Learning the Lessons: Alan Cameron on Audit Committees at the joint IGAP & CPA Australia Annual Forum.

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Camerron photoAlan Cameron AO used his address to the IGAP and CPA Australia Annual Forum in 2014 on ‘The evolving role of audit committees’ to draw lessons from the HIH and Centro cases for contemporary audit committees.

Cameron is current Chair of the ASX Corporate Governance Council and several large public companies, and also a former Deputy Chancellor of the University of Sydney.

He addressed the IGAP and CPA Australia Annual Forum in his personal capacity, drawing on his extensive experience to provide insights into what the Centro and HIH judgements reveal about good audit committee practice.

Cameron’s keynote address emphasised directors’ role in addressing governance issues early, rather than becoming ‘gatekeepers’ after the fact:

‘To me gatekeepers are auditors and regulators and other people who look at the results afterwards. I think directors are rather earlier in the line than gatekeepers’.

Looking back over the Centro and HIH cases, Cameron highlighted three key lessons for how boards and audit committees can best execute their functions.

  1. Keeping the board and audit committee separate

The HIH judgement underscored how audit committees need to meet separately from the board if the accounts are to be examined rigorously. In Cameron’s words:

‘If the whole board is involved in the work of the audit committee, the audit committee is not doing its job. Its job is to have a first detailed look and if the whole board is there all the time as a matter of routine that isn’t going to happen’.

‘To me a troubling aspect of the processes of the HIH audit committee was its practice of meeting before and effectively in the presence of the board. As a result of that practice it operated as little more than an extension of the board… I see that now all over the place’.

  1. Making time to review financial reports properly

Another impediment to rigorously examining the accounts is not allowing the audit committee and the board time to consider the financials properly. Among other issues, the HIH judgement criticised ‘the practice of the six monthly financial reports being considered by the audit committee, approved by the board and announced all on the same day’.

Not only do directors need time between meetings to adequately review the financial reports, they also need time to access the right people:

‘The audit committee should meet auditors in the absence of management before or in the course of each meeting or at least from time to time. The material should be distributed well in advance of a committee meeting’

  1. A clear audit committee charter

Cameron’s analysis of the HIH judgement also highlighted the absence of a clear role for the audit committee in that company. By contrast, a clear and detailed charter can help define and clarify the audit committee’s role:

‘The [HIH] charter is short and the terms of reference are couched in general language. They do not clearly define and establish the role and responsibilities of the committee and its relationship to the board. There is no evidence that the terms were reviewed annually to see that the committee in its role remained relevant to the needs of HIH. So I think the clear message from that is short might be dangerous. You do need to review it every year’.

Learning the Lessons

Although Cameron’s address focused on audit-committee practice, he also reminded participants of the whole board’s responsibilities under law:

‘Whilst an audit committee has an important role of monitoring oversight that is not to the exclusion of the role of a director to consider the financial accounts for him or herself’.

Cameron concluded by highlighting several practices that directors might adopt, including:

  • Insisting on reviewing paper copies of the reports;
  • Checking organisations’ systems for dealing with whistle-blowers; and
  • Paying attention to internal audit.

Ultimately though, Cameron stressed that there is no substitute for directors using their limited time to investigate the right issues:

‘We can set up all these structures, but if people don’t ask the right questions, and be appropriately sceptical, then you will still have these problems’

What does the market expect of audit committees? Michael Coleman at the joint IGAP & CPA Australia Annual Forum.

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MC picWhat does the market expect of audit committees? Increasingly, ‘everything’, Michael Coleman told the Annual Forum, held in October, 2014.

The joint IGAP and CPA Australia Annual Forum gathers leaders from industry, the accounting profession and academia to address key issues in contemporary governance and performance.

This year’s topic – ‘The  evolving role of audit committees’ – explored how audit committees are responding to rapidly evolving risks, liability, technological advancements and complexity in reporting, among a myriad of other challenges.

Coleman was Chair of the Financial Reporting Council (FRC), sits on a number of prestigious boards and has also had 30 years as an audit partner. He used his keynote address to highlight a potential expectations gap between what markets expect of audit committees and what directors can reasonably deliver.

Coleman highlighted several key challenges that audit committees are facing:

  • Changing expectations of regulators and the market; for example, that audit committees should be satisfied that auditors are doing their job or commenting on financial reviews;
  • A greater focus on risk; and
  • The proliferation of reports (e.g. Integrated Reporting).

A particular difficulty Coleman highlighted is the expectations for audit committees to form a judgement on audit quality:

“So whether it’s a good audit or not a good audit is a tough one and this is something that as audit committees we’re probably going to have to take a reasonable amount of time to consider.”

“We need to question amongst other things whether or not the auditor has been sufficiently sceptical. Now, how does an auditor demonstrate to the board that they’ve been sceptical?”

Coleman also highlighted how Australia has to some extent followed the United States trend of increasing the responsibilities of audit committees:

“In particular in my experience it’s become common for audit committees to approve fees over a certain level in relation to non-audit services provided by the auditor and audit committees have taken on a far more extensive role in relation to overseeing the financials.”

However, unlike in the United States, Australia still sees the audit committee as a sub-committee of the board:

“It’s not a separate creature, it’s not a separate animal and so therefore, and especially following Centro, we have the situation where boards, very, very rigorously in my experience, are actually as a whole considering the financials.

“The audit committee might look at the detail, but then the board as a whole still wishes to satisfy itself that it’s actually doing the right thing.”

Finally, Coleman observed how the expectations on audit committees would continue to evolve in the future with the release of a new auditing reporting standard in June 2016, which “will require the auditor’s report to include commentary on their key audit matters”. The new standards are likely to some interesting discussions, and to some changes to the dynamic of the relationship between the auditor and audit committee.

Audit, Aristotle and the Clean Energy Regulator

The Clean Energy regulator used its Annual Audit and Assurance Workshops held earlier this year to emphasise the importance of audit to the agency. This including having two members of the regulator – Annie T. Brown and Michael D’Ascenzo – as keynote speakers to ‘reinforce the point that the Clean Energy Regulator takes its audit functions very seriously’.

IGAP’s Prof. Nonna Martinov-Bennie, who also sits on the Australian Auditing and Assurance Standards Board (AUASB), was also a keynote speaker.

Prof. Nonna Martinov-Bennie presented on the key audit concept of ‘professional scepticism’. The presentation was based on in-depth interviews with senior audit practitioners, and covered a number of aspects of professional scepticism and their practical implications. Prof Martinov-Bennie also highlighted the apparently conflicting views of audit scepticism as a relatively fixed character trait, but also a ‘skill’ that can be trained over time.

The presentation introduced an ‘Aristotelian’ idea of professional scepticism – developed in collaboration with A/Prof Dyball and Dr Dale Tweedie – which shows how these seemingly contradictory elements of audit scepticism might be resolved. Far from being simply ‘academic’, Prof. Martinov-Bennie outlined important practical implications of understanding audit scepticism in this way.

Prof. Martinov-Bennie and A/Prof Dyball also presented their research findings at the ICAA academic leadership series. Slides of both presentations are available below:

Clean Energy Regulator Presentation >

< ICAA Academic Series >

For more information on this research and analysis, contact: nonna.martinov-bennie@mq.edu.au

Des Pearson on Public Sector Audit

DP PicThe International Governance and Performance (IGAP) Research Centre was pleased to host Mr Des Pearson, who recently retired as Auditor General of Victoria, as the IGAP Executive in Residence sponsored by CPA Australia. Des’s public sector career spanned over 40 years and 5 jurisdictions, with more than 30 years’ experience at senior, chief executive and statutory officer levels. Des has worked in governance, financial and program management, performance evaluation and accountability roles, including more than 21 years as an Auditor General across two jurisdictions.

During his time at IGAP, Des presented two seminars: at an IGAP/ CPA Australia Roundtable on performance reporting; and at Macquarie University’s Department of Accounting and Corporate Governance on public sector reporting. The slides and key points from Des’s presentations are below.

Performance Reporting (at CPA Australia)

  • Public sector audits include financial and non-financial audit: both financial ‘how much’ and performance ‘how well’, are critical.
  • While financial reporting in the public sector is well-developed, performance reporting is still ad-hoc.
  • Public sector audits have unique challenges: a democracy (and therefore adversarial governance); and the rationing of limited (taxpayer funded) resources against excess demand (from the community).
  • Other challenges include: adopting market models within the public sector; co-ordination between the government and other entities; and public sector timelines (3-4 year terms of office).
  • Possible responses to these challenges are: comprehensive performance reporting; sustainability and integrated reporting; and, building on the Productivity Commission’s Report of Government Services.

SLIDES: PERFORMANCE REPORTING CPA

Public Sector Reporting (at Macquarie University)

  • The Federal, NSW and Victorian state public sectors arguably represent Australia’s first, second and third largest businesses. The auditor general needs to provide assurance to Parliament that these sectors are performing and accountable.
  • Public sector clients are diverse, including local governments, water corporations, police, emergency services, financial institutions, and universities.
  • The key focus for all audits is accountability: that is, reporting back to those who have charged you with a responsibility. The funding of the public sector by a forcible extraction of funds via taxes and charges adds an extra layer of accountability as there is an obligation to apply these funds ‘in the public interest ‘.
  • The Australian public sector needs to be made accountable, not only for probity, integrity and performance management, but also for a working democracy. Quality in public service audit, means reliable assurance of efficiency, economy and effectiveness in program delivery.

SLIDES: PUBLIC SECTOR ACCOUNTING MACQUARIE UNIVERSITY

What promotes confidence and trust in the audit function?

Confidence in the financial reporting of established and emerging firms, the credibility of the audit function and perceptions of audit quality are critical to the success of the Australian economy, argue Professor Nonna Martinov-Bennie and Dr Alan Kilgore from IGAP, in an article published in the October 2012 edition of Think and Grow Rich.

?????????????????????????????????????????????????????????????????????????????Increased Scrutiny of Audit

In the wake of corporate collapses and the Global Financial Crisis,  what actually constitutes a high quality audit has come under public and regulatory scrutiny. This has most recently taken form in the establishment of the Advisory Committee on the Auditing Profession in the United States, and the release of key frameworks and documents internationally, including:

  • the International Auditing and Assurance Standards Board (IAASB)’s consultation paper: A Framework for Audit Quality (2013);
  • the Public Company Accounting Oversight Board’s Strategic Plan: Improving the Relevance and Quality of the Audit for the Protection and Benefit of Investors (2012);
  • the European Commission’s (EC) Green Paper Audit Policy: Lessons from the Crisis  (2010);
  • Audit Quality in Australia – A Strategic Review (2010); and
  • the Audit Quality Framework (2008) in the United Kingdom.

As Martinov-Bennie and Kilgore argue, the credibility of the audit function plays an important role in establishing and maintaining an effective and efficient capital market. There are public and private benefits to these efficiencies: the equitable distribution of investment gains; reliable financial statements that encourage a broader range of investors; and the potential for higher investment returns through reducing financial statement risk.

Key Audit Quality Attributes – The Audit Team

However, as highlighted in a recent study by Kilgore and colleagues, with representative users of audit services (audit committee members, financial analysts, and fund managers), perceptions of quality also play an important role in maintaining trust and credibility in the audit function.

The study established that factors relating to the audit team were perceived to be relatively more important than factors related to the audit firm. More specifically, perceptions of five key audit team attributes were found to be relatively more important than perceptions of audit firm attributes such as audit quality assurance review and audit firm industry experience; namely:

  1. the partner / manager attention to the audit
  2. the manager knowledge of the client industry;
  3. knowledge and experience of the audit team;
  4. communication between the audit team and client; and
  5. the partner knowledge of the client industry.

Only audit firm size was considered relatively more important than these five audit team attributes.

In another project, commissioned by Association of Chartered Certified Accountants (ACCA), Dr Kilgore, Prof Martinov-Bennie and Associate Professor Sue Wright are currently undertaking research on perceptions of audit quality among other stakeholders. Preliminary results suggest that while different stakeholder groups have different views, audit team characteristics remain important to perceptions of audit quality.

Implications and Future Research

The implications of these findings are important at both national and international levels for the audit profession, regulators, and standards setters, and for efforts aimed at improving the effectiveness and integrity of the audit process. These findings are particularly important  for regulatory and professional accounting bodies working to improve audit quality, since they have tended to focus on audit firm factors, in lieu of (perceptions of) audit team expertise and experience. Combined, the findings suggest that not only do different stakeholders have different perceptions of the key drivers of audit quality, but also that audit quality is viewed by market participants as a multi-dimensional construct. In trying to better understand what makes a quality audit, we really need to know more about the people who actually perform them.

Carbon Accounting: New Reporting and Assurance Challenges

The growing international impetus to address climate change means that it is increasingly important for organisations to understand and manage their environmental impacts. In a 2012 article, Nonna Martinov-Bennie reviewed the introduction of carbon management legislation in Australia, and explains the key reporting and assurance issues.

http://www.dreamstime.com/stock-images-co2-emissions-image17305254Carbon Legislation in Australia

The main climate change legislation in Australia is the Clean Energy Act 2011. The Clean Energy Act has four major initiatives: a carbon pricing mechanism, support for innovation in renewable energy, energy efficiency and enhancement in land management. Arguably, the policy with the most significant reporting implications – and also the most controversial – is the carbon pricing mechanism or ‘carbon tax’. The carbon pricing policy establishes an initial fixed price of $23 per tonne of CO2. This price will increase at 2.5% plus inflation until 2015, and then transition to a price determined by a carbon market. While the carbon price is new, it builds on an on-going legislative and reporting framework in Australia that began with the National Greenhouse and Energy Reporting Act in 2007.

Carbon pricing: key issues

As Martinov-Bennie explains, carbon reporting and pricing challenges business to improve their reporting and management in several key areas:

  • Reporting rigour: Because organisations’ survival has not historically depended on its control of environmental impacts, non-financial reporting has not attained the same rigour as financial reporting. By putting a cost on environmental performance, carbon pricing provides incentives for firms to bring environmental reporting standards and controls up to the same high standards.
  • Timely data: Emissions data is typically reported annually. However, the creation of a carbon price questions whether annual reporting is adequate. More frequent   reporting better reflects organisations’ costs and liabilities and can support more effective management of outputs. At least one large mining company is already moving to monthly reporting for operations of over 50-kt CO2.
  • Robust reporting systems: The current legislative framework requires secure data storage and audit trails of changes for five years. Most firms are reporting based on spreadsheets, but it is unlikely that this will be adequate over the long term.
  • Effective reporting teams: Producing effective carbon data requires organisations to create interdisciplinary teams that have the range of skills that effective carbon reporting requires.

Measuring carbon: organisational strategies

Martinov-Bennie also highlights new governance and measurement challenges involved in measuring carbon output:

  • Periodic or Continuous Carbon Reporting: Periodic reporting is the cheapest and most popular method of measuring carbon liability; however, it is also the least accurate. Organisations need to consider whether a more expensive continuous measurement system might better manage the risk of highly variable emissions.
  • Measuring the Right Activity: Accurately measuring carbon emissions requires a thorough and holistic understanding of production, especially when using contractors. For example, a landfill company that outsources emissions to a third party through gas flaring needs to report those emissions.

The future of carbon pricing in Australia?

Despite calls for certainty by the business community, the federal opposition in Australia has promised to repeal carbon pricing legislation if elected in September. However, while many commentators are predicting a change of government and policy, the long-term future of carbon pricing is uncertain. As a small, trade dependent nation, there are limits on Australia’s capacity to remain isolated if other nations move towards carbon reporting and assurance, as recent suggestions that China is considering a carbon pricing mechanism have highlighted.

Also, the long-term value for organisations in rigorous reporting and management of climate change data is not solely a consequence of the Clean Energy Act. Independent international initiatives to report environmental impacts, such as by the Global Reporting Initiative and the International Integrated Reporting Council, suggest growing pressure from stakeholders to report environmental outcomes. The growth in investment funds with sustainability criteria will also benefit firms who can report on their environmental management practices, and suggests a growing need for assurance of these reports.

Finally, as Martinov-Bennie’s article highlights, developing effective reporting of carbon outputs is one part of understanding and evaluating an organisation’s production process. From this perspective, carbon reporting and assurance is not solely an exercise in compliance, but also an opportunity to develop a more rigorous assessment of an organisation’s non-financial impacts and management strategies.

Internal Audit ‘After the Crisis’

In the aftermath of prominent corporate scandals and the global financial crisis, corporate governance has received close attention from regulators and the public. Regulatory responses have focused on increasing governance requirements and disclosures and this has, in turn, driven increased awareness and demand for internal assurance within organisations. Internal audit is integral to corporate governance, and is well placed to provide this assurance. In a recent article, Dominic Soh and Nonna Martinov-Bennie used interviews with audit committee chairs and chief audit executives to investigate internal audit functions in the Australian context, and to consider how their effectiveness might be improved.

 KEY FINDINGS ??????????????????????????????????????????????????????????????????????????????????????????????

1. The scope of the internal audit function has expanded and refocused in recent years. Internal audit is increasingly involved in risk management rather than traditional “tick and flick” financial audits. There is also greater engagement in operational areas, and increased focus on performing a value-adding role, such as identifying how businesses can increase their efficiency and effectiveness. There is a clear expectation that in addition to its assurance role, this ‘value-added’ emphasis will continue.

2. The changing role of internal audit is largely due to regulatory reforms. Increased sensitivity to directors’ liabilities, particularly of those directors on the audit committee, has meant increased acceptance of the importance and value of the internal audit function as the ‘eyes and ears’ of the organisation. Some audit committee chairs described the assurance and comfort from internal audit as greater, and perhaps more valued, than from external audit.

3. The effectiveness of internal audit depends on its structure, resourcing and organisational status.

  • There was a clear preference for an in-house function (or at least an internal chief audit executive), on the basis that intimate business knowledge contributes to an effective audit function and makes it better equipped to meet the audit committee’s assurance needs.
  • Interviewees highlighted the importance of key competencies (audit, finance, operational, technological, and legal), but especially the capacity of the chief audit executive to ‘command the confidence and respect of the people out in the field so as to be able to gain access and cooperation’.
  • Good relationships with, and support from, the audit committee and senior management were seen as critical to an effective internal audit function. For example, it is imperative that the audit committee supports and protects the status and visibility of the function e.g. by providing a platform for internal auditors to present their findings at audit committee meetings, ensuring the chief audit executive is present in operations meetings, and ensuring that management undertakes appropriate remedial action in response to audit recommendations.

4. Performance metrics have not evolved in line with internal audit’s role. Common measures of effectiveness related to the annual audit work plan and to measures of acceptance and adoption of audit recommendations. Since these measures were similar to prior surveys, it is clear that performance evaluation mechanisms have not evolved alongside the expansion and refocus of the internal audit function.

IMPLICATIONS:

1. Internal audit cannot be evaluated in isolation. The quality and effectiveness of the internal audit function is largely dependent on other parties within the organisation, especially the audit committee and senior managers. Consequently, an ineffective internal audit function might indicate that there are broader issues in the organisation’s corporate governance.

2. Whether internal audit meets stakeholder expectations is unclear. The misalignment between the current and evolving role of internal audit and static performance measures makes it difficult to assess whether internal audit is meeting stakeholders’ expectations. Given that the internal audit function serves different stakeholders (who at times have divergent interests) within the organisation, more diverse metrics are required to measure whether internal audit is meeting the potentially different needs of stakeholders. For example, while audit committee chairs emphasised the value of assurance, chief audit executives emphasised ‘value added’ from the organisation’s perspective.

3. New performance metrics may be required. Given the increasing emphasis on the consulting and value adding role of the internal audit function, alternative metrics such as value tracking by cost savings or value creation may better measure the performance and effectiveness of the function. There is however a potential risk that such metrics would impair internal auditor’s independence and objectivity, with implications for the external auditor’s evaluation and reliance on the internal audit function.

4. The chief audit executive skills need careful assessment. The increasing involvement of internal auditors in consulting and operational areas requires staff with industry knowledge and experience. In addition to strength of character and an inquiring mind, the chief audit executive needs strong communication skills to build bridges with all business areas, and to confidently report to higher organisational levels. Developing these competencies is no mean feat, and would take considerable time. Organisations therefore need to consider how limited tenure or rotation of this role could work, if it is required or even tenable.  These also have implications for what the career path of a chief audit executive would ultimately look like.

See: Dominic Soh’s and Nonna Martinov-Bennie’s article and abstract: