Caribbean Association of Audit Committee Members AUDIT COMMITTEES: MAKING CORPORATE GOVERNANCE WORK

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Caribbean Association of Audit Committee
MembersAUDIT COMMITTEES MAKING CORPORATE
GOVERNANCE WORK IN THE CARIBBEAN

• Castries, St. Lucia
• June 21 22, 2007

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AUDIT COMMITTEE FUNDAMENTALSTOPIC

• International Financial Reporting Standards

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Agenda

• Introduction to Financial Reporting and Investor
  Relations
• What are International Financial Reporting
  Standards (IFRS)
• Introduction to the Framework of Financial
  Reporting
• Bridging the Gap Management Accounts and
  Financial Statements,
• Understanding Financial Statement Assertions
• Probing Questions to ask of Management on
  Financial Reporting
• Closing remarks

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Introduction to Financial Reporting
Investor Relations
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Introduction to Financial Reporting and Investor
Relations
IGNORANCE IS BLISS???

• Think back to the ENRON debacle..
• Who would you say was most disadvantaged by the
  undoing of
• ENRON?
• Who would you say was most culpable for the
  demise of ENRON?
• What could the investors have done differently?
• What could those charged with corporate
  governance have done
• differently?
• How could more timely, higher quality financial
  information
• have made a difference?

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Introduction to Financial Reporting and Investor
Relations
INVESTOR RELATIONS

• WHAT ARE SOME OF THE NEEDS OF INVESTORS?
• Positive returns on investments.
• Information to assist in deciding when to buy,
  hold or sell an equity investment.
• More quality investment options from which to
  choose to increase their net worth.
• Accountability from management, Boards of
  Directors, Audit Committees in their stewardship.
• Confidence in quality of their investments.
• Confidence in quality of financial information
  relating to their investments.
• Information to assess (a) the ability of the
  entity to pay and provide other benefits to its
  employees, (b) the security of amounts lent to
  the entity, and (c) current and future
  obligations (eg. Litigation, pensions, capital
  commitments, etc).

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Introduction to Financial Reporting and Investor
Relations
FINANCIAL REPORTING

• WHAT IS THE MAIN OBJECTIVE OF FINANCIAL
• STATEMENTS?
• To provide information on the financial position,
  
• overall performance, cash flows and the entity's
  ability
• to adapt to changes in the economic environment
  in
• which it operates.
• The main objective of the financial statements is
  
• decision usefulness.

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Introduction to Financial Reporting and Investor
Relations
FINANCIAL REPORTING

• The 4 characteristics of the content and quality
  of financial
• statements are as follows
• Decision usefulness
• Qualitative factors Understandability
  Comparability
• Relevance Reliability
• Constraints Timeliness Cost-benefit
  balance
• True and Fair View

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Introduction to Financial Reporting and Investor
Relations
FINANCIAL REPORTING

• The financial reporting characteristics and
  constraints are all self
• explanatory. We will however take a closer look
  at these
• Understandability
• The information presented to the users should be
  in state that it is not
• confusing. There is a reasonable expectation
  that financial information is generally
  understood by those for whom it is prepared.

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Introduction to Financial Reporting and Investor
Relations
FINANCIAL REPORTING

• Comparability
• Users must be able to compare an entitys
  financial statements
• through time in order to identify trends in
  financial performance. Hence
• policies on recognition, measurement and
  disclosure must be applied
• consistently over time.
• Where an entity changes its accounting for the
  recognition or
• measurement of transactions, it should disclose
  the change in the Basis of Accounting section of
  its financial statements and follow the guidance
  set out in IFRS.

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Introduction to Financial Reporting and Investor
Relations
FINANCIAL REPORTING

• Relevance
• The information presented to the users is
  relevant if it has the capacity to influence
  users economic decisions. Relevant information
  will help users to evaluate the past, present
  and, importantly, the future events in an
  entity.

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Introduction to Financial Reporting and Investor
Relations
FINANCIAL REPORTING

• Reliability
• The information presented to the users must
  represent faithfully the effect of transactions
  and events that it reflects. The true impact of
  transactions and events can be compromised by the
  difficulty of measuring transactions reliably.
  Financial information is reliable if it is free
  from material error and is complete. Information
  is material if its omission or misstatement could
  influence decisions that users make on the basis
  of the financial statements.
• Reliability is a function of several factors
• Reliability of underlying information prepared by
  the Companys information (IT) system
• Reliability of underlying management information
• Expertise and competence of the Companys
  financial professionals
• Expertise and competence of the Board of
  Directors and
• Expertise and competence of the Audit Committee.

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Introduction to Financial Reporting and Investor
Relations
FINANCIAL REPORTING

• The Organisation as a whole has a responsibility
  to ensure the
• quality of the financial information disseminated
  for the
• consumption of the users.
• Specifically, the following groups are
  accountable for the
• quality and reliability of the financial
  information disseminated
• Management
• Board of Directors
• Audit Committee

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WHAT ARE INTERNATIONAL FINANCIAL REPORTING
STANDARDS (IFRS)
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What are International Financial Reporting
Standards (IFRS)?
IFRS

• International Financial Reporting Standards
  (IFRS) refers to the
• group of standards issued by the International
  Accounting
• Standards Board (IASB) as guidance in
  preparation of financial
• statements.
• IFRS is one of several frame works that an
  organisation can adopt for the preparation of its
  financial statements. E.g., in the UK there is
  UK GAAP, in the USA there is US GAAP. Globally
  IFRS is one of the most widely used frame-works
  for the preparation of financial statements.

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What are International Financial Reporting
Standards (IFRS)?
IFRS

• The Standards provide guidance for preparers to
  deal with
• The recognition,
• The measurement,
• The presentation and
• The disclosure requirements for transactions and
  events.
• Most IFRS are intended for application across
  industries. A second
• tier of guidance comes from the Interpretations
  developed by the
• Standing Interpretations Committee, now IFRIC.
  These
• pronouncements clarify or interpret the standards
  where the preparer community identifies the need
  for improved guidance.
• The IASB has issued a total of 68 exposure drafts
  (EDs), 41 International Accounting Standards
  (IAS), 8 International Financial Reporting
  Standardsand 25 Interpretations of IAS (IFRICs).

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What are International Financial Reporting
Standards (IFRS)?
IFRS

• The focus of international standard setting is on
  profit-oriented reporting entities,
• including non-corporate entities such as mutual
  funds. Despite concentrating on
• profit-type entities, the IASB envisages that
  non-profit entities in the private and
• public sectors may nevertheless find its
  Standards an appropriate basis for financial
  reporting.
• A non-profit entity that states compliance with
  IFRS should, however, comply with IFRS in full.
• A profit-oriented reporting entity is one that
  reports to users, who rely on the
• financial statements as a major source of
  financial information about the entity.
• IFRS are directed to the information needs of
  users such as investors and potential investors,
  employees, lenders, suppliers, creditors,
  customers, governments and the public at large.

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What are International Financial Reporting
Standards (IFRS)?
IFRS

• The term financial statements refers to several
  statements that
• display different aspects of the entity's
  financial performance.
• Financial position is reflected in the balance
  sheet and a statement of changes in shareholders'
  equity.
• Financial performance is reported in the income
  statement and
• liquidity position in the cash flow statement.
• These statements are supplemented by a series of
  detailed notes.

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Introduction to the Framework of Financial
Reporting
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INTRODUCTION TO THE FRAME-WORKOF FINANCIAL
REPORTING
International Financial Reporting Standards

• WHY IFRS?
• What GAAP is currently used by your entity?
• What is the recognised / codified frame-work of
  your territory/ island/ country?
• The IASBs goal is that of establishing an
  accounting frame-work which can be used globally
  allowing for consistency, transparency and
  comparability in financial information and
  overall international harmonisation.

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INTRODUCTION TO THE FRAME-WORKOF FINANCIAL
REPORTING
International Financial Reporting Standards

• WHO IS THE IASB?
• The IASB is the international standard setting
  body responsible for existing
• IASs, IFRSs and future standards.
• The IASB achieves its objectives primarily by
  developing and publishing
• IFRSs and promoting the use of those standards in
  general purpose
• financial statements and other financial
  reporting. Other financial
• reporting comprises information provided outside
  financial statements that
• assists in the interpretation of a complete set
  of financial statements or
• improves users ability to make efficient
  economic decisions.
• In developing IFRSs, the IASB works with national
  standard-setters to
• maximise the convergence of IFRSs and national
  standards.

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INTRODUCTION TO THE FRAME-WORKOF FINANCIAL
REPORTING
International Financial Reporting Standards

• The IASBs objective is to require like
  transactions and events to be accounted for and
  reported in a like way and unlike transactions
  and events to be accounted for and reported
  differently, both within an entity over time and
  among entities.
• Consequently, the IASB intends not to permit
  choices in accounting treatment. Also, the IASB
  has reconsidered, and will continue to
  reconsider, those transactions and events for
  which IASs permit a choice of accounting
  treatment, with the objective of reducing the
  number of those choices.

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INTRODUCTION TO THE FRAME-WORKOF FINANCIAL
REPORTING
International Financial Reporting Standards

• WHY IFRS?
• The adoption of IFRS (encouraging international
  harmonisation
• convergence) is seen to have several potentially
  positive affects for
• regional development and institutions in
  developing economies in
• general, with regards to their financial
  reporting. Specifically, where
• financial information is prepared under a
  universally understood frame-work
• - Access to international financing and
  investment opportunities (growth in foreign
  investment) increases.
• - Ability to establish linkages, partnerships,
  networks, mergers, etc. (e.g., correspondent
  banks, international related parties) increases
  and
• - Ability to comply with non local /
  international financial reporting requirements
  that may arise as a result of cross-border
  transactions increases.

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INTRODUCTION TO THE FRAME-WORKOF FINANCIAL
REPORTING
International Financial Reporting Standards

• HOW SHOULD STANDARDS BE IMPLEMENTED?
• Once an entity adopts IFRS it must comply with
  all of the Standards and
• Interpretations, despite any differences that may
  exist between an entitys local GAAP and IFRS.
  (E.g., loan loss provision per IAS 39 versus
  local Central Bank).
• All changes of each individual standard must be
  implemented at the same point. Selective
  application of different elements within an
  individual standard is not permitted.

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Bridging the Gap Management Accounts
Financial Statements, Understanding Financial
Statement Assertions
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Bridging the Gap
Management accounts Summary

• These are primarily financial information
  prepared for internal purposes only.
• Management accounts are prepared for management
  information purposes.
• These are used for managements decision making
  within the business.
• These do not generally take a prescribed format.

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Bridging the Gap
Financial statements Summary

• These are primarily financial information
  prepared for external purposes.
• Financial statements are used by different
  stakeholders for varying information purposes.
• These are used for a wide range of
  decision-making.
• These generally take the prescribed format, as
  shown below

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Bridging the Gap
Financial statements Summary

• A complete set of financial statements includes
• a balance sheet,
• an income statement,
• a statement showing either all changes in equity
  or changes in equity other than those arising
  from capital transactions with owners and
  distributions to owners,
• a cash flow statement, and
• accounting policies and explanatory notes.
• The term financial statements includes a
  complete set of financial statements prepared for
  an interim or annual period, and condensed
  financial statements for an interim period.

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Bridging the Gap
Financial statements Summary
Underlying assumptions Financial statements
must be prepared on the accrual basis of
accounting, and on the assumption that the entity
is a going concern. The accrual basis requires
that the effects of transactions and other events
are recognised as and when they occur and not
when cash is received or paid. Financial
statements should be prepared on the assumption
that the entity is a going concern and will
continue to operate for the foreseeable future.
Hence the user can assume that the entity has
neither the intention nor the need to liquidate
or curtail materially the scale of its
activities. The going concern basis of
accounting should only be abandoned when the
entity cannot or will not continue to operate for
the foreseeable future.
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Bridging the Gap
Can the Gap be Bridged?
The characteristics of financial statements
prepared under a recognised financial reporting
frame-work, results in these being distinctive
from management accounts. There will continue
to be a gap between the level of reliance that
can be placed on management accounts (generally
low) compared to the reliance that can be placed
on financial statements once certain differences
exist. The Gap between the level of
reliability that can be placed on Management
accounts compared to Financial statements is
primarily reflective of the following - The
fact remains that management accounts are
generally not prepared within the context of a
financial reporting frame-work and - They tend
to be less reliable as there information content
is driven by the needs of management (who within
this context is usually the primary and only user
of these statements).
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Bridging the Gap
Understanding financial statement assertions
Accuracy
Completeness
Valuation Allocation
Existence/Occurrence
Cut-off
Classification Understanability Presentation
Disclosure
Rights Obligations
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Bridging the Gap

• Management is responsible for the fair
  presentation of the financial statements. This
  is a requirement of International Standards on
  Auditing (ISA 500.5).
• In representing that the financial statements are
  true and fair/presented fairly, in all material
  respects, in accordance with the applicable
  financial reporting framework, management
  implicitly makes the assertions as stipulated in
  ISA (ISA 500.15). Risks of material misstatement
  at an assertion level are assessed by considering
  the different types of potential misstatements
  that may occur. Management is expected to design
  and implement controls and procedures that are
  responsive to mitigating against those risks.

Can the Gap be Bridged?
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Bridging the Gap

• Assertions about classes of transactions and
  events for the period under audit include
• Occurrence  transactions and events that have
  been recorded have occurred and pertain to the
  entity
• Completeness  all transactions and events that
  should have been recorded have been recorded
• Accuracy  amounts and other data relating to
  recorded transactions and events have been
  recorded accurately
• Cutoff  transactions and events have been
  recorded in the correct accounting period
• Classification transactions and events have been
  recorded in the proper accounts

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Bridging the Gap

• Assertions about account balances at the period
  end include
• Existence assets, liabilities and equity
  interests exist
• Rights and obligations  the entity holds or
  controls the rights to assets and liabilities are
  the obligations of the entity
• Completeness  all assets, liabilities and equity
  interests that should have been recorded have
  been recorded
• Valuation and allocation  assets, liabilities
  and equity interests are included in the
  financial statements at appropriate amounts and
  any resulting valuation adjustments are
  appropriately recorded

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Bridging the Gap

• Assertions about presentation and disclosure
  include
• Occurrence and rights and obligations  disclosed
  events, transactions, and other matters have
  occurred and pertain to the entity
• Completeness  all disclosures that should have
  been included in the financial statements have
  been included
• Classification and understandability financial
  information is appropriately presented and
  described and disclosures are clearly expressed
• Accuracy and valuation financial and other
  information are disclosed fairly and at
  appropriate amounts

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Probing questions to ask management
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Probing Questions to Ask Management
FINANCIAL STATEMENTS

• What financial reporting frame-work are the
  financial statements prepared under?
• Has IFRS been followed in its entirety (where
  applicable)?
• Has IFRS adoption been modified in any way as a
  result of custom or local practice or regulation?
• What are the accounting policies adopted in
  preparing the financial statements?
• For each balance sheet and income statement item,
  which standard is applicable? Has the standard
  been properly applied?
• Have the accounting policies been consistently
  applied on a yearly
• basis?

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Probing Questions to Ask Management
FINANCIAL STATEMENTS

• What are the complex accounting issues in the
  Companys financial statements?
• Have all assets and liabilities whose recognition
  is required by IFRS been recognised? Has all
  applicable IFRSs been applied in measuring the
  Companys assets and liabilities?
• Have all disclosure matters required under the
  following (presentation related) standards been
  addressed?
• - IAS 1 Presentation Disclosure (e.g. Critical
  accounting estimates and judgments)
• - IAS 24 Related Party Disclosure
• - IFRS 7 Financial instruments Disclosure
• Has revenue been duly reported within the context
  of IAS 18?

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Probing Questions to Ask Management
MANAGEMENT INFORMATION

• Have all underlying accounts been reconciled and
  reconciling items duly investigated and resolved?
• Have all bank accounts been reconciled and agreed
  with the Bank?
• Have all suspense accounts been reconciled and
  cleared out in a timely manner?
• Have all provisions and accruals been properly
  established within the context of IAS 37?
• Has all the information in the underlying sub
  ledgers been reconciled to the general ledger and
  included in the accounts?

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Probing Questions to Ask Management
MANAGEMENT INFORMATION SYSTEMS

• Have there been any issues / problems during the
  year with the Companys IT systems?
• Has there been any upgrades or enhancements to
  the Companys IT systems ?
• How has internal audit been involved with the
  internal control environment during the year?
• Were there any weaknesses and / break-downs in
  internal controls that internal audit became
  aware of? How have these been remedied?

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Probing Questions to Ask Management
OTHER QUESTIONS

• Have there been any instances of regulatory non
  compliance, breaches of loan covenants, litigious
  exposure, etc.?
• Have all balances included in the financial
  statements that are based on expert information
  been supported by the experts report? For
  example, pensions based on IAS 19.
• Have investment securities been included in the
  financial statements at fair value within the
  context and guidance of IAS 39?
• How has fair value been determined for thinly
  traded equity securities?
• How has the loan loss provision been derived?

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Closing Remarks
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Regional Governance Committees must
take up the challenge posed by a more complex
financial reporting environment, as the
stakeholders expect more accountability and also
become more sophisticated/knowledgeable.IFRS is
a proactive move towards international
harmonisation.Lack of Local GAAP in some
territories continues to undermine regulation,
monitoring and consistency in financial
reporting. A frame-work must be followed for
consistency, transparency and comparability to be
demonstrable.A lack of knowledge and / or
expertise at the senior levels of organisations
can only undermine the decision usefulness of the
financial statements.
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Membership on a governance committee
must be seen in a new light. This is a position
of fiduciary responsibility and where one lacks
the skill set, expertise, willingness, available
time, etc to act in a effective and efficient
manner, one should not hold such an office as
such a person would generally add no value to
achieving the objectives of a properly
functioning Audit Committee. As a Board sub
committee, the onus is on the Companys directors
to hire suitably qualified committee members!
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OVER TO YOU!