Audit Committees Receive Guidance on Issues Arising from Financial Crisis

As the financial crisis continues, audit committee are facing more and more challenges involving risk and uncertainties and valuing financial instruments The UK Financial Reporting Council has issued guidelines to help audit committees navigate the issues. The FRC has oversight of corporate governance. In 2003, the FRC set up an independent group to clarify the role and responsibilities of audit committees, which culminated in the Smith Guidance for Audit Committees within the overall corporate governance code.

Broadly, the audit committee should consider whether there is a need for additional disclosures about company circumstances, such as going concern issues, in preliminary announcements or other regulatory reports before the annual report is published. The committee should ensure that the annual report sets forth a fair review of the company’s business and how the business may have been changed to address the effects of the recession. Also, the committee should consider whether the board of directors needs to amend the strategic plan, including expectations of future growth and the company’s ability to sustain its business model

The audit committee must also ask if further analysis is needed of how the business has been affected by the recession. For example, if the terms of trade have been changed, the system of internal controls should be reconsidered. In particular, if sales terms and conditions have been changed, the company’s revenue recognition policy should be reviewed.

According to the FRC, the audit committee should also determine whether the company’s outside auditors have allocated sufficient additional resources to address heightened risks and, if not, negotiate to secure additional commitments. Moreover, the committee must be comfortable with the boundary between internal and external audit.

Regarding the vexing area of valuations, the FRC urged audit committees to ensure that there are procedures in place and that controls have been applied to the group’s use of models to generate cash flow and accounting valuation information, including the choice and consistent use of key assumptions. The committee must also consider if there should be changes to last year’s assumptions and whether those changes are consistent with external events.

When facing illiquid markets where securities are not traded, the committee must be satisfied that appropriate additional procedures have been taken to estimate fair values through the selection of market-based variables and the use of appropriate assumptions. Computer models used to estimate the value of assets must be tested for impairment, said the FRC, and assumptions underlying impairment tests must be consistent with how the prospects for the business have been described elsewhere in the annual report.

.