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FINANCIALREPORTINGCOUNCIL
CHALLENGESFORAUDITCOMMITTEES ARISINGFROMCURRENTECONOMICCONDITIONS
NOVEMBER2008
IntroductionCurrenteconomicconditionsprovideparticularchallengestoallinvolvedwithannualreportsandaccounts.Thepurposeofthisdocumentistoassistauditcommitteesbyidentifyingkeyquestionsthatthattheymayneedtoconsiderwhenpreparingfortheyearendandincarryingouttheirroleinrelationtoannualfinancialstatements.Itdoesnotestablishanynewrequirements.TheFinancialReportingCouncil(FRC)hasalsopublished“Anupdatefordirectorsfordirectorsoflistedcompanies:goingconcernandliquidityrisk”whichbringstogethertheexistingguidanceandrecentdevelopmentsrelatingtogoingconcernandliquidityriskwhichmayusefullybereadinconjunctionwiththisdocument.http://www.frc.org.uk/corporate/goingconcern.cfm)RequirementsofthecombinedcodeandrelatedguidanceTheFRCisresponsiblefortheCombinedCodeonCorporateGovernance(theCode)anditsassociatedGuidanceoninternalcontrol(theTurnbullGuidance),Guidanceonauditcommittees,andonGoingconcernandfinancialreporting.PrincipleC.1oftheCodesetsoutthattheboardshouldpresentabalancedandunderstandableassessmentofthecompany’spositionandprospects.Further,theboardisresponsibleforthepreparationoffinancialstatementsthatgiveatrueandfairview.PrincipleC.3setsoutthatboard’sshouldestablishformalandtransparentarrangementsforconsideringhowtheyshouldapplythefinancialreportingandinternalcontrolprinciplesandformaintaininganappropriaterelationshipwiththecompany’sauditors,andprovisionC.3.1ofthecodeenvisagesthatboardsshouldestablishanauditcommittee.TheGuidanceonauditcommitteessetsoutthemainroleandresponsibilitiesofanauditcommittee.Particularlyrelevantincurrenteconomicconditionsismonitoringtheintegrityofthefinancialstatementsofthecompanyandanyformalannouncementsrelatingtothecompany’sfinancialperformance,reviewingsignificantjudgmentscontainedinthem,andreviewingthecompany’ssystemofinternalfinancialcontrolsandinternalcontrolsandriskmanagementsystems.Theattachedquestionsseektoaddressissuesthatwillberelevanttotheworkofmanyauditcommitteesoverthenextfewmonths.
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KeyissuesforauditcommitteestoconsiderwhenpreparingforyearendprocessesandreportsYearendplanningconsiderationsBusinessriskshavechangedconsiderablyinrecentmonths.Thefinancialcrisishasledtostressinthenonfinancialpartsoftheeconomy.Theupdatefordirectorsongoingconcernandliquidityriskemphasisesthebenefitofplanninghowtoaddressthegoingconcernassessmentasearlyaspracticable.Auditcommitteesmayneedtoreconsidertherisksthattheirbusinessfacesandtoensurethattheyhaveconsideredtheimpactofthesenewrisksontheirworkinadvanceoftheannualreportingseason.Theyarealsolikelytowanttobesatisfiedthatappropriateplansfortheassessmentofgoingconcernhavebeenmade.Effectivesystemsareparticularlyvitalattimesofeconomicstress,inordertoreacttofastchangingmarketsandtohelpmanageanincreasedriskoferror,omissionandfraudwhenmanagementandsupportingfinanceteamsareunderabnormalpressures.Auditcommitteesmaywishtoreconfirmthatreportingandinternalcontrolsystemsareinplaceandfunctioningeffectivelyandthatresourcesareinplacetosupportandauditdifficultyearendjudgments.LiquidityriskandgoingconcernSomecompaniesarefacingadditionaldifficultiessecuringfinanceandsomearereportedtohaveexperiencedreducedfacilities,increasedcostand/ormoredemandingcovenants.Thesetrendsarelikelytocontinue.Heightenedliquidityriskmaynecessitategreaterattentiontothekeyassumptionsandprocessesthatleadtocashflowforecasts.Insomecases,detailedconsiderationwillneedtobegiventodeterminewhetherthereare,orarenot,materialuncertaintiesleadingtosignificantdoubtaboutwhetherthebusinessisagoingconcern.Auditcommitteesarelikelytoexamineinmoredetailtherigourwithwhichtheanalysissupportingthegoingconcernjudgmenthasbeenmadeandtheintegrityofthedisclosuresaboutgoingconcerninthefinancialstatementsandothermarketcommunications.RelianceonassumptionsandmodelsforcashflowandvaluationinformationThevolatilemarketconditionsmeanthatmanycompanieswillneedtoconsiderawiderrangeofreasonablypossibleoutcomeswhenperformingsensitivityanalysisontheircashflowprojectionsthatsupportassetvaluationsandassetimpairmentassessments.Thisincreaseintherangeofreasonablypossibleoutcomesfacedbybusinessesintroducessignificantadditionalpressureonthejudgmentsneededtoevaluateilliquidassetvalues.Inviewofthecontinuingvolatilityoffinancialandnonfinancialmarkets,auditcommitteesarelikelytowantabetterunderstandingofthesejudgmentsandarelikelytorequiremoredetailedanalysisandsupportinginformationthaninpreviousyears.
2 Challenges for Audit Committees arising from current economic conditions (November 2008)
SignificantaccountingandreportingjudgmentsPrinciplesbasedaccountingandreportingstandardsdependuponthembeingappliedinaconstructiveandtransparentmannerwithafocusonusefulcommunications,notjusttheminimumnecessarytocomplywithlawsandregulations.Attimesofstress,auditcommitteesarelikelytowanttobeassuredthatkeyjudgmentsaresupportedbyagreaterdegreeofrigourandanalysisthaninmorenormalcircumstances.ThefollowingschedulesetsoutinmoredetailpotentialkeyquestionsthatmayberelevanttoauditcommitteesastheyseektoaddressthesechallengesTheimportanceofthedifferentquestionswillvarydependinguponindividualfactsandcircumstances.November2008
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AreaofconsiderationYearendplanningconsiderations
Keyquestions
2008/09 Corporate Reports Key Questions for Audit Committees
Hastheauditcommitteeconsideredhowitshouldrespondtoaheightenedriskoferrors,omissionsormanipulationofreportedfinancialresultsorbalancesheetpresentation?Hasitassessedhowtheseriskshavebeenmitigatedordoesithaveplansinplacetodoso?
Doesthecommitteeneedtoaddtoitsmembershiporbringinspecialistadviserstohelpittomeetitsresponsibilities?Ifso,havetheadditionalresourcesbeensecured?
Doesthecommitteeneedfurtheranalysisoftherisksfacingthebusinessandhowthoserisksarebeingaddressed?Ifthisisnecessary,hastheanalysisbeencommissionedandadeadlineagreed?
Isthecommitteesatisfiedthattheboardhasrespondedeffectivelytobusinessriskswhichhavedevelopedovertheyearwithappropriatemodificationstothegroup’sstrategy?Ifthisisinprogress,isthereanagreedtimetabletoreportbacktothecommittee?
Hasarecentreviewbeenconductedofreportingarrangementstoensurethathighquality,wellcontrolledandtimelymanagementdataisavailable?Didthatreviewconcludethatadditionalresources,controlsorprocedureswerenecessaryand,ifso,isthereadatetoreportprogresstothecommittee?
Hasthecommitteeconsideredwhetherthegroupfinancefunctionneedsadditionalspecialistskills,experienceorresourcestopreparetheannualreportandsupportingyearendinformationfortheboardandthecommittee?Ifadditionalresourcesarerequired,hasaplantoincreaseresourcesbeenmadeandimplemented?
Hasthecommitteeconsideredwhetherthegroupreportingtimetablehasadequatetimeforallissuestobeproperlyaddressedandistheresufficientflexibilitytobeabletocopewithunexpectedevents?
Hasthecommitteerecentlyreviewedtheprincipalgroupaccountingpolicies?Didthatreviewconsiderallareasthatmayhavebeenimpactedbychangingeconomicconditionsandevents?Isthereaneedtoscheduleanupdatebeforetheyearend?
4 Challenges for Audit Committees arising from current economic conditions (November 2008)
Liquidityriskandgoingconcern
2008/09 Corporate Reports Key Questions for Audit Committees
Hasthecommitteeconsideredwhetherthegroupauditplanhasbeenupdatedtoaddresscurrentrisks?Havetheexternalauditorsallocatedsufficientadditionalandexperiencedresourcestoaddressheightenedrisksand,ifnot,arenegotiationsscheduledtosecureadditionalcommitments?Isthecommitteesatisfiedthatappropriateplansareinplacetomakeaconsideredassessmentabouttheuseofthegoingconcernbasisofaccountingatthedateofapprovaloftheannualreportandaccounts,andthatanynecessaryremedialactionhasbeenidentified?Whereaninternalauditfunctionexists,hasthecommitteeconsideredwhetheritwishesinternalaudittoconductadditionalworkuptoorattheyearendandifso,arearrangementsinplacetoensurethattheworkiscompletedandreportsmadeavailableonatimelybasis?Willtheauditcommitteeneedadditionalinformationtoenableittocompleteitsworkattheyearend,andifsohavearrangementsbeenmadeforthistobeprovidedonatimelybasis?Hastheauditcommitteeconsideredwhethertheboardmayneedtoamendthegroupstrategicplanincludingexpectationsoffuturegrowthandthegroup’sabilitytosustainitsbusinessmodel?Hasthegroupmonitoreditspositioninrelationtocontinuedvolatilityinthefinancialmarkets,includingitsexposuretoliquidityriskandcounterpartydefaultrisk?
Isthecommitteesatisfiedbytheprocessthattheboardhasconductedtoconcludethatthefinancialstatementsshouldbepreparedonagoingconcernbasis?Wasreferencemadeto“GoingConcernandFinancialReporting:GuidancefordirectorsoflistedcompaniesNovember1994”.
Isthecommitteesatisfiedthatproperconsiderationhasbeengiventocashflowforecastspreparedforatleast,butnotlimitedto,twelvemonthsfromthebalancesheetdateincludingananalysisofheadroomagainstavailablefacilities?Hasthecommitteeconsideredwhetherthereisaneedtoextendthecashflowforecastexercisetoevaluateissuesthatmayariseaftertheendoftheperiodcoveredbycashflowforecasts?
Isthecommitteesatisfiedthatappropriateevidencehasbeenobtainedaboutthegroup’sabilitytosecurenewortorenewfundingcommitments?Isadditionalevidenceneededabouttheintentionsofinvestorsandlenders?
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Relianceonmodelsforcashflowandvaluationinformation
2008/09 Corporate Reports Key Questions for Audit Committees
Hasthecommitteeconsideredananalysisofthetermsofcurrentbankingfacilitiesandcovenants,andhasthisanalysisidentifiedrisksthatneedtobeaddressed?Ifso,areplansinplacetomanagethoserisks?
Isthecommitteesatisfiedthatfullconsiderationhasbeengiventoguarantees,indemnitiesorliquidityfacilitiesthathavebeenprovidedtootherentitiesthatthegroupmaybecalledontohonour?Havethedirectorsconsideredwhetherthegrouphastheresourcestomeetsuchobligationsshouldtheyarise?
Hastheauditcommitteeconsideredtheprocessesinplacetoensurethatappropriateproceduresandcontrolshavebeenappliedtothegroup’suseofmodelstogeneratecashflowandvaluationinformation,includingthechoiceandconsistentuseofkeyassumptions?
Istheauditcommitteesatisfiedthatkeymodelshavebeensubjecttoindependentanalysisandverification,forexamplebyinternalaudit?
Istheauditcommitteesatisfiedthatappropriatesensitivityanalysishasbeenconductedtoflexassumptionstoidentifyhowrobustthemodeloutputsareinpracticeandthattheassumptionsarefreefrombias?Isitclearthatthesensitivityanalysishasconsideredappropriatelythepotentialimpactofreasonablypossibleevents?Forexample,haverelationshipswiththirdpartiesincludingsuppliersandcustomersbeenreviewedinthelightofrecenteventsandhasthepotentialforthirdpartydefaultsbeentakenintoaccount?
Whereassetsarenottraded,perhapsbecausemarketsarenolongeractive,hasthecommitteesatisfieditselfthatappropriateadditionalprocedureshavebeenundertakentoestimatefairvaluesthroughtheselectionofmarketbasedvariablesandtheuseofappropriateassumptions?
Wheremodelshavebeenusedtoestimatethevalueofassetswhichmustbetestedforimpairment,isthecommitteesatisfiedbytheproceduresadoptedtoestimatecashflowsandtheappropriateadjustmentsmadeforrisk?
6 Challenges for Audit Committees arising from current economic conditions (November 2008)
Significantaccountingandreportingjudgments
2008/09 Corporate Reports Key Questions for Audit Committees
Istheauditcommitteesatisfiedthatappropriateandbalanceddisclosureshavebeenmadeaboutgoingconcernandliquidityriskthatdrawonthespecificcircumstancesofthecompanyandthegroup?
Istheauditcommitteesatisfiedthatthebusinessreviewpresentstheprincipalrisksanduncertaintiesassociatedwiththegroup’sactivitiesinafairandtransparentway?Hasunnecessaryclutterbeenremovedandgenericcommentbeenkepttoaminimumsothatthekeymessageshavenotbeenobscured?
Hasthecommitteeconsideredwhetherthegroup’sbusinessreviewadequatelyaddressestheadditionalrequirementsintroducedbyrecentrevisionstothebusinessreviewrequirementsoftheCompaniesAct?Forexample,disclosureisnowrequiredofthemaintrendslikelytoaffectfuturebusinessdevelopment.Isthecommitteesatisfiedthatthebusinessreviewisconsistentwiththerestoftheannualreport?
Isthecommitteesatisfiedthatappropriatedisclosurehasbeenmadeofwriteoffsandpotentialwriteoffsofgoodwillorindividualassetsimpactedbycurrentevents,includinginformationaboutkeyassumptionsandsensitivityanalysis?Hasthecommitteeconsideredwhetheranyidentifiedimpairmentscouldbeeitherinsufficientorexcessive?
Hasthecommitteeconsideredwhethertheauditedfinancialstatementsdescribeallofthekeyjudgmentsabouttheapplicationofaccountingpoliciesandtheestimationuncertaintiesthatcouldresultinmateriallossesinthenextyear?Inparticular,haveallrelevantissuesthathaveconcernedmanagementduringtheyearandthathavebeendrawntotheattentionoftheboardand/ortheauditcommitteebeenconsideredfordisclosure?
Isthecommitteesatisfiedthatfullconsiderationhasbeengiventopostbalancesheeteventsuptothedateofapprovaloftheannualreportandaccounts?Arethereanysignificantadversetrendsincashflowsorassetvaluesoroffbalancesheetarrangementsthatmayneedspecialmention?
Hasthecommitteeconsideredwhetherthereisaneedforadditionaldisclosuresaboutcompanycircumstancesinpreliminaryannouncementsorotherregulatoryreportsbeforetheannualreportispublished?Forexample,earlydisclosuremayneedtobeconsideredwhendirectorsfirstconcludethatsignificantdoubtsexistaboutgoingconcern.
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