Recent months have seen dramatic liquidity challenges for financial institutions and there are indications that these conditions are affecting the availability of credit to companies more generally.
Financial reporting issues are now coming to the fore because a substantial number of UK listed companies have financial years ending in December.
The Financial Reporting Council (FRC) believes that recent credit market conditions mean that the risks to confidence in corporate reporting and governance are higher than they have been for some years. The FRC believes that these increased risks require additional diligence on the part of preparers of accounts, members of audit committees and auditors this year.
Paul Boyle, FRC Chief Executive said:
“Corporate reporting and auditing will be particularly challenging this year and needs to be matched by increased diligence and then clarity as to the basis on which judgements have been exercised.”
The FRC believes that existing accounting standards, if applied with appropriate professional judgement, continue to be fit-for-purpose. However, with accounting standards which are predominantly principles-based, companies may find that their precise circumstances are not expressly provided for in the standards; indeed this is one of the strengths of such standards. Corporate reporting always involves the use of estimates and the exercise of judgement and those estimates and judgements are likely to be particularly challenging this year.
The need for judgement also applies to the business review which must be a fair review of the business and include a description of the principal risks and uncertainties facing the company.
The FRC has responsibility for the Combined Code on Corporate Governance and its associated guidance on internal control (the Turnbull Guidance) and audit committees (the Smith Guidance). While the FRC believes that this guidance continues to be appropriate, it felt that members of audit committees might find it helpful to have a reminder of some of the key issues to be considered in preparing corporate reports in the coming months.
The FRC has, therefore, prepared some additional questions for audit committees to consider. A first group sets out questions which are likely to be relevant to audit committees of all companies. A second group of questions is likely to be relevant to audit committees of financial institutions or other companies which make use of complex financial products. These sets of questions are not exhaustive but are intended to stimulate consideration and discussion of the relevant issues. These questions are attached as an Appendix.
The FRC’s Operating Bodies are taking a number of other actions which are relevant to addressing the risks. These include:
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Last month, the Financial Reporting Review Panel (FRRP) published the focus of its review activities in 2008/09. The FRRP has identified areas of annual corporate reporting that are likely to be of particular interest during a period of illiquidity in wholesale financial markets. The Panel will pay particular attention to disclosures relating to financing arrangements and uncertainties in the light of credit market conditions at the time of approval of financial statements. Directors and auditors may want to pay increased attention to these aspects of annual report and accounts.
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The Auditing Practices Board’s (APB) existing auditing standards and guidance address current issues, including auditing fair values and going concern. The APB plans, however, to issue a Bulletin in early January 2008 that will alert auditors to the issues and to help them locate the relevant standards and guidance.
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The Professional Oversight Board’s Audit Inspection Unit in its monitoring in 2008 will pay particular attention to the way in which auditors have dealt with the risks arising from the credit market conditions.
The FRC will keep these matters under review as the reporting season progresses.
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