Issues of the Day for Boards and Audit Committees

by Mak Keat Meng and Glenn Daly, Apr 24 2009 The faltering economic conditions in global capital markets and tightening of credit flow witnessed in 2008 have left many companies facing profit erosion or losses by the close of the year. Not surprisingly, increased scrutiny by investors and stakeholders has heightened the pressure and spotlight on boards and audit committees.

Charged with oversight responsibilities over most, if not all, aspects of the business, boards and audit committees find themselves confronted with new challenges, or old fundamentals that have assumed unprecedented significance. Pertinent issues ranging from financing to financial communications to risk management and controls, which have been extensively discussed and debated in the boardroom, are expected to continue into 2009.

With exposure to financial instruments hogging headlines in 2008, liquidity and valuation issues remain vital concerns for most companies. This calls for boards and audit committees to sharpen their focus on the company's working capital, and look into revising or upgrading their treasury governance processes where necessary.

Swift action by treasury departments in managing and forecasting cash flow is critical to financial performance. The lines of communication between board, audit committees and the treasury department should be kept open. Boards and audit committees need to consider carefully the safety of the company's funds in its banks and investments, and ensure they are informed of treasury-related risks, which should rightfully be incorporated into the enterprise-wide risk programme. It is also timely to review the company's investment portfolio and policy to clearly define the types and volumes of treasury risk a company can undertake.

In addition, boards and audit committees should advise management to exercise prudence and patience in seeking new acquisitions or opportunities, and re-assess significant expenses in 2009.

Protecting the company from excessive risk continues to be a top priority. Getting risk management right often requires re-visiting the fundamentals. The board is ultimately responsible for ensuring that the management has established adequate risk management policies and systems to safeguard shareholders' investment and company assets. A basic, yet critical, governance consideration is whether the audit committee is adept at reviewing the adequacy of the risk management process in the company, or if a separate risk committee with the right composition and experience, or even an external adviser, is necessary.

In addition, it is important that the company's risk management framework recognises a broader risk universe that includes strategic, operational and compliance exposures beyond financial risks, and that this mindset is embedded in the company's risk culture. Encourage management to 'think below the radar' and ensure that the risk profile is continually updated and presented at board meetings.

Efforts in risk management can sometimes be dispersed and be unrelated to the wider organisation strategy. Boards and audit committees can influence the management to consider integrating risk and performance management to bridge this gap. Consider incorporating key risk indicators in the same manner as key performance indicators are used in the company's balanced scorecard, to ensure that success is not achieved at the expense of risk exposures.

Most companies are also actively identifying their counterparty risks - an omnipresent risk in every contract, which is a real concern today, given the extent of the financial crisis. Counterparty risk should not deter business activities though. Rather, boards and audit committees can help to manage exposures by examining the controls in place, reviewing them on a regular basis and ensuring appropriate levels of disclosures in financial statements.

The increased pressure to achieve financial goals and potentially reduced investment in internal controls as part of enterprise-wide cost reduction, may inadvertently lead to a rise in risk of unethical behaviour and fraud. Boards and audit committees should drive internal auditors to concentrate on areas that are predisposed to performance pressures, consider carefully the possibility of fraudulent financial reporting, and ensure there is a robust whistle-blowing programme in place to enable inappropriate behaviour to be flagged for swift attention. Regardless of market conditions, audit committees play an important role in overseeing the accuracy, integrity and clarity of their company's financial reporting. The current economic volatility has necessitated some changes in the way audit committees perform their role.

For example, many audit committees are expanding their scope of oversight to include broader financial communications such as analyst calls and earnings press releases. They are also more sensitive to the language and tone in financial announcements, such as ensuring disclosures in the financial statements do not appear overly 'aggressive' or 'conservative' during these times, while continuing to give a true and fair view of the company's financial performance.

The market disruptions in 2008 have resulted in the impairment of goodwill and intangible assets, hitting the balance sheets of many companies. Obtaining fair values has also become more challenging. As such, boards and audit committees are spending more time to examine and evaluate the assumptions, estimates and judgments used in valuations in order to ensure that these are in line with evolving market conditions.

Lastly, in the preparation of financial statements by management, one of the fundamental assumptions is that the company will continue as a going concern in the next financial year. The current financial upheaval challenges this assumption, and raises substantial doubts over the accessibility and availability of funds for companies on an ongoing basis. As such, boards and audit committees need to be aware of the impact of the downturn on their companies' operating prospects and sources of funding in 2009. It will be worthwhile for them to engage in thoughtful analyses and dialogue with the management and the auditors regarding going concern assessments, so that sources of uncertainty can be addressed in a timely manner.

Mak Keat Meng is head of assurance services, Ernst & Young, and Glenn Daly is partner, business risk services, Ernst & Young Solutions.