In this case study, you are one of four non-executive directors who sit with the managing director on the board of a listed company. The company was the first in its country to early-adopt International Financial Reporting Standards (IFRSs), commencing with its unaudited interim financial statements on December 31, 2005. The financial statements were approved by the board and signed off by the auditors on March 6, 2006.
On December 31, 2005, the company had £100 million of bank liabilities which it classified as long-term, even though technically speaking the company had breached bank covenants which permitted the bank to call in the liabilities at any time. Two pages buried deeply in a 1,180-page board pack a number of months prior to the approval of the financial statements clearly showed that the bank facilities were short term.
The company went into receivership in September 2006. The regulator took an action against the directors on the grounds that:
i. the directors failed to comply with applicable financial reporting standards; and
ii. they failed to take all reasonable and proper steps to ensure that applicable financial reporting standards would be complied with.
The directors accepted the first charge. In relation to the second charge, the directors argued that although the covenants had been breached, the bank had rolled over the loans in previous years and the directors, therefore, had a reasonable expectation that the bank would roll over the loans for another 12 months.
In addition, they had relied on a qualified, competent, well-resourced financial management team. They had also established a comprehensive transition process to IFRS Generally Accepted Accounting Principles and had engaged a ‘big-four’ audit practice to identify key areas and issues to be addressed in transitioning to IFRSs.
A steering committee of the company’s accounting staff and big-four audit practice staff had been put in place to review and ensure compliance with IFRSs. The big-four audit practice was engaged to review IFRS compliance and advise the board thereon. The managing director and financial controller had provided declarations of compliance with IFRSs to the board. There was a properly constituted audit committee.
The audit committee meeting to review the interim statement commenced at 11.30 am and finished at 4 pm. At the audit committee meeting, the minutes recorded that the managing director had asked the Big-Four audit firm partner ‘Can you assure me that these accounts comply with IFRSs’. The audit firm partner had responded ‘yes’.
Have the directors breached their legal duty to exercise due care and skill by relying on experts?