chapter 16 auditing and corporate governance. contents corporate governance independent directors ...
TRANSCRIPT
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
CHAPTER 16Auditing and corporate
governance
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Contents Corporate governance Independent directors Chairman of the board and chief executive
officer Institutional shareholders Statutory audit Issues in international audit Audit independence Internal control and risk management Audit committee
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Corporate governance
Agency problem: the owners of a business (principals) need means to ensure that those whom they appointed to run the business (agents) do so in a way that matches with shareholders’ needs
Agency problem has been broadened out into the concept of corporate governance
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Corporate governance (cont.)
Increased emphasis on the effectiveness and accountability of corporate boards of directors
Extending the shareholder perspective to wider stakeholder concerns
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Corporate governance regimes
Governance regimes are heavily influenced by the institutional environment
Stakeholder model (Continental Europe) versus shareholder model (Anglo-Saxon environment) of corporate governance
Tendency towards convergence on the issue of effectiveness and accountability of corporate boards
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Reporting on internal control
An effective system of internal control is seen as crucial for good goverance
Reporting on the effectiveness of internal control as a governance requirement
COSO Framework is considered to offer an established set of control criteria to assess the effectiveness of internal control
US Sarbanes-Oxley Act of 2002
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
US Sarbanes-Oxley Act
Each annual report filed with the SEC has to include an internal control report Management’s responsibility for establishing
adequate internal control over financial reporting
Management’s assessment of its effectiveness The independent auditors must attest to
and report on the assessments made by company management
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Independent directors Independent directors are non-
executive directors who attend board meetings on a regular basis and monitor corporate behaviour
A (unitary) board should include a significant portion of independent directors
In a dual-board system, the supervisory board exercises oversight over what executive directors in the management board are doing
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Independent directors (cont.)
Independent directors should be free of personal or business ties with the company
They are increasingly asked to participate in subcommittees to deal with particular tasks Remunertaion committee Audit committee
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Chairman of the board
Most corporate governance codes recommend a clear division of responsibilities at the top between the chairman of the board and the CEO Ensures a balance of power and
authority Less acute in a dual-board system
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Institutional shareholders
Financial institutions (banks, insurance companies, fund managers, pension funds, etc.) with large shareholdings
Institutional shareholders increasingly pressure companies to sign up to codes of conduct
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Statutory audit The independent auditor’s assurance plays a
central role in corporate governance Auditing (multinational) group accounts is
more complicated than individual accounts, as subsidiaries are working in different legal environments and involves intra-group reconciliations. Moreover, it adds time pressure
The auditor of group accounts is responsible for any error in the group audit, even if such an error has arisen because of a mistake by the auditor of a subsidiary
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
International audit Multinationals tend to have an exclusive
auditor (large audit firm) for all their subsidiaries
The conduct of an international audit is usually guided by the set of international auditing rules put out by the International Federation of Accountants (IFAC)
The audit report should specify what auditing rules have been followed by the auditor
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Audit independence The value of an audit depends partly upon
the technical skills of the auditor and partly upon his independence and ethical qualities
Independence issues: Restrictions on the type of non-audit services
that an auditor is allowed to provide to audit clients
Employment of former audit firm employees by the audit client
Periodic audit partner rotation Limits to the audit appointment
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Internal control and risk management
Effective risk management should enable companies to take risks with more confidence and in a rational and informed manner
Those charged with corporate governance are expected to systematically identify, evaluate and respond to company risks
COSO’s Enterprise Risk Management – Integrated Framework (2004)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Enterprise risk management -Definition
“Enterprise risk management is a process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.”
Source: COSO, Enterprise Risk Management – Integrated Framework, 2004
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Enterprise risk management COSO sees internal control as a subset of
risk management Other risk management devices include
transferring risk to third parties, risk-sharing, contingency planning and consciously excluding activities deemed too risky
Risk disclosure requirements may empower shareholders to use disclosures to bring companies to adopt more elaborate risk management standards
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Audit committee Independence is an essential quality for
audit committee members The audit committee should provide a
quasi-independent forum where those concerned with checking the effectiveness and quality of the company’s accounting and control should be able to meet and discuss with shareholder representatives (independent directors) and raise issues of concern
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Audit committee roles
Oversee of the financial reporting process
Monitor the effectiveness of the system of internal control (and possibly of the enterprise risk management system)
Act as an intermediary between the board of directors and the external auditors (and possibly internal auditors as well)