This article was first published in the January 2014 UK issue of Accounting and Business magazine.
If company boards are to set themselves a New Year’s resolution, improving the quality of audit committee reporting should be it. This is not just because the UK Competition Commission has recommended an advisory shareholder vote on the audit committee report. It is because this central part of the independent directors’ job must be better explained.
Wearing my CFA UK hat, representing users of accounts, I read several audit committee reports last year and gave feedback to the FRC’s Financial Reporting Lab, which published guidance in October.
If I had received £10 for every mention of the word ‘review’ to describe what these committees do, I’d be rich. With some honourable exceptions – Barclays has been in the vanguard – these reports tended to be bland and complacent.
One of the challenges for audit committees is that other contributors to annual reports have upped their game. Remuneration committees have been under constant pressure to disclose more. On the executive side, various initiatives on narrative reporting have fed through into more intelligent discussions of strategy and business models. The financial crisis has prompted better reporting of top or emerging risks, with mitigating action explained.
Take Debenhams’ report for the year to 31 August 2013: there’s a Q and A on the market context and an independent expert’s view on the changing nature of retail. Michael Sharp, chief executive, is asked how he is tackling declining store profitability and why he thinks it is worth opening more stores in an internet age.
Key performance indicators and their link to remuneration are spelt out. The CFO’s report is always a must-read. Debenhams’ explains capital allocation and has a table that links the main cashflow movements to the change in net debt.
After all that, the audit committee report is an anti-climax. The description of its role and activities has no distinguishing features. No shareholder would be any the wiser about significant financial reporting issues and how they were addressed.
This is not unusual and it indicates massive scope for improvement. A good example comes from Ashmore Group, the emerging markets investment manager. With a year-end of 30 June, it set out to modernise its audit and risk committee report – the same applied to the auditor’s report by KPMG.
‘Significant accounting matters’ in the audit committee report include whether carrying values for goodwill and other intangibles should have been impaired. The committee ‘critically reviewed the analyses performed by management’. The auditor talked about ‘headroom’ and the sensitivity of the outcome to the assumptions used. The issue was declared ‘a key audit risk’.
Now that does give investors a good prompt for questions. It also shows how the audit committee and the auditor can produce complementary reports. Committee chairman Nick Land, an FRC board member, is deliberately taking a lead. Gareth Horner, at KPMG, has spotted an area where value can be added by embracing proposed reforms – at national and international level – to auditing standards.
One of the trickiest tasks in the wake of the Competition Commission’s insistence on five to 10-year tendering is to reassure users about the audit committee’s ability to run that process. Schroders had a good try but was stumped when its first choice, KPMG, belatedly discovered it did not meet all the regulatory rules for independence.
The difficulty lies in convincing shareholders that the audit committee is really seeking out an auditor that will mount a robust challenge to management when the client is the company being scrutinised. As the pivot between shareholders and management, the committee has to demonstrate that it is, above all, representing the former’s interests.
Jane Fuller is former financial editor of the Financial Times and co-director of the Centre for the Study of Financial Innovation think-tank