What the research shows

Greg Couttas reveals how the 125 audit committee chairmen polled in a recent Deloitte study believe life has changed since the Centro judgment.

It is over a year since the Federal Court’s Justice John Middleton found eight of Centro’s directors had breached their statutory duties of care and diligence and had failed to take reasonable steps to ensure compliance with their financial reporting obligations.

But how much has really changed since June 2011 when the judgment was announced? At that time, we had just begun our second major survey of audit committee chairmen at many of Australia’s leading companies. This gave us a unique opportunity to discuss the decision with them afterwards and to see what changes boards were making.

At the heart of the Centro judgment was the incorrect classification of debt of about $1.5 billion as non-current and a failure to properly disclose certain guarantees entered into after balance date in the company’s financial statements. Justice Middleton found that while there was no suggestion of dishonesty on the part of the directors, each should have:

• Identified the debt and guarantee issues.
• Been aware of related accounting principles.
• Made more vigorous inquiries of the company’s management and advisers.

These three items have since become a checklist for many boards, especially as directors consider half- and full-year financial statements.

What became clear from our interviews with 125 audit committee chairmen for the latest Deloitte Audit Committee Effectiveness survey was that while most directors believed the judgment did not alter the law, almost all boards used the decision to pause and review the way they functioned. Many have since reinforced and refined their existing processes and extended the length and depth of their reviews of financial statements.

More detailed analysis

Boards are seeking more detailed analysis and discussion, especially around areas of judgment and potential subjectivity in financial statements. This includes the classification of debt, asset impairment, the valuation of investments (especially where they are marked to market) and provisioning for liabilities.

In turn, the questioning of CFOs and internal and external auditors is becoming more detailed, and committees and boards are allowing more time for reviews. As one audit committee chairman told us: "The environment after the global financial crisis (GFC), Centro and other company failures has resulted in audit committees being much more challenging of management and auditors. It’s a tougher, more inquiring environment and there is more documentation."

Audit committee chairmen and other directors also report spending more time with the CFO and finance team to better understand developments, address issues and set agendas. This will often include meetings at company premises. Audit committee members are also holding more formal and informal meetings with internal and external auditors. This includes "pre-meetings" held in advance of formal committee meetings to ensure chairmen are well informed. There is also more use of "closed" sessions, at which audit committees are able to question external auditors and others in a confidential setting. Such closed sessions used to be short, but can now run for up to half an hour.

Enhanced reporting

There is more focus on the quality and relevance of the material provided to the board by management, as well as the insight it provides.

Many audit committees had previously been frustrated after being inundated with material from management teams taking a "fire hose" approach to reporting.

But boards are now seeking more concise material as well as greater analysis. For example, there was evidence of directors being provided with richer "left-hand notes" alongside financial statements, where the CFO could highlight points or add commentary.

In line with the increased interest in their deliberations, many audit committees are also providing more comprehensive reports back to the full board. "We have spent a lot of time improving our minutes," one audit committee chairman told us. "They used to be short and meaningless."

Wider attendance at audit committee meetings

One of the survey findings was the extent to which non-committee members were now attending board audit committee meetings.

While most audit committees have always had a standing invitation for board members to attend their meetings, more directors are taking this up – especially when committees are considering the half- or full-year accounts, as it gives non-audit committee directors an opportunity to get a more detailed overview of the financial statements.

According to one audit committee chairman, non-committee members don’t necessarily expect to follow all the technical details, but they are keen to hear the discussion first hand, and to understand the flavour of the discussion and personalities of the individuals involved.

More attention to training

Justice Middleton’s view that the Centro directors should have been more aware of accounting principles has struck a chord with many directors.

This isn’t surprising given the numerous complex changes to accounting standards here and overseas.

In response, there is greater demand for education and briefings, including updates from internal experts, such as members of the finance and risk teams, and external advisers, including auditors and lawyers.

Another potential driver for this increase is that audit committees – and whole boards – are seeking to ensure they include directors with a wide mix of technical expertise, industry knowledge and understanding of the business.

This is creating a need for technical training for non-specialists, many of whom are more concerned about their responsibilities and exposures since the Centro decision.

Taking time to reflect

Some boards are taking more time to consciously reflect on the information put before them and on their overall performance as directors.

This might include making time for a board to pause and, in effect, say: "We’ve reviewed the financial statements in detail, but do they really capture the position of the business as we know it?"

This simple step can lead to valuable and sometimes unexpected lines of discussion and increased confidence in decisions. It also ties back to a key part of the Centro judgment, in which Justice Middleton said: "All the directors failed to see the ‘obvious errors’ because they all took the same approach in relying exclusively upon those processes and advisers. No director stood back, armed with his own knowledge, and looked at and considered for himself the financial statements."

This final point might be seen as the lasting effect of the Centro decision. While the judgment simply clarified directors’ existing legal responsibilities, it has led many directors to focus on how they and their boards are operating, to ensure they are receiving the information and education they need and to ask more incisive questions. This is despite many large companies already having high-quality processes in place to ensure board effectiveness.

With no end in sight to the continued volatility in the local and global economies, it also appears likely that the boosting of the governance capacity of boards following the Centro decision and the GFC in general will play a critical role in helping corporate Australia weather future storms.

Greg Couttas
Partner
Deloitte Touche Tohmatsu