Housing Association Guide Part 1 - Appendix 12 Annex D-EAnnex D Internal Financial Control and Financial Reporting1.01Introduction - as a result of the report in GB of the Cadbury Committee on "The Financial Aspects of Corporate Governance" guidance for directors of listed companies was issued. This appendix adapts the relevant principles to suit Associations and concentrates on the need for reports to be made on the effectiveness of each Association's system of internal control. This guidance is consistent with "Internal Control and Financial Reporting Guidance for directors of listed companies registered in the UK” published in December 1994 and applies to all Registered Housing Associations.
2.01The Department's Requirements - the Committee of Management should include a statement with its audited financial statements about the Association's system of internal financial control. (See Section 4 below)
3.01Definition of 'Internal Financial Control' - 'Internal financial control' is defined as 'the internal controls established in order to provide reasonable assurance of:
- The safeguarding of assets (against unauthorised use or disposition); and
- The maintenance of proper accounting records and the reliability of financial information used within the Association or for publication’.
3.02In principle, the definition of internal financial control - excludes efficiency, value for money, and legal and regulatory compliance issues. In practice, however, consideration of the effectiveness of internal financial control may need to include other controls for activities which have a potentially material impact on the 'true and fair view' presented in the audited accounts.
3.03The effectiveness of internal financial control - is a matter of judgement. Internal financial control cannot provide certainty against errors or losses, only reasonable assurance.
3.04The extent and formality of individual internal financial controls - should relate to the risks incurred.
4.01The Statement - the form of the statement that the Committee of Management should make about the Association’s system of internal financial control is not prescribed, other than that it should be published with the audited financial statements.
4.02The statement should contain as a minimum:
- An acknowledgement by the Committee of Management that it is responsible for the Association's system of internal financial control;
- An explanation that such a system can only provide reasonable, and not absolute, assurance against material misstatement or loss;
- A description of the key procedures [see also section 5 of this appendix] which the Committee of Management has established and which are designed to provide effective internal financial control;
- Confirmation that the Committee of Management has reviewed the effectiveness of the system of internal financial control. [An opinion on the effectiveness of its system should only be expressed with considerable caution]; and
- Information about those weaknesses in internal financial control that have resulted in material losses, contingencies, or uncertainties that require disclosure in the financial statements or the auditors' report on the financial statements.
4.03Where the Association has not complied with any of the requirements of this guidance - the Committee of Management should disclose the reasons for non compliance in its statement.
4.04The Committee of Management's statement - should cover the period of the financial statements, and should also take account of material developments between the balance sheet date and the date upon which the financial statements are actually signed.
4.05A separate statement - will be required for each Association. In addition, the Committee of Management of a parent association preparing group financial statements should make a statement regarding internal financial control in respect of the group as a whole, including any unregistered subsidiaries.
5.01Key Procedures - the description of the key procedures, that the Committee of Management has established, is an essential element of the statement. It should outline the specific high level procedures used by the Association/group and the process by which the Committee of Management reviews the effectiveness of the system of internal financial control.
6.01Role of the External Auditors - the external auditors will review the Committee of Management's statement on internal financial controls and issue a report to the Association regarding their review of the statement. They will follow the guidance set out in the Auditing Practices Board (APB) Bulletin 1995/1 'Disclosures Relating to Corporate Governance'. The object of this review is to enable them to conclude:
- That the Committee of Management has provided the disclosure required by this appendix; and
- That the Committee of Management's comments are not inconsistent with the information of which they are aware from their audit work on the financial statements (and the limited additional procedures specified in the Bulletin).
6.02The external auditors are not required - to review the effectiveness of the Association's procedures for ensuring compliance with this circular, nor to investigate the appropriateness of the reasons given for any non compliance with the requirements of this circular. These are matters upon which the users of annual reports may form their own views on the basis of the Committee of Management's statement.
6.03In order to avoid any misunderstanding - regarding the objective and scope of the engagement, and the method of reporting by the auditors, a reference to the auditors' review of the Committee of Management statement should be included in the engagement letter. The report should be included as an additional section of the auditors' report on the financial statements. It should be clearly identified by an appropriate heading such as 'Corporate Governance Matters,' and make clear that the review is additional to and separate from the audit of the financial statements.
[Note: All paragraphs in section 6 of this appendix are for the information of the Committee of Management and employees of Associations. They do not constitute guidance for auditors.]
7.01Financial Reporting - For associations that:
- Own and/or managing more than 250 units at the start of the financial period; and/or
- Are listed in the development programme; and/or
- Have an annual rental income stream of £500,000 or more;
the board should include, with its audited financial statements, a statement of internal control that refers to the board's annual review of the effectiveness of the association's internal control systems. If the association is the parent company of a group, the statement should refer to the board's annual review of the internal control systems of the group. The statement should include:
- An acknowledgement by the board that it is responsible for the association's system of internal control and for reviewing its effectiveness;
- An explanation that such a system is designed to manage rather than eliminate the risk of failure to achieve business objectives, and can only provide reasonable, and not absolute assurance against material misstatement or loss;
- An explanation that the process for identifying, evaluating and managing the significant risks faced by the association is ongoing; has been in place for the year under review and up to the date of approval of the annual report and accounts; and is regularly reviewed by the board;
- A summary of the process the board has adopted in reviewing the effectiveness of the association's system of internal controls;
- A summary of the main policies which the board has established and which are designed to provide effective internal control; and
- Information on the process that the board has adopted in addressing material internal control aspects of any significant problems disclosed in the annual report and accounts. Reference to regulatory concerns should also be considered, where these have led us to intervene in the affairs of the association.
If the board cannot comply with any of the requirements of this paragraph it should make a statement to this effect and give an explanation for the statement.
8.01Small Associations - non-developing Associations owning and/or managing 250 or fewer units at the start of the financial period and a rental income stream below £500,000 per annum are not required to include a statement of internal control alongside their audited accounts. However, small associations should consider publishing an appropriate form of statement, taking into consideration the following factors:
- Proximity to the 250-unit cut-off point;
- Range of activities in which the association is involved;
- Proximity to the rental income stream of £500,000 per annum cut off point;
- Level of turnover - e.g. a supported housing provider with 200 units may have a turnover level equivalent to a general needs association with considerably more units; and
- Plans for expanding the range or extent of operations.
It is for the board of each association to decide how it obtains assurance on the effectiveness of the association's system of internal controls. Possible methods include the following (which should not be regarded as an exhaustive list):
- Board/audit committee overview;
- Management assurances on internal controls;
- Management reports on operational and financial matters;
- Risk management activities;
- Internal audit;
- Quality management systems;
- External audit;
- Key performance indicators; and
- External regulatory reports and other external reports.
Code of Audit Practice
1.01Introduction - the Code of Audit Practice for Associations seeks to:
- Confirm the responsibilities of Associations and their internal audit functions in relation to external audit matters; and
- Prescribe the Department's requirements and recommendations in respect of the establishment, duties and powers of an audit committee and internal audit function, if appropriate, in associations.
2.01Internal Audit - the Code sets down both minimum requirements and a series of options for the acquisition or delivery of an internal audit service. Associations should consider these options carefully to ensure that the method of delivery chosen is commensurate with the size, complexity and delivery of their operations.
3.01External Audit - larger Associations (those with 500 or more homes) will in addition be required to demonstrate that their external auditor is fully, and seen to be, independent of the client association and not normally involved in accountancy work. It is recommended they form an Audit Committee and they must be able to demonstrate that the key function of such a committee is being discharged by an Audit Committee or adequately carried out within the terms of reference of an established Finance Committee. Additionally larger Associations should conduct a tendering process for the External Auditors appointed every 7 years or sooner if appropriate.
4.01Implementation - Associations are expected to have fully implemented the code of audit practice in so far as it applies to them.
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