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Quarterly 35

Baroness Hogg – Sarasin Responsible Investment Conference

Why health and safety is key for business success

Social media – time for a governance framework

Where does the audit committee want to spend more agenda time?

The Sharman Inquiry

Financial reporting update

2 Audit Committee Institute

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About the Audit Committee Institute Recognising the importance of audit committees, the Audit Committee Institute (ACI) has been created to serve audit committee members and help them to adapt to their changing role. Sponsored by KPMG, the ACI provides knowledge to audit committee members and is a resource to which they can turn for information or to share knowledge.

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative, a Swiss entity. All rights reserved.


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Introduction 4

Baroness Hogg – Sarasin Responsible Investment Conference 6

Why health and safety is key for business success 10

Social media – time for a governance framework 12

Where does the audit committee want to spend more agenda time? 14

The Sharman Inquiry 16

Financial reporting update 20

Contents

For more information on the work of the ACI please click on our web site www.kpmg.co.uk/kpmg/aci

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Nicola Collins

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Tel: 020 7694 8855 e-Mail: [email protected]


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Welcome to the thirty-fifth edition of the UK Audit Committee Institute Quarterly – the publication designed to help keep

audit committee members abreast of regulatory matters, company law,

accounting & audit issues and changes in the corporate governance arena.

Introduction

Oliver Tant

Head of Audit KPMG in the UK



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In this issue of the ACI Quarterly we include a speech by Baroness Hogg, chair of the Financial Reporting Council, given at the Sarasin Responsible Investment Conference. Next, Andrew Walsh, KPMG, explains why health and safety compliance is key for business success. We also present two articles from the U.S. ACI on social media and audit committee agenda time.

We briefly set out the recommendations issued by the Sharman Inquiry regarding going concern and liquidity. This edition of the Quarterly finishes with our regular financial reporting update.

I encourage all readers to support the ACI. We each fulfil our own role, but by working together to raise awareness and share knowledge we can all help ensure we adopt leading practice in our roles as audit committee members.

I hope this publication serves its intended purpose of briefing you on the important developments affecting your role as an audit committee member. If you require further information, the ACI web site (www.kpmg.co.uk/aci/index. cfm) provides additional information, including the previous editions of the UK ACI Quarterly, and other useful publications, surveys and information. Q35


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6 October 2011

Baroness Hogg’s speech given at the Sarasin Responsible Investment Conference

“ Thank you very much for inviting me to speak at your conference today. For us at the Financial Reporting Council, it is always interesting to hear the views of investors and asset managers, so it is a real pleasure to be here. But most importantly, in these days of volatile and uncertain markets, it is also a timely opportunity to remind ourselves of the role that good governance and well-functioning boards can play in helping companies navigate through turbulent waters.



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I thought it would be useful to spend a little time today stripping away some of the detail and going back to some core principles. I want to focus my remarks on the contribution that directors can make. I don’t want to do this in a prescriptive way – but more because I believe that a clear understanding of the basic task helps us all to confront the issues.

The financial crisis, regulatory responses and market turbulence have presented us with some serious challenges to governance. How, for example, can boards of financial institutions reconcile accountability to regulators with their accountability to the shareholders who provide their capital? Or, to take an entirely different but equally topical question, how can directors of companies with a dominant shareholder exercise their responsibility to all?

Financial companies will inevitably be subject to more regulation in the wake of the global banking crisis. We all have to understand and live with that. Similarly it is not our job at the FRC to set standards on what companies should or should not be eligible for listing. That is the job of the Listing Authority, which derives its mandate from European and English law.

But it is our job to promote good governance, to help provide a framework that facilitates this and, where that framework exists, to encourage people to use it and to warn when we think it is at risk. We do this not for its own sake but because of the widely held belief in the UK that high standards of governance strengthen the ability of companies to make good strategic decisions and manage risk, and also reinforce their accountability to shareholders. The confidence that brings is good for the capital market and ultimately also, therefore, for

economic prosperity. London’s reputation as a market with high standards, where shareholders’ rights are respected, is critical to the flow of capital needed for growth.

It should go without saying – but unfortunately doesn’t, always! – that equity markets are crucial to our economic system. They enable companies to raise risk capital, and savers to share in the growth of successful enterprises. This role is often underestimated, or neglected, by policy-makers, particularly when the troubles of debt markets are so high on their agenda. But we had a reminder of the critical role of equity markets at the peak – perhaps I should say the last peak – of the financial crisis. When governments ran out of money and credit markets froze, it was equity investors who stepped up to the plate, with £50bn of rights issues in a single 18-month period in London alone.

I stress this point because an essential element in this dynamic is the accountability of companies, and their boards in particular, to shareholders. There is too much of a tendency, in certain parts of the European regulatory architecture, to see shareholders as part of the problem rather than part of the solution.

Of course not all shareholders behave like responsible owners! Some clearly exacerbated rather than restrained the foolhardiness of management in the credit bubble. Some have trading strategies that are avowedly uninterested in the concept of ownership. Fair enough – the market is there for all and it is not part of our role to dictate investment strategies. But to put it at its simplest, if governments and regulators usurp the rights attached to the providers of risk capital, those providers are likely to take their money elsewhere.



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It will always be easier for a director

to find a solution if he – or hopefully

increasingly she – has a clear

idea of the answer to the question:

“what am I here for?”

So all parties involved need to remain aware of their respective rights and responsibilities. And today, as I mentioned, I should like to highlight the position of independent directors, who can easily find themselves pulled in several different directions. These pressures can come from all quarters and from people whose motives may conflict – from management, regulators, dominant shareholders, short term traders, lobby groups, to name but a few. But it will always be easier for a director to find a solution if he – or hopefully increasingly she – has a clear idea of the answer to the question: “what am I here for?”

The best place to start is company law, because the statement of directors’ duties contained in the Companies Act not only codifies those duties but was also the culmination of a great deal of discussion, in particular, in relation to the concept of enlightened shareholder value introduced in section 172 of the Act.

This requires directors to act in a way “most likely to promote the success of the company for the benefit of its members as a whole.” It of course goes on to say that, in fulfilling this general duty, directors must have regard, amongst other matters, to the likely consequence of their decisions in the long-term, the interests of employees, business relations with suppliers and customers, community impact, the desirability of maintaining a reputation for high standards of business conduct, and the need to act fairly between members of the company. A director is obliged to have regard to these factors, not actively to promote them.

It’s not my purpose today to deliver yet more detailed guidance on what all this means. The FRC’s UK Corporate Governance Code is already, I hope, a good elaboration of best practice which commands a wide consensus of support, and we have also published guidance suggesting how companies can implement it productively. Rather than drill down further, my purpose today is to highlight the essence of this duty.

The following points seem both clear and important:

1. First, all board members have equal responsibilities as directors. The law makes no distinction between executive and non-executive in terms of duties owed to the company, although in practical terms the nature of their contribution will be different. Second, this duty requires all directors to consider the company’s “members as a whole.” They must act to promote the success of the company, not in their own or somebody else’s interest, or in the narrow interest of one particular shareholder. This overarching requirement should influence directors’ actions and should help them set priorities when confronted with the types of challenge outlined above.

2. We live in the real world. We can’t pretend that pressures and conflicts don’t arise, or that they can always be reconciled successfully. We should not expect more of directors than they can reasonably deliver. That’s like pretending no company should ever fail! But in dealing with these conflicts, the duty to promote the success of the company for the benefit of members as a whole should help directors to steer a straight course.

3. Incidentally, a director “representing” a dominant shareholder has the same duty to promote the success of the company for the benefit of members as a whole as an independent director, whose concern may be to ensure that the dominant holder does not trample over the interests of minorities. One reason, perhaps, why the block holder model appears to work in Sweden is that the dominant holders in that country seem prepared to act in the general interest of the company rather than in their own interest. The result is a much lower “block holder discount” than in companies where the dominant shareholder shows no such respect for minorities.



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Q35

For further information please visit:

www.frc.org.uk

Of course, as the financial crisis illustrated, there are failures of governance as well as of regulation. Just as we should not expect too much of directors, equally we should not expect too little. UK Shareholders now have the opportunity, in most major companies, of an annual election to vote off the board those who they reckon are not doing a good job, and every right to use that power.

But I start from the presumption that today, most directors do try to do their job conscientiously, and some indeed show remarkable courage in difficult circumstances. For our part we will always try to support the efforts of directors to carry out their duties. And – critically – we urge shareholders to do the same. Shareholders should be clear in their expectations, and consistent in their voting policies. That, in essence, is what stewardship is all about.

It is also crucial that regulators do not usurp the role either of shareholders or of boards. At the FRC we will sound warnings if we see the chain of accountability being threatened. Of course the regulation of financial firms has become more intrusive: when governments have to rescue commercial entities, they are bound to assert taxpayers’ rights.

But we obscure the responsibilities of directors (and for that matter, auditors) to shareholders at our peril.

We ourselves are embarking on reforms designed to streamline and focus our organisation to deliver its primary purpose, which is to promote good governance and reporting in order to foster investment. Everything we do, with respect to accounting, audit, actuarial standards, financial reporting, corporate governance and stewardship, should ultimately be directed to that end; and we should test everything we are asked to do against that objective. Indeed, part of our reform agenda is to seek to identify areas where we can and should do not more, but less.

So we will try to watch both sides of the coin! We will remind directors and shareholders, but also government and other regulators, of the purposes of the codes for which we are responsible. These purposes are to enhance governance and stewardship, not to act as a conduit for other policies, however desirable these may be. And, at the same time, we will sound warnings if we see signs of these principles becoming lost in the turmoil of conflicting international pressures.”


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Why health and safety is key for business success

Health and safety experts do not hinder business – they actively help. Andrew Walsh, Health and Safety Specialist, KPMG, explains the benefits of compliance.

The media, in particular, loves to embellish stories of local authorities ruling against hanging-baskets in public places or innocent games of conkers – stories that often, by the way, turn out to be myths.

All this is far from my reality as a health and safety adviser. In the corporate world, health and safety (H&S) experts aim to help businesses manage risk and protect employees without putting the brakes on operations. Virtually anything is possible with the right people and time to plan.

At the same time, the public is increasingly concerned about the possibility of big businesses not being held to account for wrongdoing or negligence. We’re seeing that concern in much wider public condemnation of corporate failure, as in the case of the Gulf of Mexico oil spill. There are much larger fines than ever before

with directors being personally held to account in court proceedings.

Recently, the Court of Appeal upheld a £400,000 fine and conviction against retailer New Look for a fire at its Oxford Street store in 2007. Earlier this year, the first successful conviction under the Corporate Manslaughter and Corporate Homicide Act, in which Cotswold Geotechnical Holdings was fined £385,000 following the death of a surveyor, caused shockwaves in the business world.

Simply put, board members and senior business people need to address health and safety in a much more transparent, concerted and strategic way. Regulators won’t tolerate major gaps in compliance or workplace fatalities and the conviction against Cotswold, a small company, may open the floodgates for more actions and higher fines.



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I believe board directors need to be able to state with conviction that they know for sure that all key risks are managed within their organisation. Often boards receive reports detailing leading and lagging indicators across a range of H&S issues. But does that tell them enough to enable them to properly scrutinise and lead the risk management process? Are they sufficiently curious about the mechanics and effectiveness of H&S procedures?

Many companies are going through restructuring and reorganisation, which may include headcount reduction or a different operational approach. They may have had an extensive safety management in place before, but they will need to review the relevance of those procedures for the newly reformed company.

It’s clear that investors and stakeholders are taking more interest in corporate H&S performance. For any multinational listed in London, there are calls for greater disclosure. What that will certainly reveal is that most H&S performance reporting systems aren’t up to the job. If production is solid and the share price is increasing, but injuries and even deaths still occur, then there is a gulf between internal controls, effectiveness of management and capability on the ground. Companies must foster a corporate safety culture with a focus on people once management systems and procedures are established.

When I ask board directors what their H&S strategy is, some of them question my approach because they don’t perceive that safety can be strategic. To identify what actually happens on the ground,

“the unwritten rules of the game”, a strategic approach is required. Increasing levels of sickness absence for example, can put pressure on resources to maintain normal production and be a marker that existing arrangements may be inappropriate.

I believe organisations should take every opportunity to learn from the mistakes of others, including catastrophes and disasters, irrespective of industry or geography. The Deepwater Horizon incident in the Gulf of Mexico demonstrates how H&S leadership must come from the top, how internal controls must be clear and effective and bureaucracy must be balanced with empowered management. A strategic approach to health and safety shouldn’t stop at reviewing internal events and procedures. It is a discipline that is all about the willingness to learn lessons. Q35



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Social media is no longer just social – these tools are commercial, and they are becoming a key element of business strategy. From engaging customers in real time, to adding sales channels, to enhancing market research, companies are discovering many ways to take advantage of social media. And this is only the beginning. But for all their advantages, social media also bring inherent risk, even to those companies not actively using them – e.g., threats to confidential information or intellectual property, reputational risk and the potential for regulatory infractions, to name a few. As a result, it is critical that management develop and maintain a clear-cut governance framework as a central part of its social media development initiatives. A key challenge for audit committees is to help ensure that management (often spearheaded by marketing and closely supported by legal/ compliance and IT) has in place a social media governance framework that effectively addresses the range of internal and external risks, and that it is designed to keep pace with the rapid speed at which this area is evolving.

Social media – time for a governance framework

To address this challenge we suggest five areas of

focus for audit committees:

Can management demonstrate

an understanding of how the use

of social media is evolving and

impacting the business – and the

associated risks?

How can social media impact our marketing strategy, our sales channels, and how we reach customers? How do social media affect our advertising and communications strategies, and how we listen to what the marketplace is saying about the company? Have we identified and communicated the risks posed by our use of social media, including unique risks to the organisation in areas such as workforce effectiveness, information protection, reputation risk and legal/ regulatory risk? How effective are our controls around these risks?

Is someone actively monitoring

the major social media networks

to identify potential problems

and opportunities?

Is the company using a social media-monitoring tool, and is the use of such a tool incorporated into the company’s enterprise risk management process? How does the company decide when to react to potential reputational issues being discussed in various social media – and, when needed, how does the company respond?



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Q35

Article produced by: Audit Committee Institute in the US

Do we have a single, clearly

defined policy regarding employee

use of social media both on the

company’s enterprise technology

and employees’ personal devices?

Employee use of social media raises a host of issues unique to the company, including employee commentary on company matters and workplace conduct, the protection of the company’s IP rights (logos, registered phrases, developing products, business plans), information privacy, proper use of company devices to access external social media sites, and the company’s right to monitor employee postings on those sites. What training on the use of social media do we provide employees?

Does the company’s social media

governance framework define

how the “voice of the company”

will be managed through use of

social media for marketing and

communications?

Without such guidance, employees by default become unsupervised spokespeople for the company. Investor relations and marketing/ communications should play a central role here. How will social media be used, and by whom? What is the target audience, and what behaviors do we want to drive? Have we identified and trained the organisations and key staff – and clarified roles and responsibilities – that will be accountable for the company’s social media activity? Do we have formal guidelines for all market-facing organisations? Do we have procedures for message approval so that key constituents (e.g., legal/regulatory, IR, marketing/ communications, et al) can have timely input?

How do we monitor compliance

with the company’s social media

policy? Who is responsible for

enforcement of the policy?

Internal audit may have a central role to play, focusing particularly on the adequacy of controls around the key risks posed by the use of social media, and auditing the adequacy of the company’s social media governance framework, including employee adherence to the policy – and the effectiveness of employee training. Boards should no longer be asking if social media will be used by the company; instead they should be asking for transparency in how social media are being used and managed across the enterprise.



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Where does the audit committee want to spend more agenda time?

As a barometer, audit committee agendas offer an important view – not only for directors but for management teams as well – of some of the critical issues that companies face in the current environment and in the months ahead. Even deeper insight can come from knowing where the audit committee wants to devote more of its agenda time. Clearly, audit committees will continue to focus the lion’s share of their attention on financial reporting issues. But in our 2011 Audit Committee Member Survey, respondents indicated four areas where they would like to devote more time over the next 12 months:

• IT risk and emerging technologies,

• risk management,

• corporate strategy, and the

• impact of public policy initiatives.

Risks posed by growth plans and innovation also featured prominently in the 250 survey responses – not surprising, given the tremendous pressures on companies to grow in a tepid economic recovery.



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Article by: Audit Committee Institute in the US

As you think about how your audit committee/board will prioritise and allocate its agenda time in the months ahead, consider the following survey findings as data points and discussion starters.

IT risk and emerging technologies were most frequently cited as the issues audit committee members want to devote more time to, and for good reason: only 61 percent of respondents said they were satisfied with their process to oversee IT risk, and they ranked the quality of the information they receive about IT risk lowest among all categories.

Few rated their company’s strategic planning process as “very effective” in dealing with the pace of technology change and innovation, and cyber-security was cited as the second-biggest systemic risk facing the organisation. The person audit committee members said they would most like to hear from more frequently was the CIO. Given the financial, legal, reputational and strategic issues posed by information technology – from cloud computing to social media to mobile devices – IT risk and data governance are rapidly moving beyond the IT shop and onto the board’s agenda.

Risk management is still a work in progress. While 42 percent of survey respondents said their company’s risk management system is “robust and mature” (up from 29 percent last year), an equal number said their risk management system requires “substantial work.” Many gave low marks to the quality of information they receive regarding “significant risks facing the business,” and want to hear more frequently from the CRO and mid-level management. Indeed, only 34 percent are satisfied that they hear dissenting views about the company’s risk environment and related controls.

With crisis readiness and response, systemic risk and supply chain issues of particular concern, audit committees want to spend more time on risk management. Fifty percent said their audit committee is responsible for oversight of the “risk process generally.” Growth plans, strategy and innovation risk are also likely to get more air time. As companies search for growth – which most survey respondents said will come mainly from new products and services, M&A and new talent – many audit committee members are concerned that the company has not effectively identified the risks to

its growth plans and implemented controls to monitor them, and some 70 percent are concerned about the risk posed by a “lack of innovation by the company.”

Corporate strategy, while clearly a full board matter, was ranked third highest among the issues audit committees want to devote more time to. The impact of public policy initiatives on compliance, controls, risk and reporting will continue to get considerable attention in the months ahead. Uncertainties (including “unintended consequences”) related to health care and tax reform, energy initiatives, financial services regulation, the impact of fiscal crisis and more, make business planning difficult and compliance challenging.

Coupled with current legal/regulatory mandates – including Dodd-Frank whistleblower rules, FCPA and the new U.K. Bribery Act – the changing public policy landscape will consume time and attention as companies work to ensure effective compliance and controls. At the same time, as a number of survey respondents noted, a key challenge will be staying focused on the business and the pursuit of performance. Q35



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The Sharman Inquiry – lessons for companies and auditors addressing going concern and liquidity



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On 8 March, 2011, the Financial Reporting Council

announced the launch of an Inquiry led by Lord Sharman.

The aim of the Inquiry was:

• to identify lessons for companies and auditors

addressing going concern and liquidity risks; and

• to recommend measures, if any, which are necessary to

improve the existing reporting regime and related guidance

for companies and auditors in relation to these matters. The Inquiry was also asked to

have regard to the proposals in the Financial Reporting Council’s paper Effective Company Stewardship – Enhancing Corporate Reporting and Audit. Although recent events most spectacularly exposed the vulnerabilities of the banks, which has led to many developments relevant to their going concern assessments, the Panel’s primary aim was to learn lessons that could be applied more generally. Many of the identified lessons learned by banks (such as the importance of rigorous stress testing) can be applied elsewhere, if appropriately adapted.



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Both solvency and liquidity risks are important considerations in understanding risks to the viability and success of the company.

The viability of a company’s business model and the risks to its success are fundamental aspects of stewardship and governance. The purpose of the going concern assessment and disclosures should be to provide information to stakeholders about these matters and they should be designed to encourage appropriate business behaviours (good risk decisions, informing stakeholders about those risks and early identification and attention to economic and financial distress).

There are a number of ways in which the current requirements present barriers to these desired behaviours: expectation gaps persist about when to give more detailed disclosures about going concern; the perception that a high hurdle for doing so implies less need for a robust going concern assessment process and for stakeholders to understand the key risks and vulnerabilities, below this threshold; and the binary disclosure model heightens fears that significant doubts disclosed will become a self fulfilling prophecy of failure.

The purpose of the going concern assessment should be clarified to address the expectation gaps

identified. The Panel is also recommending changes that would integrate going concern reporting with the Effective Company Stewardship proposals – a move to a model in which the directors always report how they arrived at the going concern statement, as part of their discussion of strategy and principal risks in the company’s narrative report, with the audit committee report confirming that a robust process has been undertaken and demonstrating its effectiveness. Auditors may then only need to signal where the directors fail to adequately describe their process and its outcome.

Outside the financial services sector, the principal focus of the going concern assessment appears to be on liquidity risk. Both solvency and liquidity risks are important considerations in understanding risks to the viability and success of the company. The Panel is recommending that for all businesses the going concern assessment should focus not only on short term liquidity risks but also on solvency risks that could threaten the company’s survival over the business cycle or that could cause

significant damage to the community and environment, bearing in mind the directors’ responsibilities under the Companies Act 2006.

These proposals should encourage greater integration of the going concern issue into the entity’s wider on going risk management and governance processes and reporting, encourage greater openness between companies and investors and enable investors and other stakeholders to be better informed on a ‘business as usual’ basis about a company’s key vulnerabilities.

This initial report is a consultative document. The report sets out the Panel’s preliminary recommendations and conclusions. Their principal focus to date has been on developing appropriate recommendations for listed companies. Views are being sought about extending the final recommendations to, or adapting them for, other entities. The Panel intends to issue a final version of its recommendations in February 2012 in the light of responses received and further discussions held between now and the end of the consultation period on 31 December 2011.



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Recommendation

1

The Panel recommends that the FRC should seek to establish protocols with BIS and with other regulatory authorities that will enable the FRC to take a more systematic approach to learning lessons relevant to the scope of its functions when significant companies fail, through assessing the underlying circumstances. This might be achieved through a combination of approaches, including analysis of Insolvency Practitioner reports and Inspector reports to BIS and inquiries by the FRC alone or in conjunction with BIS, other regulatory authorities and others appointed by them to investigate or inquire into such circumstances.

Recommendation

2

The Panel recommends that:

a. The FRC should seek to harmonise, and to clarify, the common purpose of the going concern assessment and disclosure process in the Code (and related guidance for directors and auditors) and in FRS 18 – and, in doing so, should reconsider whether the language of the provision of the Code, to the effect that the directors should state that the entity IS a going concern, is too definitive;

b. The FRC should engage with the UK LA to seek to maintain the existing congruence of the Code with Listing Rule 9.8.6 (3), in light of these changes; and

c. The FRC should engage with the IASB to seek amendments to IAS 1 to accord with the resulting position in the Code and FRS 18.

Recommendation

3

The Panel recommends that the FRC should review the Guidance for Directors to ensure that the going concern assessment:

• reflects the right focus on solvency risks, not only on liquidity risks, whatever the business. In relation to solvency risks, this should include identifying risks to the entity’s business model or capital adequacy that could threaten its survival, over a period that has regard to the likely evolution of those risks given the current position in the economic cycle and the dynamics of its own business cycles;

• is more qualitative and longer term in outlook in relation to solvency risk than in relation to liquidity risk; and

• includes stress tests both in relation to solvency and liquidity risks that are undertaken with an appropriately prudent mindset. Special consideration should be given to the impact of risks that could cause significant damage to the community and environment, bearing in mind the directors’ responsibilities under the Companies Act 2006.

Recommendation

4

The Panel recommends that, in taking forward its work on reporting under ECS, the FRC should move away from a model where disclosures about going concern risks are only highlighted when there are significant doubts about the entity’s survival, to one which integrates going concern reporting with the ECS proposals through seeking to ensure that:

a. the discussion of strategy and principal risks always includes, in the context of that discussion, the directors’ going concern statement and how they arrived at it; and

b. the audit committee report illustrates the effectiveness of the process undertaken by the directors to evaluate going concern by:

• confirming that a robust risk assessment has been made; • providing an explanation of the material risks to going concern considered and addressed; • identifying any that they have not been able to resolve;

and recommending that the FRC should amend standards and guidance for directors and auditors accordingly when the ECS proposals are finalised.

Recommendation

5

The Panel recommends that, as part of its work on auditor reporting arising from the ECS proposals, the APB should:

a. consider moving UK auditing standards away from the three category model for auditor reporting to a statement in the auditor’s report as to whether the auditor is satisfied that, having considered the directors’ going concern assessment process, they have nothing to add to the disclosures made by the directors about the robustness of the process and its outcome; and

b. seek to encourage the International Auditing and Assurance Standards Board to accommodate this approach in the International Standards on Auditing. Q35

For further information please visit: http://www.frc.org.uk/about/sharmaninquiry.cfm


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Financial reporting update

Shown opposite are the key developments during the last quarter for IFRS and UK GAAP:

Title of article Subject Effective date

IASB Exempting investment entities from consolidation requirements

Exposure draft Comments are required by 5 January 2012

IASB Revenue recognition Exposure draft Comments are required by 13 March 2012

FRRP FRRP Annual Report Annual Report N/A

IASB Boardroom diversity Changes to UK Corporate Governance Code

Financial years beginning on or after 1 October 2012



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Exempting investment entities from consolidation requirements

In August 2011, the IASB published its long-awaited proposals to amend IFRS 10 Consolidated Financial Statements to introduce a mandatory exemption for investment entities from the requirement to consolidate subsidiaries. The amendments would require qualifying investment entities to account for subsidiaries at fair value through profit or loss. The proposals are likely to be welcomed by funds that have previously argued that consolidating subsidiaries does not provide useful information to investors. They argue that investors in a fund monitor its investments’ performance on a fair value basis.

The IASB has defined what it believes to be an investment entity using six criteria supported by detailed application guidance. To comply with the criteria:

1) the entity’s only substantive activities must be investing in multiple entities for capital growth and/or investment income (there are several detailed provisions underlying this criterion);

2) the entity must have made an explicit commitment to investors that its purpose is to invest for capital growth and/or investment income;

3) the entity must be owned through units (e.g., shares) that give rights to a proportionate share of its net assets;

4) a significant part of the entity must be owned by independent investors who pool their funds to benefit from professional investment management;

5) the performance of nearly all of the entity’s investments must be evaluated on a fair value basis; and

6) the entity must provide financial information about its investment activities to investors.

The scope of the exemption is more likely to be too narrow than too wide. For example, because of the proposed limitations on the activities of an investment entity, a real estate fund that is actively involved in the development or operation of properties would not qualify. It is anticipated that some funds will be surprised to find they might not qualify because of the strict criteria proposed in the exposure draft (ED). Private equity sector and real estate funds in particular should review the criteria closely.

Comments are required by the IASB by 5 January 2012.

The IASB’s Press Release is available at: http://www.ifrs.org/News/Press+Releases/ED+investment+entities+aug+2011.htm


http://www.ifrs.org/News/Press+Releases/ED+investment+entities+aug+2011.htm


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Revised revenue recognition proposals

The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have issued a revised draft standard to improve and converge the financial reporting requirements of International Financial Reporting Standards (IFRSs) and US General Accepted Accounting Principles (GAAP) for revenue (and some related costs) from contracts with customers.

The boards decided to re-expose the proposals because of the importance of the financial reporting of revenue to all entities and the boards’ desire to avoid unintended consequences arising from the final standard. The proposed standard would improve IFRSs and US GAAP by:

• providing a more robust framework for addressing revenue recognition issues;

• removing inconsistencies from existing requirements;

• improving comparability across companies, industries and capital markets;

• providing more useful information to users of financial statements through improved disclosure requirements; and

• simplifying the preparation of financial statements by streamlining the volume of accounting guidance.

The core principle of this revised proposed standard is the same as that of the 2010 exposure draft: that an entity would recognise revenue from contracts with customers when it transfers promised goods or services to the customer. The amount of revenue recognised would be the amount of consideration promised by the customer in exchange for the transferred goods or services. However, in response to feedback received from nearly 1000 comment letters on the 2010 exposure draft and extensive outreach activities, the boards further refined their original proposals.

In particular they:

• added guidance on how to determine when a good or service is transferred over time;

• simplified the proposals on warranties;

• simplified how an entity would determine a transaction price (including collectability, time value of money, and variable consideration);

• modified the scope of the onerous test to apply to long-term services only;

• added a practical expedient that permits an entity to recognise as an expense costs of obtaining a contract (if one year or less); and

• provided exemption from some disclosures for non-public entities that apply US GAAP.

If adopted, the proposed standard would replace IAS 18 Revenue, IAS 11 Construction Contracts and related Interpretations.

Comments are required by the IASB by 13 March 2012.

The IASB’s Press Release is available at: http://www.ifrs.org/News/Press+Releases/rev+rec+reexpose+14+Nov+2011.htm

FRRP Annual Report

The Financial Reporting Review Panel’s Annual Report issued on 28 September presents a wide-ranging assessment of the current state of financial reporting in the UK. Highlighted issues include:

• Quality of corporate reporting: generally found to be good although the Panel expressed concern about the quality of reporting by some smaller listed and AIM quoted companies;

• Business reviews: the Panel continues to call for reviews which are fair and balanced and which reflect honest straightforward reporting of both the good and less good aspects of the company’s performance. It will still look for comprehensive disclosure where necessary. It notes that disclosure in RNS announcements is no substitute for disclosure within the annual report;

• Principal risks and uncertainties: the Panel notes widespread improvement in the description of these with boards now more likely to describe how they are taking action to mitigate the effects of risks and uncertainties; and

• Cutting clutter: the Panel feels that disclosure of immaterial or irrelevant detail is an indication that certain boards do not apply a materiality threshold when preparing their accounts. The Panel is encouraging boards to determine and apply a quantitative threshold and qualitative assessment for materiality with the aim of providing accounts that are more meaningful, focused and relevant to users.

Developments at the Panel The report identifies a number of areas that could well have a bearing on the Panel’s future work:

• the Panel’s emphasis for 2011/12 (being companies outside the FTSE 350) will look to focus on companies that have a market capitalisation of over £50 million to give better coverage of higher impact companies;


http://www.ifrs.org/News/Press+Releases/rev+rec+reexpose+14+Nov+2011.htm


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• the Panel found that its ‘characteristics of good corporate reporting’ guidance, provided for the first time last year, was well received and has included it again in the 2011 report;

• the Financial Reporting Council (FRC) will look to obtain a consensus on what shareholders expect when companies provide ‘explanations’ for departures from the UK Corporate Governance Code and, if a consensus is reached, the Panel might take a role in encouraging companies to provide more informative explanations; and

• feedback from audit committee chairs indicated that the Panel should focus on material and substantive issues and avoid more minor omissions. Whilst the Panel is clear that it discourages unnecessary disclosures it is not always able to identify whether an omitted item might be material at the time it raises its initial queries.

Statistics In the year to 31 March 2011 301 sets of accounts (2010: 308) were reviewed, including 33 (2010: 46) referred to the Panel. 141 companies (2010: 146) were approached by

the Panel for further information or explanation. Four companies (2010: 3) were the subject of a Panel press release and four other companies (2010: 5) made a reference to the Panel when explaining a correction in their accounts.

Detailed findings The review covers mainly accounts for financial years ending from December 2009 to September 2010. Matters of substance reported by the Panel include:

Capital management disclosures

The Panel’s targeted review found that the majority of companies failed to convey in any meaningful way how they assessed or managed capital. The Panel will continue to focus on this area, looking for summary quantitative data about what Boards manage as capital in addition to a description of objectives, policies and processes.

Business review -environmental disclosure

The Panel noted that the disclosure required should be based on what is needed to understand the development, performance or position of the company’s business and should look to be balanced.

Revenue Policies were found to be generic in nature and not focused on a company’s own particular products and services. Revenue recognition in media and information technology companies was a particular concern, with questions regarding sale of licences renewable annually, connection commissions and sales via third parties.

Deferred tax assets relating to unused tax losses

Loss-making companies were reminded to carry these assets only to the extent that it is probable that future taxable profits will be available.

Inclusion of entities within a company’s control

Judgement applied in some cases was questioned and insufficient disclosure of the basis for the judgements taken was identified.

Impairment of assets The Panel expects clear disclosure of pre-tax discount rates applied. Individual discount rates are expected where the entity has disparate activities. The Panel also noted the challenges in arriving at pre-tax discount rates from post-tax information and the need to use an up-to-date, asset-specific discount rate.

Business combinations The Panel queried whether asset purchases, particularly those which involve a mixture of assets along with employees, should instead be accounted for as business combinations. It also raised questions regarding whether all identifiable intangibles had been properly recognised in an acquisition and found that companies were recognising adjustments to prior period provisional fair values as current year items rather than restating comparatives as required by IFRS 3.

Segmental analysis Instances of apparent inconsistencies between narrative reporting on various elements of a group and the segments actually reported were questioned. Aggregation of segments which did not appear economically similar was also questioned.

The FRRP’s Press Release is available at: http://www.frc.org.uk/frrp/press/ pub2637.html

Boardroom diversity

The Financial Reporting Council (FRC) has amended the UK Corporate Governance Code to strengthen the principle on boardroom diversity.

The amendments call for listed companies to report annually on:

• their boardroom diversity policy (including gender);

• any measurable objectives that the board has set for implementing the policy; and

• the progress it has made in achieving the objectives.

In addition, the FRC will update the Code to include boardroom diversity as one of the factors to be considered when evaluating the board’s effectiveness. The new diversity provisions will apply for financial years beginning on or after 1 October 2012. However, the FRC strongly encourages all companies to apply and report on the diversity additions to the Code voluntarily with immediate effect.

The FRC’s Press Release is available at: http://www.frc.org.uk/ press/pub2645.html Q35


http://www.frc.org.uk/frrp/press/pub2637.html

http://www.frc.org.uk/ press/pub2645.html

http://www.frc.org.uk/ press/pub2645.html

The ACI launches its 2012 events programme

The ACI has recently sent its members the 2012 professional development programme for non executive directors. This year we will continue with the BOFI Programme for financial service organisations as well as build on the success of the Local Government Programme. We also have a broad range of events for other corporates that we feel will address your professional development needs.

Please contact:

Nicola Collins


Contact us

If you have feedback on this issue or would like to suggest a topic for a future edition, please contact:

Nicola Collins


www.kpmg.co.uk/aci

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.


The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

RR Donnelley | RRD-263057 | December 2011

http://www.kpmg.co.uk/aci



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