professional and regulatory requirements
- Developing and implementing policy on the engagement of the external auditor to supply non-audit services
- Reporting to the board on how it has discharged its responsibilities.
What issues should the audit committee raise with the BOARD?
NB - You’ll have access to this via the FRC website but it’s long and hard to summarise.
Issues to be raised with the board are:
Any significant issues that the audit committee considered in relation to the financial statements and how these issues were addressed
The audit committee’s assessment of the effectiveness of the external audit process and its recommendation on the appointment or reappointment of the external auditor
The audit committee’s assessment of the effectiveness of the internal audit function
Feedback on the audits carried out by internal audit
Any other issues on which the board has requested the committee’s opinion.
The FRC Guidance on Audit Committees states that the audit committee has a role in ensuring that SHAREHOLDER interests are properly protected in relation to financial reporting and internal control. In carrying out this role, what should the audit committee consider?
NB - You’ll have access to this via the FRC website but it’s long and hard to summarise.
Consider the clarity of its reporting and be prepared to meet investors
Develop for inclusion in the annual report a separate report describing the work of the audit committee in discharging its responsibilities, which should be signed by the chair of the audit committee.
What should the audit committee annual report include?
NB - You’ll have access to this via the FRC website but it’s long and hard to summarise.
A SUMMARY OF THE ROLE AND WORK of the audit committee
How the audit committee COMPOSITION requirements have been addressed, and the names and qualifications of all members
The NUMBER OF audit committee MEETINGS
HOW the audit committee’s PERFORMANCE EVALUATION HAS BEEN CONDUCTED
An explanation of HOW the committee has ASSESSED the effectiveness of the EXTERNAL AUDIT PROCESS
the approach taken to the APPOINTMENT or reappointment of the EXTERNAL AUDITOR; the length of tenure of the current audit firm
The CURRENT AUDIT PARTNER name, and for how long the partner has held the role
When a TENDER was last conducted and advance notice of any retendering plans
If the external auditor provides non-audit services
How auditor objectivity and independence is safeguarded
The audit fees for the statutory audit and for audit related services and other non-audit services including the ratio of audit to non-audit work
For each significant engagement, or category of engagements, explain what the services are and why the audit committee concluded that it was in the interests of the company to purchase them from the external auditor
An explanation of how the committee has assessed the effectiveness of internal audit and satisfied itself that the quality, experience and expertise of the function is appropriate for the business
The significant issues that the committee considered, including: issues in relation to the financial statements and how these were addressed,
The nature and extent of interaction (if any) with the FRC’s Corporate Reporting Review team.
What is the role of the Co Sec in relation to the Audit Committee?
Not on FRC website.
The company secretary would typically be involved in:
Developing the terms of reference for the audit committee
Advising the board on the appropriate composition for the committee
Conducting an induction for new members of the audit committee
Developing an annual calendar of activities for the committee
Ensuring that the committee has sufficient resources to carry out its role.
Assisting committee members in their understanding of current and emerging issues, especially those from shareholders, regulators and other stakeholders
Assisting the committee in sourcing advice of experts on issues under the committee’s responsibility.
Organising professional development for committee members either individually or as a group.
Organising the annual evaluation of the performance of the committee and its chair
Drafting, in liaison with internal audit and the chair of the audit committee, the audit committee report to be included in the annual report
Acting as secretary to the committee providing governance and procedural advice and logistical support to the committee, its chair and other members
What type of companies need to have an independent external auditor?
Every company, with the exception of dormant companies, must have an independent external auditor who carries out the annual audit of the company which is published in the annual report and accounts.
What is the role of the external auditor?
To give an expert and independent opinion on whether the financial statements give a true and fair view of the financial position of the company
To give an expert and independent opinion on whether the financial statements comply with the relevant laws.
The external auditor of a listed company Is also required to review the company’s compliance with the 2018 Code, and to obtain evidence to support the company’s statement, included in the annual report and accounts, of its compliance with the 2018 Code.
The external auditors’ report provides an opinion on compliance with the law and accounting standards and whether the accounts that have been prepared by the board present a true and (in some cases) fair picture of the financial reality of the company. They are not responsible for detecting fraud or errors in the organisation’s financial statements. This is the responsibility of the board of directors.
Auditors may issue a modified or unmodified report. Explain what these are.
Unmodified - Auditors are stating that the company’s financial statements DO present a true and fair view of the financial position of the company.
Modified - implies there are POTENTIALLY GRAVE CONCERNS about the financial statements and the financial condition of the company. It also implies that the external auditor and the board of the company could not agree on the application of accounting policies and hence the content of the financial statements.
There are 3 types of modified auditor opinion. Summarise what they are.
- A QUALIFIED AUDIT OPINION which is given when, in the opinion of the external auditor, the financial statements would give a true and fair view except for a particular matter, which the external auditor explains.
- AN ADVERSE OPINION which is given when the external auditor considers that there are material mis-statements in the accounts and that these are ‘pervasive’. In effect, the external auditor is stating that they believe that the information in the financial statements is seriously incorrect.
- A DISCLAIMER OF OPINION which is given in cases where the external auditor has been unable to obtain the information that they need to give an audit opinion. The lack of information means that the auditor is unable to state that the financial statements give a true and fair view, and that there may possibly be serious mis-statements that the external auditor has been unable to check.
