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CORPORATE REPORTING AND DISCLOSURE PRACTICES - ROLE OF ... CORPORATE REPORTING AND DISCLOSURE PRACTICES - ROLE OF ... Presentation Transcript

  • CORPORATE REPORTING AND DISCLOSURE PRACTICES – ROLE OF INDEPENDENT DIRECTORS Presentation by P.R. Ramesh August 6, 2006 ICAI NIRC New Delhi
  • CONTENTS THE REPORTING LANDSCAPE OBJECTIVES OF FINANCIAL REPORTING TYPES & ISSUES IN REPORTING AND DISCLOSURE TOWARDS TRANSPARENCY IN REPORTING AND DISCLOSURE ROLE OF DIRECTORS IN RELATION TO CORPORATE REPORTING AND DISCLOSURE
  • The Reporting Landscape
    • Global Markets – the Services Revolution
    • Accountability
    • Cross border Capital flows
    • Basis for business decisions
    • Corporate Reporting Failures
    • Corporate Governance
    • Regulatory Framework
    • Changes in Technology and Products
  • Accountability
    • A business enterprise receives capital from outside investors, lenders, and other creditors.
    • It is accountable to them – it has an obligation to keep them informed about performance, conditions, and prospects.
    • Also accountable to others who provide resources or environment in which to operate: Employees, government, community at large.
  • Cross border Capital flows
    • On many stock exchanges foreign listings are a large % of total. USA December 2003:
      • NASDAQ: 10% (338 cos., 37 countries).
      • NYSE: 20% (467 companies, 50 countries).
        • Foreign is 33% of market value.
      • US SEC total:
        • 1981: 173 foreign companies listed in US.
        • 1991: 439 foreign companies listed in US.
        • 2002: 1,400 foreign out of 16,000 total.
  • Basis for business decisions
    • Capital Market transactions
    • Mergers & Acquisitions
    • Employee Stock Options
    • Borrowing and Lending
  • Company failure – director failure !! October 16, 2001 Issue : Off-Balance Sheet Accounting and Financial Reporting Fraud Impact : $3 billion in undisclosed losses June 20, 2002 Issue : Financial Reporting Fraud Impact : $9 billion in unreported expenses March 28, 2002 Issue : Financial Reporting Fraud and embezzlement Impact : $2.5 billion of hidden debt January 31, 2002 Issue : Financial Reporting Fraud through improper revenue recognition Impact : $12.4 billion in overstated earnings
  • Corporate Governance Pillars
    • Primary characteristics to be embedded
    • Discipline – universally accepted behaviour
    • Transparency – candid, accurate, timely information
    • Independence – no board/committee conflicts (of interest)
    • Accountability – by law/statute to company
    • Responsibility – to relevant stakeholders
    • Fairness – current & future interests/minorities
    • Social responsibility – not discriminatory or exploitive environmentally and personally
  • Regulatory Framework
    • Sarbanes Oxley
    • Reporting in the financial services sector
    • Quotas, obligations, etc.
    • Taxation
    • Eligibility for business transactions
  • Changes in Technology and Products
    • Intangible Assets – Licences, Rights, etc
    • Tangible Assets – component accounting
    • Barter transactions
    • Options and Swaps
    • Futures
          • Complex arrangements – BOOT, BOT, BOMT, Service concession agreements, etc
  • CONTENTS THE REPORTING LANDSCAPE OBJECTIVES OF FINANCIAL REPORTING TYPES & ISSUES IN REPORTING AND DISCLOSURE TOWARDS TRANSPARENCY IN REPORTING AND DISCLOSURE ROLE OF DIRECTORS IN RELATION TO CORPORATE REPORTING AND DISCLOSURE
  • Financial Statements - Objectives
    • Provide information that is useful in making business and economic decisions to users
    • internal users: detailed information external users: summary information
    • provide information which will aid in predicting future cash flows
    • provide information relative to an enterprise’s economic resources, the claims to those resources (obligations) and effects
  • Conceptual Framework ELEMENTS RECOGNITION MEASUREMENT ACCOUNTING REPORTING FINANCIAL STATEMENTS EARNINGS FUNDS FLOWS OBJECTIVES QUALITATIVE CHARACTERISTICS
  • Financial Statements – Qualititative Characteristics
    • Relevance
    • Reliability
    • Comparability (including consistency)
    Quality in a product or service is not what the supplier puts in. It is what the customer gets out and is willing to pay for. A product is not quality because it is hard to make and costs lot of money, as manufacturers typically believe. This is incompetence. Customers pay only for what is of use to them and gives them value. Nothing else constitute quality – Peter Drucker
  • Relevance
    • IASB : Information is “relevant” when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting their past evaluations
    • FASB: ….. accounting information must be capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct expectations
    Definitions differ in whether information must actually make a difference in a decision or be capable of making a difference in a decision
  • Relevance
    • Predictive value
    • Confirmatory value
    • Timeliness
  • Financial Statements - Reliability
    • Representational faithfulness - must potray the important financial relationships of the enterprise
    • Verifiability - several independent measures will obtain the same accounting measure
    • Neutrality - accounting information should serve to communicate without attempting to influence behaviour
    • Prudence or conservatism?
    Conservatism introduces a bias into financial reporting and tends to conflict with significant qualitative characteristics, such as representational faithfulness, neutrality, and comparability (including consistency)
  • Purpose
    • Accountability
    • Decision-making
  • Content
    • Historical
    • Forward looking/predictive
    • Risks
    • Values
    • Health - Security - Liquidity - Profitability
    • Complexity
    • Conservative/Fair
  • User expectations
    • Meaningful disclosures in the areas of:
      • Operational metrics in case of typical industries e.g IT
      • Contingent liabilities
    • Consolidated financial statements
      • Inter corporate holdings
      • Accounting for Minority Interest
    • Quality Notes to Accounts
    • Segmental analysis
    • Ratio analysis
    • Related party disclosures with quality info on:
      • Identity of related party and Nature & Terms of transaction
  • CONTENTS THE REPORTING LANDSCAPE CAUSE AND EFFECT TYPES,ISSUES IN REPORTING & DISCLOSURE TOWARDS TRANSPARENCY IN REPORTING AND DISCLOSURE ROLE OF DIRECTORS IN RELATION TO CORPORATE REPORTING AND DISCLOSURE
  • Transparency
    • Oxford English Dictionary – Transparent: easily seen through, recognized, understood, or detected; manifest, evident, obvious, clear and frank, open, candid, ingenuous
    • Transparent information results from applying several qualitative characteristics : faithful representation, neutrality, completeness, understandability
  • Transparency in financial reporting
    • “If you can’t convince them, confuse them”- Harry Truman
    • “Put it before them briefly so they will read it, clearly so they will appreciate it, picturesquely so they will remember it and, above all accurately so they will be guided by its light” – Joseph Pulitzer
  • Transparency in Financial Reporting – Key Elements
    • Basis of reporting
    • Assumptions
    • Unusual/non-recurring/extra-ordinary items
    • Key events
    • Changes to business structure, etc
    • Measurement metrices
    • Risks and their impact
    • Plain English
    • No fine print
  • Disclosures and Reporting - Types
    • Governance related disclosures
    • Governance related reporting
    • Financial information disclosures
    • Attestation or other credibility enhancing reporting
    • Investor/investment related disclosures
    • Disclosures for regulators and for other national purposes
  • Disclosures and Reporting – Key Issues
    • For whom ?
    • For what ?
    • What should one report?
    • What should be the medium of reporting?
    • Relevance
    • Reliability
    • Timing
    CREDIBILITY
  • Disclosures and Reporting – For whom?
    • Disclosures to Boards
    • Disclosures to shareholders
    • Disclosures to regulators
    • Disclosures to potential investors
    • Disclosures to general public
  • What should one report?
    • Reporting of information
    • Reporting compliance
    • Reporting by exception
  • Disclosures and Reporting
    • Disclosures in Financial statements
    • Disclosures in Annual Reports
    • Disclosures in Offer documents
    • Disclosures in filings
  • Clause 49 disclosures
    • Compensation philosophy and statement of entitled compensation in respect of non-executive directors
    • Details of shares held by non-executive directors, including on an “if converted basis”
    • Declaration by CEO that all Board Members and senior management comply with laid down code of conduct
    • Disclosure if accounting treatment is different from that prescribed in Accounting Standards
  • Clause 49 disclosures
    • Affirmation that it has not denied any personnel access to the audit committee of the company and that it has provided protection of “whistle blowers” from unfair termination and other unfair or prejudicial employment practices
    • When money is raised through an Initial Public Offering disclosure of the uses/application of funds by major category on a quarterly basis. Further, on an annual basis, the company shall prepare a statement of funds utilized for purposes other than those stated in the offer document/prospectus
  • Clause 49 disclosures
    • Pecuniary relationship or transactions of the non-executive director’s vis-à-vis the company to be disclosed in Annual Report
    • Remuneration to directors
    • Stock option details
  • Management Discussion and Analysis contents
    • Industry structure and developments
    • Opportunities and Threats
    • Segment-wise or product wise performance
    • Outlook
  • Management Discussion and Analysis contents
    • Risks and concerns
    • Internal control systems and their adequacy
    • Discussion on financial performance with respect to operational performance
    • Material developments in Human Resources/Industrial Relations front, including number of people employed
  • Report on Corporate Governance
    • Brief statement on company’s philosophy on code of governance
    • Board of Directors
    • Audit Committee
  • Report on Corporate Governance
    • Remuneration Committee
    • Shareholders Committee
    • General Body Meetings
    • Means of communication
    • General shareholder information
  • Report on Corporate Governance
    • Disclosures on materially significant related party transactions that may have potential conflict with the interests of company at large
    • Disclosure of accounting treatment if different from accounting standards, with explanation
    • Details of non-compliance by company, penalties, strictures imposed on the company by Stock Exchange or SEBI or any statutory authority, on any matter related to capital markets during last three years
    • Whistle blower policy and affirmation that no personnel has been denied access to the audit committee
  • CARO Reporting
    • End use of funds from financial institutions /banks/public issues
    • Use of short term funds for long term purposes
    • Defaults in repayments to institutions/banks
    • Frauds on or by the company
  • Reporting and Disclosure Issues
    • Different GAAPs
    • Non-GAAP financial information
    • Data vs. information
    • Measurement matrices
    • Litigation concerns
  • COMPLIANCE ISSUES
    • Letter vs. spirit
    • Form and substance
    • Competitive harm
    • Non-mandatory rules
    • Penalties
  • CONTENTS THE REPORTING LANDSCAPE OBJECTIVES OF FINANCIAL REPORTING TYPES & ISSUES IN REPORTING AND DISCLOSURE TOWARDS TRANSPARENCY IN REPORTING AND DISCLOSURE ROLE OF DIRECTORS IN RELATION TO CORPORATE REPORTING AND DISCLOSURE
  • Disclosure Trends
    • Disclosure of circumstances “reasonably likely to occur and not “more likely than not”
    • “Pro forma earnings” and non-GAAP information should include plain English reconciliation
    • Clear, complete and transparent disclosure
    • Focus on helping the reader understand the substance of the company’s risks and rewards
  • Trends in Accounting Standards
    • New concepts – e.g. Deferred Taxation., Accounting for Investments based on Equity Method of Accounting
    • Relevant disclosures – e.g. Segment Reporting, Consolidated Financial Statements
    • Subjectivity – reliance on projections e.g. Impairment of assets
    • Complexity – AS 11 on Accounting for Foreign Exchange transactions
  • Recent and Emerging Trends in International Accounting Standards
    • Greater use of fair values in measuring transactions:
      • Impairment recognition.
      • Prohibit poolings.
      • Non-monetary exchanges.
    • Fair values on balance sheet for both financial and non-financial assets:
      • Financial Instruments.
      • Agriculture.
      • Investment property.
      • Commodity inventories.
  • Recent and Emerging Trends in International Accounting Standards
    • More unrealised components of income:
      • Performance reporting becomes key.
    • No income smoothing, cost deferrals, general provisions:
      • Remove corridor approach to pensions.
      • Balance sheet approach to deferred tax.
      • No accruals for future losses.
      • Rigorous hedge accounting rules.
  • Recent and Emerging Trends in International Accounting Standards
    • Eliminate off-balance sheet items:
      • Derivatives.
      • Special purpose entities.
      • Stock compensation.
    • More disclosure, especially judgements, plans, assumptions:
      • Judgement in applying accounting policies.
      • Risk management policies.
      • Sensitivity analyses.
    • Eliminate accounting choices.
  • THE WAY FORWARD
    • Burial of Schedule VI
    • Modular financial statements
    • Measurement metrices
    • Analysis of Financial Position and Performance
    • Forward looking information
    • Disclosure of assumptions
    • Adieu to historical cost
    • Sensitivity analysis
    • Global language
    • Transparency
  • Transparency in Financial Reporting Act of 2006
    • Act passed by the U.S. House of Representatives
    • Requires SEC, PCAOB, etc to regularly:
      • reassess complex and outdated accounting standards
      • improve understandability, consistency and overall usability of the existing accounting and auditing literature
      • develop principles based accounting standards
      • encourage the use and acceptance of interactive data, and
      • promote disclosures in plain English
  • CONTENTS THE REPORTING LANDSCAPE OBJECTIVES OF FINANCIAL REPORTING TYPES & ISSUES IN REPORTING AND DISCLOSURE TRENDS IN REPORTING AND DISCLOSURE ROLE OF DIRECTORS IN RELATION TO CORPORATE REPORTING AND DISCLOSURE
  • ROLE OF INDEPENDENT DIRECTORS
    • Matters to be considered
    • What directors should seek
    • Conduct
  • Matters to be considered by Directors
    • Accounting Policies
    • Judgement and estimates
    • Maintenance of records and safeguarding of assets
    • Risks of fraud, etc.
    • Warning signals
  • Accounting policies
    • Selection
    • Changes – circumstances
    • Proper explanation relating to material departures
    • Reporting effect of changes - in financial statements - in quarterly financial information
  • Judgements and Estimates
    • Gratuity, leave encashment, etc.
    • Contingent liabilities.
    • Events occuring after the balance sheet.
    • Off- balance sheet items.
    • Capital and revenue.
    • Commencement of commercial production .
  • Judgements and Estimates
    • Provisions for doubtful debts, loan losses, etc,
    • Erosion in the value of investments.
    • Useful life of assets.
    • Realizable value of current assets, loans and advances – note (m) part I of schedule VI.
    • Provision for warranty and other obligations .
  • Maintenance of adequate records and other controls
    • Asset register
    • Stock register
    • Reconciliations - control accounts and subsidiary accounts - inter division, inter branch, etc - bank accounts, receivables and payables
    • Investment Register
    • Up-to-date financial information
    • Disaster prevention and recovery plans
  • Preventing and detecting fraud etc.
    • Risk Management Policy and Strategies
    • Internal controls and Internal Audit
    • Control consciousness and control mechanisms
  • Some signals
    • Cash does not lie
    • Significant Related Party transactions
    • Investments in and exposures in associates
    • Inter corporate lending
    • Aggressive tax claims
    • Mergers and de-mergers
    • Intangible assets and intangible items
    • Defaults in statutory dues and other payments
    • Attrition of key personnel
  • What should you seek ?
    • Resolved differences with statutory auditors
    • In camera meetings with auditors
    • Management Letters
    • Views of statutory auditors on accounting policies and disclosures
  • What should you seek ?
    • Monthly financial information
    • Detailed presentation by management
    • Analytical Review information
    • Quantitative information
    • Complaints
  • CONDUCT
    • Be prepared in advance
    • Do not attempt to run the business
    • Be firm – this is not about friendship
    • Do not hesitate to seek external help
    • Defer the matter, seek more time or schedule another meeting in case matter is not addressed to your satisfaction
    • Be prepared to step down – it is your future which is at stake
    • Remember you are an independent director and not a dependant director
  • Concluding remarks
    • By and large, Indian listed companies have been legally mandated to follow fairly strict standards of corporate reporting and disclosure
    • Comparisons will show that the standards are far stronger than all Asian Countries, and in general stronger than most OECD countries
    • Indian corporate sector regulators and companies have been quick to incorporate some of the best international corporate reporting and disclosure practices
    • The need of the day is more training of directors, audit committee members and senior executives of companies
    • The challenge is to design and sustain a system that imbibes the spirit of Corporate reporting and not merely the letter of law
    • Thank You