Chaper 9 - Financial Reporting to Shareholders & External Audit Flashcards
(49 cards)
1
Q
In what way is financial reporting connected to corporate governance?
A
Financial reporting falls within the context of corporate governance as it involves the concepts of accountability and transparency.
2
Q
Why is the purpose of financial reporting different in listed companies?
A
More rigourous than those for private companies.
Due to fact have to be accountable and transparent to their shareholders because of the separation of ownership and control between shareholders and the board of the company whom the company appoint to manage the company on its behalf.
3
Q
List stakeholders who may be interested in company’s financial reporting and reasons why they might be interested
A
Investors - to assist in their decision to hold, buy or sell.
Suppliers – to understand the company’s ability to pay for their goods or services
Creditors – interested in the security of their debt
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
Employees – to understand the security of their employment
4
Q
According to Coyle & Hill what are the duties of CA2006 in respect of financial reporting?
A
S.393 – P&L and balance sheet must give true and fair view;
S.394 – Directors to prepare P&L and balance sheet;
S.414 – Directors must prepare a strategic report;
S.415 – Directors must prepare a directors’ report; and
5
Q
What other requirements are there for financial reporting under CA2006?
A
Keep adequate accounting records sufficient :
- Show/explain transactions
- Disclose with reasonable accuracy, at any time, the financial position of the company at that time
- Enable directors to ensure any accounts prepped comply with CA2006/IAS requirements
Directors should prepare accounts for every financial year compliant with IAS
6
Q
What are some financial reporting requirements under LR/DTR?
A
To keep their listing - must compy
L.R
- LR 9.7 - voluntary preliminary statements/dividend announcements
- LR 9.8 - annual report disclosures
- LR - VIABILITY STATEMENT in AR - appropriateness of adopting ‘going concern’ basis of accounting
-LRs are in addition to company law but often overlap
DTRs
- DTR 7.2 - CG statements in directors’ report or published separately
- Other additional disclosures under DTR
7
Q
What companies are required to adopt IFRS accounting standards and what components does it require for compliant financial statements?
A
Listed companies in the UK
- Statement of Comprehensive Income (akin to P&L)
- Statement of financial position (akin to balance sheet)
- Cash flow statement
- Statement of changes in equity
- Notes to accounts - CS could be involved in drafting
8
Q
What are the main UKCGC provisions regarding financial reporting?
A
PRINC.N - fair, balanced and understandable assessment of company’s position and prospects
PRINC.M - re listed boards and ACs - policies and procedures to ensure independence and effectiveness of external audit. Satisfy themselves with integrity of company’s financial and narrative statements.
PROV.27 - requirements for director explanations in AR
- Responsibility for preparing
- Consider AR/FS - as a whole - fair/balanced/understandable
- AR/FS have info necessary for shareholders to asess position, performance, business model and strategy
PROV.30 - state in AR/half-yearly accounts - appropriateness of going concern basis - identify material uncertainties to ability to do so over 12 months from date of approval
PROV.31 - taking financial position/principal risks into account- explain in AR how assessed company’s prospects - over what period - whether reasonable expectation company able to continue in operation/meet liabilities as they fall due.
9
Q
What 3 main points does FRC Guidance on Risk Management, Internal Control and Related Financial Reporting make regarding annual report and accounts?
A
- Board should provide clear & concise info…avoid standardised language which may be long on details, but short on insight.
- Accounting standards require companies to adopt the going concern basis of accounting, except in circumstances where management intends to liquidate the entity of cease trading.
- (Appendix B: Para 2) Reasonable expectation does not mean certainty.
10
Q
In what 5 ways might a company misreport financial numbers in order to improve its apparent financial position?
A
- Over-value of assets
- Use of accounting policies that give a more flattering picture of the company’s position
- Claiming revenue / profits were earned earlier than should have
- Removal of debt’s from balance sheet
- Disguising money from loans as operating income.
11
Q
What are the current challenges faced by the current annual report?
A
FRC - MATTER OF PRINCIPLES: THE FUTURE OF CORPORATE REPORTING (OCT 2020)
Art present ‘pushed and pulled to meet increasing demands’ = confusing document as result
New Model seeks to
- Unbundle existing purpose/content/intended audience - move to network structure
- Facilitate a more HOLISTIC APPROACH governed by a set of overarching principles
- More objective-driven framework around principles of effective communication
- Establish framework consistent with recommendations of independent reviews(ex. Kingman/Brydon)
- Think beyond paper format- embrace technological opportunities presented
- Enable corporate reporting to be more flexible/responsive to changing demands/circumstances
12
Q
What is the board’s role in financial reporting?
A
Satisfy themselves with the integrity of annual report and financial statements by ensuring:
- Compliance with financial reporting standards (typically delegated to AC)
- Effective arrangements for oversight of the auditors (typically delegated to AC)
- Independence and objectivity of the auditor assessed periodically;
- Significant audit matters and how these were addressed are disclosed; and
- Auditor’s report disclosed to the shareholders and board should respond to any issues or queries in relation to the report, typically carried out at AGM.
13
Q
What is the role of the Company Secretary in financial reporting?
A
- Compliance
- Interpret financials into non-financial terms for shareholders and other users
- Assist draft/proof “notes to the accounts” (narrative reporting role)
- Advise boards on potential reputational risk / other implications of performance/disclosure
- Provide advice/oversight on the board’s behalf re financial reporting, half yearly and annuam reports
- Oversee distribution/circulation of documents
14
Q
What are the requirements for a company to have an audit committee?
A
- All companies which are financial institutions
- DTR 7.1 requires it for premium listed companies (mandatory)
CODE (part 4- Audit, Risk and Internal Controls)
* Principle M
- Formal/transparent policies to ensure effectiveness/independence of internal and external audit function; and
- Satisfy itself on the integrity of financial and narrative statements
- Prov. 24 - AC of NEDs to be established with min. 3 members (2 where below FTSE350)
- Prov. 25 - roles and responsibilities of the ACT
- Prov.26 - requirement to describe work of the AC in the annuakl report
- PROV.24 - board to establish an AC of independent NEDs with min membership of 3 (below FTSE350, 2)
- PROV.25 - lists the main roles and responsibilities of the AC.
- PROV.26 - requires AC to describe its work in the annual report
15
Q
What are the requirements for the composition of the audit committee?
A
DTR 7.1
- Majority independent NEDs, including the chair
- At least one with competencies in accounting or audit, or both
- Members who, as a whole have competencies relative to sector org operates in
UKCGC 2018 (STRICTER)
- Minimum 3 directors (2 where below FTSE350)
- 1 should have RECENT/RELEVANT financial experience
- Members who, as a whole have competencies relative to sector org operates in
ULTIMATELY company chair should not be a member
FRC Guidance - appointments made by board on recommendation of NC in consultation with AC chair.
16
Q
What is the purpose of the audit committee?
A
- The audit committee is key to ensuring organisation has robust/effectiveness processes relating to financial repoting, IC, RM and ethics.
- The commitee is the main oversight body for the internal and external auditors.
- 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
17
Q
Briefly describe 4 areas over which the audit committee would typically have responsibility.
A
- Annual report and other periodic reports
- ICs & RM systems
- Internal audit
- External audit
18
Q
Audit Committee role re annual report and other period reports?
A
- Whether appropriate accounting policies, any changes to them;
- Methods/accounting treatments;
- Clarity/completeness of disclosures and that they are set properly in context
- Related info presented with FS (inc. strate report / CG sttement as far as it relates to audit and RM)
- Consider contsents of AR and Accs and advise the board on whether, taken as a whole, it is fair, balanced and understandable.
- Whether reports and accounts provide necessary information for shareholders to assess the company’s position and performance, business model and strategy
19
Q
Audit Committee role re ICs & RM systems?
A
- Company’s internal financial controls, as part of expected roles/responsibilities in 2018 Code
- If a separate Risk Committee not established, AC should review company’s RM systems
- Reports from mgmt on effectiveness of systems established
- Conclusions of testing by internal/external audit
- Satisfy itself that ICs are operating effectively.
20
Q
Audit committee role re internal audit?
A
AC should review the need and advise board on whether to establish an internal audit function.
Where an internal audit function exists, the AC should:
- Review and approve the role and mandate of internal audit function
- Approve yr int audit plan/budget- ensure the resources available to carry out role effectively
- Monitor and review effectiveness of the work of internal function
- Review and annually approve the internal audit charter - meet needs of the org
- Approve appointment / termination of appointment of the Head of IA.
21
Q
Audit Committee role re external audit?
A
- Tender process - fees/scope of auditt ( formal recs to board on appointment, reappointment, removal of ext auditors)
- Annually assess / report to board on qualification expertise, resources, independence of the external auditors and the effectiveness of the audit process
(Recommend to board whether OR NOT they should propose to the shareholders for reappointment) - Policy re non-audit services by the external auditor;
- Review audit LoR before signature - especially where non-standard issues #
(Confirms information complete, correct and appropriate to board’s best knowledge) - Review/monitor management responsiveness to findings/recommendations of the ext. auditor
- Assess effectiveness of audit process
- Investigate reasons for auditor resignation and whether any action will be required
- After audit - review with the external auditors, findings of their work and the auditor’s report.
22
Q
What should the audit committee report report on?
A
FRC Guidance on ACs
AC report a separate part to be included in AR & should report on the following:
- Summary and role;
- Composition requirements
- Meetings (numbers, names and qualifications)
- RE their performanance evaluation
- How effectiveness of external audit has been assessed
- Approach to appointment/re-appointment
- Name of external firm, partner, tentures (when last tender/any notice of retender plans)
- Policy for non-audit services if applicable
(for each significant engagement or category - define the services and rationale why best company interests to purchase service from the external auditor) - Safeguarding of auditor objectivity/independence
- Fees info (audit v non-audit and ratios)
- How internal audit effectiveness assessed and if still appropriate co’ has this function
- Significant issues considered RE FS - regard to matters from auditor - but need not repeat information disclosed elsewhere, could signpost
- Nature and extent of interaction (if any) with FRC’s Corporate Reporting Review Team.
23
Q
What can the company secretary do in order to support the audit committee?
A
- Advise on appropriateness of AC
- Draft/review ToR
- Advise on AC composition
- Ensure board will have appropriate levels of skill/experience re succession planning
- Calendar based on ToR to ensure all responsibilities covered
- Ensure sufficient resources (inc. setting up RM/IA functions if needed)
- Budgets
- Assist with resourcing expert advice
- Act as committee secretary
- Organise professional development
- Organise induction
- Help members understand new and emerging issues
- Draft/review AC report (with Chair of AC and IA)
24
Q
What are (if any) requirements on meetings of the audit committee?
A
- CoSec / AC Chair decide timing and frequently.
- As many / few as are required to deliver their roles and responsibilities.
-
FRC Guidance
- No less than 3 a year
- To coincide with key financial reporting/audit cycle dates
- Only AC Chair and members should be present, unless invited for specific meeting/agenda item
- Expected heads of internal/external audit and the FS will be regularly invited -
BEST PRACTICE-
- Sufficient time between AC and Board meetings for AC work to be carried out and reported on
- Where not possible, CS to help AC chair report for BoD to consider at their meetings (issues/recs)
AC should meet int/ext auditors without management at least annually - discuss issues/points arising from audit.
25
What issues should be raised by the audit committee to the board?
* Significant issues with FS - how addressed
* External audit(or) effectiveness
* Recommendation for appointment/reappointment of auditor
* Effectiveness of internal audit
* Feedback on audits carried out by the IA function
* Any other issues board requests their opinion on
26
What is the audit committee's role in respect of the Company's shareholders?
Ensure their **interests are properly protected** in respect of financial reporting and internal controls
27
What should the audit committee do in carrying out its role/obligations re the company's shareholders?
* Consider **clarity** of reporting
* Be prepared to **meet** investors
* Separate report describing how they have **discharged their responsibilities**
* Chair of AC should be @ **AGM** and prepared to answer **questions** on AC section of the AR/any other questions in AC remit
28
What is the general requirement for audit?
All companies must have an indepedent external auditor (exemptions exist, ex. dormant companies)
29
Who is eligible to be a company's auditor?
* must be a member of recognised professional body
* independent from the company
30
Are external auditors liable to third parties?
* **Duty of care** is owed to the **company** and its **shareholders**
* **Caparo** case: Liability of auditor for mis-statements was to shareholders as a body, not one shareholder or the public who may have relied on the FS
* **BANNERMAN**- no disclaimer when it could have, duty accepted because not denied- ICAEW since advise a '**Bannerman Disclaimer**' in audit reports.
31
What is the criminal liability of external auditors?
* Can limit liability through via agreements with the companies they are auditing.
* CA 2006 - companies to disclose in notes to annual accounts:
- **Fees receivable** by their external auditors
- **Any** limited liability **agreements made** with external auditors
Since 2008 - criminal offence for auditor knowingly/recklessly to
* Include any matter that is ‘*misleading, false or deceptive*'; or
* *Ommit* a statement that is required by CA 2006’.
Punishable by fine which can apply to individuals
32
What is the role of the external auditor / purpose of their report?
That, in their expert opinion, the financial statements:
* Give a true and true view (of the financial position during and at end of FY)
* Are compliant with relevant laws, regulations, standards and codes
LISTED COMPANIES - assess compliance with UKCGC & obtain evidence to support the company's statement regarding its compliance with the UKCGC
**NOT THEIR RESPONSIBILITY TO DETECT FRAUD OR ERROR - THIS IS THE RESPONSIBILITY OF THE BOARD**
33
What are the two main types of audit report?
- **Modified**: serious issue, implies **potentially grave concerns** re FS/financial condition of the company. Implies auditor/board could not agree on application of **accounting policies** thus the **content** of the FS themselves.
- Unmodified
34
What are the 3 types of modified audit opinion?
- **Qualified**: FS would give a true and fair view except for a **PARTICULAR** matter, which the external auditor explains.
- **Adverse**: material misstatements in accounts and these are '**pervasive**' - information is believed to be **seriously incorrect**
- **Disclaimer** of opinion: **unable to obtain** information required to give opinion so unable to state FS a true and fair view.
35
What are the main threats to watch out for (re independence) when conducting audits (IFAC)?
* Self-interest
* Self-review
* Advocacy (re public statements/support during litigation)
* Familiarity threat
* Intimidation threat
(Mutual business interests and personal connections)
36
What are the 6 main measures to protect auditor independence?
* Appointment by **shareholders** (CA 2006: Appointment/remuneration of auditor should be approved by shareholders at GM, will often be at the AGM)
* Restricting or prohibiting supply of **non-audit services**
* Assessment of independence by **audit firm employees** (AC responsible for reviewing/monitoring)
* **Rotation** (partner/firm)
* Requesting auditor makes **public statements on behalf** of the company – AC should monitor to avoid the audit firm carrying out advocacy role on behalf of the company
* Management intimidation – AC should **meet** with external audit firm **at least annually without management**.
37
What are the two measures that a company can take, in respect of non audit work, to protect the independence of the auditor?
* **Restrict amount** of non-audit work to no more than **70% of the average fees** from audit work over the previous **3** financial years
* Impose a **ban on certain types** of non-audit work, ex: tax advice; services involving management/decision making for the client; book-keeping; and designing or implementing internal controls relating to financial information
38
What should the AC assess when considering the provision of non-audit services by the external auditor?
* **Threats/safeguards**
* **Nature** of service(s)
* If skills/experiencemake audit firm **most suitable** supplier
* **Fees** incurred/to be incurred
* **Compensation criteria** for individuals performing the audit
39
What does the UKCGC require in terms of reporting in respect of external audit independence/objectivity (when considering the provision of non-audit services)?
Annual report should explain how auditor independence/objectivity safeguarded re provision of non-audit services
40
Per FRC Guidance, what is the normal period for rotation of audit engagement partner/key audit partners?
5 yrs
41
When can the general rule on audit partner/key partner rotation be extended?
AC can extend the 5 year period if **safeguarding the quality of the audit**
* Audit engagement partner - up to 2 more years - no more than 7 in position
* Where extended - must be disclosed to shareholders ASAP
42
Per EU directive / SATCAR - how often should PIEs rotate audit firm?
All listed companies to conduct a **tender** at least every **10** years and **rotate** auditors after at least **20** years.
43
What is the Company Secretary's role in respect of external audit?
* **Appointment/remuneration** process in liaison with CFO/finance department (advice on *timelines*, ex. to line up with AGM for shareholder approval)
- **Liaising** with ext & int audit function (on behalf of board) during audit process
- Assessment of **independence**
- **Advise** board/AC on auditor **independence** and acceptable levels/types of **non-audit work**
- Ensure external auditor **attends AGM & briefed** about potential questions
- Advising board and/or AC on **rotation** requirements
- Ensure action plan developed regarding any recommendations for improvement in IC/RM processes set out in auditor’s **management letter** and report.
- Ensure items in management letter stay on **board agenda** until all resolved
44
**What factors should be considered when appointing an auditor?**
AC responsibility, under the Companies Act 2006 (Part 16), under the EU Audit Regulation and under the UK Code (Provision 25) of initiating the audit tender process and negotiating the fee and scope of the audit.
Under the UK Code (Provision 26) the audit committee report in the annual report should include advance notice of any audit tender plan
The audit committee would make the recommendation to the Board on the appointment of the new auditor following a tender process, with the Board then confirming the appointment by Board resolution.
Under the Companies Act 2006 and the EU Audit Regulation, the appointment of the auditor, even if originally made by the Board, must be approved by the shareholders in general meeting each year.
During a tender process for a new auditor, the audit committee should determine which factors should be identified in the tender process in order to analyse the bids and determine their choice.
These include the auditor’s experience of work with companies of a similar size and business sector. The key deciding factors should be the quality and effectiveness of the audit that the auditor will provide.
The audit committee should therefore be focused on what the auditor says about how it will go about achieving an effective and robust audit.
Price is only one factor to consider – the audit committee, and Board, should not choose a new auditor based on price alone. Even if the Chair has concerns about the level of fees of the existing auditor, that level of fees should not be a determining factor in deciding whether to allow the existing auditor to re-tender for the audit work, and in deciding how to choose between the audit firms that tender for the audit work.
INDEPENDENCE OF AUDITOR - SEEK ASSURANCE AND INFORMATION FROM FIRM DURING TENDER PROCESS
PROVISION OF NON-AUDIT SERVICES - CONSIDER POTENTIAL CONFLICT - Responsibility of the AC to ensure provision of non-audit services will not impair the external auditor's independence or objectivity
POTENTIAL FOR MUTUAL BUSINESS INTERESTS / PERSONAL CONNECTIONS in audit firm
ASSURANCE OF AUDIT FIRM INDEPENDENCE- NC BUT RESPONSIBILITY ON FIRM
45
What is FRC best practice for the holding / frequency of audit committee meetings?
* Sufficient interval between AC meetings and Board to allow work arising from AC meetings to be carried out and reported to the board as appropriate.
* Where not possible, CoSec/AC Chair should prepare report covering issues and recommendations of AC for the board to consider at their meeting(s)
46
What should audit committees assess regarding provision of non-audit services and put into any formal policy regarding this?
CONSIDERATIONS
* **Threats** /any **safeguards**
* **Nature** of services
* If **skills/experience** of audit firm make it the **most suitable** supplier
* **Fees** incurred/to be - individual and aggregate - relative to audit (including special t&c)
* Criteria governing **compensation** of those performing an audit
POLICY CONTENTS
* **Pre-approved** non-audit work external auditor can provide (trivial matters only)
* **Reporting** of the use of non-audit services should include and those subject to pre-approval
* How will **assess** if non-audit services have **DIRECT/MATERIAL impact** on audited FS statements
* How will **assess/explain estimation of the effect** on the FS
* How it will **consider auditor independence **
* CODE - AR explain **how** auditor **independence/objectivity safeguarded** re provision of non-audit services
47
**Recommendations of Brydon Review in respect of audit/the audit profession.**
* Define audit and its purpose
* Create corporate auditing profession governed by principles
* Introduce suspicion into the qualities of auditing
* Extend concept of auditing beyond financial statements
* Have mechanisms - encourage greater shareholder engagement (audits/auditors)
* Change to language of audit opinions
* Intro of corp Audit & Assurance policy, resilience statement and public interest statement
* Suggest to info work of BEIS re internal controls/improve clarity on cap maintenance
* More clarity around AC role
* Package - measures re fraud prevention/detection
* Improved comms/transparency of auditors
* Obligations to acknowledge EXTERNAL signs of concern
* Extend audit into new areas including Alternative Performance Measures
* Increased used of technology
48
**Brydon recommendations regarding corporate governance**
* Directors - set in public interest statement (in strat rep ) - how view legal/social/financial/enviro responsibilities to public interest. Explain how discharged its self-declared ‘public interest’ obligations/responsibilities- actions taken to mitigate any externalities caused during period and effectiveness of these actions.
* Audit report - new section - if s.172 state based on observed reality to auditor’s knowledge.
* Director risk report - published prior to AC meeting where scope of next audit topic - gives sufficient time for shareholders to comment
* AC to publish formal invite to SH to express any reqs re areas of emphasis they want auditor to incorporate into audit plan - AC state auditor’s proposed materiality levels with invite.
* AGM agenda - added standing item - questions to chair of AC / questions to the auditor
* Ac publish 3 year rolling Audit & Assurance policy - put to annual advisory SH vote at AGM
* Mechanism for workplace concerns re risk/assurance developed - co obliged to then respond way in which is has reacted to requests
* Gov - seriously consider mandating UK INTERNAL CONTROLS STATEMENT
o Signed attestation by CEO/CFO to board that evaluation of effectiveness of the int. controls over fin reporting completed (whether effective or not) - as in SOX
o To be received no more than 28 days before accounts signed
o Board to report to SH that it has received this attestation
* Board make RESILIENCE STATEMENT - incorporates/enhances/buildings on current GOING CONCERN/VIABILITY STATEMENTS
* Any KPIs used for calculating exec remuneration should be subject to audit
* Amendments to CA2006 to clarify/strengthen process of how co/auditor lets shareholders/other stakeholders know of their resignation, dismissal or dec not to participate in a retender
* Resignation/dismissal of audit - company to be required to hold a GM
o Within 42 days of receiving letter of res / sending notice of dismissal
o Departing auditor would attend to answer SH questions
o Board plan for appointing new auditor / manage transi (consistent with A&A Policy)
* AC minutes published with a time-lag of 12-18 months & with approved redactions
49
Give some of the recommendations made by the FRC Review of Corporate Reporting (Nov 22)
* **Clear, meaningful explanations** of good governance in line with flexibility offered by code
* Cleasr show **impact of engagement with stakeholders** on decision-making, strategy and long-term success
* Better assess and monitor **culture**
* Demonstrate **committment to DIVERSITY AND INCLUSION** with *actions*
Feb 2021 advice
- How to report **transparently and effectively** on code departures
- How to **embrace** Code's **flexibility**/develop **bespoke governance practices**
- Make it **easier for readers to locate/find** departures from code in AR
- Ensure **full, clear, meaningful explanations** for such departures
