A recent court decision against the directors of a major company demonstrates how demanding are a director's duties when approving financial statements.
To meet those demands, boards may seek to change the way in which financial information is presented to directors and how they review it. Information overload is not an excuse for failing to read, understand and focus on material provided to the board, especially material relating to the approval of financial statements.
The decision identifies limits on the extent to which directors can rely on management and external advisers. The law imposes a special responsibility on directors for approving financial statements. They cannot simply delegate that responsibility. Where directors know enough to spot a possible error in draft financial statements, they must question management and their external advisers.
It means that directors must have a degree of financial literacy. This knowledge should extend at least as far as basic accounting concepts and conventional accounting practices. However, the decision leaves unclear the question whether a director's knowledge should extend beyond this and, if so, how far.
The court ruled that current and former directors of Centro, a debt-laden shopping centre owner, had broken the law by approving incorrect financial accounts which classified more than $2 billion in short term loans as long term loans.
The company's former chief financial officer admitted to having broken the law but, in their defence, the directors said they had employed a major accounting firm to make sure the accounts were correct.
The judge decided that eight men had contravened the Corporations Act because they did not check that the accounts were correct.
"The directors are intelligent, experienced and conscientious people," he said. "There has been no suggestion that each director did not honestly carry out his responsibilities as a director … However, I have found … that the directors failed to take all reasonable steps required of them, and acted in the performance of their duties as directors without exercising the degree of care and diligence the law requires of them."