Reporting to Shareholders on Internal Control:

1). The requirement to report to the shareholders on internal control:

A system of good governance should include a requirement for the board of directors to report to shareholders on internal control and the effectiveness of the internal control system.The board is responsible for ensuring that a sound system of internal control is maintained and it should be required to account to the shareholders to explain how they have fulfilled this responsibility.However the specific requirements for reporting to shareholders vary between different countries.

 

• In the US,the annual report of stock market companies must include a statement on internal control that includes an assessment of the effectiveness of the internal control system and procedures for financail reporting.The internal control report relates to financial controls only (not operational controls or non-financial compliance controls) but it must provide an evaluation of those controls.Any material weaknesses in financial controls must be disclosed.

• In the UK listed companies are required to conduct a review of the effectiveness of the system of internal controls and report to the shareholders that they have conducted such a review .The board is not required to provide detailed information about the review and so is not required to provide shareholders with as assessment of its effectiveness.

 

There are several reasons why the reporting requirements in the UK and Singapore differ from the regulation in the US.

• The main argument is cost.To comply with the requirements of section 404 of the sarbanes-oxley act requires a large amount of management time and the cost of compliance are high.It has been suggested that the requirements of section 404 help to explain the preference of many foreign companies for seeking a listing for their shares in london(where the principles-based requirements are much less strict) rather then listing in New York.

• Supporters of the principles-based approach in the UK (and critics of the rules-based approach in the US) argue that the board of directors should have freedom to decide what it is appropriate to report to shareholders.The US approach is based on compliance with detailed procedures and a 'box-ticking' mentality.

• The sarbanes-oxley report on internal control relates to financial controls and financial reporting only,not to operational controls and compliance controls.It has been argued that it is difficult to assess the effectiveness of operational controls,because there is no objective standard for what these controls should achieve.

• It is also argued that if the board has to make a report to shareholders on the effectiveness of internal controls the directors would want to avoid any personal liability for incorrect statments.As a consequences board statements would be written in legal language with the assistance of the company's lawyers and would not contain any information of value to shareholders.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2). The content of a board report on internal control:

The report by the board of directors to shareholders on internal control should be included in the company's annual report.In the UK guidance on the content of this statement is provided by the Turnbull Report.

• The report to shareholders should provide meaningful highlevel information that the board considers necessary so that shareholders are able to unstated the main features of the company risk management processes and system of internal control.The information provided should not give a misleading impression.

• In its report the board should discloase that :

      -there is an ongoing process for identifying,evaluating and managing significant risks faced by the company.

      -the system has been in place for the entire year under review and up to the date that the annual report and accounts were approved by the board.

       -the system is regularly reviewed by the board.

• The report should include a statement by the board that it is responsible or the companys system of control and for reviewing its effectiveness.

• The report should also state that the system of internal control is designed to manage risk rather than to eliminate the risk of failure to achieve business objective.The internal control system can therefore only provide reasonable and not absolute assurance against material misstatment or loss.

 

The information provided to shareholders doesnot need to go into details about controls and control processes.High Level information is sufficient.The Turnbull Report also states that in the report to shareholders the board should:

• Disclose the process it has used for dealing with the internal control aspects of any significant problems revealed in the annual report and accounts.

• Confirm that action has been taken to remedy any significant weaknesses or failings that were found in the systems as a result of the review.

• Summarise the process it has used or board committees have used to review the effectiveness of the system of internal control.(The board of directors is not required to provide detailed information about the processes it has used only a summary).

If the board has failed to conduct a review of the effectiveness of internal control and risk management,a UK listed company must disclose this fact in its annual report.