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Second audit report concerns

AMID the hype surrounding the release of the ninth instalment of the Federal Government’s Corporate Law Economic Reform Program, another report into audit independence slipped through relatively unnoticed.

However, one recommendation from the Federal joint parliamentary committee of public accountants and audits, if adopted, could have dire consequences for WA’s small-cap stocks.

Through what is known as the Charles Report, the joint committee recommended that: “The Corporations Act 2001 be amended to require all publicly listed companies to have an independent audit committee and the Act prescribe the minimum requirements in regard to the role, responsibilities and composition of the audit committee”.

In CLERP9 there was only a requirement for the top 500 Australian listed companies to have an independent audit committee.

About 80 of WA’s listed companies sit in the top 500. This means the Charles Report re-commendation would hit around 200 listed WA companies, with the potential that their boards be forced to expand

The going rate for a non-executive director is understood to be around $30,000 per year, however, if the Charles Report recommendation becomes overly prescriptive – such as requiring audit committees to include accountants – the cost could be much higher.

This is not taking into account the higher costs a company could face through having to take out directors’ and officers’ insurance cover for these new directors.

Indeed, a move requiring accountants on audit committees could also create a raft of audit independence issues.

Bentleys MRI partner in charge of audit and corporate finance, Jeff Vibert, said the recommendation could put onerous compliance burdens on small listed companies.

“Audit committees should ideally have non-executive directors on them. However, some small listed companies only have about three directors and two of them are usually operating in an executive capacity,” he said.

“Even an experienced company director with good business skills and financial nous may not know the accounting standards. It is a very specific area but one becoming increasingly important.

“If the Government ends up demanding that all companies have audit committees then these small companies will have to expand their boards. They will have to find people that can ask the hard questions on the accounts. HIH brought to light how directors were not experienced in the way their company worked.

“In the old days directors could rely on gut feel and intuition. Now business has become much harder and regulations have become much more prescriptive.”

PKF managing partner Neil Smith said the Charles Report re-commendation could put a lot of pressure on WA’s small-cap companies.

“A lot of small-caps don’t have audit committees. Companies with three or four hands-on directors tend to consider their actions to be sufficient,” he said.

“This suggestion will put a compliance and cost burden on such companies. There will be a requirement for extra meetings and bring another level of formality that will have costs attached to it.”

However, Mr Smith said the extra cost and compliance burdens could be necessary.

“It has to be remembered that these things are all being done for a reason. Investors need to be protected,” he said.

Australian Institute of Company Directors CEO John Hall said the institute favoured the CLERP9 recommendation that only the top 500 listed companies be required to have audit committees.

“The Charles Report recommendation could cause boards to expand. However, I don’t think this will be a big problem,” he said.

Mr Hall said he believed the Government would be more likely to back the CLERP9 recommendations than the Charles Report.

Indeed, besides the differing requirement for audit committees there is little difference between Charles and CLERP.

Institute of Chartered Accountants in Australia regional councillor Graham McHarrie said he didn’t believe the Charles Report recommendation would pose an insurmountable problem for small listed companies.

“The practical issue is that smaller companies have smaller boards and their directors are usually drawn from the technical side rather than the financial side,” he said.

“However, I think a person without a strong financial background can still sit on a board and understand the financial principles.

“I understand why smaller companies would see something like this as a bit of a concern but in reality it is not a major practical problem.”

What does remain clear, whether CLERP9 or Charles is followed, is that something needs to be done to bolster corporate governance in Australian companies.

A recent report by accounting house Ernst & Young into the compliance standards of Australia’s top 200 listed companies found that most could not meet strict new corporate governance standards being introduced by the New York Stock Exchange.

In the area of audit committees the survey found more than one quarter of Australian audit committees currently included executive directors – something that would not meet the new standards the NYSE is calling for. The Australian Stock Exchange is yet to mandate specific corporate governance practices. For example, it has no rules on audit committees.

p Next issue: The business of corporate governance.

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