FINANCIAL REPORTING AND IR

In 2014, audit committee agendas will be influenced by continuing economic uncertainty, globalization and geopolitical turbulence, more government regulation, and an interconnected world where technology is accelerating everything.

Focused yet flexible agendas, exercising judgment about what belongs (or does not belong) on the agenda, and taking deep dives on key risks and challenges facing the business, will be critical.

The following are key areas and actions that we recommend audit committees will need to keep top of mind.

Stay focused on job #1: Financial accounting and reporting

Challenging global economic conditions, coupled with major public initiatives like deficit reduction and tax reform, financial services regulation, new accounting standards and a complex regulatory environment, demand the attention of every audit committee. This will require continuing monitoring of fair value estimates, impairments, and management’s judgment of key assumptions underlying critical accounting estimates. It is also essential to have a solid understanding of management’s framework for making accounting judgments and estimates.

In addition, audit committees should stay apprised of key IASB and FASB projects (such as revenue recognition, leases, financial instruments, and insurance contracts), which have significant implications not only for the company’s financial reporting and accounting, but also staffing and resources, processes and, perhaps most significantly, IT systems.

Financial reporting quality starts with the CFO and the finance organization. Maintain a shared focus on leadership and talent. Make sure the team has the resources to succeed and encourage ongoing focus on the company’s long-term performance.

Monitor key regulatory changes and proposals impacting the external auditor’s role

Regulators globally are advancing an array of initiatives focused on enhancing auditor independence, objectivity and professional skepticism as part of an ongoing effort to improve audit quality and transparency.

These initiatives range from already enacted audit firm rotation requirements in Argentina and the Netherlands, and proposals on mandatory rotation and restrictions on non-audit services in the European Union, to Public Company Accounting Oversight Board (PCAOB) projects on audit quality indicators and proposed changes to the auditor’s reporting model. They may have a significant impact on the audit process across jurisdictions.

Audit committees should stay up-to-date on these initiatives and their implications and also assess the quality of audits by weighing key indicators such as the relevant knowledge and industry experience of the engagement team, feedback from management, and the audit firm’s internal quality reviews.

In terms of investor communications, consider expanding the audit committee’s report to provide investors with more insight into how the committee carries out its oversight responsibilities. 

Leverage internal audit

There may be a need to refine internal audit’s role, potentially sharpening its focus on key areas of risk and the adequacy of the company’s risk management processes generally.

Internal audit is most effective when focused on the critical risks to the business, including key operational and technology risks and related controls, not just compliance and financial reporting risks.

What’s changed in the operating environment? What are the risks posed by the organization’s sourcing, outsourcing, sales and distribution channels? Be sure internal audit focuses on the adequacy of management review controls (i.e. the precision of those controls and corresponding documentation).

Provide internal audit with clear expectations and assess whether it has the resources, skills, and expertise to succeed in the role that management and the audit committee envision.

Ensure ethics and compliance programs keep up with fraud and misconduct vulnerabilities

Whether moving quickly to capitalize on growth opportunities in new markets, leveraging new technologies and data, or dealing with more vendors and third parties across longer and increasingly complex supply chains, companies face heightened risk of fraud and corruption. These vulnerabilities, coupled with the multifaceted global regulatory environment – including CFPOA[1] in Canada, FCPA^[2] in the United States and the UK Bribery Act, the SEC’s whistleblower program, and the sheer volume and scope of new regulations – will require continuing attention.

Audit committees should ensure the company’s regulatory compliance and monitoring programs cover all vendors in the supply chain and clearly communicate the company’s expectations for high standards of ethics and social responsibility. More broadly, audit committees should recognize that the radical transparency enabled by Twitter, YouTube, Facebook and other social media has effectively put every company in a fishbowl. The company’s culture and values, its commitment to integrity and legal compliance, and ultimately, its brand reputation, are on display as never before.

Understand the company’s significant tax risks and tax risk appetite

The days are gone when tax was solely an expense to be managed. Companies today must deal with fundamental changes in attitudes and approaches to tax globally, with notions of ‘fairness’ and ‘morality’ influencing the debate.

Understanding the company’s international tax risks and the reputational implications will be important for audit committee members, particularly in light of efforts to address perceived base erosion and profit shifting techniques. Be prepared for individual countries to implement formal ‘tax transparency’ requirements, including quantifying the ‘total tax contribution’ made to the reporting jurisdiction. This will require that tax decisions take into account potential reputational risks and not simply whether the company has technically complied with the tax laws in various jurisdictions.

Given the importance and sensitivity of tax risk today, the company’s tax risk appetite should be carefully considered and articulated. Establish a clear communications protocol for the chief tax officer to update the audit committee regularly and ensure the adequacy of the company’s tax resources and expertise globally.

Investor Relations

The ever-increasing business and regulatory challenges facing companies operating in our increasingly global world show no signs of abatement. Audit committees are being expected to play a key role in providing direction, and support, to corporate managements as they navigate these turbulent times. Investor relations can play an important role in communicating to shareholders how their audit committees are delivering against those expectations.