A corporate board of directors essentially has two areas of responsibility pertaining to financial accounting. First, boards must embrace an ethical culture and actively promote it throughout the company. Second, board directors must be assured that the finance committee is adequately providing oversight to the accounting department and the audit process. All board directors should be familiar with the types of reports that accounting departments produce and have a sufficient level of comprehension to detect anomalies and to ask questions about variable results.
The Board’s Role in Promoting Ethical Culture
Despite the fact that boards are aware of their responsibilities to promote an ethical culture and tone from the top, a 2015 Deloitte survey indicated that 87% of the members surveyed considered culture and engagement to be one of their top challenges. A 2016 Deloitte study showed that only 28% of executives felt they understood their company’s culture. Only 12% believed that their company drove the right culture.
All boards have a code of ethics that describes and promotes ethical behavior among board directors. The company’s mission statement also often lends support for ethical behavior. The code of ethics tells about why the company exists and what defines it. Board directors must emulate the culture in word and deed.
One theory is that boards don’t tend to spend enough time on how to promote an ethical culture, even though they agree that culture is a key driver of ethical behavior, especially when it comes to accurate financial reporting. Some boards have attempted to solve this problem by scheduling at least one board meeting per year for the sole purpose of focusing on developing an ethical corporate culture. Board directors use the time to discuss their concerns, problems and any red flags on ethical matters.
While board directors are willing to accept the challenge of overseeing ethics and compliance matters, they’re often unsure about what questions to ask and what information they should be looking for. As a result, they’re apt to miss some important red flags. Developing strategies for ethical behavior and communicating them is a skill board directors can work on. Many directors need additional training to become as disciplined in how to oversee corporate culture and risk management as they are proficient in operations, planning and other skills.
Questions Boards Should Ask Themselves Regarding Culture
A red flag may be nothing more than an issue that makes a board director uncomfortable, or that doesn’t sit well with them. Maybe it’s nothing, but it’s best to trust your instincts and to make further inquiries.
Boards should be particularly tuned in to any issues that could cause embarrassment to the company. These issues sometimes get revealed through the company grapevine or during confidential conversations.
Board directors should also make note of any issues that they may have discussed with the CEO, the CFO or other officers where they failed to pass important information down to the audit committee.
The media is quick to jump on stories of corporate fraud. Board directors should be quick to act on past, present or potential areas of fraud.
Addressing issues of ethics is a sensitive area and one that makes people uncomfortable. It’s best to deal with issues up front rather than risk a potentially more serious situation down the line.
Boards Are Responsible for Oversight of Accounting
While several different parties are involved in the process of ensuring accurate accounting practices, the board of directors is ultimately responsible for the financial health of the organization. Board directors should expect to see consistent reports at least annually. Boards often require reports at least quarterly and sometimes more often than that. Frequent financial reports assist board directors in addressing issues while problems are still small. The financial reports should be comprehensive, while being easy to comprehend and compare.
At the minimum, board directors should become proficient at reading four essential financial statements: the balance sheet, the income statement, the cash flow statement and the statement of shareholders’ equity. However, certain circumstances may require board directors to take a more focused look at situations that require it.
The balance sheet provides a quick glance at the company’s current financial condition. Directors should insist upon a standard format that is easy to compare with previous balance sheets. The balance sheet lists assets first and then liabilities. The final section lists stockholders’ or owners’ equity.
The income statement shows the company’s revenues for a specific accounting period. This statement provides a detailed breakdown of expenditures. The report should include figures for depreciation, taxes, interest earned or paid, and other nonoperating revenues and expenses. The bottom line is the company’s net earnings, which tell the board where the company’s money went.
Cash Flow Statement
The cash flow statement is much like your personal checking account. It shows a pattern of incoming funds and outgoing funds to demonstrate changes in the amount of money the company has in hand at any one juncture.
The cash flow statement typically has three sections. The first report shows changes due to operating activities. The second report shows the effect of investment activities, such as changes due to purchasing equipment or asset sales. The third report shows cash on hand as a result of selling or purchasing stock, borrowing money and repaying debts.
Statement of Shareholders’ Equity
Finally, the statement of shareholders’ equity depicts changes in the equity of the company due to retained earnings and the sale or repurchase of stock. Board directors and shareholders can compare the previous total shareholders’ equity at the top of the financial statement with the current equity at the bottom of the statement to see how much the total shareholders’ equity has changed during a specified accounting period.
Boards must include annual versions of all reports in the annual company report. These statements will provide the general context for any supplementary reports the board chooses to include in their disclosures.
It’s important for boards to maintain a consistent corporate culture despite other changes occurring rapidly to assure shareholders and other stakeholders that the company demands ethical behavior in all aspects of the business. Financial reports support the company’s commitment to transparency and accuracy in disclosures. Ethics and financial oversight form the basis for board involvement in accounting practices.