Enhancing the value of the audit committee report - ACCA

28 Pages·2014·1.27 MB·English

Enhancing the value of the
audit committee report
About ACCA
Using examples drawn from
current practice, this paper
explores how a small sample of
FTSE 100 company audit
committees address the external
audit aspects of the reporting
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© The Association of Chartered Certified Accountants
M2 arch 2014
1. Introduction and background
The UK Corporate Governance (CG) The ‘real world’ disclosures selected to responding well to the challenge of
Code (FRC 2012) addresses the illustrate current good practice were ensuring investor engagement (as
relationship between a company’s drawn from a number of FTSE 100 highlighted in Crump 2013, reproduced
corporate governance committee and companies shortlisted for one or more in Box 1).
the independent external auditor. It categories in the 2013 PwC Building
does this in two main ways –by setting Public Trust Awards. The examples are A follow-up paper will be published
out, firstly, the issues relating to the not necessarily ‘best practice’ but later this year examining whether audit
external auditor and the external audit should be seen as illustrative of the way committee reports issued in the first
process that the committee should in which audit committees are trying to half of 2014 are tackling the new
consider and, secondly, the issues fulfil their responsibilities under the challenges posed by the proposals from
concerning the external audit that the 2012 edition of the UK CG Code. The the Competition Commission and, if
committee should report on externally first section of the analysis also shows they are, how they do so.
to the members. As the examples cited that some of the companies studied are
in this exploratory report demonstrate,
UK listed companies are making lengthy
disclosures along the lines required by
the UK CG Code.
Box 1: Investors call for bespoke audit committee reports
A recent report by the FRC’s Financial
Reporting Lab (see Box 1) has, however,
by Richard Crump, 25 October 2013
found that that investors are demanding
more – they want audit committee
Investors would engage more with audit committee reports if they provided ‘hooks’ to
reporting to be bespoke (rather than form a discussion around, the UK’s reporting watchdog has been told.
boiler-plated) and company specific,
and for the most significant financial From the views of 19 companies and 25 investor analyst groups, the FRC’s Financial
statement issues to be disclosed Reporting Lab found that information on audit committee judgements related to
financial statement issues had the most scope for improvement and could help them
annually.
in developing views on valuation.
Using examples drawn from current
‘It’s not useful to have four pages on immaterial issues – far better to be shorter and
practice, this paper explores how a focus on real issues,’ one respondent suggested.
small sample of FTSE 100 company
audit committees address the external There were also specific recommendations that the audit committee chair be more
audit aspects of the reporting accountable by personalising the report; describe in detail actions taken rather than
just the functions they serve and depict their specific activities during the year and
responsibilities assigned to them by the
their purpose, using active, descriptive language.
UK CG Code (FRC 2012).
Audit chairs were also advised to disclose judgements made for the year, and the
At the time of writing (February 2014) it sources of assurance and other evidence used to satisfy themselves of the
appears likely that the provisions of the appropriateness of the conclusion and consider their audience in describing issues
2012 Code will be updated to include and their context.
the proposals of the Competition
‘Investors have told us that they will pay more attention to audit committee reports if
Commission issued in October 2013.
they provided more meaningful information,’ said Sue Harding, director of the
Both the existing FRC requirement and
Financial Reporting Lab. ‘Audit committee reports should form part of the
the new proposals are summarised in
conversation between companies and investors, building confidence in this important
Chapters 1 and 2 below.
area of governance and showing how it contributes to good financial reporting.’
Source: Crump (2013).
ENHANCING THE VALUE OF THE AUDIT COMMITTEE REPORT 3
2. The requirements of the UK Corporate Governance Code 2012
The UK CG Code sets out the minimum The UK CG Code also prescribes the With regard to the financial accounts
requirements for those issues relating minimum content for a section within themselves, the audit committee must
to the external auditor that the audit the annual report and accounts also consider:
committee should consider. These are: describing how the audit committee
has carried through the responsibilities • the quality and acceptability of
• to make recommendations to the set out above. These minimum accounting policies and practices
board, for it to put to the reporting requirements are:
shareholders for their approval in • the clarity of the disclosures and
general meeting, in relation to the • the significant issues that the compliance with financial reporting
appointment, re-appointment and committee considered in relation to standards and relevant financial and
removal of the external auditor1 and the financial statements, and how governance reporting requirements
to approve the remuneration and these issues were addressed
terms of engagement of the • material areas in which significant
external auditor • an explanation of how it has judgements have been applied or
assessed the effectiveness of the there has been discussion with the
• to review and monitor the external external audit process and the external auditor, and
auditor’s independence and approach taken to the appointment
objectivity and the effectiveness of or reappointment of the external • whether the annual report and
the audit process, taking into auditor , and information on the accounts, taken as a whole, is fair,
consideration relevant UK length of tenure of the current audit balanced and understandable and
professional and regulatory firm and when a tender was last provides the information necessary
requirements conducted, and for shareholders to assess the
Company’s performance, business
• to develop and implement policy on • if the external auditor provides model and strategy
the engagement of the external non-audit services, an explanation
auditor to supply non-audit services, of how auditor objectivity and The audit committee’s judgements on
taking into account relevant ethical independence is safeguarded.2 these last four points do need to be
guidance regarding the provision of communicated to the board, although
non-audit services by the external many published audit committee
audit firm; and to report to the reports also make an attempt to
board, identifying any matters in address them.
respect of which it considers that
action or improvement is needed
and making recommendations as to
the steps to be taken.
1. FTSE 350 companies should put the external
audit contract out to tender at least every 10 years.
If the board does not accept the audit committee’s
recommendation, it should include in the annual
report, and in any papers recommending
appointment or re-appointment, a statement from 2. Disclosure requirements relating to the
the audit committee explaining the disclosure of audit fees and fees paid to the
recommendation and should set out reasons why auditor for non-audit services are dealt with
the board has taken a different position. separately under the Companies Acts.
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3. The recommendations of the Competition Commission – October 2013
The proposals issued by the The FRC’s Audit Quality Review (AQR) Measures will be introduced to
Competition Commission in October team should review every audit strengthen the accountability of the
2013 are likely to become ‘mandatory’ engagement in the FTSE 350 on external auditor to the audit committee
and will in due course be absorbed into average every five years. The audit and reduce the influence of
the UK CG Code. The key committee should report to management, including a stipulation
recommendations regarding corporate shareholders on the findings of any that only the audit committee is
audit committees and external auditors AQR report concluded on the permitted to negotiate audit fees and
are set out below. company’s audit engagement during influence the scope of audit work,
the reporting period. initiate tender processes, make
FTSE 350 companies must put their recommendations for appointment of
statutory audit engagement out to There will be a prohibition of ‘Big-Four- auditors and authorise the external
tender at least every ten years. This only’ clauses in loan agreements (ie audit firm to carry out non-audit
differs from guidance introduced by the clauses that limit a company’s choice of services.
Financial Reporting Council (FRC) in auditor to a preselected list or
2012, which encouraged companies to category), although it will be possible to
go to tender on a ‘comply or explain’ specify that any auditor should satisfy
basis. No company will be able to delay objective criteria.
beyond ten years, and the Competition
Commission believes that many There must be a shareholders’ vote at
companies would benefit from going the AGM on whether audit committee
out to tender more frequently at every reports in company annual reports are
five years. If companies choose not to satisfactory.
go out to tender this frequently, the
audit committee will be required to
report in which financial year it plans to
put the audit engagement out to tender
and why this is in the best interests of
shareholders.
ENHANCING THE VALUE OF THE AUDIT COMMITTEE REPORT 5
4. Examples of current reporting practice
COMMENTARY • whether the annual report and
(1) The significant issues accounts, taken as a whole, is fair,
Disclosures in this area usually fall within balanced and understandable and
that the committee
a description of the work undertaken by provides the information necessary
considered in relation the committee at its various meetings for shareholders to assess the
during the year. These descriptions are Company’s performance, business
to the financial
almost invariably lengthy and detailed. model and strategy; and
statements, and how Thus, with the exception of Vodafone,
only brief extracts have been • any correspondence from regulators
these issues were
reproduced below. The Vodafone in relation to our financial reporting.
addressed. extracts give a good ‘window’ into the
way in which the audit committee ‘To aid our review, the committee
should go about addressing significant considers reports from the Group
accounting issues. Financial Controller and the Group
Financial Reporting Director and also
In this context it is interesting to note reports from the external auditor on the
SOURCES the recent conclusions of the UK FRC’s outcomes of their half-year review and
Financial Reporting Lab (see page 3) annual audit. As a Committee we support
All the examples of current which recommend that ‘information on Deloitte LLP in displaying the necessary
reporting practice in this section audit committee judgments related to professional scepticism their role requires.
are quotes from the following financial statement issues had the most
sources: scope for improvement and could help ‘The primary areas of judgement
them in developing views on valuation’. considered by the Committee in
• Anglo American plc (2012: relation to the 2013 accounts, and how
102–7) EXTRACTS these were addressed, were:
• British Land Company plc Vodafone • Goodwill impairment testing: The
(2013: 86–9) ‘The primary role of the Committee in judgements in relation to asset
relation to financial reporting is to review impairment largely relate to the
• National Grid plc 2013: 63–5) with both management and the external assumptions underlying the
auditor the appropriateness of the calculation of the value in use of the
• Vodafone Group plc (2013: half-year and annual financial statements business being tested for impairment,
61–2) concentrating on, amongst other matters: primarily the achievability of the
long-term business plan and
• WPP plc (2013: 118–20). • the quality and acceptability of macroeconomic assumptions
accounting policies and practices; underlying the valuation process.
• the clarity of the disclosures and • Taxation: Provisioning for potential
compliance with financial reporting current tax liabilities and the level of
standards and relevant financial and deferred tax asset recognition in
governance reporting requirements; relation to accumulated tax losses
are underpinned by a range of
• material areas in which significant judgements
judgements have been applied or
there has been discussion with the • Liability provisioning: The level of
external auditor; provisioning for contingent and
other liabilities is an issue where
management and legal judgements
are important. These are addressed
through the Committee discussing
with management the key
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judgements made, including National Grid non-standard transactions, the
relevant legal advice that may have ‘Financial reporting: The committee treatment of exceptional items and in
been received.’ monitors the integrity of the Company’s provision calculations.
financial information and other formal
Anglo American documents relating to its financial ‘Summarised below are some of the
‘Role and responsibilities: Monitoring performance and makes appropriate significant issues the National rid Audit
the integrity of the annual and interim recommendations to the Board before Committee considered in relation to the
financial statements, the accompanying publication. financial statements during the year
reports to shareholders and corporate (extracts only provided):
governance statements…At the ‘A key factor in the integrity of financial
December 2012 meeting the statements is ensuring that suitable and • US financial controls programme: An
Committee reviewed the significant compliant accounting policies are important milestone of the
audit and accounting items for the 2012 adopted and applied consistently on a programme took place when we
year end. This included the process for year-on-year basis and across the implemented a new enterprise
reviewing the valuation of the Minas-Rio Company. In this respect, the resource planning system, which
project, the accounting implications of committee also considered the went live during November and
the Platinum structure review and the estimates and judgements made by December 2012.
accounting treatment for De Beers.’ management when accounting for
• Environmental provision: At the half
Some companies sought to make year and year end we reviewed the
disclosures in this area more accessible Company’s environmental provision
by using diagrams and tables. to ensure that it remained
appropriate.
British Land
• Pensions: Movements in the market
value of plan assets and changes in
economic assumptions, principally
the discount rate, were noted along
with their consequential impact on
net pension and other post-
retirement liabilities.
• Recoverability and disclosure of
storm costs: The committee
discussed the disclosures around
the financial impact of Superstorm
Sandy in our half-year results
Aviva statement, and the impact of storm
costs on cash flows and working
capital.’
ENHANCING THE VALUE OF THE AUDIT COMMITTEE REPORT 7
COMMENTARY EXTRACTS
(2) An explanation of
The UK GC Code requires that audit Vodafone
how the audit
committees report on how they have ‘The effectiveness of the external audit
committee has assessed auditor effectiveness, not just process is dependent on appropriate
on whether they have or not. There are audit risk identification and at the start
assessed the
many ‘auditor effectiveness assessment of the audit cycle we receive from
effectiveness of the tools’ available. EY summarise the key Deloitte LLP a detailed audit plan,
parts of the process as follows. identifying their assessment of these
external audit process.
key risks. For 2012 the primary risks
Auditor assessment: Frequent areas of identified were in relation to goodwill
audit committee focus: impairment, provisioning for current tax
liabilities and deferred tax asset
• technical competence recognition due to the inherent
management judgement required in
• knowledge of company strategy and these areas. These risks are tracked
risks through the year whenever we receive
reporting from Deloitte LLP. We hold
• quality-control processes private meetings with the external
auditor at each Committee meeting to
• independence provide additional opportunity for open
dialogue and feedback from the
• professional scepticism Committee and the auditor without
management being present. Matters
• partner temperament typically discussed include the auditor’s
assessment of business risks and
• communication and reporting management activity thereon, the
transparency and openness of
• global capabilities. interactions with management,
confirmation that there has been no
The most detailed statement of how restriction in scope placed on them by
effectiveness was assessed was management, independence of their
provided by Vodafone – although the audit and how they have exercised
strong emphasis attributed to risk professional scepticism. I also met with
assessment by Vodafone suggests that the external audit partner outside the
reporting requirement ‘(1) Significant formal committee process throughout
issues considered in relation to the the year.’
financial statements’, has been
combined with reporting requirement Anglo American’s audit committee
‘(2) How the effectiveness of the report is more focused on audit process
external audit process is assessed’. effectiveness.
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Anglo American WPP
‘The effectiveness assessment involves ‘In line with the committee’s
a review, with the senior finance responsibility to review and appoint the
managers in each of the business units external auditors and approve their
and relevant corporate functions, of the remuneration and terms of
audit process, including the planning, engagement, in 2012 we monitored
execution and reporting activities along Deloitte’s independence, objectivity
with an assessment of the quality, and performance with reference to
quantity and leadership of each of the frequent reports from Deloitte during
external audit teams involved in the the year covering the overall audit
audit. Any improvement opportunities strategy and the progress and results of
identified are discussed with the the audit. The committee concluded
external auditors….’ that it continues to be satisfied with the
performance of Deloitte and that
In contrast to Vodafone and Anglo Deloitte continues to be objective and
American, the audit committee reports independent‘.
of National Grid, British Land and WPP
are far less detailed and focused – Finally, Aviva produced a good example
indeed the word ‘effectiveness’ is hardly of a ‘comply or explain’ statement.
used – two of the companies preferring
to use the word ‘performance’ instead. Aviva
‘Given the resignation of Ernst & Young
National Grid LLP as external auditor in early 2012 and
‘The annual review includes that PwC has only just completed its
consideration of: the external audit first full-year audit, no external auditor
process globally; the auditors’ effectiveness review was carried out in
performance; the expertise of the firm 2012. A review will be conducted in 2013.’
and our relationship with them; and the
results of questionnaires completed by
National Grid employees engaged with
the audit and members of the Audit
Committee’
British Land
‘In accordance with its normal practice,
the Audit Committee considered the
following: the performance of the
External Auditor, including: value for
money; and quality and effectiveness in
the Audit Committee’s own assessment
and, where available, according to
external regulatory review’
ENHANCING THE VALUE OF THE AUDIT COMMITTEE REPORT 9
COMMENTARY • ‘The performance of the External
(3) Information on the Auditor, including:
The UK GC Code requires audit – value for money, and
approach taken to the
committees to report publicly on the – quality and effectiveness in the
appointment or approach that they have taken to the Audit Committee’s own
appointment or reappointment of the assessment and, where available,
reappointment of the
external auditor. Disclosures in this area according to external regulatory
external auditor. frequently merged with those required review.
on audit tendering and assessment of
objectivity and independence, National • ‘The External Auditor’s:
Grid and British Land being examples – independence
of this. – compliance with relevant
statutory, regulatory and ethical
EXTRACTS standards, and
– objectivity, as assessed by the
National Grid Committee.’
‘An annual review is conducted by the
committee of the level and constitution Vodafone addresses the issue slightly
of the external audit and non-audit fees differently, providing one piece of
and the effectiveness, independence discretionary information that is found
and objectivity of the external auditors. in only one of the other reports
Following this year’s annual review, the reviewed – lead audit partner rotation.
committee is satisfied with the
effectiveness, independence and Vodafone
objectivity of the external auditors, and ‘The Committee considers the
recommend to the Board their reappointment of the external auditor,
reappointment for a further year. A including the rotation of the audit
resolution to reappoint PwC and giving partner, each year and also assesses
authority to the Directors to determine their independence on an ongoing
their remuneration will be submitted to basis. The external auditor is required
shareholders at the 2013 AGM’. to rotate the audit partner responsible
for the Group audit every five years. The
British Land current lead audit partner has been in
‘Following best practice and in place for three years…In accordance
accordance with its Terms of Reference, with section 489 of the Companies Act
the Audit Committee annually reviews 2006, a resolution proposing the
the audit requirements of the Group, reappointment of Deloitte LLP as our
both for the business and in the context auditor will be put to the shareholders
of the external environment, and at the 2012 AGM. There are no
considers whether to undertake a contractual obligations restricting the
formal tender. There are no contractual Committee’s choice of external auditor
obligations which would restrict the and we do not indemnify our external
selection of a different auditor. In auditor’.
accordance with its normal practice, the
Audit Committee considered the
following:
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