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CHAPTER 1 | Regulation in a Global

Economy

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Table of content

1.The Need for Regulation ...................................................................................................................... 9

2.Assurance Engagements ...................................................................................................................... 9

2.1. What is an Assurance Engagement? .............................................................................................. 9

2.2.The Three party Relationship ....................................................................................................... 10

2.3.What is an External Audit? .............................................................................................................. 10

3.Regulatory Framework ...................................................................................................................... 11

3.1 What is the International Federation of Accountants (IFAC)? ....................................................... 12

a. OECD Principles of Corporate Governance ....................................................................................... 14

b.Responsibilities of the Board ............................................................................................................. 15

a.Good Corporate Governance ............................................................................................................. 15

b.Requirements.16

4.Audit Committees17

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1. The Need for Regulation

Corporate failures - Failures of businesses over the years have increased the need for regulation in order to ensure consistent and high quality audits. Well known failures include Enron, Parmalat and Lehman Brothers.

Public confidence - Independent audit and assurance has a key role to play in providing confidence in financial information issued by companies and hence facilitate the decision making of investors and the smooth functioning of the markets.

Risk management - Regulation enables the users of financial statements to make better decisions based on the risks.

Globalisation / Harmonisation - Increasingly businesses operate across borders and are thus exposed to more complex legal, tax and accounting issues. Regulation is necessary to deal with this complexity, and harmonizing regulations across the world would go a long way to simplifying matters.

Shareholder Management relationship - In larger organizations the owners and the managers are different persons giving rise to agency costs. They therefore need assurance that the organization is being run in their best interests.

Stability in world economy - Governments want to smooth out the fluctuations in the economy and hence eliminate events triggered from corporate failures.

2. Assurance Engagements

2.1. What is an Assurance Engagement?

DEFINITION

An engagement in which a practitioner expresses a conclusion designed to

enhance the degree of confidence of the intended users other than the

responsible party about the outcome of the evaluation or measurement of a

subject matter against criteria.

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The objective of an AE is for a professional accountant to evaluate a subject matter which

is the responsibility of another party against identified suitable criteria and to express a

conclusion that provides the intended user with assurance about that subject matter.

2.2. The Three party Relationship

2.3. What is an External Audit?

DEFINITION

An External Audit is an Assurance Engagement ISA200 states that the

objective of an audit of FS is to enable the auditor to express an opinion on

whether the FS are prepared, in all material aspects, in accordance with the

financial reporting framework

RESPONSIBLE

PARTY

(management)

INTENDED

USER

(shareholders)

Practitioner

(auditor)

SUBJECT MATTER

(financial statements)

Assures

Evaluates

Prepares

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An external audit (or statutory audit) is defined as a reasonable assurance

engagement

Other assurance engagements may give a lower level of assurance , called limited

assurance

Responsible party Company Directors

Intended users Shareholders (as a body)

Practitioner Independent auditor

Subject matter Financial Statements

Criteria Accounting Standards, legal requirements

3. Regulatory Framework

The conduct of audits is governed by three sets of rules:

Auditing Standards (ISAs)

Rules of Professional Conduct

Codes of Ethics

Issued by the IFAC Issued by the ACCA Issued by the IFAC

The Regulatory

Framework of Auditing

International

Standards on Auditing

(ISAs)

Rules of Professional

Conduct

Code of Ethics for

professional

accountants

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3.1 What is the International Federation of Accountants (IFAC)?

The global organization for the accountancy profession Formed in 1977, based in NY

160 member bodies (including ACCA), 120 countries, 2.5 million accountants Its mission:

to serve the public interest strengthen the accounting profession contribute to the development of strong economies via establishing

high quality standards

DEFINITIONS

Professional Accountant - is a member of the IFAC member Body (Auditor or Practitioner Accountant in public practice) who has to observe the Fundamental Principles of the IFAC code of Ethics

Professional Accountant in Public Practice Accountants offering professional services (e.g. audit firms)

Employed Professional Accountant Accountants working in the industry, commerce, government or education sectors

The IFAC consists of several sub-committees including:

International Auditing and Assurance Standards Board (IAASB) The IAASB works to improve the uniformity of auditing practices and related services throughout the world. This is done by issuing pronouncements on a variety of audit and assurance functions and by promoting their acceptance worldwide.

It is the body responsible for promoting ISAs and other assurance standards.

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International Ethics Standards Board for Accountants (IESBA)

Develops guidance on professional ethics and promotes its understanding and acceptance by member bodies. The committee continually monitors and stimulates debate on a wide range of ethical issues to ensure that its guidance is responsive to the expectations and challenges of individuals, businesses, financial institutions and others relying on accountant's work.

It is the body responsible for promoting the IFAC Code of Ethics.

Transnational Auditors Committee (TAC)

It is the executive committee of the Forum of Firms (FoF) and a committee of IFAC. Membership to FoF is open to all firms performing or wishing to perform transnational audits. Member firms will be expected, among other things, to conform to the FoF Quality standards. This is more fully explained in Chapter 10 Group Audits.

Is the IFAC independent?

Matters to consider:

IFAC is financed by the accountancy body Different arguments (approaches) from different countries on the implementation of

international standards

Large professional firms dominate the authority/power of the body

4. Corporate Governance

Incorporated businesses are usually owned by one group of people (the owners or

shareholders) whilst being run by another group of people (the management or the

directors). This separation of ownership from management creates an issue of trust (also

called Agency Cost).

The management have to be trusted to run the company in the interest of the shareholders

and other stakeholders.

Good corporate governance means governing the corporation in such a way that the

interests of the shareholders are protected whilst ensuring that the other stakeholders

requirements are fulfilled as far as possible.

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a. OECD Principles of Corporate Governance

OECD Organisation for Economic Co-operation and Development

Principles issued in order to:

Assist governments in their efforts to evaluate legal, institutional and regulatory framework for corporate governance in their countries

Provide guidance and suggestions to stock exchanges, investors and other parties that have role in developing good corporate governance

Principles:

1. Ensuring the basis for an effective CG framework The CG framework should promote transparent & efficient markets, be consistent with

the rule of law and articulate the division of responsibilities among different supervisory,

regulatory and enforcement authorities.

2. The rights of shareholders and key ownership functions The framework should protect and facilitate the exercise of shareholder rights (from

directors not acting for the shareholders best interests).

3. The equitable treatment of shareholders The framework should ensure equitable treatment of ALL s/h including minority interest

and foreign s/h. All s/h should have the opportunity to obtain effective redress for

violation of their rights.

4. The role of stakeholders in CG The framework should recognise the rights of stakeholders established by law or through

mutual agreements & encourage active cooperation between corporations &

stakeholders in creating wealth, jobs, and the sustainability of financially sound

enterprise.

5. Disclosure and transparency The framework should ensure that timely and accurate disclosure is made in all material

matters regarding the corporation (including financial situation, performance, ownership

and governance of the company).

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6. The Responsibilities of the BoD Ensure the strategic guidance of the company, the effective monitoring of management

by the board, and the boards accountability to the company and the shareholders

(introduction of audit committee and NED).

b. Responsibilities of the Board

Monitor the effectiveness of corporate governance practices and make changes as

needed

Review corporate strategy, planning, budgeting, implementation (risk policy, budgets)

Select executives and monitor their performance and remuneration Monitor conflicts of interest of management (agency theory, including misuse of

assets, abuse in related party transactions)

Ensure integrity of accounting & financial reporting systems (including independent internal audit, risk management systems)

Oversee process of disclosure and communications

a. Good Corporate Governance

Follow the corporate governance framework guidelines

Establish Audit, Remuneration and Nomination committees

Risk management

Internal audit review the need for one on an annual basis

Segregation of duties - best practice suggests that the role of Chairman (NE) and that of Chief Executive Officer should be held by different individuals (to avoid unrestricted power by one person for decision making & conflict of interest)

Annual review of the internal control system by directors and reporting to members

Directors/auditors should state their respective responsibility for preparing /auditing FS

Directors should be subject to re-election on an annual basis

Directors can obtain independent professional advice to better perform their duties at the company's expense

The board should have a formal agenda for decisions

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b. Requirements

Corporate Governance is not a legal requirement there are no legal consequences if

the guidance is not followed.

It is a requirement for listed companies in many countries to follow Corporate Governance

guidance and to report on an exception basis should any of the provisions not be met.

Management responsibility

Auditor responsibility

The directors have to disclose, in a narrative

statement in the annual report, how they have

applied the Code principles.

The statement should mention whether they

have complied throughout the year with the

Code Provisions, and if they have not, they

should describe and explain why not.

Read the statement (not an audit)

If it is misstated then ask directors to

amend. Otherwise seek legal advice

(depending on country of operations).

Audit procedures to review the statement

Review board minutes Review supporting documents prepared by the board of directors Make enquiries of the directors and the company secretary

Attend meetings of the audit committee (or other committees) Obtain Management Representation letter

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4. Audit Committees

The Audit Committee should consist of at least 3 non-executive directors with pre-defined

duties and responsibilities (terms of reference).

Objectives

Increasing public confidence in published FS Assisting executive directors in their duties (esp. financial reporting) Strengthening the position of the external auditor (and internal auditors)

Functions

Monitor the integrity of the FS Review internal control procedures Review internal audit function Review of companys accounting policies Review of regular management information Review of annual FS presented to S/H

Review external auditors findings Recommend nomination and remuneration of external auditors

Advantages:

improve quality of management accounting better communication between auditors/directors helps to avoid conflicts between management/auditors

enhances independence of internal/external auditors

Disadvantages

fear that their purpose is to catch management out non-executive directors dealing with details (may not have in-depth knowledge of the

business)

expensive to maintain may not be given adequate power/responsibilities

Relationship with Internal Audit

The audit committee acts as the intermediary between the BoD and the Internal Audit

department. Internal audit reports to the Audit Committee which then reports to the BoD.

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Ensures that the internal audit department has direct access to board chairman and the BoD

Reviews and assesses the annual internal audit work plan Receives periodic reports on the results of internal audit work Reviews managements responsiveness to the internal auditors findings and

recommendations

Meets the external auditor at least once a year without the presence of management

Monitors and assesses the effectiveness of internal audit in the overall context of the companys risk management system

EXAM TIP

A Common mistake made by students concerns

questions in the exam asking for the role/functions of

the Audit Committee, but the answer given consists of

advantages and disadvantages.