Corporate governance and reporting watchdog takes next steps to improve the quality of reporting and audit
On 1 September 2011 the Financial Reporting Council published a paper titled “Effective Company Stewardship – Next steps” (the Paper), setting out proposed reforms in the field of corporate reporting and audit. The Paper can be read here and the attendant press release can be read here. The Paper follows on from the FRC’s consultation document, “Effective Company Stewardship – Enhancing Corporate Reporting and Audit“, published in January 2011.
The most noteworthy of the measures in the Paper are:
- The FRC intends to consult on amending the UK Corporate Governance Code to require companies subject to the Code to put their audits out to tender every 10 years, or explain why they have not done so;
- Changes to the role of the audit committee, which would extend its remit and responsibilities; and
- The need for more work to be done to “demonstrate that auditors are achieving the fundamental purpose of an audit”.
Most of the FRC’s proposals apply principally to listed companies and in particular those listed companies that have to “comply or explain” with the UK Corporate Governance. The proposals around “Audit and the Role of Auditors” (see below) will be relevant to all companies.
The full list of proposed reforms and next steps, as reproduced from the Paper, is:
Narrative Reporting
1. The FRC will work with the Department for Business, Innovation and Skills to support implementation of the Government’s proposals on narrative reporting due to be published in the autumn. [We discuss the Government's work on narrative reporting in this post.]
2. The FRC will further develop the concept of, and model for, reporting standards to test further whether there is sufficient support for the development of narrative reporting standards, on a comply or explain basis where appropriate.
3. The FRC has established a steering group to help develop the concept of a Financial Reporting Laboratory. It is scheduled for launch in October 2011.
Strategy, Risk and Going Concern
1. The FRC believes that, in future, narrative reports should focus primarily on strategic risks rather than operational risks and those risks that arise naturally and without action by the company; and disclose the risks inherent in their business model and their strategy for implementing that business model.
2. The FRC has established an enquiry under the chairmanship of Lord Sharman of Redlynch to identify whether there are lessons to be learned by companies and auditors addressing going concern and liquidity risks. [We discuss Lord Sharman's enquiry in this post.]
3. The FRC intends to update the Turnbull guidance to reflect the lessons from its work on risk, and will also consider whether changes should be made to the UK Corporate Governance Code as a result of that work and the Sharman Enquiry.
4. The review of the Turnbull Guidance will not be a root and branch revision – rather it will be developed to reflect improvements in practice and to clarify the board’s responsibility for determining the nature and extent of the significant risks it is willing to take.
The Role of the Audit Committee
1. The FRC proposes that the audit committee should report to the whole board and, after that report has been accepted by the whole board of directors, it should be published in full in the company’s annual report.
2. The FRC proposes to develop and consult on revisions to the UK Corporate Governance Code and related Guidance for Audit Committees with the aim of extending the remit of the audit committee to include consideration of the whole annual report, including the narrative report, to determine whether the information provided is necessary for stakeholders to assess the performance and prospects of the company and whether the report, viewed as a whole, is fair and balanced.
3. A key aim of these changes is to enable effective interaction to take place between investors and companies – a key contributor to making the UK’s ‘comply or explain’ approach to corporate governance effective.
Audit and the Role of Auditors
1. The FRC believes that more needs to be done to demonstrate that auditors are achieving the fundamental purpose of an audit – namely to carry out an independent check into whether a company’s financial statements, including the decisions, judgements and estimates involved, have been properly prepared and are fair and balanced.
2. The FRC believes that auditors can and should provide increased insight into the audit process so as to reassure users of financial statements that all material matters have been properly disclosed.
3. To address the need for the contribution by auditors to be more transparent, the FRC proposes to review and consult on revisions to the auditing standards governing reporting by auditors to audit committees (ISA (UK & Ireland) 260) and audit reports (ISA (UK & Ireland) 700).
Other Aspects of the Audit Market
1. To address concerns relating to the length of time that some companies retain the same audit firm the FRC intends to consult on proposals to amend the UK Corporate Governance Code to require companies to put their audits out to tender at least once in every 10 years, or explain why they have not done so; and to require companies to publish an explanation in the annual report of the steps they took when deciding whether or not to put the audit out to tender and their reasons for proceeding in the way they did.
2. The FRC’s generally preferred approach is to avoid amending the UK Corporate Governance Code on a piecemeal basis and, so far as possible, it aims to co-ordinate the implementation of the proposals in this Paper with any that may arise from other initiatives currently under consideration unless there is an overriding case made for earlier action.
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