Audit Committee Quarterly

Issue 11

March 2007

Welcome 1

ODCE guidance on auditcommittees 2

Local regulatory update 5

Confronting earningsmanagement 8

IFRS implementation findings 10

EU matters 12

Other international matters 14

Financial reporting update 18

Events 20

Sponsored by

Audit Committee Institute Ireland

Issu

e11

Background

Recognising the importance of audit committees, Audit Committee InstituteIreland (ACI) has been established to serve audit committee members and helpthem to adapt to their changing role.

Historically, audit committees have largely been left on their own to keep pacewith rapidly changing information related to governance, audit issues, accountingand financial reporting. Supported by KPMG, the ACI provides knowledge to auditcommittee members and a resource to which they can turn at any time forinformation or to share knowledge.

Our primary objective is to communicate with audit committee members andenhance their awareness and ability to implement effective audit committeeprocesses.

The ACI aims to serve as a useful, informative resource for audit committee membersin such key areas as:

� audit committee governance, technical and regulatory issues;

� sounding board for enhancing audit committees' processes and policies;

� surveys of trends and concerns.

The ACI is now in direct contact with over 1,000 audit committee members. For more information on the work of the ACI please click on our Web site:

www.auditcommitteeinstitute.ie or e-mail: info@auditcommitteeinstitute.ie

Welcome to the latest edition of Audit Committee Quarterly Ireland, a publication designedto help keep audit committee members abreast of developments in corporate governanceand related matters. For those of you new to Audit Committee Institute (ACI) and thispublication in particular, a brief outline of the background to ACI is set out opposite.

The ODCE guidance on audit committees was issued just before Christmas. Commentaryand evaluation of the guidance is included on page 2.

Given the current intense focus on public company financial reporting, Confronting

earnings management on page 8 provides guidance for audit committee members asinvestors and regulators demand better transparency.

The Financial Reporting Review Panel in the UK has issued its first report outlining thepreliminary findings of its review of IFRS implementation by listed companies. IFRS

implementation findings on page 10 highlights a number of issues of relevance to UK and Irish companies planning the preparation of their second IFRS annual accounts.

Also included are our regular round ups of regulatory developments locally on page 5 andinternationally on pages 12 and 14 together with an update of selected financial reportingmatters on page 18.

I hope you will continue to enjoy the ongoing benefits of ACI. Please contact us atinfo@auditcommitteeinstitute.ie with any comments or suggestions of topics you would like to see covered and do visit our website at www.auditcommitteeinstitute.ie for furtherinformation on ACI.

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Kevin O’DonovanChairmanAudit Committee Institute Ireland

Welcome

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ODCE guidance on audit committees

The Director of Corporate Enforcement, Mr PaulAppleby (Director) has chosen to leavecomments on broader issues to the Minister,making the focus of the guidance – issued asDecision Notice D/2006/1 – primarily a rehearsalof the 2003 Act’s requirements couched in morestraightforward language than tends to be usedfor legislation, with little added comment. This isnot without value, as anything that helps to makethe law better understood is beneficial – but isperhaps also a lost opportunity, in terms ofdeveloping thinking and a thoughtful applicationof best practice in audit committee work to theIrish environment.

The Director also chose to publish beforecommencement of the relevant section of the2003 Act, with an accompanyingrecommendation to the Minister that therequirements be brought into effect fromsummer 2007 – albeit with a clearacknowledgement in his letter to the Minister,available on the ODCE website, that manycommentators had suggested a longer period forreflection, particularly in light of the need toassess the impact of the finalised 8th Directive’sprovisions.

The Director’s decision to refer broadercomments to the Minister rather than attempt todeal with their implications directly could also betaken to imply that there are underlyingdifferences in approach that cannot be reconciledby giving interpretational guidance. Certainly,

despite its merits, the guidance does not providedirection on two key points, highlighted below.

What practical arrangements and day-to-dayoperations will meet the Act’s requirements in amanner that enhances business and governancein a cost efficient manner?

Analysing the extent to which pre-existingarrangements may or may not meet the 2003Act’s provisions is crucial. Many companies haveprovisions in place to meet the principles of theCombined Code on Corporate Governance – notjust listed companies, who are required by theListing Rules to apply the Code but others whohave chosen to adopt similar practice or arewithin scope of the Department of Finance’sCode of Governance, which draws on theCombined Code. Such an assessment is ofparticular importance as the wording of the Act’sprovisions suggests an underlying logic that isnot compatible with the Code, as the next issueillustrates.

Does Ireland’s implementation of the 8thDirective mean that we need to reconsider the 2003 Act’s provisions?

The Act and the Directive take rather differentapproaches in setting out their requirements –immediately noticeable is that the Directive setsAudit Committee obligations at a rather higherlevel, giving only four duties compared with theAct’s more detailed fourteen. Of itself, that is nota difficulty, though the wisdom of having detailed

The Office of the Director of Corporate Enforcement (ODCE) Paper on auditcommittee responsibilities, issued just before Christmas, raised expectations ofan interesting read, judging by the range of comments and suggestionsprompted by the consultation draft issued earlier in 2006. In this article ShelaghMcAlpine, Director, KPMG, evaluates and comments on the Paper.

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prescriptive requirements in primary legislationcan be queried. However, there are otherdifferences that merit attention, as set out below.

What type of entity needs an auditcommittee?

The 8th Directive’s provisions have a clear focuson public interest. Those entities that are ofpublic interest are those it determines asneeding audit committees, with some allowancefor member states to apply judgment indetermining how to apply this concept inparticular cases.

The 2003 Act on the other hand focuses directlyon public limited companies and larger privatecompanies limited by shares. This could be seenas a sub-set of “public interest” entities – but isit? Is a private company owned and run by itsshareholder/directors within the 8th Directiveprovisions simply because it is successful? Is anorganisation that is established as a companylimited by guarantee automatically not of publicinterest?

Who should be a member of an auditcommittee?

The Directive gives member states a choicebetween non-executive members of the board orother members appointed by the company’smembers in general meeting. It goes on torequire that there must be at least one memberwho is:

� independent;

� competent in accounting and/or auditing.

This is a clear extrapolation of the public interestconcept into ensuring that the audit committee isplaced to comment on and challenge theexecutive’s approach.

In contrast, the 2003 Act indicates that the auditcommittee must consist of two or moredirectors, other than the chairman of the board,provided that they have not been employees ofthe company or one of its subsidiaries in the lastthree years. The appointment is entirely withinthe control of the executive – members are to besuch as the board sees fit.

The Act makes no mention of independenceand has no requirement for accounting orauditing competence. These two qualities areessential if audit committees are to have any value.

It also appears that the Act may bar non-directormembers being co-opted to the committee,which would mark a significant change in practicefor part of the Irish business community. This tooneeds some reassessment.

What should an audit committee do?

Leaving aside any issues raised by the Act’sgreater level of detail, there are also differencesin the way it and the Directive describe thecommittee’s responsibilities.

The Directive speaks in terms of “monitoring”and “reviewing”, stating the committee is to:

� monitor the effectiveness of the company’sinternal control, internal audit whereapplicable, and risk management systems;

� monitor the statutory audit of the annual andconsolidated accounts;

� review and monitor the independence of thestatutory auditor or audit firm, and in particularthe provision of additional services to theaudited entity.

It also prefaces the requirements by stating thatthe provisions are without prejudice to the dutiesof the board as a whole.

The 2003 Act also speaks of “reviewing” butthen goes on to require the audit committee to“determine” various matters, for example:

� to determine, in advance of the board doingso, whether the financial statements give atrue and fair view and comply with theCompanies Act’s provisions and then torecommend to the board whether to approvethem;

� to determine whether compliance statementsare fair and reasonable – wording that mustalso change to be aligned to amendedprovisions resulting from the Company LawReform Group’s review of compliancestatements;

� to determine whether proper books ofaccounts have been kept.

The list, though long, does not include anyprovision equivalent to the Directive’srequirement that committees monitor theeffectiveness of risk management and internalcontrol – though listed companies and othersoperating in accordance with the Combined Codewill already do so.

The Act makes nomention of

independence andhas no requirement

for accounting orauditing competence.

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The Act couches its duties in terms of the auditcommittee having a primary responsibility in eacharea and there is no equivalent to the Directive’s“without prejudice” provision. This brings the riskthat audit committees will be encouraged to actin a manner that dilutes responsibility of theboard as a whole for governance and financialreporting. The ironic – and no doubt unintended –effect of the 2003 Act could then be a narrowingof oversight of governance and financial reporting

issues to a sub-set of the board with no realindependence.

There are other areas of the Act and theDirective that could be considered: but thesethree may help to illustrate the need for carefulanalysis of how we can best implement the 8thDirective before asking companies to take actionto meet new legal requirements. It is an areathat would benefit from the Company LawReview Group’s attention during 2007.

Shelagh McAlpine is a Director in KPMG’s Professional Standards department.

The ODCE paper is available online athttp://www.odce.ie/en/media_decision_notices_article.aspx?article=86101051-7690-4c78-b797-

f10479e22d07

APB issues revised guidance on commencement of extended duty of auditors to report to the Director ofCorporate Enforcement in Ireland

The Auditing Practices Board (APB) published Bulletin 2007/2 The Duty of Auditors in the Republic of Ireland to Report to the Director of Corporate Enforcement on 2 March 2007.

Bulletin 2007/2 was developed in consultation with the Director and CCAB-I and revises guidance for auditors on their statutory duty to report indictable offences under company law first set out in Bulletin 2002/1 (issued in 2002) for:

� changes to section 194 of the Companies Act, 1990 introducing an additional obligation on auditors to provide, if requested by theDirector of Corporate Enforcement, further information relating to reports made to him and taking effect from 1 March 2007. Therevised legislation also contains exemptions in relation to privileged information, and;

� experience since the duty to report indictable offences under company law was introduced in 2001.

Copies of the Bulletin may be downloaded from the Publications section of the APB website at:http://www.frc.org.uk/images/uploaded/documents/APB%20Bulletin%202007-2.pdf

Stop press

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Local regulatory update

The Investment Funds, Companies andMiscellaneous Provisions Act 2006 (the 2006 Act) was signed into law on 24 December 2006.The 2006 Act does not affect the form of thefinancial reporting framework established by itsnamesake in 2005 but makes a number ofimportant amendments.

Key elements of the 2006 Act are:

� provisions providing new vehicles for collectiveinvestment schemes, permitting privatecompanies to offer debt securities to “qualifyingindividuals”, as defined in the ProspectusDirective. The Financial Regulator has alsoissued a Consultation Paper Authorisation ofQualifying Investor Schemes – amendments tothe application process (CP26);

� provisions extending the limits for auditexemption to turnover of €7.3 million andbalance sheet total of €3.65 million, replacingthe previous figures of €1.5 million andapproximately €1.9 million respectively. Thenew thresholds took effect on 24 Decemberwhen the Bill was signed into law and apply tofinancial years in progress which have morethan two months to run after the date ofsignature of the Bill and to other financial years commencing after the date of the Bill’ssignature. Other criteria for audit exemptioncontinue to apply;

� clarification that it is no longer necessary toobtain consent from auditors for inclusion inprospectuses of their previously publishedreports on financial statements.

The Investment Funds, Companies and Miscellaneous Provisions Act 2006

Audit committees’ discussions with auditors infuture could be significantly affected by proposalsin a recently issued exposure draft of InternationalStandard on Auditing (ISA) 580 WrittenRepresentations, which has been revised andredrafted as part of the International Auditing andAssurance Standards Board (IAASB)’s ClarityProject.

This exposure draft represents a significantrevision of the current ISA and, in particular,requires the auditor to obtain “general writtenrepresentations” concerning the premises uponwhich an audit is conducted. These include:

� acknowledgement from boards of theirresponsibilities for preparing and presentingthe financial statements in accordance with

the applicable financial reporting frameworkand confirmation of whether the boardbelieves the financial statements are preparedin accordance with that framework, togetherwith a number of specific representations onkey issues to be addressed;

� acknowledgement of boards’ responsibility fordesigning, implementing and maintaininginternal controls relevant to preparing andpresenting financial statements that are freefrom material misstatement and confirmationthat the directors believe that the internalcontrols they have maintained are adequatefor that purpose;

� confirmation of the completeness ofinformation made available to the auditor.

New proposals for representations to auditors arising from the international Clarity Project

…writtenrepresentation…

[confirming] that thedirectors believe thatthe internal controls

they have maintainedare adequate...

In addition, please refer to our UK matters section on page 14 for details in relation to the UK Companies Act 2006.

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If the representations are not given, the proposedISA leads to the conclusion that the auditor willnot have obtained sufficient appropriate auditevidence and that the possible effects on thefinancial statements are so pervasive that theauditor shall disclaim an opinion.

Other Clarity Project drafts

The Clarity Project was a highly significantelement of IAASB’s work throughout 2006 andwill continue to be so in 2007. Its aim is toimprove the quality of International Standards on Auditing (ISAs) by:

� setting an overall objective for each ISA;

� clarifying obligations by using the word “shall”for all requirements intended to apply to everyaudit to which the ISA is relevant;

� eliminating ambiguity about the status ofmaterial intended to be guidance rather thanrequirements;

� improving the overall readability andunderstandability of the ISAs.

In addition to the proposed “clarity” version ofISA 580, the IAASB also recently issued fiveexposure drafts of ISAs redrafted in accordancewith its Clarity Project drafting conventions:

� ISA 230 (Redrafted), Audit Documentation;

� ISA 540 (Revised and Redrafted), AuditingAccounting Estimates, Including Fair Value

Accounting Estimates, and RelatedDisclosures;

� ISA 560 (Redrafted), Subsequent Events;

� ISA 610 (Redrafted), The Auditor’sConsideration of the Internal Audit Function;

� ISA 720 (Redrafted), Reading OtherInformation in Documents Containing AuditedFinancial Statements.

With the release of these drafts, “clarity”versions of approximately half the total of 33 ISAshave now been released for comment.

The APB staff have prepared versions of theclarity exposure drafts, together with coveringpapers and comparisons with existing ISAs toassist assessment of the effect for auditors inIreland and the UK. This material is available inthe Publications (IAASB Clarity Documentation)section of the APB’s Web site: www.apb.org.uk

The IAASB’s comment periods for the exposuredrafts of ISA 580 (Revised and Redrafted) and ISA540 (Revised and Redrafted) end on 30 April 2007.The APB would welcome comments on theexposure drafts from auditors and otherinterested parties by 30 March 2007, before itprepares its responses to the IAASB.

The IAASB’s comment periods for the otherexposure drafts referred to above, which redraftcurrent ISAs using the Clarity Project draftingconventions, end on 31 March 2007.

The APB wouldwelcome comments

on the exposure draftsfrom auditors and

other interestedparties by 30 March

2007, before itprepares its

responses to the IAASB.

Quality can be an elusive concept – seeking todefine and then support quality in the context of adynamic process such as audit is no exception. ADiscussion Paper issued by the Financial ReportingCouncil (FRC) grapples with these issues and seeksopinions on whether, within the existing legal andregulatory framework, all appropriate steps arebeing taken to maintain and enhance the quality ofaudits and, if not, seeks views on what more couldor should be done.

The Discussion Paper – which has been developed inthe context of the financial reporting framework inboth Ireland and the UK – includes a comprehensivesummary of the current environment in which auditsare conducted and then sets out a description of thekey drivers that the FRC believes are central to

achieving a high quality audit of listed companies andthen considers whether there are “threats” whichweaken the effective operation of those drivers.

Views are sought from stakeholders and otherswith an interest in the audit – with commentsinvited by 31 March 2007. Thereafter the FRC hasindicated that it envisages holding meetings atwhich the suggestions that emerge can bediscussed and will formally consult on anyproposals that it intends to take forward – and thatshould the comments reveal a consensus forchange or action that is outside the FRC’s powers,it will raise those matters with those responsible.

Promoting audit quality – the Financial Reporting Council seeks views

Copies of the Discussion Paper are available athttp://www.apb.org.uk/publications/pubs.cfm

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Audit reports, as the main channel ofcommunication between auditors andshareholders, are too boilerplate and standardised,says the Audit Quality Forum (AQF) in a paper,Fundamentals - Auditor Reporting.

The audit report is a signed document expressingthe truth and fairness of a company’s financialstatements, which goes to the heart ofdiscussions around transparency and confidencein the independent audit.

The AQF working group on auditor reporting wastasked with considering whether the wording of theaudit report satisfies shareholders' expectations.

To achieve this, the group considered theinformation that shareholders wish to see withinthe audit report, why they require this informationand whether the current audit report meets theirneeds.

The paper recommends that the audit reportshould, within a clearly defined framework and inline with applicable European Commission (EC)requirements, include the following:

� an opinion paragraph adopting as soon aspracticable the wording and structure ofSection 495(3) of the Companies Act 2006 inits three distinct parts. Clearly, the wording ofaudit reports will have to comply with the lawfrom the effective date of the Companies Act2006 regardless of whether there is earlyadoption;

� a positive statement that adequate accountingrecords have been kept;

� a positive statement that there are no mattersthat auditors wish to draw attention to by wayof emphasis under Section 235(2A)(b) of theCompanies Act 1985 or Section 495(4)(b) ofthe Companies Act 2006;

� improving the readability of audit reports bymoving the opinion to the front and much ofthe standardised boilerplate text to the back orinto an appendix.

Richard Reid, chair of the AQF working group onAudit Reports said:

“On one hand, investors would like to understandmore about the key issues and discussions thattake place during the course of the audit. On theother hand, auditors are constrained by case lawand clauses around confidentiality, legislation andauditing standards. But at the crux of all of this

was also the impact on business.

"The question we have therefore tried to addressis how to maintain a balance so that shareholdersare able to get the information that they wouldlike without compromising auditors’ duties aroundconfidentiality, but without all of this creating anunnecessary burden on those that have toprepare the information, the companies.”

The paper also proposes a review of the followingareas:

� to meet the investors’ requirements for morecompany-specific information (of key subjectiveareas), a review needs to be carried out of thecurrent disclosures within the annual accounts,and information to be provided under futurenew requirements, to assess the extent towhich disclosures being made in practice, go allor part of the way to meeting the wishes ofinvestors for further information;

� the Combined Code recommendations for auditcommittee disclosures could be reviewed andamended such that audit committees would beexpected to include more specific informationthrough their report to shareholders, includingidentifying key issues and significant accountingand reporting matters discussed with auditorsas a result of the audit.

This review would also need to consider theauditors' reporting role in relation to thesedisclosures. In the meantime, the working groupencourages audit committees to do this as amatter of course and would like to see thisevolving as best practice.

All the recommendations will also need to beconsidered in the context of the EC's appetite fora single common audit report in Europe.

The working group recommends that theDepartment of Trade and Industry (DTI), theFinancial Reporting Council (FRC) and other UKstakeholders encourage the International Auditingand Assurance Standards Board (IAASB), the ECand other bodies that operate at European level toconsider the recommendations above, especiallyin discussions around the development of ISA700 The Independent Auditor’s Report on GeneralPurpose Financial Statements.

In the longer term, these recommendationswould need to be considered in the context ofthe requirements of the 8th Directive.

Audit Quality Forum calls for audits to be more open

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Audit committee members need to understandthe pressures on management to meet theearnings expectations of analysts, investors orsenior management. They also need to be alert tored flags that executives may be engaging inearnings management techniques to help makethe numbers. The audit committee should help toensure that management has a long-term focusand is not unduly focused on short-term reportedresults.

What can be done?

There are many actions that can mitigate the riskof inappropriate earnings management techniquesbeing used by a company.

Tone at the top

The tone at the top of any organisation shoulddemand that management focuses on qualityfinancial reporting and on long-term financialperformance. The commitment to report qualityearnings should extend to all levels in the companyand should be a key element in the controlssystem, especially those controls surrounding thefinancial reporting process. The audit committeecan assess the tone at the top through its periodicmeetings with senior management and indiscussions with the internal and external auditors.These meetings can be augmented with othermeetings involving other management and linepersonnel to evaluate whether the tone at the toprelating to quality financial reporting has filtereddown throughout the company. The audit

committee should be alert to numerous top-sideentries or last minute adjustments necessary toclose the books as these may be indicators ofearnings management processes.

Executive remuneration

The audit committee needs to examine andunderstand the executive (and perhaps non-executive) remuneration plans.

The audit committee should understand thoseelements of the remuneration plan, including cashbonuses and share options, which are based onattaining financial targets. Such targets representpotential pressures on senior executives tomanage earnings (for example if goals are basedon company or divisional earnings, profit margins,revenues, efficiencies or earnings per shareamounts). This pressure can all too often lead tobiased, aggressive and sometimes inappropriatefinancial reporting considerations. Managementmay have been put into the position of havingboth the incentive and opportunity to manageearnings. This problem can become even moretroublesome if goals and targets are based onshort-term outcomes as opposed to being basedon long-term results.

In addition, the audit committee should inquireinto the status of previously issued share options,both vested and unvested, since there may bepressure to increase the company's share price tomake these options more valuable to employeesand management.

Rarely has there been such intense focus on public company financial reportingas exists today. There is increasing evidence of investors and regulatorsdemanding more and better transparency.

Confronting earningsmanagement

Management mayhave been put into the

position of havingboth the incentive and

opportunity tomanage earnings.

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Trends in estimates

The audit committee should have a solidunderstanding of the company’s criticalaccounting policies and estimates. The auditcommittee should hold regular, in-depthdiscussions with management about thesignificant estimating processes used and thedata and assumptions inherent in thoseestimates, particularly for those that are highlyjudgmental, for example the valuation of long-term work in progress. Estimates that aregenerated by quantitative models may requirespecial scrutiny. The audit committee shouldunderstand management’s process for helping toensure the accuracy and validity of such modelsand be comfortable that management’s process isrobust and based on realistic assumptions, whichare regularly updated.

The quality of the processes and systems and thereliability of the data underlying management'sestimates should be challenged. At least on anannual basis, the audit committee should obtainfrom management a retrospective analysis as tohow the historical estimates have compared withactual results. Such an analysis of the ‘run off’ ofestimates should consider issues such as:

� how the value of the initial estimate haschanged over time?

� what additional estimates have been providedfor in the intervening periods?

� what were the actual amounts realised?

� what events caused the actual results to bedifferent from the estimated amounts?

This may flag areas where reserves are beingestablished or drawn down inappropriately.

Materiality

The concept of materiality plays a vital role in thefinancial reporting process. Insignificantmisstatements that result from the normal courseof business (rather than from an intentionalscheme to manage earnings) are generally not ofsignificant concern unless they are indicative ofweaknesses in internal control over financialreporting.

However, intentional errors and misstatementsmade by management on the basis they are notmaterial should be challenged by the auditcommittee. In addition, misstatements createdwith the principal intent of managing earnings(e.g., creating unsupported accrued revenue tooffset against known misstatements) also shouldnot be acceptable. Where misstatements offsetone another, each misstatement and itsmateriality should be considered both separatelyand in aggregate.

Dealing with earnings management

To fulfil its financial reporting oversightresponsibilities properly, the audit committeeneeds to have a good understanding of thevariety of earnings management opportunitiesthat exist. This requires an appreciation of thedifferences between earnings managed in theordinary course of business and earningsfraudulently managed in an attempt to deceivethe financial community.

It is important not only to carefully scrutinise theunrecorded audit adjustments but also to obtainfrom management an understanding as to whysuch items arose. In these circumstances, theaudit committee has a key role to play in helpingto ensure that the company reports qualityearnings.

There are incentives and pressures both fromwithin the company and from outside thecompany to engage in inappropriate earningsmanagement activities. The audit committeeshould be vigilant as to the possibility of earningsmanagement and be alert to the warning signsthat it is occurring. The audit committee shouldobtain a thorough understanding of thecompany’s processes to make or modifyaccounting policies, estimates and judgments sothat those processes can be assessed. The auditcommittee should also assess the role thatcompensation and bonus plans, which are tied toperformance, can have on earnings management,and clearly understand their consequences. Itshould be remembered that the pattern ofearnings is rarely smooth, and financial reportingshould not mask that reality.

This piece is adapted from an Audit Committee Insights feature by Michael Meagher, ACI Canadapublished in June 2006. To subscribe to Audit Committee Insights click on www.kpmginsights.com

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IFRS implementationfindings

The Financial Reporting Review Panel (FRRP) in the UK has issued its firstreport outlining the preliminary findings of its review of IFRS implementation bylisted companies. Its review continues but it has identified a number of issueswhich it believes should be drawn to the attention of companies planning thepreparation of their second IFRS annual accounts. While the observations relateto the UK accounts which were received, they apply equally to Irish companiesreporting under IFRS.

In keeping with the FRRP’s earlier activity report,the FRRP reports a good level of compliance withIFRS and recognises the significant amount ofwork by companies that has gone into theaccounts production process. The FRRP identifiedseveral key areas for improvement which arediscussed in more detail below:

� accounting policies;

� disclosure of judgements and estimates;

� disclosure of reasons for goodwill;

� intangible assets;

� impairment testing;

� related party disclosures;

� new standards and interpretations;

� presentation.

Accounting policy descriptions were found to be alittle too generic with companies opting to usewording from the standards, rather than adaptingthe wording to describe more accurately theissues relevant to the company’s individualcircumstances. Also old Generally AcceptedAccounting Principles (GAAP) terminology wasstill found, despite this issue being highlighted intheir report on interims. For example, revenuerecognition policies may need to include a

description of the methods applied to determininga transaction’s stage of completion. In addition,the FRRP found that some stated accountingpolicies were irrelevant since there were noaccounting transactions falling within their scope,e.g., the inclusion of a policy in respect ofhedging when this was not applied in practice. Inits report, the FRRP encourages companies todisclose only those accounting policies applied inpractice, with information provided being specificto their particular circumstances.

IAS 1 Presentation of Financial Statementsrequires disclosure of the key sources ofestimation uncertainty and key assumptionsconcerning future events that have a significantrisk of causing material adjustment in the carryingamounts of assets or liabilities in the subsequentyear. It also requires disclosure of the judgementsmade by management in applying the accountingpolicies that have the most significant impact onthe amounts recognised in the accounts. TheFRRP found that practice varied with somecompanies providing detailed disclosures of theirkey judgements and estimation uncertainties,whereas others provided only disclosures similarto those required by IAS 37 Provisions,Contingent Liabilities and Contingent Assets.Others provided “bland” disclosures that bore norelation to the company’s particular

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circumstances; they should always cover specificinformation relevant to understanding, inparticular, a company’s key sources of estimationuncertainty.

The FRRP also reminds preparers that wheregoodwill is recognised on an acquisition, IFRS 3requires an explanation of why that goodwillarises and an explanation of any intangible assetsthat were not recognised, including why theirvalue could not be measured reliably. In addition,IAS 36 Impairment of Assets requires goodwilland those intangible assets with indefinite lives tobe tested for impairment annually. In particular,paragraph 134 of IAS 36 requires disclosuresregarding the method and assumptions used todetermine the recoverable amount for a cash-generating unit that contains goodwill orindefinite-lived intangibles, whether or notimpairment has been charged. In some cases, theFRRP found that these disclosures were omitted.

IAS 24 Related Party Disclosures includes keymanagement within the definition of a relatedparty and requires certain disclosures in respectof transactions with those related parties,including remuneration. The Companies Actcontinues to require disclosure of directors’remuneration but the remuneration of keymanagement personnel was sometimesoverlooked as a related party transaction underIAS 24. In other cases companies stated that

their only key management were their directors:the FRRP specifically states that where narrativereports elsewhere in the annual accounts refer tomanagement personnel by name, companiesshould consider whether their remuneration andother details should be included within the IAS 24disclosures.

The FRRP also noted that some companies hadfailed to comply with the requirement under IAS 8Accounting Policies to disclose details of theimpact of new standards and interpretations thatwere issued but not yet effective (“issued”means endorsed for use in Europe). Where theimpact is not known or reasonably estimable, thisfact should be stated.

As a final point, the FRRP comments on thepresentation of the primary statements, inparticular the income statement, and the narrativereports. It found that some companies providedadditional line items in their income statements,similar to those found under old GAAP such asamortisation or impairment charges. Although IAS1 allows additional line items, the FRRP statesthat in its view, these should be included onlywhen they are necessary to explain elements offinancial performance. The report also remindscompanies that non-GAAP performancemeasures should be defined and reconciled toGAAP measures and should not be given undueprominence.

disclosures… shouldalways cover specific

information relevant tounderstanding… a

company’s keysources of estimation

uncertainty

The FRRP’s preliminary report is available on the Web at www.frc.org.uk/frrp/press/pub1206.html

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EU matters

During January, the European Commission (EC)issued a consultation paper seeking views onwhether there is a need to reform rules on auditors’liability in EU member states – and how this couldbe achieved.

The consultation follows on from findings in areport commissioned by the EC from LondonEconomics, whose findings indicated that thestability and flexibility of the audit market is affectedin a significant manner by the unlimited liability. Inparticular, the report noted that:

New entrants to the international audit market areunlikely, limiting choice

Currently, this market and that relating to largerdomestic companies is highly concentrated anddominated by the Big-4 networks (Deloitte, Ernst &Young, KPMG and PricewaterhouseCoopers).Under the current circumstances, middle-tier firmsare unlikely to become a major alternative if a Big-4network fails.

Entire international audit networks are at risk whenlarge claims arise

Unlimited liability applies in an environment wherethe level of auditor liability insurance available forhigher limits has fallen sharply in recent years. Theremaining source of funds to face claims mayessentially be the income of partners belonging tothe same international network. Consequently,large claims could jeopardize the continuedoperation of an entire network’s audit business.

The potential effects could create serious difficultiesfor companies seeking to appoint auditors

The failure of a network could lead to difficultconsequences for the wider economy – asignificant reduction in audit firms with the capacity

to deal with large company statutory audits has thepotential effect of a shortfall in the availability ofauditors with the capacity and scale to deal withlarge, international businesses. Inability to obtain anaudit in the context of capital markets andregulatory regimes that require audited informationcould have a significant impact on the companiesaffected.

Limitation on auditor liability would reduce this risk

The report’s conclusions prompted the Minister torequest the Company Law Review Group (CLRG) toexamine the question of auditor liability in thecontext of the existing legal framework in Ireland, asconfirmed by the Minister in the course ofannouncing other developments in the InvestmentFunds, Companies and Miscellaneous Provisions Act2006.

The EU’s consultation paper was issued on 17January and puts forward four possible solutions:

� the introduction of a fixed monetary cap atEuropean level;

� the introduction of a cap based on the size ofthe audited company, as measured by its marketcapitalisation;

� the introduction of a cap based on a multiple ofaudit fees charged by auditors to their clients;

� the introduction by Member States of theprinciple of proportionate liability, whereby eachparty (i.e., auditor and client entity) would beliable only for the portion of any loss thatcorresponded to the relevant party’s degree ofresponsibility.

The last has long been argued by auditors in Irelandand the UK as having the additional benefit of

Auditor liability

13

ensuring that both markets and directors appreciatethe extent to which the latter are responsible for thequality of financial information provided by acompany. The audit is an important checkunderpinning that quality – but the most vigilantauditor, in the timeframes that capital marketsdemand financial information, is vulnerable tocollusion or other steps to disguise the true impactof events affecting a company, underminingjudgments made on evidence available during theaudit.

However, no one solution is likely to provide ananswer for all EU states, given the differences thatalready exist in this area – for example, Germanyand a number of other states already have arelatively low cap on the extent of auditor liability,making a move to share a proportion of a largerwhole rather less attractive. Meanwhile, in the UKthe new Companies Act sets out a framework forgreater transparency of arrangements between acompany and its auditors, including the potential to

allow auditors to contract with companies to limitliability.

Audit committees, with their focus on the integrityof financial reporting by companies, have asignificant interest in identifying steps to achieve abalance of risk and reward that encourages highquality audits – the EU proposals would supportaudit committees in this regard.

Comments have been requested by 15 March 2007and the Consultation Paper is available on theEuropa website. IAASA has also made it availableon its site at http://www.iaasa.eu/news/index.htm.In doing so, IAASA has not added any specificcomments of its own – but with increasinginvolvement in EU debates and the government’sreferral of auditor liability to the Company LawReform Group, committees may like to contributeto the development of views in the Irish businesscommunity as well as to respond to the EU’sinvitation.

no one solution islikely to provide an

answer for all EUstates, given thedifferences thatalready exist in

this area

14

Other internationalmatters

The Accounting Standards Board (ASB) hasrecently published its first review of narrativereporting by UK listed companies, with the aimof keeping the spotlight on narrative reportingand the importance of encouraging continuingimprovement in this area.

The review, which also draws on work by otherbodies in the field, found that while mostcompanies were good at describing their

strategy and current performance, they wereweaker on providing forward looking informationand identifying their principal risks and how they are managed.

The purpose of this review is to highlight thestrengths and weaknesses of current narrativereporting, in the interests of widespread adoptionof best practice. The ASB, as part of its role inpromoting confidence in corporate reporting, will

The UK Companies Act 2006 (Act) was brought intolaw in November 2006 and whilst earlieramendments to facilitate the introduction of IFRSremain broadly unchanged, the Act marks asignificant overhaul of the framework of companylaw in the UK, following discussion and analysis thatcommenced with the launch of the Company LawReview in 1998.

A major question addressed in the course of theAct’s development has been that of for whom thecompany is run. In codifying the case law ofdirectors’ duties, the Act provides that the directorsare to run the company for the benefit of itsmembers. However, in taking decisions to promotethe success of the company for the benefit ofmembers, directors are to take into account, inthose decisions, specified corporate socialresponsibility factors.

The UK 2006 Act also requires, to the extentnecessary for an understanding of thedevelopment, performance or position of thebusiness, trends and factors that may be relevant tothe future and disclosure in the area of specifiedcorporate social responsibility factors. These rangefrom the environment through to – in a late addition

during the legislative process – persons with whomthe company has essential relationships orarrangements, e.g., potentially the supply chain. Inrecognition of the more forward-looking nature ofthis review, a safe harbour and an exemption fromdisclosure on the grounds of serious prejudice incertain cases are introduced.

Other key elements of the Act include:

� enfranchising beneficial owners – institutionalinvestors are required to allow beneficial ownersto have a right to all communications that wouldotherwise be sent by the company to members(e.g., the annual accounts);

� company administration and communications –provisions aimed at simplifying the process ofadministration. These include changes relating tofiling and also to facilitate the use of electroniccommunications with shareholders.

The UK 2006 Act’s communication provisions cameinto force in January 2007; consultation on detailedplans for the rest of the Act is expected duringFebruary and it is expected that all provisions will bebrought into force by October 2008.

UK matters

ASB publishes review of narrative reporting

UK Companies Act 2006

15

continue to review progress in the UK and be aleading contributor to any internationaldevelopments on management commentary.

The report had dual objectives of assessing:

� best practice – the degree to whichcompanies have adopted therecommendations in the ASB’s ReportingStatement on the Operating and FinancialReview (OFR), given that it is the mostcomplete and authoritative source of bestpractice guidance; and

� compliance – how UK companies areperforming in the light of the requirementunder the EU Accounts ModernisationDirective for companies to provide a businessreview in the Directors report in their 2006Annual report.

Whilst companies are generally complying withthe legal requirements, when measured againstthe best practice recommendations set out in theASB’s Reporting Statement, the following wasfound:

Areas of good reporting

� companies are generally good at providingdescriptions of their business and markets,together with their strategies and objectives,although some improvements could be madein providing information on their externalenvironment;

� all companies within the sample providedsatisfactory or better descriptions of the

current development and performance of thebusiness;

� there has been an increase in companiesreporting environmental, employee and socialissues although very few discuss theircontractual arrangements and relationships inany depth.

Areas for improvement

� the greatest area of difficulty for companieswhen producing their narrative reports is thedisclosure of forward-looking information. Theproposed “safe harbour” provisions in theCompanies Act 2006 may encouragecompanies to provide greater detail in thefuture;

� companies need to improve their descriptionsof resources available to the entity, inparticular intangible items such as brandstrength, corporate reputation and naturalresources not reflected in the balance sheet;

� companies need to describe more carefullytheir principal risks and uncertainties, and setout their approach to managing and mitigatingthose risks, rather than simply providing a listof all their risks and uncertainties (33 risks inone case);

� many companies are providing a good deal ofinformation on measures and indicators, butimprovements can be made in identifying their key performance indicators, bothfinancial and non-financial.

The ASB reports referred to in this article are available athttp://www.frc.org.uk/asb/press/pub1228.html

Under a registration payment arrangement, acompany may issue equity-based financialinstruments (for example, equity shares orwarrants) and agree to register the underlyingshares with the SEC (or other applicable regulatorif shares are to be registered outside the US).Such arrangements may also require that thecompany maintains an effective registrationstatement for the resale of shares upon exercise

or conversion of the financial instruments. Ingeneral, companies must use “best efforts” or“commercially reasonable efforts” to file theregistration statement and have it declaredeffective by the SEC within a specified period oftime. A company failing to meet these conditionsmay have to make payments in cash or otherconsideration to an investor until such time as theconditions are met.

US matters FASB staff issues staff position on accounting for registration payment arrangements

16

FSP AUG AIR-1 Accounting for Planned MajorMaintenance Activities prohibits companies fromaccruing as a liability in annual and interim periodsthe future costs of periodic major overhauls andmaintenance of plant and equipment. Othermethods of accounting for planned majoroverhauls and maintenance previously acceptableunder US Generally Accepted AccountingPrinciples (GAAP) will continue to be permitted.

The prohibition against accruing future majormaintenance costs will affect companies thatcurrently accrue those costs over several fiscalyears and companies that accrue the costs overinterim reporting periods within the annual periodin which the costs are expected to be incurred.The prohibition applies to entities in all industriesfor fiscal years beginning after 15 December 2006and must be applied retrospectively.

The Emerging Issues Task Force (EITF) hasconcluded on the following EITF issues:

� EITF 06-1 Accounting for Consideration Given bya Service Provider to Manufacturers or Resellersof Equipment Necessary for an End-Customer toReceive a Service from the Service Provider;

� EITF 06-4 Accounting for DeferredCompensation and Postretirement BenefitAspects of Endorsement Split-Dollar LifeInsurance Arrangements;

� EITF 06-5 Accounting for Purchases of LifeInsurance – Determining the Amount That CouldBe Realised in Accordance with FASB TechnicalBulletin No. 85-4 Accounting for Purchases ofLife Insurance;

� EITF 06-6 Debtor’s Accounting for a Modification

(or Exchange or Convertible Debt Instruments);

� EITF 06-7 Issuer’s Accounting for a PreviouslyBifurcated Conversion Option in a ConvertibleDebt Instrument When the Conversion OptionNo Longer Meets the Bifurcation Criteria inFASB Statement No. 133, Accounting forDerivative Instruments and Hedging Activities;

� EITF 06-8 Applicability of the Assessment of aBuyer’s Continuing Investment under FASBStatement No. 66 for Sales of Condominiums;

� EITF 06-9 Reporting a Change in (or theElimination of) a Previously Existing Differencebetween the Fiscal Year-End of a ParentCompany and That of a Consolidated Entity orbetween the Reporting Period of an Investor and That of an Equity Method Investee.

FASB staff issues staff position on planned major maintenance

Emerging Issues Task Force approves seven consensuses

The Position is available at http://www.fasb.org/fasb_staff_positions/fsp_augair-1.pdf

The EITF consensuses are available on the FASB’s Web site athttp://www.fasb.org/eitf/agenda.shtml

The Position is available at http://www.fasb.org/fasb_staff_positions/fsp_eitf00-19-2.pdf

FSP EITF 00-19-2 Accounting for RegistrationPayment Arrangements provides guidance inaccounting for contingent obligations arisingunder these arrangements and requires that if, atinception, the payment is probable andreasonably estimable, a liability should beseparately recognised and measured inaccordance with FASB Statement No. 5,

Accounting for Contingencies. The guidance inthis FSP is effective immediately for new ormodified arrangements and must be applied toexisting arrangements for fiscal years beginningafter 15 December 2006 through recognition of acumulative effect adjustment on retainedearnings as of the beginning of the year of adoption.

17

SEC Staff Accounting Bulletin (SAB) No. 108Considering the Effects of Prior YearMisstatements when Quantifying Misstatementsin Current Year Financial Statements addresseshow uncorrected errors in previous years shouldbe considered when quantifying errors in currentyear financial statements. The SAB requiresregistrants to consider the effect of all carry-overand reversing effects of prior-year misstatements

when quantifying errors in current year financialstatements. The SAB does not change the SECstaff’s previous guidance on evaluating themateriality of errors.

The SAB allows registrants to record the effects ofadopting the guidance as a cumulative-effectadjustment to retained earnings. This adjustmentmust be reported as of the beginning of the firstfiscal year ending after 15 November 2006.

SAB 108:The effect of prior-year errors on current-year materiality evaluations

SAB 108 is available at http://sec.gov/interps/account/sab108.pdf

The SEC recently adopted changes to therequired disclosures about executive and directorcompensation, related person transactions,director independence and other corporategovernance matters, and ownership of securitiesby officers and directors. Under therequirements, foreign private issuers maycontinue to follow the compensation disclosurerequirements in Form 20-F, but must disclosemore detailed information if it is made publicly

available for some other reason, such as a home-country requirement (e.g., in the UK, a Directors’Remuneration Report prepared in accordancewith Schedule 7A of the Companies Act 1985).The rules generally become effective for fiscalyears ending on or after 15 December 2006. Thepotential effect of the new rules on complianceobligations is a legal matter on which companiesshould consult their securities counsel.

SEC adopts new compensation disclosure requirements

The rule is available at http://www.sec.gov/rules/final/2006/33-8732.pdf

The final rule is available at http://www.sec.gov/rules/final/2006/33-8730a.pdf

SEC matters The SEC and PCAOB have recently issuedproposed guidance intending to make compliancewith the requirements of Section 404 of theSarbanes-Oxley Act more cost effective. The SEC’sproposed interpretive guidance for managementdescribes a top-down, risk-based approach inassessing internal control over financial reporting.An evaluation that complies with this interpretiveguidance would be one way to satisfy the rules formanagement’s annual evaluation of internalcontrols. However, registrants would be allowed tocontinue to follow their current 404 assessmentapproach.

Consistent with the SEC’s proposed guidance, theproposed PCAOB auditing standards are intendedto achieve a more efficient, risk-based and scalableaudit approach. The proposed standard would alsofacilitate the elimination of certain procedures,including the requirement for auditors to evaluatemanagement’s assessment process.

The SEC final rule defers the requirement toprovide an auditors’ report on internal control overfinancial reporting for foreign private issuers thatare accelerated filers (but not for those that arelarge accelerated filers) until fiscal years ending onor after 15 July 2007.

SEC and PCAOB issue proposed guidance and final rules on Section 404

and internal control over financial reporting

18

In order to qualify for the exemption, the companymust either be a wholly-owned subsidiary or theparent must hold more than 50% of the sharesand no request to prepare group accounts musthave been received from minority interests withinsix months of the previous financial year end.Exemption is also conditional upon compliancewith all of the following conditions:

� the relevant company and all of its subsidiaryundertakings (as defined in Regulation 4 of theGroup Accounts Regulations and FinancialReporting Standard (FRS) 2) are included in theconsolidated accounts for a larger group drawnup to the same date or to an earlier date in thesame financial year;

� the larger group’s accounts and, whereappropriate, the annual report (the equivalentof the UK directors’ report) are drawn up inaccordance with the relevant EU directives, orin a manner so equivalent;

� the consolidated accounts are audited;

� the company discloses in its individual accountsthat it is exempt from preparing group accountsand states the name of its higher parent inwhose consolidated accounts it is included andthe place of its incorporation (if outside EEA);

� the company delivers to the Registrar a copy ofthe group accounts together with the annualreport (where appropriate) and audit report.

UITF 43 and interpretation of equivalence

The Urgent Issues Task Force (UITF) has issued UITF Abstract 43 “TheInterpretation of Equivalence for the Purposes of Section 228A of theCompanies Act 1985”. The equivalent legislation in the Republic of Ireland isRegulation 9A of the European Communities (Companies: Group Accounts)Regulations 1992 (“Group Accounts Regulations”) which provides an exemptionfrom preparing consolidated accounts for intermediate parent undertakingswhose parent entity is not established under the law of a European EconomicArea (EEA) State, subject to certain conditions. The Abstract has effect foraccounting periods beginning on or after 1 January 2005.

Financial reportingupdate

19

The Abstract addresses whether a higher parent’sconsolidated accounts are drawn up in a mannerequivalent to the directives. Whilst the Abstractnotes that EU-adopted International FinancialReporting Standards (IFRS), IFRS and nationalGenerally Accepted Accounting Principles(GAAPs) in EEA States are directives-equivalent,beyond that it does not provide a definitive list ofGAAPs considered equivalent. It does howeverstate that, in other cases, equivalence of a set ofaccounts does not require compliance with everyprovision of the directives, but only with the basicrequirements thereof.

It specifically considers US, Canadian and JapaneseGAAPs and states that, subject to three points,

they “normally” lead to equivalent accounts. TheAbstract does not provide an exhaustive list ofpotential areas of non-equivalence.

This exemption was introduced into the GroupAccounts Regulations, European Communities(Credit Institutions: Accounts) Regulations 1992and European Communities (InsuranceUndertakings: Accounts) Regulations 1996 whichare applicable to limited companies. There areconcerns as to whether it is therefore appropriatefor unlimited companies to apply this exemptionalso. As such, to the extent that directors of anunlimited company are proposing to avail of thisexemption, consultation with their legal advisorsand auditors is recommended.

The Abstract is available at www.frc.org.uk/asb/uitf/pub1181.html

The most recent detailed calculation of therecoverable amount of a CGU to which goodwillhas been allocated may be brought forward froma preceding period and used in the current periodprovided that:

� the assets and liabilities of the CGU have notchanged significantly since the most recentcalculation of recoverable amount;

� that recoverable amount calculation exceededthe carrying amount of the CGU by asubstantial margin;

� the likelihood (based on an analysis of events

and circumstances occurring since the lastcalculation of recoverable amount) that acurrent calculation of recoverable amountwould fall below the current carrying amountof the CGU is remote.

In the event that a company preparing accountsunder IFRS as adopted by the EU meets all thesecriteria, the disclosures of its estimates andassumptions used in calculating the recoverableamount will be based on the recoverable amountfrom the prior period, i.e., an entity will simplyrepeat disclosures reported in its prior yearaccounts.

IAS 36 and goodwill impairment

IAS 36 “Impairment of Assets” requires cash generating units (CGUs) thatcontain goodwill to be tested for impairment annually and whenever there isany indication of impairment. The standard requires extensive disclosures of theestimates and assumptions used in the calculation of the CGUs’ recoverableamounts for the purposes of the impairment test. However, in order to reducethe financial burden of carrying out annual impairment tests, the standardallows the recoverable amount calculated for a CGU in prior periods to be usedin the current period, subject to certain conditions being met.

20

Events

The latest breakfast seminar hosted by the AuditCommittee Institute took place on 24 January2007 at The Berkeley Court Hotel in Dublin.Speaking at this well attended event were PaulAppleby, Director of Corporate Enforcement, andJohn Barry, Director of Corporate Broking fromCoyle Hamilton Willis.

The seminar covered:

ODCE Guidance for Audit Committees

Mr. Paul Appleby provided an outline of the newlegal provisions relating to audit committees inIrish company law following the recentpublication of his Office’s Guidance on AuditCommittees.

His presentation included key aspects of theselegal provisions, their impact, potentialexemptions under consideration and likelycommencement date.

Directors’ indemnity insurance

Mr. John Barry provided an outline on keyconsiderations for directors in managing the riskof personal financial exposure for auditcommittee members following the results of arecent survey showing 78% of respondentswere concerned about this potential risk.

His presentation included an overview ofDirectors’ and Officers’ liability cover, standardexclusions and key areas to be aware of.

Pictured at the last ACI seminar from left to right: Paul Appleby, Kevin O’Donovan (ACI Chairman) and John Barry

If you wish to receive a training certificate in relation to attendance at an ACI seminar, please email us atinfo@auditcommitteeinstitute.ie or phone us at +353 1 410 1160.

More information on ACI events is available on our Web site:www.auditcommitteeinstitute.ie/events.htm

Let us know what you thinkWe are always grateful for feedback regarding topics for breakfast seminars,roundtables and Audit Committee Quarterly. Let us know what you would likecovered by phoning us at +353 (1) 410 1160 or emailing us at:info@auditcommitteeinstitute.ie.

The information contained herein is of a general nature and is not intended toaddress the circumstances of any particular individual or entity. Although weendeavour to provide accurate and timely information, there can be noguarantee that such information is accurate as of the date it is received orthat it will continue to be accurate in the future. No one should act on suchinformation without appropriate professional advice after a thoroughexamination of the particular situation.

© 2007 KPMG, an Irish partnership and amember firm of the KPMG network ofindependent member firms affiliated withKPMG International, a Swiss cooperative. Allrights reserved. Printed in Ireland.

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Publication Date: March 2007.