assessing the integrity of current accounting practices

Assessing the Integrity of Current Accounting PracticesNik Mohd Hasyudeen Yusoff

Corporate Governance Summit 2009

29 September 2009

Competitiveness Through Innovation and Strategy


Agenda

• The financial reporting supply chain

• Stress points in financial reporting

• The response from the accounting profession

• Reform in the regulatory landscape

• Would reporting failure occur again?

• Moving Forward Thoughts


The financial reporting supply chain• The accounting and auditing

practices and the accounting profession itself have been under scrutiny since the collapse of Enron in 2001

• Since then the landscape has changed in line with the development in corporate governance globally


The financial reporting supply chain• A business:

▫ Need to serve customers

▫ Need to compete

▫ Business environment keeps on changing

▫ Affected by global developments

▫ Stakeholders beyond shareholders

▫ Profit is the result of risk taking


The financial reporting supply chain• The financial reporting supply

chain refers to the people and processes involved in the preparation, approval, audit, analysis and use of financial reports. All links in the chain need to be of high quality and closely connected to supply high quality financial reporting 11 Financial Reporting Supply Chain:

Current Perspectives and Direction

International Federation of Accountants 2008


The financial reporting supply chainPlayer Role in financial reporting supply chain

Management Prepares financial statements

Board Provides direction and approves

Auditors Provide independent opinion

Media Disseminates financial information

Investors/Stakeholders Make economic decisions

Professionals – Valuers, Lawyers Valuation, professional opinion

Bankers, Rating agencies Corporate proposals

Standards setters and Professional bodies Set standards – financial reporting, auditing, ethicsEnforce standards

Regulators Ensure market integrity, enforcement actions


The financial reporting supply chain

Financial

And Business

Reporting Supply

Chain

Source:

XBRL

International


The financial reporting supply chain


Stress points in financial reporting

• Complexity of business▫ Size

▫ Geographical coverage

▫ Industry

• Application of financial reporting standards▫ Complexity

▫ Mark-to-market issues

▫ Capacity to comply

▫ Lack of infrastructure



• Tone from the boardroom▫ Not given enough priority

▫ Heavy reliance on management’s assurance without adequate oversight

• Audit committee ineffectiveness▫ Lack of expertise

▫ Blind reliance on external auditors

▫ Not enough support from internal audit



• Failure of risk management▫ Financial reporting risks not

adequately address on timely manner

▫ Internal control break down

▫ Fraudulent behaviour not detected

• Meeting market expectation▫ Attempting to meet analysts’

expectation

▫ Avoiding consequences of enforcement actions or debt covenant



• Breakdown in auditors’ independence▫ Financial interests from cross-selling of

other services

▫ Major clients

▫ Close relationship between auditors and clients

• Quality control practices within auditing firms▫ Lack of leadership

▫ Inadequate understanding of business and risks



•Greed!▫ Unmitigated excessive risk taking

▫ Independent directors turn dependent

▫ Executive incentives linked to performance

▫ Auditors putting business interests above professional values



Business failure

Governance failure Audit failure

Oversight failure


The response from the accounting profession

• “You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things you think you could not do before”

Rahm Emanuel

White House Chief of Staff



• Improvement in audit standards setting process, International Auditing and Assurance Standards Board (IAASB) reconstituted in 2002

• IAASB came under the preview of the Public Interest Oversight Board in 2005

• Completed the auditing standards clarity project in 2008



• Forum of Firms, which was established in 2002, is an association of international networks of accounting firms that perform audits of financial statements that are or may be used across national borders

• The obligations of members include:

▫ Maintain appropriate quality control

▫ Policies and methodologies based on ISAs

▫ Policies and methodologies conform with IFAC’s code of ethics for professional accountants

▫ Submit annual report on meeting obligations



• Improvements in ethical standards including:▫ Strengthening of the independence

requirements by using the threats-safeguards approach

▫ Auditors rotation

▫ Network firm rules

▫ Clarifying guidance on non-assurance services

▫ Relative fee size



IdentifyThreats

EvaluateThreats

ApplySafeguards

Decide onEngagements

Self-Review

Self-Interest

Advocacy

Familiarity

Intimidation

Significant?Assuranceteam, firm,

network firm?

Profession orlegislation

Assuranceclient

Firm’sInternal

procedures

Eliminatethe threatsor withdrawfromengagement



• Competency requirements for audit professional standard was issued in 2006▫ Knowledge content

▫ Professional skills

▫ Professional values, ethics and attitude

▫ Continuing professional education

▫ Assessment

▫ Competent requirement for engagement partner



• International Standards on Quality Control▫ Leadership Responsibilities for Quality

within the Firm

▫ Ethical requirements

▫ Acceptance of Continuance of Clients Relationships and Specific Engagement

▫ Human Resources

▫ Engagement Performance

▫ Monitoring

▫ Documentation



• The Malaysian Institute of Accountants has also been active in improving audit quality in Malaysia through:▫ Increased education activities on audit

quality and ethics

▫ Adopting international auditing standards

▫ Financial Reporting Standards Implementation Committee

▫ Establishment of Ethics Standards Board and Audit and Assurance Standards Board


Reform in the regulatory landscape


Reform in the regulatory landscape• The regulatory landscape has

changed and will continue to change such as:

▫ Incorporation of whistle blowing provisions in the securities law and company law

▫ Independent audit oversight such as the PCAOB, the Malaysian Audit Oversight Board will be established soon

▫ Making auditing standards law e.g. Australia


Would reporting failure occur again?• Unfortunately, the answer is

YES

• While the structure and form of governance, standards and regulation are there, it is the PEOPLE that would eventually determine whether future shocks could be avoided

• If the root cause is greed, how do we overcome this?


Would reporting failure occur again?• Is there another way of guiding

people to perform?

• MIA published a monograph on human governance which focuses on the inside-out approach instead of parameter-driven rule-based governance

• Spiritual aspect is recognised


Moving Forward Thoughts• Audit quality is the responsibility

of every player in the financial reporting supply chain

• If a component fails, the stress would be transferred to the next component until the chain breaks

• While regulatory reform and response from the accountancy profession has improved audit practices, the threat of future failures remain real


Moving Forward Thoughts