I SWEAR…

Lectures That to the best of my

knowledge (which is
13-14 pretty poor and maybe
revised in the future), my
Corporate Social company's accounts are
Responsibility and (more or less) accurate.
I have checked this with
Auditing
my auditors who (I pay
to) agree with me…

Dr Simona Scarparo 1
Lecture Summary
 The need for corporate governance (CG)
 Nature of CG and causes for current discussions
 CG in different countries
 CG structures
 CG codes
 Evaluate the role of the auditor in corporate
governance
 The role and function of audits
 Audit theories, concepts and market trends

Dr Simona Scarparo 2
“Since the collapse of Enron at the end of last year, it
has been almost impossible to open the business
pages of a newspaper without finding reference to
corporate governance.”
An extract from the ICAEW’s president, Peter Wyman Speech on Corporate
Governance at the ICAI/ICAEW Joint Conference - September 2002.

Dr Simona Scarparo 3
 Asian
finan
cial c
BCCI risis

BA N K
IN G S
BAR Fraud

Enron
Creative accounting

dCo m
Wo rl Earnings management
The need for CG

Ownership &
Management

Ownership Management
(Principals) (Agents)
The need for CG

 Arises when shares are widely held, and

the management of the company is
delegated to directors who are not
major shareholders of the company.
 With the separation of ownership from

management, minimising agency

problems.
 The nature of CG
 Is concerned with holding the balance between economic
and social goals and between individual and communal
goals. The corporate governance framework is there to
encourage the efficient use of resources [by directors]
and equally to require accountability for the stewardship
of those resources. The aim is to align as nearly as
possible the interests of individuals, corporations and
society" (Sir Adrian Cadbury in ‘Global Corporate
Governance Forum’, World Bank, 2000)
 The system by which businesses are run. This includes
the director's duty to ensure that the business is
properly and honestly managed (NAO, 2002)
 The branch of management, which deals with the
relationships among a company’s top management,
board of directors and shareholders. (Google).
Causes of current discussions on CG

Enron, Barings, BCCI,

Maxwell, Worldcom,
Bankruptcies, fraud Comroad

& mismanagement.
Increasing influence Royal shell: sink an
outdated oil platform at
of public, customers sea or dismantle it?
and media
Globalisation of
capital markets IFRS by 2005 in
Europe

Developments in IT Disclosure: New XBRL

for business reporting
CG structures
Corporate behaviour is influenced by cultures (masculine and feminine cultures
- Hofstede)

Market oriented Network oriented

(Anglo-Saxon) (Continental)
 Confrontation  Consensus
 Shareholders:  Shareholders
◦ Great spread ◦ Less spread
 Shareholder  Stakeholder approach
relations  Two-tier boards
 One-tier boards
 CG in different countries
 The development of CG is correlated to:
1. The ratio of the value of listed companies to
the country’s GDP
Value of listed companies to the country's GDPs

1993 1996
France 38% 38 %
Germany 25 % 28 %
Italy 15 % 21 %
Norway 28 % 36 %
Spain 26 % 33 %
UK 132 % 142 %
The development of CG is correlated to..

2. How widely the shares of listed

companied are held
3. The level of gearing (shareholders
vs financial institutions)
4. Cultural considerations (e.g.
former colonies)
5. The different levels of
management in the organisation
structures of companies
 CG guidelines in different countries

Aus. Can. H.K. India Mal. OECD Sing. UK USA

Discl of complia. Yes Yes Yes Yes Yes Yes Yes Yes N/c

Board resp. to… SH SH N/c N/c SH N/C SH SH SH

Separation of Yes Yes N/c N/c Yes Encgd. N/c Yes N.F.R
chairman&CEO
Non-exec Maj Maj N/c Maj Min 1/3 Maj N/c Yes Maj
directors
Audit committee Y all Y all Y maj Y all Y maj Y maj Y maj Y maj Y onl
NED NED NED NED NED NED NED NED NED
Gov. committee N/c Yes N/c N/c N/c N/c Yes N/c Yes
Recommendations or requirements
 The previous table highlights
recommendations (biased?)
 Currently the London Stock Exchange’s
Combined Code includes the following
requirements:
◦ The chairman of the board should be a different
person to the Chief Executive.
◦ At least one third of the directors on the company
board should be independent non-executive
directors.
Recommendations or requirements
◦ Cadbury chose to make the non-executive
directors control three important committees, the
remuneration to the directors, the appointment
of directors and most important, the audit
committee.
◦ Service contracts should be no longer than a year
in length.
◦ The board should produce a clear policy on
executive pay.
◦ Disclosure of directors remuneration (Gent and
Vodafone 2000)
 The role of the audit committee
The UK Code of Corporate Governance sets out the role of the audit
committee as:

To monitor the integrity of the

financial statements.

To review the company’s internal controls.

To make recommendations concerning the appointment and

removal of the external auditor.

To review the independence, objectivity and

effectiveness of the external auditor.

To establish policies concerning the supply of non-audit

services by the external auditor.
 Audit committee
When reviewing the financial statements the following should be
considered:

Accounting policies adopted

Change to accounting policies

Estimates and judgements made in key areas

Any unusual items

Any unusual trends

Why do we need the Audit function?

 Certain identifiable activities in human

behaviour trigger doubts and uncertainties
in the minds of individuals affected by
them e.g.:
 medical 2nd opinions are always sough
 a manuscript review is provided for publishers
looking for an expert basis to either reject or
accept a publication.
 Property surveys..
 Reduce or remove doubts held by
interested parties, especially shareholders.
Audit Theories
1. Concepts and Postulates Approach (Mautz and Sharaf,
Flint, Lee). The postulates and concepts are ideas to
guide the performance of the audit function rather than a
theory for its existence (JUSTIFYING, BEHAVIOURAL,
FUNCTIONAL)
2. ‘Market-based’ Approaches: Information economics and
cost-benefit analysis From the principal point of view:
monitoring in a cost effective way, insurance. Also agents
(as distinct from principals) can drive the demand for
audits.
3. ‘Alternative’ Perspectives: Moving audit research out of
the laboratory. Exploring rather than presuming auditor
expertise
What does audit verify?
There are different types of audit: based
on audit objectives
1. There is a subject matter (e.g. financial
representation of a business) whose
condition is in doubt, relating to:
1. Contents of financial statement
2. The various accounting processes by which (1) was
produced/reflected
2. Auditing has to do with enhancing the
quality of information as a basis for
control decisions; elements for a
control system include:
 Objective
 Model of Organisational (Operating) system
 Monitoring mechanism
 Intervening mechanism
 Defining the control system
Interest
Groups/
Participants

Entity
Environment
Control system and accountability
 The choice of boundaries:
◦ defines the control system the audit is
contributing to; i.e. who the audit is for.
◦ helps determine the scope and objectives of
audit;
Entity alone: Internal Audit
Entity + suppliers of capital: Financial Audit
Entity + several interest groups: Operational & Social
Audit
 Accountability:“Auditors act in the
interest of shareholders, whilst having
regards to the wider public interest”.
 Involves: responsibility and explanation
 Arises: Action is "on behalf of" – agency
 Requires: information to be relevant & credible
 Internal audit

Usually involves a review of:

Internal control systems to see whether they safeguard

the company’s assets and help prevent errors and fraud.

Accounting systems to see whether they provide reliable

information.

Internal operations and processes to see whether they are

efficient and provide value for money.
What is an Audit?
 An audit is the work performed by auditors so they
can provide an informed professional independent
opinion on whether financial statements portray a
true and fair view, and that is all.
 This opinion is based on accounting practices,

principles and norms. These are captured in

accounting standards.
 Financial statements that comply with accounting

standards give a true and fair view.

 Deviations from accounting standards result in

financial statements that do not provide a true and

fair view.

Dr Simona Scarparo 23
 Formal Auditing Definitions
Defining Financial Statements Audit

“the independent examination of, and expression

of opinion on, the financial statements of an
enterprise by an appointed auditor in pursuance
of that appointment and in compliance with any
statutory obligation” (ICAEW)

“an examination of the quality of a company’s

accounts to reassure shareholders that the
information in them is useful and free from bias
for the purposes of deciding whether their
resources are being used efficiently and to
confirm, as far as is reasonable, their freedom
from fraud and error” (Sherer and Kent).
Audit and the role of auditors
 Annual audit required for all limited
companies except small companies
 Auditors are not part of the company but are

responsible to shareholders with the main

duty of reporting whether the financial
statements show a true and fair view and
comply with statutory, regulatory and
accounting standard requirements.
 Audit is big business!
Non-audit fees
Audit fees
Company paid to auditors Auditor
£million
£million
BP plc 20.0 36.4 Ernst & Young
Vodafone Group plc 1.0 16.0 Deloitte & Touche
HSBC Holdings plc 18.4 10.7 KPMG
Astra Zeneca plc 2.3 9.9 KPMG
Royal Bank of Scotland plc 4.9 8.3 PricewaterhouseCoopers
Lloyds TSB plc 4.0 32.0 PricewaterhouseCoopers
Barclays Bank plc 4.6 27.0 PricewaterhouseCoopers
British Telecom. plc 2.7 19.1 PricewaterhouseCoopers
Diageo plc 2.5 7.0 KPMG
Cable & Wireless plc 2.5 14.5 KPMG
Total £62.9 £180.9

Audit fees and non-audit fees paid to the auditors of 10 of the largest
companies listed on the London Stock Exchange in 2000 (Porter et al., 2003)

26
 Ratio of non-audit fees : audit fees
FTSE 100
4.00
3.50
3.00
2.50
Ratio

2.00
1.50
1.00
0.50
0.00
(Source: Accountancy Magazine, Sept/Oct issues, 1992-2004)

Year 27
R Khalifa: IB1090 WBS
Important auditing concepts
 Materiality: “The magnitude of an omission or
misstatement that, in the light of surrounding
circumstances, makes it probable that the
judgment of a reasonable person relying on the
information would have been changed or
influenced by the omission or misstatement.”
(FASB)
 The expectations gap: Auditors are performing at
variance with the beliefs/desires of those for
whom the audit is being undertaken (objectives
and accountability rights).
 Independence: "The overriding requirement (is)
that…. a member must at all times perform his
work objectively and impartially and be free from
influence from any consideration..."(ICAEW)
The Expectation Gap
 The expectations gap is the gap between the
auditors’ role and opinion and the public’s
perception of the auditors’ role.
 Many members of the public believe that auditors
are looking for fraud when they undertake an audit,
that auditors say the financial statements are
accurate, that the auditors are responsible for the
financial statements and that auditors should give
warnings about the future of the entity when they
suspect it is going to fail.

Dr Simona Scarparo 29
The Expectation Gap (cont)
 The audit report does not say the financial
statements are correct.
 Auditors only check a sample of transactions
not every transaction, therefore, they cannot
guarantee that fraud will be detected.
 An audit does not guarantee that a company
will succeed in the future.
 Management are responsible for the financial
statements that they prepare, or that are
prepared on their behalf.
 Management are also fully responsible for the
running of the company.

Dr Simona Scarparo 30
Conclusions
 CG proposals are a step in the right direction
 There are now more than 60 governance
codes in 30 countries, as well as numerous
international codes
 On directors’ remuneration, CG in the UK does
not seem to be working (their remuneration is
increasing faster than employees wages).
 Auditing is inherently connected with
processes of accountability and control
 Accountability offers a criterion for
establishing the control system that auditing
and CG is contributing to
Suggested readings
 Chapter 6 “Auditing, Corporate Governance
and Ethics”(pp. 82-96), in Introduction to
Financial Accounting, by Andrew Thomas and
Anne Marie Ward, McGraw Hill, 2010, 6th
Edition.
 Chapter 11 “Governing a company” (pp.390-

439), in Financial Accounting for Decision-

Makers, by Peter Atrill and Eddie McLaney, FT
Prentice Hall, 2011, 6th Edition (5th edition has
a similar chapter).

Dr Simona Scarparo 32