Smaller Listed And AIM Quoted Companies
ICAEWIN ASSOCIATION WITH THEFINANCIAL REPORTING COUNCILSmaller Listed and AIMQuoted CompaniesA PRACTICAL GUIDE FOR AUDIT COMMITTEESON IMPROVING FINANCIAL REPORTINGicaew.com
IC AEW IN ASSOCIATION WITH THE FRCA joint publication from the Financial Reporting Council (“FRC”) and the Institute of CharteredAccountants in England and Wales (“ICAEW”).This guide offers practical suggestions for audit committees and boards of smaller listed andAIM quoted companies seeking to deliver high quality financial and risk reporting. ICAEW 2019All rights reserved. If you want to reproduce or redistribute any of the material in this publication, you should first getICAEW’s permission in writing. ICAEW will not be liable for any reliance you place on the information in this publication.You should seek independent advice.2
A PR AC TICAL GUIDE FOR AUDIT COMMIT TEES ON IMPROVING FINANCIAL REPORTINGContentsEXECUTIVE SUMMARY2INTRODUCTION4IMPROVING THE QUALITY OF REPORTING: PRACTICAL GUIDANCE6Understanding the importance of high-quality financial and non-financial reporting7Nurturing a culture of improvement7Timing and planning9Skillset and experience9Using the auditors wisely10CONCLUSIONS12USEFUL RESOURCES131
IC AEW IN ASSOCIATION WITH THE FRCExecutive summarySMALLER QUOTED COMPANY PRACTICAL GUIDE TO IMPROVINGFINANCIAL REPORTINGAudit committees can play a pivitol role in driving up the quality of financal reporting by promoting aculture of improvement. This can be achieved, in part, by asking the right questions at the right time.Below we summarise some suggested questions (found within the guide) that can help the auditcommittee of a smaller quoted company bring about a step change in the quality of itsfinancial reporting.PLANNINGFORMULATEACTION PLAN FORNEXT YEARTHE CORPORATEREPORTING CYCLEPRODUCTION OFINTERIM AND ANNUALREPORTSREVIEWPERFORMANCEFigure 1 The Financial Reporting Cycle.PLANNINGQuestions for the audit committee to consider W hat lessons can we learn from last year’sfinancial reporting process? W hat action has been taken to ensure thatthe key financial reporting issues during lastyear’s audit are less of a challenge this year? H ave there been any financial reportingstandard changes during the year? W ill there need to be any changes to our keyaccounting policies? H ave our systems been adapted to takeaccount of any changes? W hat are the company’s key financialreporting risks for this year? A re there any unusual transactions or areasof significant judgement that will affectthe preparation of the annual report and2accounts? What action has been taken tomanage risks of misstatement that may arisefrom these? H ow have the CFO and finance teamaddressed the points in the FRC’s year-endletter and matters previously raised by theauditor?Questions to ask the external auditor C an you explain the rationale for the auditplan and timetable? W hat is your view of the finance process andfunction? W hat are the key audit risks this year and howdo these impact on financial reporting? W hat financial disclosures are critical inconnection with the key audit risks and why?
A PR AC TICAL GUIDE FOR AUDIT COMMIT TEES ON IMPROVING FINANCIAL REPORTINGPRODUCTION OF INTERIM ANDANNUAL REPORTSFORMULATE ACTION PLAN FORNEXT YEARQuestions to ask the external auditor duringthe auditQuestions for the audit committee to consider What information are current and futureinvestors likely to be interested in? Are theregaps in the current information the companycommunicates? What financial and non-financial informationand reports are used for internalmanagement purposes, and how doesthis information compare to the scope andcontent of our external reporting? How do we ensure that the company iscomplying with its reporting obligations? How does the audit committee ensure thatit is up to date with the latest reportingrequirements? W hat is the attitude and level of commitmentof management to financial reporting? A re there any unidentified risks we should bearticulating in the annual report?Questions to ask the external auditor at theaudit completion meeting Have you noticed any changes in the qualityof the company’s financial reporting? W hat can be done to make the financialreporting process more effective? W hat three things should the company dodifferently?REVIEW PEFORMANCEQuestions to ask the external auditor at aprivate meeting D oes management generally address issuesraised during the audit? W hat aspects of the financial statements andassociated notes need improving? Have these issues been identified previously? H ave you discussed your views with the CFOand other executive directors? H ow do we compare in this area to othercompanies of a similar size?Questions to ask the CFO and finance team What level and type of resourcing does thefinance team need, have any gaps beenidentified and how can they be filled? What knowledge, including financial andother relevant qualifications, and experiencedo members of the finance team and boardbring? How do we ensure that the finance teamcomply with continuing professionaldevelopment (CPD) requirements? Is thisdocumented and reviewed? Is complying with CPD requirements akey performance indicator within theorganisation’s appraisal system? How are knowledge gaps and training needsidentified and addressed? When does planning for the year end begin?What factors drive this decision and could thetiming be improved? Was there a clear timetable for last year’sfinancial reporting process? Was it realisticand was it met? What are the key deadlines for this year?Where are the pressure points and how willwe manage this? How will we gather and collate the dataneeded to comply with new standards andregulations? How do we ensure that financial reportingsystems continue to be robust and fit forpurpose as the company grows? What process is in place to identify errorsand inconsistencies in the annual report, forexample, between narrative sections and thefinancial statements?3
IC AEW IN ASSOCIATION WITH THE FRCIntroductionThe core purpose of the UK financial reportingregime1 is to ensure that the informationneeds of investors and other users are met.The requirement for compliance with relevantreporting frameworks and regulation helps usersto assess the financial integrity of a company andhold management to account. More than this,high quality financial reporting contributes to astrong and efficient economy by improving trust,transparency and liquidity, thereby lowering thecost of capital.2In its capacity as a provider of independentgovernance over the annual corporate reportingprocess, the audit committee plays a crucial rolein driving quality. It oversees the integrity ofthe financial statements and related reportingprepared by management and it managesthe company’s relationship with the externalauditors for the benefit of shareholders and otherstakeholders. Including an audit committee reportwithin the annual report can also offer importantinsights for investors, thereby strengthening trustin the financial reporting process.The FRC’s discussion paper in 2015, ‘Improvingthe Quality of Reporting by Smaller Listed and AIMQuoted Companies’3&4 found that:‘whilst the system of financial reporting is notfundamentally flawed, there is a higher incidenceof poorer quality annual reports by smaller quotedcompanies than by their larger counterparts’.The FRC discovered that financial reporting is notalways seen as a top-tier issue by smaller quotedcompanies. It also found that smaller quotedcompanies are not always up to date with the mostrecent reporting requirements. Thus, they maynot appreciate the full extent of the accountingconsiderations that need to be applied to theirreporting of potentially complex transactions. Thediscussion paper proposed a number of initiativesto support improvement in the quality of reportingby smaller companies.The board, and the audit committee in particular,have an important role to play in improving thereporting process and driving higher qualityin financial reporting. This can be achievedby developing productive relationships withmanagement, particularly the CFO and the financefunction, and with both internal and externalauditors, as set out in figure 2.Figure 2THE AUDIT COMMITTEE:KEY AUDITINTERNALAUDITASSURANCEPROVIDERSQCA Audit Committee Guide. Link: https://bit.ly/2Dx7xAPFurther information on the specific role andresponsibilities of the audit committee can befound in the UK Corporate Governance Code, theQuoted Companies Alliance’s (QCA) CorporateGovernance Code and associated guidancematerial. Links to these resources can be found inthe ‘Useful Resources’ section at the back of thisguide.RECENT DEVELOPMENTSIn the four years since the FRC published itsdiscussion paper, a number of regulatorydevelopments have altered the landscape forfinancial reporting by smaller quoted companies,presenting new challenges for those responsible.Financial reporting: who does what? (ICAEW 2019) Link: https://bit.ly/2DCst9P Growth, development and accounting: seeing the bigger picture (ICAEW 2017) Link: https://bit.ly/2XPL9e03 Improving the Quality of Reporting by Smaller Listed and AIM Quoted Companies (FRC 2015) Link: https://bit.ly/2V19Gzu4 For the purposes of this report, we have in mind companies listed on the main market with a market capitalisation of between 20m and 100m and UKcompanies quoted on the Alternative Investment Market (AIM) with a market capitalisation greater than 5m.1 24
A PR AC TICAL GUIDE FOR AUDIT COMMIT TEES ON IMPROVING FINANCIAL REPORTINGThese developments reinforce the need foreffective engagement by the audit committee inthe financial reporting process. This involvementis particularly important given the effects ofthe Markets in Financial Instruments Directive II(MIFID II), which is expected to lead to a fall in thenumber of broking houses and analysts publishingresearch on mid and small-cap companies. TheQCA/Peel Hunt Mid and Small-Cap Investor surveypublished in April 2018 found that fund managersare already noticing a decrease in research andexpect this to continue.5 Investors are likely toplace increasing reliance on the annual reportand accounts in the absence of other sources ofinformation.While the review highlighted where therewas still scope for improvement, there werealso promising signs that progress is beingmade.‘ The better practice examples identified bythe thematic review indicate that smallercompanies are able to provide high qualityinformation to stakeholders.’Paul George, FRC Executive Director,Corporate Governance and Reporting.New standards: in the last few years, threenew international accounting standards,on revenue (IFRS 15), leases (IFRS 16) andfinancial instruments (IFRS 9), have come intoeffect. A significant effort continues to berequired by many companies to adapt theirsystems and reporting processes to meet therequirements of these major new standards.In addition, the publication of the Competition andMarkets Authority’s Report into the audit market inApril 20196 – which set out proposals for enhancedregulatory scrutiny of audit committees in relationto the year-end accounts and audit process – is asign that the quality of financial reporting and therole of audit committees are likely to remain underthe spotlight for the foreseeable future. Otherrelevant developments are described in Figure 3.New regulations: amended regulationsand guidance covering the Strategic Reportrequirements place greater emphasis onthe duties of directors under section 172of the Companies Act 2006 to promote thesuccess of the company for the benefit ofshareholders. The Strategic Report mustnow include a statement describing howthis duty has been fulfilled, taking accountof the consequences of any decision in thelong term, the interests of the company’semployees, suppliers, customers, widerstakeholders, and the impact of thecompany’s activities on the communityand environment.Figure 3Corporate governance: with effect fromSeptember 2018, the London StockExchange requires each AIM companyto report which ‘recognised’ corporategovernance code it has applied. While thereis flexibility over which code is adopted,both the QCA Code and the UK CorporateGovernance Code emphasise directors’duties and responsibilities for financialreporting. This is intended to ensure thatfinancial reporting is seen as a priority by theboard and its audit committee.FRC thematic review: in November 2018,the FRC published the results of its thematicreview on reporting by smaller listed andAIM quoted companies.7 The aim of thereview was ‘to assess the extent of anyimprovement in the general quality ofcompliance’ by smaller companies since thepublication of the FRC’s 2015 discussionpaper and the implementation of itsproposals. The review focused on specificaspects of financial reporting with referenceto the priority areas identified in that paper.8These changes, which came into effectfor large companies for financial periodsbeginning on or after 1 January 2019,9will place even greater emphasis on theimportance of providing high-qualityinformation in the annual report.The New World of MIFID II. Unintended Consequences. The QCA/PeelHunt Mid and Small-Cap Investor survey. (QCA 2018)Link: https://bit.ly/2LgvvHc6 Statutory audit services market study (CMA). Final Report. 18 April 2019Link: https://bit.ly/2L3Ws0n7FRC’s thematic review findings. Link: https://bit.ly/2AT1Lsn8 Topics included alternative performance measures (APMs), pensiondisclosures, accounting policies including critical judgements andestimates, cash flow statements and tax disclosures.9 To meet the definition of ‘large’, a company must meet two of the followingthree criteria: turnover over 36m; balance sheet total of over 18m; 250or more employees.5 5
IC AEW IN ASSOCIATION WITH THE FRCImproving the Quality ofReporting: Practical GuidanceThis guide offers practical suggestions for auditcommittees and boards of smaller listed andAIM quoted companies4 seeking to deliver highquality financial and non-financial reporting tothe users of the annual report and accounts. Itbuilds on key themes that emerged from theFRC’s 2015 discussion paper, which identified fourareas where sharper focus could help companiesimprove the quality of their annual report andaccounts. These areas are: a dequate time and resources available toproduce good quality annual reports; e arly engagement on the annual report by thosecharged with governance; d eeper understanding of relevant reportingstandards and requirements; and a ppropriate rigour by the auditor in the auditof financial statements and review of annualreports.6This guide outlines practical tips and questionsaudit committees can consider asking as a wayto challenge management on current financialreporting practices.Our suggestions are not mandatory orprescriptive, and the guide is not a comprehensivelist of all audit committee responsibilities. It aimsto encourage good practice and to help auditcommittees and boards evaluate the adequacyof a company’s financial reporting function andprocesses and drive improvements in quality.
A PR AC TICAL GUIDE FOR AUDIT COMMIT TEES ON IMPROVING FINANCIAL REPORTINGUNDERSTANDING THE IMPORTANCEOF HIGH-QUALITY FINANCIAL ANDNON-FINANCIAL REPORTINGEnsuring a company complies with financialreporting requirements is an essential task formanagement, with serious consequences for noncompliance in the form of penalties and potentialreputational damage. A concerted effort, includingthe commitment of resources, is required toensure full compliance with reporting obligations,including the relevant requirements of the UKListing Authority or AIM Rules.It is therefore important for the audit committee, inoverseeing the financial reporting process, to havean understanding of the company’s reasons forlisting, its shareholder base and how the companyintends to raise finance in the future. Collectively,these factors will influence how financial reportingis perceived within the company and allow theaudit committee to recognise where there maybe challenges in persuading management toprioritise high-quality financial reporting.NURTURING A CULTURE OFIMPROVEMENTAudit committees have responsibility foroverseeing the integrity, compliance and quality ofthe financial statements and disclosures preparedby management. They should help to ensurethat financial reporting is prioritised within thecompany. This can be achieved by: nurturing a culture of improvement; e ncouraging better understanding throughoutthe company of the importance of financialreporting; and c hallenging current practices where they appearto fall short of expectations.‘The audit committee provides confidence toshareholders on the integrity of the financial resultsof the company expressed in the annual report andaccounts and other relevant public announcementsof the company. The audit committee shouldchallenge both the external auditors and themanagement of the company.’QCA Corporate Governance Code 2018Questions for the audit committee toconsider W hat information are current and futureinvestors likely to be interested in? Arethere gaps in the current information thecompany communicates? W hat financial and non-financialinformation and reports are used forinternal management purposes, and howdoes this information compare to thescope and content of external reporting? H ow do we ensure that the company iscomplying with its reporting obligations?The FRC’s 2015 discussion paper identifiedaudit committee engagement as an area forimprovement, reporting that, ‘52% of respondentsto our survey of finance directors indicated that theaudit committee or board provides only limitedchallenge to the annual report and financialstatements’.Knowing how to start to bring about change canbe the biggest obstacle in driving up the qualityof financial reporting. However, it will rarely be thecase that it is necessary to overhaul all processesand procedures and so financial reportingchanges should be viewed as part of a drive forcontinuous improvement. Below are some simple,practical steps that may help accelerate thisjourney.7
IC AEW IN ASSOCIATION WITH THE FRCPractical Tips- R ead the FRC’s Annual Review of CorporateReporting, published every October, whichis a good starting point for audit committeeswanting to improve the financial reportingprocess. The review sets out areas of reportingthat the FRC has identified (through itsmonitoring activities) to have the greatestscope for improvement. The report includesan open letter to audit committee chairs andfinance directors, which focuses on key areas forimprovement and other topical and significantissues that should be addressed for the nextannual reporting cycle.- F ocus on the generic areas of reporting that area particular focus for investors in smaller quotedcompanies. The FRC’s 2015 discussion paperidentified these areas as follows: b usiness model, principal risks anduncertainties; cash flow statements; u nderstanding the underlying financialperformance of the company; d isclosure of accounting judgements andestimates; a ccounting policies, in particular revenuerecognition and capitalisation policies; and p rovisions – both new provisions and thosereleased during the year.- R efer to concerns identified during the prioryear’s financial reporting process as a way toinitiate change. Each concern should be revisitedto understand the steps that have been takento mitigate them in the current year. If no suchsteps have been taken, the audit committee willneed to understand why not and act accordinglyto ensure the concerns are addressed in a timelymanner.- E ngage early in the financial reporting andauditing process to set the right tone fromthe top and demonstrate the company’scommitment to high quality financial reporting.This engag
A PRACTICAL GUIDE FOR AUDIT COMMITTEES ON IMPROVING FINANCIAL REPORTING. 2 ICAEW IN ASSOCIATION WITH THE FRC A joint publication from the Financial Reporting Council (“FRC”) and the Institute of Chartered Accountants in England and Wales (“ICAEW”). This guide offers practical suggestions for audit committees and boards of smaller listed and AIM quoted companies seeking to deliver high .
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