Chapter 7 - Reporting To Shareholders And External Audit

Question 1

In what ways might financial statements be misleading to shareholders and other investors?

Answer 1

• fraudulent misrepresentation of the company’s affairs (lying)
• accounting policies might present the accounts more favourable than they really are (bending the truth)
• the complexity of the accounts can make them difficult to understand. (confusing the truth)

Question 2

What is meant by “window dressing” of financial statements?

Answer 2

Using accounting methods to hide the true state of affairs in a company.

Question 3

What are “bond credit ratings”?

Answer 3

A scheme used by bond investors to assess the creditworthiness of companies in which they invest.

Question 4

What does the UK Code state about the transparency of the annual report and accounts?

Answer 4

The board should present a fair, balanced and understandable view of the position and performance of the company.

Question 5

What does the UK Code state about the transparency of the annual report and accounts?

Answer 5

The board should present a fair, balanced and understandable view of the position and performance of the company.

Question 6

What are 4 methods of windows dressing the accounts?

Answer 6

The company may:

• claim profits earlier than it should
• taking debts off the balance sheet
• disguise loans as income
• overvalue assets

Question 7

What were the facts in the 2002 WorldCom accounting fraud?

Answer 7

WorldCom incurred costs of $3.6bn that it accounted as capital expenditure, thereby reporting the money as “assets” instead of as what it really was - losses.

Question 8

What does “business model” mean?

Answer 8

The basis on which the company generates or preserves value over time.

Question 9

What is a going concern statement?

Answer 9

Directors must make a statement in the annual report and accounts that they believe the company will continue to trade for the next 12 months.

Question 10

What is the purpose of external audit?

Answer 10

To make sure, as far as reasonable possible, that the financial statements are objective and can be relied upon.

Question 11

Who is responsible for detecting fraud or errors in financial statements?

Answer 11

The board of directors, using the company’s system of internal control. The auditor is not responsible.

Question 12

Who is responsible for detecting fraudulent activity within the company, by some of its employees or others?

Answer 12

The board of directors.

Question 13

What are the responsibilities of the external auditors with regard to the financial statements of a company?

Answer 13

Give an expert and independent view on:

• whether financial statements are fair and true
• whether financial statements comply with the relevant laws

Question 14

What types of audit opinion might be given in an audit report?

Answer 14

Modified or unmodified

Question 15

What is the significance of a modified audit report?

Answer 15

The professional accounts have stated that the shareholders cannot trust the information given to them by directors. The quality of corporate governance could hardly be lower.

Question 16

When is an auditor liable for breach of duty?

Answer 16

CA 2006:

• knowingly causing an audit report to include misleading, false or deceptive content
• knowingly causing an audit report to omit a statement required by the CA.

Question 17

When is an auditor liable for breach of duty?

Answer 17

CA 2006:

• knowingly causing an audit report to include misleading, false or deceptive content
• knowingly causing an audit report to omit a statement required by the CA.

Question 18

What are the three types of modified audit opinion?

Answer 18

• qualified opinion (there is a single outstanding matter)
• adverse opinion (there are material misstatements in the report)
• disclaimer of opinion (the auditor has been unable to achieve the necessary information to give an opinion

Question 19

Give examples of non-audit work for a company by auditors.

Answer 19

• taxation consultancy
• internal audit systems
• valuation services
• remuneration consultancy

Question 20

What are five categories of threats to auditor independence?

Answer 20

1 Self-interest threat
2 Self-review threat
3. Advocacy threat
4 Familiarity threat
5 Intimidation threat

Question 21

What is the difference between audit firm rotation and partner rotation?

Answer 21

The first is rotation of the audit firm doing the work, the second is rotation of partners within a single firm.

Question 22

Why is it essential that auditors remain independent?

Answer 22

To ensure that their professional opinion on the accounts can be trusted.

Question 23

What is self-interest threat?

Answer 23

The auditor wishes to protect their income stream from a particular company.

Question 24

What is self-review threat?

Answer 24

The auditor is reviewing his own work that has been carried out for a company in a non-audit capacity.

Question 25

What is advocacy threat?

Answer 25

The auditor has previously given his formal support to the company on an issue (e.g. issuance of shares), and is therefore not independent.

Question 26

What is familiarity threat?

Answer 26

The auditor is over-familiar with a company's staff, and therefore is inclined to be over-trusting.

Question 27

What is intimidation threat?

Answer 27

A bullying executive may coerce an auditor in favourable reporting.

Question 28

According to the UK Code, how frequently must FTSE350 companies re-tender for audit ?

Answer 28

Every ten years.

Question 29

Who should be the members of the audit committee?

Answer 29

UK Code: - at least three members (2 for smaller than FTSE350) - all members should be independent NEDs - the company chairman should not be a member (FTSE350) - non-FTSE350 chairman may be members, as long as they were considered independent on appointment. - at least one member with recent and relevant financial experience.

Question 30

What is the legal requirement for audit committees in the UK?

Answer 30

2008 EU Statutory Audit Directive

Question 31

According to the FRC Guidance, what should be the responsibilities of the audit committee on: - audit committee meetings?

Answer 31

- no fewer than 3 per year - sufficient time in between audit and board meetings to allow work arising from audit committee meetings to be completed. - only the members and chairman may attend - meet the external and internal auditors at least once annually.

Question 32

According to the FRC Guidance, what should be the responsibilities of the audit committee on: - financial reporting?

Answer 32

Committee should review the significant financial reporting issues and judgements made with the statement, having regard to any matters communicated by the auditors.

Question 33

According to the FRC Guidance, what should be the responsibilities of the audit committee on: - provision of non-audit services by external auditors?

Answer 33

- committee is responsible for approving non-audit services - set a formal policy specifying the specific types of work for which the committee is pre-approved. - if non-audit services are provided, the annual report should explain how auditor objectivity is safeguarded.

Question 34

According to the FRC Guidance, what should be the responsibilities of the audit committee on: - review of the annual audit?

Answer 34

- committee should assess the effectiveness of the audit at the end of each cycle

Question 35

What are the provisions of the UK Code with regard to the appointment, reappointment and removal of the external auditors?

Answer 35

The audit committee is responsible maintaining the company's relationship with external auditors. The committee has responsibility to make a recommendation to the board on the appointment, reappointment or removal of the auditors.

Question 36

What measures might an audit committee take to monitor the independence of the external auditors on a regular basis?

Answer 36

- audit committee should asses independence annually - monitor the proportion of fees from audit vs non-audit work - seek annually from the firm information on policies and procedures for maintaining indepedence

Question 37

What measures might an audit committee take to monitor the independence of the external auditors on a regular basis?

Answer 37

- audit committee should asses independence annually - monitor the proportion of fees from audit vs non-audit work - seek annually from the firm information on policies and procedures for maintaining independence.

Question 38

In UK law, which companies must publish an annual strategic report?

Answer 38

All companies, except those with a small companies exemption.

Question 39

What should be the contents of an annual strategic report for a quoted company?

Answer 39

- main trends and factors likely to affect the future development, performance and position of the company's business. - information, including company policies on environmental matters, employees, and social, community and human rights issues

Question 40

What are the three sources of corporate governance disclosure requirements?

Answer 40

UK Code FCA Disclosure & Transparency Rules FCA Listing Rules

Question 41

Which law requires companies to publish an annual strategic report?

Answer 41

CA 2006 (Strategic Report and Directors' Report) Regulations 2013

Question 42

What 2 matters must the strategic report contain?

Answer 42

- a fair review of the company's business | - a description of the principal risks and uncertainties facing the company

Question 43

What is the name of the FRC best practice guidance on strategic reports?

Answer 43

FRC Guidance 2014 on the Strategic Report

Question 44

What is a safe-harbour provision for directors?

Answer 44

A director can only be liable for an incorrect annual report statement if he knew it was untrue, or was acting recklessly. This protects directors from making impossible future predictions.

Question 45

What is a safe-harbour provision for directors?

Answer 45

A director can only be liable for an incorrect annual report statement if he knew it was untrue, or was acting recklessly. This protects directors from making impossible future predictions.

Question 46

What is the IIRC?

Answer 46

The International Integrated Reporting Council

Question 47

What is the goal of the IIRC?

Answer 47

To encourage international integrated reporting by companies, combining all elements of reporting into a single report.