Article:

Critical reporting risks boards should consider when reviewing financials

27 October 2020

This article originally appeared on AICD’s Member Update on 22 October.

Insights from BDO’s recent Financial Reporting Risk Review show that of the major concerns currently facing organisations across corporate Australia, cash flow is the most pressing financial reporting risk. Here BDO’s Aletta Boshoff, National Leader, IFRS Advisory and Ashley Bleeker, Director, Innovation and Growth, overview the top reporting risks every director should consider when reviewing financials.

You are still able to complete the BDO Risk Review and receive a copy of your assessment upon completion, by clicking here.


The BDO review, conducted in September 2020, revealed alignment between directors and finance teams, with both groups identifying lease accounting as the reporting risk most critical across their organisations, followed closely by accounting standards compliance. This is not unexpected. Over the last 12 months, the new IFRS 16 Leases standard has captivated the attention of both directors and finance teams. Most entities have grappled with:

  • The magnitude of the impact of IFRS 16 on their balance sheets
  • The practical difficulties and judgements required to successfully implement it
  • Adequately explaining the impact of IFRS 16 to users of financial statements.

The review also revealed the following insights:

Directors are the gatekeepers of useful financial information

Directors are important gatekeepers in the financial system. They are the intermediary to communicate meaningful and useful information through financial reports from an organisation to its stakeholders.

Each director has a duty of skill, competence and diligence to understand the financial report to be disclosed to the public. Each director must:

  • Read, understand and focus on the content of the financial report
  • Apply their own mind to, and carry out a careful review of, the financial report
  • Determine that the information contained is consistent with their knowledge of the company’s financial position and affairs
  • Ensure that material matters known to them – or that should be known to them – are not omitted.

Maintain a clear focus and alignment on relevant risks

While boards and finance teams agree on some of the most relevant risks, they also diverge on other key elements. The biggest divergence between them relates to revenue recognition and reporting framework risk, illustrated by the fact that that revenue recognition did not even make the top 10 for finance teams, nor reporting framework for boards.

What’s also interesting is the divergence between low risk areas – boards rated their audit relationship as least relevant and finance teams rated foreign exchange as least relevant. We sense this is driven by boards interacting with auditors in a different way to management. Some finance teams may feel the auditors are reporting (directly or indirectly) back to the Board on management’s performance. Auditors are required to report significant difficulties encountered during the audit, including:

  • Significant delays by management
  • (Un)availability of key personnel, or
  • Management’s unwillingness to provide necessary information to the Board.

Finance teams might rate foreign exchange as the least relevant because of familiarity. Although foreign exchange is a complex area, the relevant accounting standard has been around since 2005 and therefore is well understood and implemented by finance teams.

The following table outlines the most relevant financial reporting risks for Boards and finance teams:

 

Relevant to boards

Relevant to finance teams

1 Lease accounting Lease accounting
2 Accounting standards compliance Accounting standards compliance
3 Fair value Staff competency
4 Impairment Reporting framework
5 Revenue recognition Communication


Overall reporting risk rating variances

Determining which risks are most relevant to organisations is important, and so too is the overall impact of those risks on the business (overall impact = likelihood x potential impact).

Boards are focusing their attention on ‘big picture’ reporting risks which could result in reputational damage for the company, whereas finance teams seem focussed on specific, detailed reporting risks related to accounting standards and complex transactions.

Boards and finance teams diverge most heavily on this for remuneration and reporting frameworks (both in the top 5 for Boards and both in the bottom 5 for finance teams). Remuneration risk relates to the incorrect or inconsistent payment of staff under awards, enterprise bargaining arrangements or other regulations. Over recent months many companies received negative press due to these remuneration issues.

Reporting frameworks in Australia are currently undergoing their greatest upheaval since the introduction of the reporting entity concept in 1990 with the imminent removal of special purpose financial statements for most companies.

The following table outlines the financial reporting risks with the highest overall risk rating for Boards and finance teams:

 

Overall risk rating by boards

Overall risk rating by finance teams

1 Cash Flows Cash Flows
2 Remuneration Uncertain tax positions
3 Complex transactions Foreign exchange
4 Board competency Impairment
5 Reporting framework Complex transactions


The results of BDO’s Financial Reporting Risk Review also indicate finance teams are placing more emphasis on:

  • Uncertain tax positions under the new IFRIC 23 Uncertainty over Income Tax Treatments
  • Staff competency
  • Communication.

In contrast, Boards are placing more emphasis on board competency.

Our interpretation here is that boards place more emphasis on board competence, including divergence of skills, to avoid group think. Whereas finance teams tend to focus more on staff competence within their teams to enable a smooth and efficient financial reporting processes.

The time to start managing the higher risk elements is now

High overall financial reporting risks represent a considerable threat to the business. Boards and finance teams should address them as a priority and allocate available resources to ensure they adequately mitigate those risks. Based on the BDO Risk Review, boards and finance teams needs to focus on mitigating the following risks when reviewing and finalising their 30 June 2020 financial statements:

  1. Cash flows
  2. Remuneration
  3. Complex transactions
  4. Reporting framework
  5. Uncertain tax positions
  6. Foreign exchange
  7. Impairment
  8. Revenue recognition
  9. Fair value
  10. Significant estimates/judgements.

Where to from here?

As economic circumstances change, we expect the relevance and overall risk rating by Boards and finance teams to change. Complete the BDO Risk Review and receive a copy of your assessment upon completion.