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; request a free guide on NISAs from Hargreaves Lansdown

News
i100
News
people Emma Watson addresses celebrity nude photo leak
News
Katie Hopkins appearing on 'This Morning' after she purposefully put on 4 stone.
peopleKatie Hopkins breaks down in tears over weight gain challenge
News
peopleHis band Survivor was due to resume touring this month
PROMOTED VIDEO
Arts and Entertainment
Robert De Niro, Martin Scorsese and DiCaprio, at an awards show in 2010
filmsAll just to promote a new casino
News
i100
News
In this photo illustration a school student eats a hamburger as part of his lunch which was brought from a fast food shop near his school, on October 5, 2005 in London, England. The British government has announced plans to remove junk food from school lunches. From September 2006, food that is high in fat, sugar or salt will be banned from meals and removed from vending machines in schools across England. The move comes in response to a campaign by celebrity TV chef Jamie Oliver to improve school meals.
science
News
people'It can last and it's terrifying'
Arts and Entertainment
tv
Life and Style
fashionModel of the moment shoots for first time with catwalk veteran
News
i100
Sport
Tom Cleverley
footballLoan move comes 17 hours after close of transfer window
Sport
Alexis Sanchez, Radamel Falcao, Diego Costa and Mario Balotelli
footballRadamel Falcao and Diego Costa head record £835m influx
Life and Style
fashionAngelina Jolie's wedding dressed revealed
News
Boris Johnson may be manoeuvring to succeed David Cameron
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

    C++ Quant Developer

    £700 per day: Harrington Starr: Quantitative Developer C++, Python, STL, R, PD...

    Java/Calypso Developer

    £700 per day: Harrington Starr: Java/Calypso Developer Java, Calypso, J2EE, J...

    SQL Developer

    £500 per day: Harrington Starr: SQL Developer SQL, C#, Stored Procedures, MDX...

    C#.NET Developer

    £500 per day: Harrington Starr: C#.NET Developer C#, WPF, WCF, ASP.NET, Prism...

    Day In a Page

    Stolen youth: Younger blood can reverse many of the effects of ageing

    Stolen youth

    Younger blood can reverse many of the effects of ageing
    Bob Willoughby: Hollywood's first behind the scenes photographer

    Bob Willoughby: The reel deal

    He was the photographer who brought documentary photojournalism to Hollywood, changing the way film stars would be portrayed for ever
    Angelina Jolie's wedding dress: made by Versace, designed by her children

    Made by Versace, designed by her children

    Angelina Jolie's wedding dressed revealed
    Anyone for pulled chicken?

    Pulling chicks

    Pulled pork has gone from being a US barbecue secret to a regular on supermarket shelves. Now KFC is trying to tempt us with a chicken version
    'I’ll tell you what I would not serve - lamb and potatoes': US ambassador hits out at stodgy British food served at diplomatic dinners

    'I’ll tell you what I would not serve - lamb and potatoes'

    US ambassador hits out at stodgy British food
    Radio Times female powerlist: A 'revolution' in TV gender roles

    A 'revolution' in TV gender roles

    Inside the Radio Times female powerlist
    Endgame: James Frey's literary treasure hunt

    James Frey's literary treasure hunt

    Riddling trilogy could net you $3m
    Fitbit: Because the tingle feels so good

    Fitbit: Because the tingle feels so good

    What David Sedaris learnt about the world from his fitness tracker
    Saudis risk new Muslim division with proposal to move Mohamed’s tomb

    Saudis risk new Muslim division with proposal to move Mohamed’s tomb

    Second-holiest site in Islam attracts millions of pilgrims each year
    Alexander Fury: The designer names to look for at fashion week this season

    The big names to look for this fashion week

    This week, designers begin to show their spring 2015 collections in New York
    Will Self: 'I like Orwell's writing as much as the next talented mediocrity'

    'I like Orwell's writing as much as the next talented mediocrity'

    Will Self takes aim at Orwell's rules for writing plain English
    Meet Afghanistan's middle-class paint-ballers

    Meet Afghanistan's middle-class paint-ballers

    Toy guns proving a popular diversion in a country flooded with the real thing
    Al Pacino wows Venice

    Al Pacino wows Venice

    Ham among the brilliance as actor premieres two films at festival
    Neil Lawson Baker interview: ‘I’ve gained so much from art. It’s only right to give something back’.

    Neil Lawson Baker interview

    ‘I’ve gained so much from art. It’s only right to give something back’.
    The other Mugabe who is lining up for the Zimbabwean presidency

    The other Mugabe who is lining up for the Zimbabwean presidency

    Wife of President Robert Mugabe appears to have her sights set on succeeding her husband