The EY’s linked report summarizes 2015 disclosures in Sept. 2015 annual reports; most importantly the “acid test” summary, copied herein, provides an interesting perspective for addressing risks and a framework for the Board to consider.
Our ‘acid test’
As we conducted this review, we found that reading risk and viability disclosures in isolation was difficult. The importance of reviewing key related and relevant narrative disclosures e.g., business model and strategy, was brought to the fore. In our September 2015 report, ‘Reflections on the past, direction for the future’, we included an ‘acid test’ — a set of key questions that preparers or reviewers should be able to answer clearly having drafted the narrative within their ARAs.
We include our acid test here again to help preparers and reviewers put all disclosures in context. We believe that investors too should view the new disclosures with these same questions in mind.
Risk management and internal control disclosures:
- ► How are the principal risks mitigated and controlled by the company’s systems of internal controls and risk management?
- ► How does the board monitor material controls on an ongoing basis to gain assurance that principal risks are being effectively managed and to take corrective action if they are not?
- ► What did the board’s review of the effectiveness of these systems encompass?
- ► Has the board identified significant failings or weaknesses?
- ► What was the basis for determining what is ‘significant’?
- ► Is it clear what actions have been or will be taken to address significant failings or weaknesses?
- ► Over what time frame has the board considered the viability of the company and why?
- ► What process did the board use to assess viability?
- ► Does the board understand which,if any, severe but plausible risks (or combination of risks) would threaten the viability of the company?
- ► What assurance did the board obtain over relevant elements (e.g., stress testing)?
- ► What assumptions did the board use in reaching their conclusion?
- ► How does the company make its money?
- ► What are the key inputs, processes and outputs in the value chain, and how are the company’s key assets (including its physical assets, IP, people, technology, etc.) engaged in the value chain?
- ► What is the company’s competitive advantage?
- ► How does the business model help deliver and sustain this over time?
Key Performance Indicators (KPI’s)
- ► What are the key metrics the board uses to measure progress against its strategic objectives?
► How has the company performed against these metrics and how are these linked to the remuneration of key executives?
- ► What did the board and its committees actually do in the year to govern the company?
- ► What, if any, changes were made to governance arrangements during the year and why?
- ► What areas for improvement were identified from the board evaluation and what progress was made against actions from the previous evaluation?
- ► How is board composition and succession planning being managed, giving due regard to skills, experience and diversity?
- ► How did the board seek to understand the views of shareholders during the year and what, if any, action was taken as a result of feedback?
Risk transparency and Board accountability for risks are increasing exponentially in the post-BEPS era, while tax authorities are simultaneously drafting risk-based legislation. The report is worthwhile reading and should provide an impetus for new Best Practices.