The elephant in the boardroom

By Jasmine Hogg

Regardless of where you stand on corporate governance and the future of director duties, this year’s federal court judgment in the Centro Properties Group case will be the elephant in the boardroom for some time.

In June, the federal court found the entire Centro board had contravened the Corporations Act by not fulfilling their duties as directors, after signing off on major errors in the company’s accounts in 2007. The case was brought by ASIC, who charged the board with failure to disclose some $1.5 billion of short-term liabilities by classifying them as non-current liabilities, and failure to disclose guarantees of short-term liabilities of an associated company of about US$1.75 billion that had been given after the balance date.

ASIC had sought fines and disqualification for each of the eight defendants – two executives and six non-executive directors. But while the August sentencing resulted in a $30,000 fine for the group’s former CEO and a two-year management disqualification for the former CFO no orders were made against the six Centro non-executive directors.

Despite the result – considered lenient by most observers – corporate Australia sat up and took notice. Justice John Middleton’s 186-page judgment was clear that the case had not been about a mere technical oversight and that the information not disclosed was a matter of significance to the assessment of the risks facing the company.

“The importance of the financial statements is one of the fundamental reasons why the directors are required to approve them and resolve that they give a true and fair view,” the judgment read. As businesses and their advisers were sucked into the whirlpool of the 30 June reporting season, it became evident that routine account reviews would be put under the spotlight, as heightened awareness of risks associated with missteps in the process grew.

Lee White FCA, executive general manager – members at the Institute, says while the Centro case has not resulted in any material changes to corporate governance structures, its impact will be felt by some sectors of the business community.

“For those organisations that are doing the right things, nothing will change – it will reaffirm their processes. For others, however, it will mean a change in terms of how accounts are reviewed, and of the relationships and procedural arrangements between directors, management and auditors. One of the central issues is where the lines of financial literacy and financial responsibility for the company intersect. The bottom line is that you can delegate activity but not responsibility,” White says.

A wake up call

“The Centro judgment was a wake-up call for directors,” says Peter J Meehan FCA, CEO and executive director of the Group of 100. “Directors need to understand more about financial statements than they may have in the past. Clearly, lack of understanding is no defence. They should ensure that the CFO demonstrates what exposures, if any, are included in the accounts and the risks inherent in these exposures. If that means more training, or more time spent with the audit committee, then they should do it,” he says.

Meehan, who was previously the CFO for Australia Post, says good CFOs are able to take the directors on a journey through the accounts to make sure they are understood. “The problem is that we have a set of accounts that most people, including some directors, just don’t understand. It is the CFO’s responsibility to ensure that complex accounts are presented in a way that directors can understand. This is particularly important as the directors are ultimately taking responsibility for the accounts,” he says.

Peter Day FCA, current chair of Centro Retail Trust and a non-executive director of several organisations, including the Accounting Professional & Ethical Standards Board (APESB), says he finds it is the exception, rather than the rule, for a director not to have an appropriate level of financial knowledge in today’s boardroom.

“Ideally you would need one or two directors to have significant financial competency, be able to converse with management and the auditors at an appropriate level and be able to provide disciplinary leadership,” Day explains. “The remaining balance of directors would typically have reasonable financial literacy but not necessarily deep expertise. Demanding such an extent of expertise could be dangerous because it might begin to compromise board diversity”, Day emphasises.

He says moving forward, financial requirements of directors will likely be more pronounced and that the response from boards will be one of re-calibration. “We are already seeing more deliberation on financial matters by audit committees and boards and more focus on excellence in process, supported by underlying robustness in substantiation. Process and substantiation should not be a distraction but rather a normal way of doing business efficiently and effectively.”

Properly reflected

Day says there is now more continuous deliberation by board members as they seek to ensure that events that are transpiring over the course of the year are properly reflected in the company’s accounts – not just a twice-a-year review but a progressive assessment.

“This is a constant process whereby directors ask questions proactively and understand how the events will be, are, and have been represented. For example, the specific treatments if there have been redundancies during the year, or if there has been a major acquisition; that is the time for directors to accumulate their understanding of the year’s events and discuss how they are captured contemporaneously,” he says.

He finds audit committees are spending more time on analytics and more (noncommittee) directors are attending audit committee meetings. “Focusing on the processes and the adoption of particular accounting treatments arrived at between a company’s directors, management and auditors is not bureaucracy – it’s common sense. If you were building a motorcar, you would implement a robust process with considerable quality control along the way. It’s a similar mindset when preparing accounts,” he points out.

But there are some pitfalls to avoid, Day says. “There are significant areas of the accounts where judgments need to be applied, for example in the valuation of assets and liabilities. Unfortunately, nearly every line item in a set of accounts can have its challenges and new standards are regular and typically more complex. And, at a whole-of-business level, fundamental issues such as liquidity and credit capacity need to be re-forecast 12, 24 and 36 months out to monitor the robustness of the enterprise,” he says.

According to Day, understanding a business “into the future”, by constantly looking forward and testing assumptions, is critical. And being briefed on the standards and their implications is part of that future assessment.

He believes non-executive directors “can never switch off”. Boards are seemingly becoming ever more ‘executive’ as the expectation from communities is that they become more deeply engaged with their organisations.

“Whether this is ‘right’ seems no longer to be the question, but rather the expectation gap is tugging directors inexorably in that direction. On some readings the Centro case can be said to likely contribute to this. “As Justice Middleton commented, a director is an essential component of corporate governance. Each director is placed at the apex of the structure of direction and management of a company. They can call for more information or make the information flow more efficiently. What they don’t seem able to do is rely on their management and advisers to the extent they might previously have thought,” Day says.

A long hard look

Nigel Underwood FCA, a member of the Institute’s NSW and national corporate advisory committees representing the interest of Chartered Accountants in commerce, says the Centro judgment is a timely opportunity for companies to take a hard look at where improvements can be made to reporting systems.

“I expect many boards will be seeking more information from their CFO to provide greater support for the information presented in the fi nancial statements,” he says. He says leading finance departments already prepare a detailed analysis and explanation of every number, movement, line and comment in the financial statements, often referred to as ‘left-hand notes’ or the ‘back-up book’. Underwood expects there will be greater demand for, and review, of these supporting notes in the future.

“The internal control sign-off requires companies to assess the effectiveness of the processes that ultimately result in the production of the fi nancial statements. A number of leading companies are improving this process by incorporating aspects of the Centro findings in the assessment.”

“I expect most Chartered Accountants will welcome the added scrutiny on fi nancial statements and will look forward to a robust discussion with their board,” he adds. But how much information is too much? White says directors should be thinking about the quantity of information they are reviewing, in order to determine the quality. “This is an opportunity for boards to reengineer what they want from their advisers,” he says.

Meehan agrees. “More engagement between the board and management is a good thing. CFOs need to ensure they are comfortable with the level of disclosure within the accounts. Then they need to make sure the CEO and the board are also comfortable,” he says.

Day believes it’s important for directors not to get stuck in an information rut. “From time to time, review the financial reports, dissect them and (re)define what you want. If the audit committee has a charter and it contains 25 paragraphs, then make sure each of those 25 activities are addressed during the year. Maybe one of those items is to review the quantity, quality and timeliness of the fi nancial content of the board papers. Put that on the agenda and perform a walk through – page turn if you have to.”

Ultimately, consensus is that companies will be best served by immaculate preparation and timing of financial statements. As Underwood puts it, “CFOs need to be disciplined enough to first find the appropriate level of information, and second, the best way to communicate that information to the board. Good CFOs will be constantly improving their accounts to contain timely, concise information.

“There’s no substitute for quality. If you prepare poor financial statements there will be errors. If you prepare good quality financial statements, the issues will be transparent, they will be easier to understand and appropriate decisions will be made.”

New guidance out soon

As a direct result of the Centro case, the G100 will be preparing a best practice guide for CFOs over the coming months. Peter J Meehan FCA says the rule of thumb for best practice governance is ‘no surprises.’

“The purpose of the guide is to help CFOs better articulate complex reports with a view to fostering greater understanding by the Board and the Audit Committee,” he says.

For its part, the APESB has recently published a proposed ethical guidance note to provide Chartered Accountants working in Business with guidance on the application of APES 110 Code of Ethics for Professional Accountants, which itself was revised in December 2010. The proposed guidance note (APES GN 40) contains 17 contemporary case studies from Australia and around the world.

Peter Day FCA says the proposed guidance gives Chartered Accountants insights on how to tackle ethical dilemmas in the workplace. APESB is looking for feedback and member views on the proposed new guidance note (comments are due to the APESB by 16 December 2011). “Members in business not only have an obligation to their employer, but also to the profession they qualified under and remain signed up to”.

A challenge for members, he says, can be to reconcile and address what might be occurring in their employer’s business compared to the ethical requirements expected from membership of the profession, which has adopted a higher-level, public interest perspective. The proposed guidance note provides practical direction on how to approach problems and tools to work through ethical dilemmas.

Day says a Chartered Accountant has a duty to the profession and to the public interest but equally, “a good quality business absolutely wants to know if there is an ethical issue it needs to deal with.”

For more information visit www.apesb.org.au

Article last updated 22 December 2011