CHAPTER 16

Auditing 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

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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
Managements responsibility for establishing
adequate internal control over financial
reporting
Managements 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

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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 auditors 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
COSOs Enterprise Risk Management
Integrated Framework (2004)

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2005 Peter Walton and Walter Aerts
 Enterprise risk management
-Definition
Enterprise risk management is a
process, effected by an entitys 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 companys 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)

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts