Monday, January 09, 2012

FRC Will Propose Changes to UK Corporate Governance Code on Auditor Selection and Audit Committee Reports

Noting that reporting by audit committees is often unenlightening, the UK Financial Reporting Council said that it would propose changes to the UK Corporate Governance Code and the related guidance on audit committees to stimulate more informative reporting and to extend the remit of the audit committee. The FRC also intends to propose that the independent outside audit of a company’s financial statements should be put out to tender at least every ten years. It is also possible that the FRC will consult on changes to the going concern provision in the Code, depending on the outcome of the current inquiry being led by Lord Sharman.

The FRC believes that how the audit committee actually discharges its duties is rarely covered and that very few audit committees report the key decisions taken or judgments made by the committee. The FRC also believes the current state of affairs threatens to undermine confidence in audit committees at a time when there is considerable skepticism about the effectiveness of the outside audit and the audit committee.

The proposed amendments to the Corporate Governance Code would extend the reports that the audit committee gives to the board and which subsequently appear in the annual report. The FRC will also consult on proposals to require clearer reporting on how the external auditor is selected. Recommendations on what companies should disclose about the selection process were incorporated into the FRC’s Guidance on Audit Committees in 2008 but, disappointingly, these have been followed by only one-third of companies.

The FRC Guidance on Audit Committees (formerly known as the Smith Guidance) is intended to assist company boards when implementing the sections of the Corporate Governance Code dealing with audit committees and to assist directors serving on audit committees in carrying out their role. The Guidance states that the audit committee section of the annual report should explain to shareholders how it reached its recommendation to the board on the appointment, reappointment or removal of the external auditors. This explanation should normally include supporting information on tendering frequency, the tenure of the incumbent auditor, and any contractual obligations that acted to restrict the audit committee’s choice of external auditors.

The initial recommendation of the Sharman Panel was that the FRC should move away from a model where disclosures about going concern risks are only highlighted when there are significant doubts about the company’s survival to one which integrates going concern reporting within a broader disclosure model in which the directors always report how they arrived at the going concern statement, as part of their discussion of strategy and principal risks in the company’s narrative report, with the audit committee report confirming that a robust process has been undertaken. The audit committee report should also provide an explanation of the material risks to going concern considered and addressed; and identify any that they have not been able to resolve.

The Panel believes that the auditor should comment in the audit report on the going concern section of the narrative report and of the audit committee’s published report, if these fail to provide the required information, and otherwise state that it has nothing to add. The final recommendations of the Sharman inquiry are expected in February of 2012. Lord Sharman was the Liberal Democrat Spokesperson for Trade and Industry/Business and Regulatory Reform from 2001 to 2010. Before that, he held numerous senior UK and international positions with KPMG