Financial Reporting and Analyses with Risk Based Approach Expectations from Internal Auditors

October 24, 2013

Dr. Paritosh Basu

Flow of Discussion
Changing trend and dimensions of Financial Reporting towards self certification Internal Audit What is so internal about it? Responsibilities of IAs in risk based Financial Reporting Internal Auditors Key Partner of CEO and CFO

Journey of an internal auditor from a score watcher to a value integrator Evolving role of internal auditors
Considering both the economic climate and ever-evolving regulations, internal audit is now at the forefront of many companies
Excerpt from KPMGs Literature on Internal Audit

Accounting and Reporting in Changing Environment

Path to the Pinnacle?

Challenges, risks and sustenance

What is the frequency?

Ideal - Monthly + many more one-offs

What are the Frameworks?

Conceptual, Institutional, Regulatory, Legal

For whom it is done? What do we do?

Stakeholders, Governance Group and Management

Transaction > Measure > Recognise > Record > Report

Let us revisit each step and reassess the emerging role

Accounting and Reporting in Changing Environment .. 2

Global Country

Entity Division

Span and perspective of Corporate financial reporting

Stakeholders Analysts Capital / Debt Market Transactions Multiple Regulators Relevance

Order of the day - Speed, Reliability, Relevance and Completeness

Inter-exchange between Tangible Assets and Intangible Factors* in an enterprises Market Value

Valuation of listed Indian Enterprises are on their way to similar transformation

*Some of such Intangible Factors are explained

in financial statements, but many are not.

The World has changed - Reporting must too

Population increase to 8.5 Bln. in 2050 from 2.4 in The world population is increasingly urban 1950 Global population by type of area and by region:
1950-2050

Shift of Economic Power West to East - India 38 Trln.

Global economic power is shifting Top 10 economies by GDP in 2050

Middle class population 400 Mln. to The global middle class is rapidly expanding 1200 .

Population in low- and middle-income countries earning $4,000-$17,000 per capita (purchasing power parity)

Growth
Source: UN Population Division, World Population Prospects: The 2008 Revision, 2008

Source: Goldman Sachs, BRICs and Beyond, 2007

Source: World Bank, Global Economic Prospects, 2007

Greenhouse gas emissions keep rising GHG emissions by regions

Environmental degradation jeopardises peoples quality of life People living in areas of water stress by level of stress

The world could be running out of some resources

Global supply forecasts according to the implied ultimate recoverable resources of conventional oil, date of peak production and the postpeak aggregate decline rate

Degradation
Source: UN Population Division, World Population Prospects: The 2008 Revision, 2008

Source: Goldman Sachs, BRICs and Beyond, 2007

Source: World Bank, Global Economic Prospects, 2007

Source World Business Council for Sustainable Development - Vision 2050

The evolution of Reporting

2000

Source: Integrated Reporting Council

Integrated Reporting * The Future

Source: International Reporting Council : PwCs World Watch, Issue 1, 2013

* Dont let others define you ! Communicate what you are trying to do
a. Strategies b. Performance c. Propects d. Governance and e. Propositions for creating and preserving values in short, medium and long term Paul Druckman, CEO of International Integrated Reporting Council IRCs final draft for consultation to be published in April 2013 Expectations from Analysts will increase manifold
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Metamorphosis in Indian Regulatory and Corporate Environment

New Companies Act CFO and CS designated as KMPs CFO to sign Annual FSs Minority Shareholders may nominate Directors in listed companies Class Action Suit permitted to be filed against a company Periodical rotation of Auditors

NFRA to also prescribe monitor Auditing Standards

Many more measures for strict enforcement of governance IAt is compulsory for Listed Cos. and Cos. with Loans & Deposits > Rs. 25 Cr. and Paid up capital > Rs. 10 Cr. Tax Accounting Standard knocking the door GST and GAAR are on their advent way Ind AS may not be far behind Ring fencing of talents will pose a problem IT enablement of systems - An imperative and not an option any more Free lance Analysts continue to remain out of regulatory clutch

Internal Audit What is so Internal About it?

Is Internal Audit at all Internal in the ultimate analysis? Who are the largest beneficiaries of Internal Audit? At what levels IA Reports are reviewed and by whom? Which external agencies rely upon IA Reports and on whose behalf Statutory Auditors Agencies that conducts due diligence Financial Modelling for valuation CGU, Business, Impairment Testing, etc. Converting hindsight into foresight for Audit Committee Annual planning and budgeting based on Risk Register Who will suggest the need for Plan - B FRP with bottom up approach How to draw comfort for Certification of True & Fair View by the CFO & CEO
Directional change seems to be proactive value addition approach

Converting hindsight to foresight for Audit Committee

The parade of business scandals and ethical lapses that has seemed to continue without significant let up has led to continued legislative and regulatory mandates for improved governance practices.
Curtis C. Verschoor, CIA, CPA, CFE, CMA

The big question Are legislative and regulatory mandates the final answer and tool to meet the challenges in the forward path?

Many leaders and regulators have recognised the need for internal

audit to play an expanded role that builds on its historic focus on value preservation - a control focus - by including activities related to value creation - a performance focus.
Excerpt from KPMGs document on Internal Audit

This demands a directional metamorphosis from traditional to InnventiveTM changes in scope and process of Internal Audit Foresight will minimise value destruction and create vistas for sustainable growth and prosperity

Critical Audit Process for Fincl. Reporting in the USA

US - SEC Listing, Application of SOX 404 with Top down risk assessment

Issuers are required to publish information concerning the scope and adequacy of the internal structure and procedures for financial reporting Auditors attest to and report on their assessment of effectiveness of the above
(SAS - 72 provides guidance to auditors about procedures to be followed for providing report after due diligence)

Need therefore is to identify and assess by both Management and Auditors

Significant financial reporting accounts or disclosures Material financial statements risks within these accounts or disclosures

Which entity-level controls would address these risks with sufficient precision
Which transaction-level controls would address these risks in the absence of precise entity-level controls

The nature, extent, and timing of evidence gathered to complete 14 the assessment of in-scope controls

Critical Audit Process for Fincl. Reporting in the UK

UK Listing Authorities Financial Reporting Practices
Statutory Auditors to review and provide comfort to Board before ITF Meeting on

Extent, Quality, Speed, Effectiveness and Top Down Risk Oriented Approach for
Enterprise Risk Management Framework (ERM) Functioning of Audit Committee Internal audit including scope and approach CFOs oversight

Operations reporting including procurement and tendering

Arms length basis of conducting inter Group Co. transactions Volatility management Interest, Currency Exchange , Commodity, Policy IT General Control (ITGC) and Information Safety Formal documentation and review of SOPs Directors Responsibilities Statement to include affirmative statements on True and fair view of assets, liabilities, financial position and profit MD&A includes fair review of developments and performance Description of principal risks and uncertainties

If you dont know what you dont know, then you dont know how to fix it

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Mandatory Reporting on Internal Financial Controls (IFCs Sec. 138)

Directors Report for Listed Cos. and Auditors Report for all to comment on whether (As per Companies Act, 2013) Adequate IFCs systems have been institutionalised Operating effectiveness of such IFCs are reliable
IFCs means policies and procedures adopted for ensuring Orderly and efficient conduct of business, including adherence to companys policies Safeguarding of assets Prevention and detection of frauds and errors Accuracy and completeness of the accounting records Timely preparation of reliable financial information Note

1. The provision covers all IFCs, including for operational areas ,unlike SOX which limits the scope to internal controls over financial reporting 2. This covers an evaluation of efficiency of operations. The provision has expand the scope of audit

Our relaisations of tomorrow are limited by questions of today

Future is shrouded with uncertainties

How future is unfolding itself? What are the critical challenges for sustainable operations and growth? Internal Auditor Is he one of the Key Partners for CEO and CFO?

Corporate Risk Profile The Role of IAs in Risk Exposure Review

Map every Cash Generation Unit vs. Risks and Mitigation Actions

External Risks Reforms, Market, Technology,

Competitor, Natural, Legal, Regulatory, Political

Currency Exchange Financial Credit

Planning

Customer Success
Human Resource Secrecy

Operational & Environmental Strategic

Goal Congruence
Health & Safety R&D Fraud

Cost of Capital

Leadership, Product Profile, Product Image Life Cycle, Business Portfolio, Business Erosion Model, Communication, Organ. Structure, Business Alliances Product / Service Pollution Failure GAAP Conversion

Info. Reliability

Liquidity

Image Erosion

Brand Compliance Erosion Direct and Indirect Taxes 18

External Reporting

Corporate Risk Profile The Role of IAs in Risk Exposure Review

Internal Audit Team The Critical Partner in Business Risks Management Value in Risk - Identification, Measurement and Prioritisation Preparation and updating Risk Register Mapping of Risk Register with CGUs Review Annual Bus. Plan and Budget w. r. t. Risk Register Assess effectiveness of initiated actions for risk mitigation Audit of IT General Control (ITGC), Information Security (ISS) and Bus. Continuity Process Management (BCPM) Proactive FRP Management IAs, the Friends and Guides Anticipate and raise alert - Pre transaction review Stress testing of systems and processes Review of Qtrly. FSs and Annual Reports Help in resolving critical audit issues for SA and minimise contents of Management Representation Letter (MRL) Take responsibility in self-certification

Sustainability Management & Internal Audit

The process of Development that meets the needs of the present without compromising the ability of future generations to meet their own needs. is Sustainable Development
World Commission on Environment and Development (The Brundtland Commission), 1987

Sustainable Management Direct the course of a company in ways that restore and enhance all forms of capital to generate stakeholders value and contribute to the well-being of current and future generations Integrate environmental, social and governance issues into business strategy Build value by defining, evaluating and reporting on indicators beyond financial performance
Set Priority in Four P Bottom Line - Profit, Product, People, and Planet

How do the Corporations worldwide think?

Source: Mc Kinsey Global Survey Result, February, 2010

How do the Corporations worldwide think? .. 2

Source: Mc Kinsey Global Survey Result, February, 2010

CEOs and CFOs Questions in Planning and

Budgeting Process for Sustainability

Organisational plans, action points, capital and revenue expenditure for Reducing material intensity Utility audit and reducing consumption of power, fuel, steam, water, etc.

Optimisation and substitution of raw natural resources

Minimising dispersion of toxic substances Green logistics for renewable and used products

Recycling of scrap, wastage and spoilage

Prolonging product life at minimum differential price Increasing service intensity to reduce frequency
CXOs to ensure viability and growth after absorbing all these expenditure

The Big Question Can IA function continue stay away from this and remain busy with transactions and proprietary audit? Can they be the facilitators?

Dont challenge your Limits, Limit your Challenges

Journey of an IA from a Score a Watcher to a Value Integrator

Crisis is a great opportunity to be wasted, achieve a state of readiness

What is the position of your team in your organisation?

Four Finance profiles become apparent when respondents are segmented by efficiency and business insight
Finance Profiles

High

Finance Efficiency

Low Low High

Business Insight
CFO Study India Point of View

Source: IBM Institute for Business Value, The Global CFO Study 2010

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The current environment has had a large impact on the role of the CFO, which has in turn changed the role of the Financial Controller and the Internal Auditor

Source: The changing role of the financial controller, Ernst & Young, 2008

Evolving Role of Internal Auditors

Your Questions and Observations

Thank You