| 32. | The Turnbull Guidance16, recommends that the company discloses a summary of the process the board (and where applicable, its committees) has adopted in reviewing the effectiveness of the system of internal control. The Turnbull Guidance17 describes the directors' process for reviewing effectiveness and in particular states18: "The board should define the process to be adopted for its review of the effectiveness of internal control. This should encompass both the scope and frequency of the reports it receives and reviews during the year, and also the process for its annual assessment, such that it will be provided with sound, appropriately documented, support for its statement on internal control in the company's annual report and accounts". |
| 33. | The objective of the auditor's review of compliance is to assess whether the company's summary of the process the board (and where applicable its committees) has adopted in reviewing the effectiveness of the system of internal control, is both supported by the documentation prepared by or for the directors and appropriately reflects that process. |
| 34. | To achieve this objective the auditor, in addition to the procedures outlined in paragraph 16; |
| (a) | obtains an understanding, through enquiry of the directors, of the process defined by the board for its review of the effectiveness of all material internal controls and compares that understanding to the statement made by the board in the annual report and accounts; |
| (b) | reviews the documentation prepared by or for the directors to support their statement made in connection with Code provision C.2.1 and assesses whether or not it provides sound support for that statement; and |
| (c) | relates the statement made by the directors to the auditor's knowledge of the company obtained during the audit of the financial statements. As explained in paragraph 36, the scope of the directors' review will be considerably broader in its scope than the knowledge the auditor can be expected to have based on their audit. |
| 35. | The auditor considers whether the directors' statement covers the year under review and the period to the date of approval of the annual report and accounts, as recommended by the Turnbull Guidance19. |
| 36. | In carrying out the review, the auditor will have regard to the knowledge of the company the auditor has obtained from the audit work. To enable the auditor to perform the audit and express an opinion on the financial statements, the auditor is required by Auditing Standards20 to obtain an understanding of the entity and its environment, including its internal control, sufficient to identify and assess the risks of material misstatement of the financial statements. Consequently, the auditor's assessment required by Auditing Standards will be considerably narrower in scope than the review performed by the directors for the purpose of reporting on compliance with Code provision C.2.1. |
| 37. | The auditor, therefore, is not expected to assess whether all risks and controls have been addressed by the directors or that risks are satisfactorily addressed by internal controls. In order to communicate this fact to users of the annual report, the following sentence is included in the auditor's report on the financial statements. |
| "We are not required to consider whether the board's statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the company's corporate governance procedures or its risk and control procedures." |
| 38. | However, ISA (UK and Ireland) 260 "Communication of audit matters with those charged with governance" requires, among other things, that the auditor communicates, on a timely basis, to those charged with governance material weaknesses in internal control identified during the audit. A material weakness in internal control is a deficiency in design or operation which could adversely affect the entity's ability to record, process, summarize and report financial and other relevant data so as to result in a material misstatement in the financial statements. A material weakness in control identified by the auditor will be considered by the directors, in the context of the reports they receive and review during the year as part of their overall process for undertaking an annual assessment of the effectiveness of the company's internal control procedures, and it may be considered by them to be a significant failing or weakness as described in the Turnbull Guidance. |
| 39. | In view of the obligations placed on directors by the Turnbull Guidance the APB recommends that any material weaknesses in internal control identified by the auditor be reported to those charged with governance as soon as is practicable. The auditor does not wait until the financial statement audit has been completed before reporting such weaknesses. In this way, the directors will be aware of the weaknesses that the auditor has identified and be able to take account of them in making their statements on internal control21. |
| 16 Paragraphs 26-32 and 36 of the Turnbull Guidance. |
| 17 Paragraphs 26-32 of the Turnbull Guidance. |
| 18 Paragraph 27 of the Turnbull Guidance. |
| 19 Paragraph 26 of the Turnbull Guidance. |
| 20 ISA (UK and Ireland) 315, "Obtaining an understanding of the entity and its environment and assessing the risks of material misstatement". |
| 21 The auditor has a responsibility under ISA (UK and Ireland) 260 to consider whether there is adequate two-way communication between the auditor and those charged with governance, such that an effective audit can take place. As part of this responsibility, amongst other things, the auditor will need to consider the appropriateness and timeliness of actions taken by those charged with governance in response to the recommendations made by the auditor including those regarding material weaknesses in internal control. |
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