A report by ACCA and CA ANZ highlights the duties of directors when it comes to financial reporting and guides them on where to challenge management
This article was first published in the January 2018 international edition of Accounting and Business magazine.
Directors’ responsibilities have increased steadily in recent years in almost every jurisdiction. Their duty of care to the organisation they govern includes the provision of useful and meaningful information for investors and other users of the financial statements.
The buck stops with directors when it comes to how well an entity fulfils its financial reporting obligations, yet directors are not expected to be accounting experts. They need to be able to understand enough to challenge accounting decisions applied in the financial statements, and to assess the independence and effectiveness of the audit.
A new guide from ACCA and its strategic alliance partner Chartered Accountants Australia and New Zealand (CA ANZ) addresses the gap between what directors need to know about financial reporting and the knowledge that those with no or limited accounting experience may have amassed. Directors Responsibilities for Financial Reporting: what you need to know sets out clearly what directors without a financial background need to know. Written in plain English, with clear explanations of some issues that often cause confusion (such as the distinction between solvency and going concern), the report is designed to be user-friendly and accessible.
The guide is structured around five questions:
- Who is responsible for financial reporting? The report explains that all directors are collectively responsible for meeting their obligations in relation to annual financial reporting. It adds that there is a distinction between the management, which is responsible for the operational process of the organisation, and directors, who are responsible for strategic oversight and for making sure that these operational processes are effective – although there may be overlap in some organisations.
- Why are directors responsible for financial reporting? The report explains that directors’ responsibilities arise from their duty of care to the organisation. Directors are accountable, on behalf of the organisation, to those who provide it with capital to operate. The financial statements are the primary vehicle to demonstrate this accountability.
- What are directors responsible for in financial reporting? The report sets out that while directors do not need to be accounting experts, they do need a level of financial literacy. They are expected to be able to read and understand financial statements, and to form a view on their accuracy, credibility and understandability. They are also expected to understand the processes for preparing and reviewing the statements. But they are not expected to prepare the statements, review transactions or reconciliations, or have detailed knowledge of internal controls.
- How do directors discharge their financial reporting responsibilities? ‘A good director will challenge the information and ideas presented by management and other parties and approach their role with an open mind,’ says the report.
- When do directors discharge their financial reporting responsibilities? The report says that while financial statements are generally prepared annually, directors should provide continuous oversight over the financial position of the organisation. ‘It is good practice for directors to review the financial reporting prepared by management at each board meeting,’ it points out.
The report outlines how directors, particularly those with a financial background, may be able to influence audit quality by:
- giving their views on financial reporting risk and the areas of the business that need specific audit attention
- considering whether audit resources are sufficient and allocated properly
- questioning auditors on their approach to the most subjective areas, such as the choice of accounting policies and the validity of management estimates
- encouraging an environment of open and candid communication between directors, management and the external auditors. ‘It is also good practice for the chair of the board, or audit committee, to meet with the external auditor without management present,’ the report adds.
The report’s appendix includes a list of questions that directors could consider asking management and the external auditors in order to meet their corporate oversight responsibilities. These include asking management about the key assumptions that were made in preparing the financial statements, the areas that required the application of most judgment, and the steps that were taken to mitigate any bias that may have affected those judgments.
Similarly, the directors may consider asking the external auditors which areas of management’s judgment they challenged during the audit and the responses to those challenges, and to identify the key areas of the financial statements that might be susceptible to error or misstatement.
The report details the legislative responsibilities of directors in Australia, New Zealand, the UK, Hong Kong, Malaysia and Singapore. Liz Stamford, CA ANZ’s general manager, policy, believes the guide will be an extremely important tool for directors working across Asia Pacific and Europe. ‘Directors have their own responsibilities and their own member bodies, but as this paper shows, we are playing a leading role in working with them so they better understand their requirements,’ she says.
Maggie McGhee, director of professional insights at ACCA, adds: ‘As well as important details on practice and process, this paper provides the questions directors need to be asking to make sure that the financial reporting process is sound and that the output of that process provides meaningful information to investors and other users. It’s a helpful reminder to our members across the world, particularly entrepreneurs and those working in and for small and medium-sized businesses, of this crucial aspect of corporate governance.’
Liz Fisher, journalist
"A good director will challenge the information and ideas presented by management and other parties and approach their role with an open mind"