Role of an Audit Committee

The role of the Audit Committee is to: Oversee the financial reporting system of the company, with a view to safeguarding the interest of the shareholders and all other stakeholders.
-ICASL: Code of Best Practice on Audit Committees

A report by the Board on the finance company's internal control mechanism that confirms that the financial reporting system has been designed to provide a reasonable assurance regarding the reliability of financial reporting, and that the preparation of financial statements has been done in accordance with relevant accounting principles and regulatory requirements
- Corporate Gov regulations for Finance Cos
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10 November 2009

Internal Controls: Points to consider

Has the system of internal control been reviewed by the board?

Has the system of internal control been in place?

What process has been applied in reviewing the system?

Is there an ongoing risk management process?

Has action been taken to remedy any significant control weakness?

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Next Steps

Establish a process for continuing education Understand the key accounting policies used in the preparation of Financial Statements and evaluate their appropriateness Determine the balances that are effected by estimates, judgments, projections and assumptions. Ensure that these are reasonable Establish policy for review and approval of all significant, complex or unusual Transactions. Have a process to determine the compliance with applicable laws regulations and contractual obligations Review and approve all RPT Transactions Establish a process for consideration of the quality of earnings and overall financial reporting Have a process to evaluate the internal controls over financial statement preparation design of the system

Audit Committees: Evaluating the Quality of Financial Information

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Appendix 1
Areas of focus on review of financial statements

Areas of focus on review of financial statements

Cash
Are there any restrictions on the use of cash? If so, are they properly disclosed? Is any portion of the cash balance held under formal or informal compensating balance arrangements? Are these facts disclosed in the financial statements? Is the presentation of the statement of cash flows consistent with previous years? Were there any significant cash transactions where management had difficulty identifying the appropriate classification (e.g., operating vs. financing activities) on the statement of cash flows? What is the Companys policy for including financial instruments within cash equivalents

Investments/Financial instruments
How does the Company invest excess funds? What are the investment policies with regard to risk and yield? Have there been significant changes during the year in the types of investments held? Has the Company invested in any exotic or unusual financial instruments? Has the Company entered into any interest rate contracts, foreign currency contracts, or other types of options, futures, forwards, swap contracts, or any other types of derivatives? How are they disclosed in the financial statements? What is the nature and extent of use of derivatives? What are the Companys policies and procedures related to entering into these agreements and evaluating them? For derivatives, are related gains and losses properly classified, described, and disclosed in the financial statements? Has the Company considered the counterpartys credit risk? How are debt and equity securities classified (i.e., held to maturity, trading, and available-for-sale)? Have other than temporary declines in value been considered? Are there any liens, pledges, or other security interests in financial instruments? If so, are they properly disclosed? Are any contingent liabilities resulting from these transactions appropriately disclosed?

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Areas of focus on review of financial statements

Lease and HP Receivables
What is the amount of bad debt expense this year? How does it compare to last year?

What is the NPL Ratio ? How has it been computed ? Is the company in line with the industry ratio? How was the allowance for doubtful Lease and HP receivables/loss reserve determined? Has there been a change in the methodology or assumptions used in determining the allowance for doubtful Lease and HP receivables/loss reserves? If so, why? How was its adequacy evaluated? Has the allowance changed from last year in proportion to changes in receivables/loans? If not, why not? Is there a high concentration of credit risk (e.g., industry, geographic area,)? What type of assets does the company lend against (e.g. motor vehicles, machinery)? What is the value of Lease/HP receivables where assets have been seized? Would their recoverable value be below the carrying value? What were the largest Lease and HP receivables written-off this year? Were they reserved at last year end? If not, why not? Does the Company participate in loans/syndications originated by others? If so, what type of independent credit analysis is performed? Are there any liens, pledges on Lease and HP receivables? If so, are they properly disclosed? Are any significant or unusual amounts due from related parties, including officers and employees? How do these amounts compare to last year end?

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Areas of focus on review of financial statements

Property, plant, and equipment
Are the estimated useful lives and methods of depreciation reasonable? Have any of the estimated useful lives or methods changed from the prior year? Does the Company periodically take a physical inventory of fixed assets? Is this physical inventory reconciled to the financial records? Does the Company have any significant proposed leases that might require capitalization? What are the Companys policies for accounting for leasehold improvements? How does the Company identify the appropriate period over which to amortize the costs of leasehold improvements? Have internal-use software costs been evaluated to determine whether those amounts are being treated properly as either capitalized or expensed costs? Has impairment of fixed assets been considered?

Other assets
What is included in other assets? Are the carrying values of intangible assets reviewed regularly to determine whether there has been an impairment in value? How were these carrying values evaluated? Are there any deferred charges? If so, have they been evaluated for recoverability? Have significant deferred tax assets been recognized for which the recovery is based on tax planning strategies or expectations as to future taxable income?

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Areas of focus on review of financial statements

Borrowings/Noncurrent liabilities
Were there any commitments or contingent liabilities indicating possible impairment of an asset or the

incurrence of a liability that were not provided for or disclosed in the financial statements? Is the Company in compliance with the provisions of its loan and debt agreements? Is the Company in danger of not complying with such agreements during the next year? What assets are pledged to secure borrowings? Have appropriate disclosures of pledged assets been made in the financial statements? Has the Company issued guarantees of the debt of others? If so, are these guarantees properly disclosed in the financial statements? What is the gearing of the Company? Is the Company within the industry norms ? Does the Company consider maturity of assets when entering into borrowing arrangements? If so how does the maturity of assets and liabilities being monitored ? Are the assumptions being used to value the pension benefit and other post-employment benefit obligations reasonable? Were there any changes in the assumptions this year as compared to last year? Were there any plan amendments during the last year?

Current liabilities
What procedures were performed to determine there are no significant unrecorded liabilities?

Are there any significant, unusual accruals? Have amounts due to related parties been identified and properly disclosed? Were any significant issues raised by counsel concerning litigation, contingencies, claims, or assessments? How are such matters reflected in the financial statements or footnote disclosures? Were there any other contingencies identified by management that require accrual or disclosure?

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Areas of focus on review of financial statements

Income taxes
Is there an unusual relationship between income before taxes and income tax expense? If so, what caused the unusual relationship? What is the effective tax rate this year and how does it compare to last years rate? Has the Company reconciled its deferred tax accounts to supporting records?

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Finance Companies (Corporate Governance) Direction

Central Bank of Sri Lanka

Key Features
1.

The Responsibilities of the Board of Directors

Board shall strengthen the safety and soundness of the finance company Board shall appoint the chairman and the chief executive officer and define and approve the functions and responsibilities of the chairman and the CEO There shall be a procedure determined by the Board to enable directors, upon reasonable request, to seek independent professional advice in appropriate circumstances, at the finance companys expense. A director shall abstain from voting on any Board resolution in relation to a matter in which he or any of his relatives or a concern in which he has substantial interest, is interested, and he shall not be counted in the quorum for the relevant agenda item at the Board meeting. Board shall have a formal schedule of matters specifically reserved to it for decision to ensure that the direction and control of the finance company is firmly under its authority. Board shall, if it considers that the finance company is, or is likely to be, unable to meet its obligations or is about to become insolvent or is about to suspend payments due to depositors and other creditors, forthwith inform the Director of the Department of Supervision of Non-Bank Financial Institutions Board shall include in the finance companys Annual Report, an annual corporate governance report setting out the compliance with this Direction. Board shall adopt a scheme of self-assessment to be undertaken by each director annually, and maintain records of such assessments.
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Key Features
2.

Meetings of the Board

Board shall meet at least twelve times a financial year at approximately monthly intervals. Obtaining the Boards consent through the circulation of written or electronic resolutions/papers shall be avoided as far as possible. Board shall ensure that arrangements are in place to enable all directors to include matters and proposals in the agenda for regular Board meetings where such matters and proposals relate to the promotion of business and the management of risks of the finance company. A notice of at least 7 days shall be given of a regular Board meeting A director who has not attended at least two-thirds of the meetings in the period of 12 months immediately preceding or has not attended the immediately preceding three consecutive meetings held, shall cease to be a director. The Board shall appoint a company secretary whose primary responsibilities shall be to handle the secretarial services to the Board and shareholder meetings and to carry out other functions specified in the statutes and other regulations If the chairman has delegated the company secretary shall be responsible for carrying out such function. All directors shall have access to advice and services of the company secretary with a view to ensuring that Board procedures and all applicable laws, directions, rules and regulations are followed. The company secretary shall maintain the minutes of Board meetings

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Key Features
3.

Composition of the Board

number of directors on the Board shall not be less than 5 and not more than 13, subject to transitional provisions total period of service of a director other than a director who holds the position of chief executive officer or executive director shall not exceed nine years. The total period in office of a non executive director shall be inclusive of the total period of service served by such director up to the date of this Direction. an employee of a finance company may be appointed, elected or nominated as a director of the finance company number of independent non-executive directors of the Board shall be at least one fourth of the total numbers of directors. Non-executive directors shall have necessary skills and experience to bring an objective judgment to bear on issues of strategy, performance and resources. With effect from three years from the date of this Direction, a meeting of the Board shall not be duly constituted, although the number of directors required to constitute the quorum at such meeting is present, unless at least one half of the number of directors that constitute the quorum at such meeting are non-executive directors. The independent non-executive directors shall be expressly identified as such in all corporate communications that disclose the names of directors of the finance company. There shall be a formal, considered and transparent procedure for the appointment of new directors to the Board. All directors appointed to fill a casual vacancy shall be subject If a director resigns or is removed from office, the Board shall announce to the shareholders and notify the Director of the Department of Supervision of Non- Bank Financial Institutions

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Key Features
4.

Criteria to assess the fitness and propriety of directors

a person over the age of 70 years shall not serve as a director of a finance company A director of a finance company shall not hold office as a director or any other equivalent position in more than 20 companies/societies / bodies corporate, including associate companies and subsidiaries of the finance company. director shall not hold office of a director or any other equivalent position in more than 10 companies that are classified as Specified Business Entities in terms of the Sri Lanka Accounting and Auditing Standards Act No. 15 of 1995.

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Key Features
5.

Delegation of Functions

Board shall not delegate any matters to a board committee, chief executive officer, executive directors or key management personnel, to an extent that such delegation would significantly hinder or reduce the ability of the Board as a whole to discharge its functions Board shall review the delegation processes in place on a periodic basis to ensure that they remain relevant to the needs of the finance company The roles of chairman and chief executive officer shall be separated and shall not be performed by the one and the same person after 3 years commencing from January 1, 2009. chairman shall be a non-executive director Board shall disclose in its corporate governance report, which shall be an integral part of its Annual Report, the name of the chairman and the chief executive officer and the nature of any relationship [including financial, business, family or other material/relevant relationship(s)], if any, between the chairman and the chief executive officer and the relationships among members of the Board. The chairman shall: (a) provide leadership to the Board; (b) ensure that the Board works effectively and discharges its responsibilities; and (c) ensure that all key issues are discussed by the Board in a timely manner. The chairman shall be primarily responsible for the preparation of the agenda for each Board meeting. The chairman shall ensure that all directors are informed adequately and in a timely manner of the issues arising at each Board meeting the chairman, shall not engage in activities involving direct supervision of key management personnel or any other executive duties whatsoever. (
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6.

The Chairman and the Chief Executive Officer

10 November 2009

Key Features
7.

Board Appointed Committees

Every finance company shall have at least the two Board committees:

Audit Committee Integrated Risk Management Committee

8.

Related party transactions

Board shall take the necessary steps to avoid any conflicts of interest that may arise from any transaction of the finance company with any person, and particularly with the following categories of persons who shall be considered as related parties for the purposes of this Direction

a) A subsidiary of the finance company; b) Any associate company of the finance company; c) A director of the finance company; d) A key management personnel of the finance company; e) A relative of a director or a key management personnel of the finance company ; f) A shareholder who owns shares exceeding 10 % of the paid up capital of the finance company; g) A concern in which a director of the finance company or a relative of a director or a shareholder who owns shares exceeding 10 % of the paid up capital of the finance company, has substantial interest.

Board shall ensure that the finance company does not engage in transactions with a related party in a manner that would grant such party more favourable treatment than that is accorded to other similar constituents of the finance company.

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Key Features
10.

Disclosures

(a) annual audited financial statements and periodical financial statements are prepared and published in accordance with the formats prescribed by the regulatory and supervisory authorities and applicable accounting standards, and that (b) such statements are published in the newspapers in an abridged form, in Sinhala, Tamil and English. A statement to the effect that the annual audited financial statements have been prepared in line with applicable accounting standards and regulatory requirements, inclusive of specific disclosures A report by the Board on the finance company's internal control mechanism that confirms that the financial reporting system has been designed to provide a reasonable assurance regarding the reliability of financial reporting, and that the preparation of financial statements has been done in accordance with relevant accounting principles and regulatory requirements The external auditors certification on the effectiveness of the internal control mechanism in respect of any statements prepared or published after March 31, 2010. Details of directors, including names, transactions with the finance company. Fees/remuneration paid by the finance company to the directors in aggregate, in the Annual Reports published after January 1, 2010. Total net accommodation in respect of each category of related parties and the net accommodation outstanding in respect of each category of related parties as a percentage of the finance companys capital funds. A report setting out details of the compliance with prudential requirements, regulations, laws and internal controls and measures taken to rectify any noncompliances.

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Key Features
10.

Disclosures (contd)

A statement of the regulatory and supervisory concerns on lapses in the finance companys risk management, or non compliance with the Act, and rules and directions that have been communicated by the Director of the Department of Supervision of Non-Bank Financial Institutions, if so directed The external auditors certification of the compliance with the Act and rules and directions issued by the Monetary Board in the annual corporate governance reports published after January 1, 2011.

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