Fi­nan­cial Re­port­ing and the re­spon­si­bil­i­ties of the Board mem­bers and Au­dit Com­mit­tee

Financial Mirror (Cyprus) - - FRONT PAGE -

A fi­nan­cial mis­state­ment usu­ally in­volves se­nior man­age­ment of public com­pa­nies, who are in a unique po­si­tion to per­pe­trate fi­nan­cial mis­state­ment by over­rid­ing con­trols. As a con­se­quence, the role of the board of di­rec­tors, au­dit com­mit­tees, ex­ter­nal and in­ter­nal au­di­tors is crit­i­cal in prop­erly ad­dress­ing fi­nan­cial mis­state­ments and over­ride of con­trols. At times of neg­a­tive eco­nomic en­vi­ron­ment, when tar­gets are much harder to achieve, in­creased pres­sure is im­posed at cor­po­rate level for bet­ter re­sults and this cre­ates in­cen­tives for fi­nan­cial mis­state­ment and fraud.

But fi­nan­cial mis­state­ment and fraud could also oc­cur at lower lev­els of man­age­ment when mid­dle cor­po­rate man­agers may claim that they did not re­alise that they were com­mit­ting a fi­nan­cial mis­state­ment or fraud, but saw them­selves as sim­ply do­ing what was ex­pected of them by se­nior man­age­ment. Mid­dle man­agers and other em­ploy­ees com­mit­ting this type of fraud may not be do­ing it for a di­rect per­sonal gain, but be­cause se­nior man­age­ment cre­ated the im­pres­sion that the ma­nip­u­la­tion (or omis­sion of ad­just­ment/ac­tion) is needed, it is for the best in­ter­ests of all, and af­ter all this is what is ex­pected of them by se­nior man­age­ment.

When faced with a ma­te­rial fi­nan­cial mis­state­ment or fraud, it is more likely that se­nior man­age­ment ei­ther knew about it, should have known about it, or have caused it by putting pres­sure on lower-level em­ploy­ees. Such be­hav­iour may be ra­tio­nalised as: “We were sure that busi­ness was go­ing to turn around in the near fu­ture and most prob­a­bly next year, we were pro­tect­ing com­pany jobs in this way, we did not in­tend in­vestors, etc.”

Se­nior man­age­ment has the pri­mary re­spon­si­bil­ity for the fi­nan­cial re­port­ing process and for im­ple­ment­ing con­trols to de­ter and de­tect fi­nan­cial mis­state­ment and fraud. But at the same time in ad­di­tion to se­nior man­age­ment, the board of di­rec­tors, the au­dit com­mit­tees, the in­ter­nal and ex­ter­nal au­di­tors have com­ple­men­tary and in­ter­con­nected roles in de­liv­er­ing high-qual­ity fi­nan­cial state­ment re­ports to the in­vest­ing public and other in­ter­ested coun­ter­par­ties. The Board of di­rec­tors and au­dit com­mit­tees are re­spon­si­ble for the over­sight of a com­pany’s busi­ness op­er­a­tions and con­trol en­vi­ron­ment.

The au­dit com­mit­tee in par­tic­u­lar is re­spon­si­ble for over­see­ing not only the fi­nan­cial state­ment re­port­ing process but also the com­pany’s ex­ter­nal au­di­tors and the in­ter­nal au­dit func­tion.

In this re­spect, board and au­dit com­mit­tee mem­bers of public com­pa­nies are ex­pected to be of high morale, well ed­u­cated and ex­pe­ri­enced in their line of busi­ness, and have a sound un­der­stand­ing of the com­pany’s busi­ness and its in­dus­try. At the same time, board mem­bers are ex­pected to put less trust on a com­pany’s se­nior man­age­ment, per­form their own due dili­gence on sig­nif­i­cant is­sues and chal­lenge a com­pany’s man­age­ment ac­tions and de­ci­sions. In other words, board mem­bers should be scep­ti­cal of se­nior man­age­ment and ask ques­tions about crit­i­cal com­pany mat­ters.

to cause any harm

to any­body in­clud­ing

Au­dit com­mit­tee mem­bers should not only pos­sess the qual­i­ties de­scribed in the pre­vi­ous para­graph but also have a work­ing un­der­stand­ing of In­ter­na­tional Fi­nan­cial Re­port­ing Stan­dards (IFRS) in or­der to be in a po­si­tion to chal­lenge se­nior man­age­ment with ques­tions on risks that could po­ten­tially cre­ate in­cen­tives for fi­nan­cial mis­state­ment. Such prob­ing ques­tions should be ad­dressed to se­nior man­age­ment, ex­ter­nal and in­ter­nal au­di­tors. Au­dit com­mit­tee mem­bers are ex­pected to have an ac­tive role, and not a pas­sive one, when deal­ing with sig­nif­i­cant fi­nan­cial state­ment re­port­ing is­sues.

The au­dit com­mit­tee should be in a po­si­tion to utilise both in­ter­nal and ex­ter­nal au­di­tors in or­der to prop­erly eval­u­ate the ef­fec­tive­ness of man­age­ment’s ac­tions with re­gard to fi­nan­cial re­port­ing mat­ters. Even though the role of the au­dit com­mit­tee is not to be di­rectly in­volved in the man­age­ment of the com­pany, its role and re­spon­si­bil­ity is clearly to over­see the fi­nan­cial re­port­ing ac­tiv­i­ties and pro­ce­dures of the com­pany.

At the same time the au­dit com­mit­tee should not only be in a po­si­tion to un­der­stand the ex­po­sure to man­age­ment over­ride of con­trols but also to take re­me­dial ac­tion and mit­i­gate the pos­si­bil­ity that an over­ride could oc­cur.

To con­clude, the au­dit com­mit­tee’s most im­por­tant role is to set the tone at the top mak­ing it clear to other board mem­bers, se­nior com­pany man­age­ment, in­ter­nal and ex­ter­nal au­di­tors that they should be do­ing the right thing at all costs by strictly fol­low­ing the fi­nan­cial re­port­ing stan­dards de­spite the con­se­quences such an ac­tion could have on the com­pany’s re­ported fi­nan­cial re­sults.

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