Wednesday, October 03, 2012

UK FRC Issues New Guidance for Audit Committees

Audit committees should be composed of three independent directors, at least one of whom should have recent and relevant financial experience, said guidance recently issued by the UK Financial Reporting Council. The audit committee should review, and report to the board on, the significant financial reporting issues and judgments made in connection with the preparation of the company’s financial statements, having regard to matters communicated to it by the outside auditor.

While ultimately it is management’s responsibility to prepare accurate financial statements and disclosures, noted the FRC, the audit committee should consider significant accounting policies, any changes to them, and any significant estimates and judgments. Management should inform the audit committee of the methods used to account for significant or unusual transactions where the accounting treatment is open to different approaches. Taking into account the external auditor’s view, the audit committee should consider whether the company has adopted appropriate accounting policies and, where necessary, made appropriate estimates and judgments.

The audit committee should also review the clarity and completeness of disclosures in the financial statements, said the FRC, and consider whether the disclosures made are set properly in context. Where, following its review, the audit committee is not satisfied with any aspect of the proposed financial reporting by the company, it must report its views to the board.

Similarly, the audit committee should review related information presented with the financial statements, including the business review and corporate governance statements relating to the audit and to risk management. When board approval is required for other statements containing financial information, such as summary financial statements, significant financial returns to regulators and release of price sensitive information, whenever practicable the audit committee should review such statements first.

When requested by the board, instructed the guidance, the audit committee should review the content of the annual report and accounts and advise the board on whether, taken as a whole, it is fair, balanced and understandable and provides the information necessary for shareholders to assess the company’s performance, business model and strategy. This report will inform the board’s statement on these matters required under the UK Corporate Governance Code. In order for the board to make that statement, any review undertaken by the audit committee would need to assess whether the narrative in the front of the report was consistent with the accounting information in the back, so as to ensure that there were no surprises hidden in the accounts.

The guidance emphasized that the audit committee is the body responsible for overseeing the company’s relations with the external auditor. In that regard, the audit committee has the primary responsibility for making a recommendation on the appointment, reappointment and removal of the external auditors. 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 reappointment, a statement from the audit committee explaining its recommendation and should set out reasons why the board has taken a different position.

Further, the audit committee should annually assess, and report to the board on, the qualification, expertise and resources, and independence of the external auditors and the effectiveness of the audit process, with a recommendation on whether the external auditor be reappointed. The assessment should cover all aspects of the audit service provided by the audit firm, and include obtaining a report on the audit firm’s own internal quality control procedures and consideration of audit firms’ annual transparency reports, where available. It might also be appropriate for the audit committee to consider whether there might be any benefit in using firms from more than one audit network.

If the external auditor resigns, said the FRC, the audit committee should investigate the issues giving rise to such resignation and consider whether any action is required. The audit committee should evaluate the risks to the quality and effectiveness of the financial reporting process, and consider the need to include the risk of the withdrawal of their auditor from the market in that evaluation.

The audit committee should develop and recommend to the board the company’s policy in relation to the provision of non-audit services by the auditor, and keep the policy under review. The audit committee’s objective should be to ensure that the provision of such services does not impair the external auditor’s independence or objectivity.

In this context, the audit committee should consider a number of factors, including whether the skills and experience of the audit firm make it the most suitable supplier of the non-audit service and whether there are safeguards in place to eliminate or reduce to an acceptable level any threat to the independence of the audit resulting from the provision of such services by the external auditor. The audit committee should also consider the nature of the non-audit services; the fees for non-audit services relative to the audit fee; and the criteria which govern the compensation of the individuals performing the audit.

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