A directors' game of Russian roulette

A report on the effectiveness of the internal control of auditing reveals many issues still to be resolved, writes Isobel Sharp

The auditing profession's standard setting body, the Auditing Practices Board, is about to issue a discussion paper on "Internal financial control effectiveness". To those who thought enough trees had already been sacrificed to provide guidance on internal control, first reactions might be to enjoy a long yawn. But for preparers, auditors and users of company annual reports, what the paper's publication will illustrate is that there is perhaps more unresolved than resolved on the subject.

When the Cadbury Report was published in December 1992, a three-fold recommendation on internal control matters was made stating that the accountancy profession, in conjunction with representatives of accounts' preparers, should take the lead in developing:

na set of criteria for assessing effectiveness;

nguidance for companies on the form in which directors should report; and

nguidance for auditors on relevant procedures and the form of their report.

The first recommendation has been met. In December 1994, aneight-page document, "Internal control and financial reporting", was published. Thus was the first misunderstanding created. The 1992 Cadbury Code required directors to report on "the effectiveness of the company's system of internal control". But what the December 1994 paper requires is less. The directors report on a subset of internal control and in terms that they have considered their effectiveness. However, there is no obligation to comment further on the results of that review.

The second misunderstanding was that the new guidance would be relatively easy to implement. Other recommendations of the Cadbury Report had been straightforward - for example, either the company had an audit committee or it did not. But internal financial control is proving more difficult to come to terms with. Matching a company's procedures with the 21 criteria set out in the guidance and then determining whether all the criteria have been met is proving a time-consuming process. And many directors are nervous about making public statements regarding the adequacy of the procedures, only to have to reportlater losses which might have been avoided if the system had been different.

With the benefit of hindsight, it is unfortunate that the working party that produced the December 1994 guidance did not also give an illustration of the form of report the directors should make - the second of the three Cadbury recommendations. While the report clearly sets out what the directors should state as a minimum, a picture of what is expected would communicate more quickly and effectively and might have avoided the misunderstanding that reporting on internal control can be handled as succinctly as other Cadbury-inspired disclosures.

But these are only starters. What this new paper from the Auditing Practices Board is set to demonstrate is that there are many unresolved issues on internal control reporting. The paper will be presumably written primarily for auditors, but, to meet the third recommendation, the issues will be equally important for directors now. For example, how many procedures must the company implement before it can say it has met any particular criteria? Do those procedures have to be applied throughout the group? If they are in operation worldwide, should they be observed with the same degree of diligence?

For a number of issues it is easy to suggest that the US study "Internal control - integrated framework", published by the Committee of Sponsoring Organisations of the Treasury Commission (Coso), provides guidance. But the UK report is more ambitious than its US equivalent; for example, it expects reporting on financial information used within the business and also that used externally while the latter deals solely with external information.

It is worth noting that the Coso report was published after a five-year study involving hundreds of individuals, including corporate executives, legislators, regulators, consultants, auditors and academics. The UK process was a David to that Goliath, but the consequence may be that a disproportionate burden is falling now on UK companies.

While the debate continues on internal control matters, attention is now being paid to the setting up of a Cadbury Mark II Committee. Agenda items are discussed widely. But attention should also be paid to the mechanics.

First, there has been a feeling over the past two or three years that there have been too many cooks each baking a tier on the same cake but not necessarily following the same recipe. While it is wholly appropriate that those with the expertise are involved in the process, there may be a case for clearer leadership on corporate governance matters.

Second, this committee should have, or have access to, better resources than its predecessor. Third, it should follow the policy of an incremental approach to improving governance, checking that proposals are achievable in theory and in practice and are wanted by those with a legitimate interest in corporate governance matters.

Otherwise, directors are being encouraged to play annually a game of Russian roulette.

The writer is technical partner at Binder Hamlyn, part of the Arthur Andersen worldwide organisation.

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

News
i100 In this video, the late actor Leonard Nimoy explains how he decided to use the gesture for his character
Arts and Entertainment
Secrets of JK Rowling's Harry Potter workings have been revealed in a new bibliography
arts + ents
News
Robert De Niro has walked off the set of Edge of Darkness
news The Godfather Part II actor has an estimated wealth of over $200m
Arts and Entertainment
Fearne Cotton is leaving Radio 1 after a decade
radio The popular DJ is leaving for 'family and new adventures'
Sport
Robbie Savage will not face a driving ban
football'Mr Marmite' faced the possibility of a 28-day ban
Voices
voices
Life and Style
Nearly half of all young people in middle and high income countries were putting themselves at risk of tinnitus and, in extreme cases, irreversible hearing loss
health
News
It was only when he left his post Tony Blair's director of communications that Alastair Campbell has published books
people The most notorious spin doctor in UK politics has reinvented himself
Life and Style
The new model would be a “pedal assist” bike in which the rider’s strength is augmented by the engine on hills and when they want to go fast
tech
Arts and Entertainment
arts + ents
Life and Style
fashion
Arts and Entertainment
James Franco and Zachary Quinto in ‘I Am Michael’
filmJustin Kelly's latest film tells the story of a man who 'healed' his homosexuality and turned to God
News
i100
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    SThree: HR Benefits Manager

    £40000 - £50000 per annum + pro rata: SThree: SThree Group have been well esta...

    Recruitment Genius: Office Manager / Financial Services

    £30000 - £37000 per annum: Recruitment Genius: Established in 1999, a highly r...

    Jemma Gent: Year End Accountant

    £250-£300 Day Rate: Jemma Gent: Are you a qualified accountant with strong exp...

    Jemma Gent: Management Accountant

    £230 - £260 Day Rate: Jemma Gent: Do you want to stamp your footprint in histo...

    Day In a Page

    HIV pill: Scientists hail discovery of 'game-changer' that cuts the risk of infection among gay men by 86%

    Scientists hail daily pill that protects against HIV infection

    Breakthrough in battle against global scourge – but will the NHS pay for it?
    How we must adjust our lifestyles to nature: Welcome to the 'Anthropocene', the human epoch

    Time to play God

    Welcome to the 'Anthropocene', the human epoch where we may need to redefine nature itself
    MacGyver returns, but with a difference: Handyman hero of classic 1980s TV series to be recast as a woman

    MacGyver returns, but with a difference

    Handyman hero of classic 1980s TV series to be recast as a woman
    Tunnel renaissance: Why cities are hiding roads down in the ground

    Tunnel renaissance

    Why cities are hiding roads underground
    'Backstreet Boys - Show 'Em What You're Made Of': An affectionate look at five middle-aged men

    Boys to men

    The Backstreet Boys might be middle-aged, married and have dodgy knees, but a heartfelt documentary reveals they’re not going gently into pop’s good night
    Crufts 2015: Should foreign dogs be allowed to compete?

    Crufts 2015

    Should foreign dogs be allowed to compete?
    10 best projectors

    How to make your home cinema more cinematic: 10 best projectors

    Want to recreate the big-screen experience in your sitting room? IndyBest sizes up gadgets to form your film-watching
    Manchester City 1 Barcelona 2 player ratings: Luis Suarez? Lionel Messi? Joe Hart? Who was the star man?

    Manchester City vs Barcelona player ratings

    Luis Suarez? Lionel Messi? Joe Hart? Who was the star man at the Etihad?
    Arsenal vs Monaco: Monaco - the making of Gunners' manager Arsene Wenger

    Monaco: the making of Wenger

    Jack Pitt-Brooke speaks to former players and learns the Frenchman’s man-management has always been one of his best skills
    Cricket World Cup 2015: Chris Gayle - the West Indies' enigma lives up to his reputation

    Chris Gayle: The West Indies' enigma

    Some said the game's eternal rebel was washed up. As ever, he proved he writes the scripts by producing a blistering World Cup innings
    In Ukraine a dark world of hybrid warfare and murky loyalties prevails

    In Ukraine a dark world of hybrid warfare

    This war in the shadows has been going on since the fall of Mr Yanukovych
    'Birdman' and 'Bullets Over Broadway': Homage or plagiarism?

    Homage or plagiarism?

    'Birdman' shares much DNA with Woody Allen's 'Bullets Over Broadway'
    Broadchurch ends as damp squib not even David Tennant can revive

    A damp squib not even David Tennant can revive

    Broadchurch, Series 2 finale, review
    A Koi carp breeding pond, wall-mounted iPads and a bathroom with a 'wellness' shower: inside the mansion of Germany's 'Bishop of Bling'

    Inside the mansion of Germany's 'Bishop of Bling'

    A Koi carp breeding pond, wall-mounted iPads and a bathroom with a 'wellness' shower