Sophie Brabants, director of KPMG's Audit Committee Institute in Antwerp, explains how boards and audit committees in Belgium are responding to the economic crisis, and shares insights on key oversight practices and critical areas of focus that all audit committees should consider.
The financial crisis has acted as a kind of alarm bell for audit committees in some countries. Is this the case in Belgium?
Generally, audit committees in Belgium were doing their jobs before the crisis, and still are doing their jobs. I think more of the pressure has been felt by CEOs rather than audit committees. But the crisis has given rise to discussions about changing the form of regulation. There is some support for moving from a British-style ‘comply or explain’ approach to more of a regulatory model. But there still is not a great deal of support for replacing this approach with law and regulation. The ‘comply or explain’ approach provides greater transparency because it obliges management to explain non-compliance. Imposing regulations could turn compliance into a box-ticking exercise. We would lose the detail and logic that the ‘comply or explain’ approach offers.
With the benefit of hindsight, are there some potential ‘lessons-learned’ from the financial crisis?
First and foremost, the audit committee should consider the adequacy and effectiveness of the company's governance processes for managing risk. The audit committee can be a catalyst in helping to pose the right questions, including:
- Can management provide a holistic view of the company's major risks, both on and off the balance sheet?
- Are the principal risks facing the company understood and agreed upon?
- How rigorously does management test key risk assumptions?
- Are the board's information sources sufficiently varied and objective?
- How does culture — as well as incentive compensation — impact the company's risk profile?
Is there a call for a new risk culture?
Not necessarily a new risk culture, but a renewed focus on key areas of risk, and on risk-oversight processes. Monitoring the impact of the economic crisis on the company is one such area. Audit committees are focusing even more on financial forecasts and early-warning indicators. The audit committee needs to understand the impact of the recession on the company's earnings, cash flow, liquidity, and compliance with debt covenants. Any indications of trouble should be closely monitored. Management could assemble a crisis management team to monitor the impact of the crisis on a ‘real-time’ basis, and to develop and test worst-case scenarios.
The audit committee should also ensure that management is monitoring the impact of the crisis on the company's key customers, suppliers, insurers, partners, banks, underwriters, counterparties, and other third parties that may be experiencing financial difficulty or have filed for bankruptcy. An up-to-date assessment of the company's potential exposure to third parties is essential.
To make such monitoring effective, the audit committee should consider whether the information it receives comes from a balanced variety of sources — as opposed to relying too heavily on information from management — and whether the information flow promotes sufficient internal transparency, versus fragmented or partial views. Getting the right information is essential to providing effective oversight of the company's financial reports, its risks, internal controls, and finance team.
What about areas to focus on in financial reporting?
Again, audit committees paid close attention to financial reporting before the crisis — indeed, it is one of their principal responsibilities. But now there are specific areas of focus.
For example, the audit committee should be focused on the company's investment portfolio, including debt and equity securities, to identify declines in value or impairments that should be reflected in the financials. The committee also should assist in ensuring that management has identified possible impairments of goodwill, deferred taxes, patents, and other intangibles, and that fair values determined by management and valuation experts are reasonable. The audit committee also should understand how changes in financial markets impact the valuation of pension-plan assets and funding requirements.
The audit committee should understand the company's disclosure processes for fair value accounting and liquidity issues and how the application and impact of fair value accounting is described in the annual report and other periodic filings. Furthermore, the committee should consider whether the description of the company's liquidity risks is sufficiently robust and specific to the company.
Has the relationship with the external auditor changed in this context?
There has been no overall change. Close cooperation with the external auditor is still the rule. But there are, again, some areas for specific focus. Audit committees should work closely with the external auditor with special attention to going concern assumptions. In this period of crisis, the audit committee should make certain that the company's future is not threatened. This should be the subject of special attention from the external auditor, the audit committee, and management when the annual accounts are drawn up.
Has the relationship with management changed?
With the financial crisis and globalization changing the world in dramatic ways, the audit committee should step back and consider what the emerging business environment will look like. Does management understand how this new environment will impact the company's risk profile, and the viability of its strategy and business model?
But in this highly-charged business environment, where pressures to meet performance expectations have all exacerbated the normal rigors of the chief financial officer's and finance teams' jobs, the audit committee should recognize its critical role in guiding the organization through the financial crisis. It should support management by helping to maintain the focus on long-term financial performance, injecting objectivity into financial disclosures, and ensuring the finance organization has the expertise and resources, including the budget, to do its job well in this tough environment.
It is more important than ever to be acutely sensitive to the tone and the example set by leadership, and to help management reinforce a culture of compliance and a commitment to financial reporting integrity throughout the organization.
Previously published in ACI Insights – May 2009 The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG’s network of firms.
