PQ corporate governance

Making companies work

Ryan Hill examines some of the issues that can hamper good corporate governance. Do you recognise them?
orporate governance was first defined as a system by which companies are directed and controlled. But what does this mean? Corporate governance stems from the agency problem. This means that the shareholders (the principle) appoint the directors (the agents) to run their company on their behalf. The problem is that the retrospective self-interests of the shareholders and the directors may conflict. For example, shareholders may want consistent returns at a predictable level of risk, whereas the directors selfinterest may revolve around: Taking excess risk to achieve their bonus. Intentional acts of fraud to gain wealth from the company. Omissions or window dressing the financial statements to protect their position. Neglecting the company or making incompetent decisions. Paying themselves excessive salaries. So the directors find themselves in a position of trust to run the company in the self-interest of the shareholders. Implementing corporate governance is to put internal controls in place that prevent the directors abusing their position of trust, instead aligning their interests with those of the shareholders. Therefore, corporate governance is one big internal control! Controls are put in place to monitor what the directors are doing and to control the directors behaviour; this ensures the company is run in the selfinterest of the shareholders. Directors are monitored by: The appointment of non-executive directors (NEDs) to make up half the board. They act as the conscience of the

Relevant to Business and Finance, Assurance, Audit and Assurance, Financial Reporting and Advanced stage

Self interest Shareholders Conflict

Corporate governance encourages transparency by implementing systems to monitor and control the directors reducing the conflict in self interest

The separation of CEO and Chairman ensures no one person has unfettered power over the company Directors are controlled by: The make-up of their remuneration the remuneration committee will ensure directors remuneration is linked to longterm business success. Regular appraisals of the board ensure the board is effective in carrying out its duties, and keeps them on their toes! The above are just a few examples of what goes into a corporate governance code, such as the UK Corporate Governance Code. Impact of corporate governance on the audit of financial statements The auditor will assess the companies commitments to good corporate governance as part of Understanding the Entity and its Environment (ISA315). Full compliance with the principles of corporate governance will reduce the risk of the directors acting in their own self-interest. As corporate governance is an internal control it lowers control risk, preventing omissions, window dressing and fraudulent reporting in the financial statements, and therefore reducing the overall audit risk. Good corporate governance also requires the audit committee to scrutinise the independence of the auditor by monitoring their length of service and the other services they provide. This prevents any familiarity, selfinterest or self-review threats that impair the judgements of the auditor; therefore their opinion on the financial statements carries greater weight. PQ Ryan Hill is a Partner at First Intuition, Reading

Self interest

Directors (Agent)

Company board, scrutinising the directors actions. The creation of board sub-committees made up of NEDs: Audit Committee: monitors the risks taken by the directors. Remuneration Committee: ensuring fair remuneration of directors.

PQ global inspiration awards

Trainees awarded for their courage and dedication

ive young trainee accountants who have had to overcome dramatic hardships and obstacles to join the profession have been jointly recognised in the 2011 Global Inspiration Awards. The accolade judged by the Chartered Accountants Benevolent Association and ICAEW Foundation aims to identify ACA PQs who have faced problems such as serious illness, injury, disability, bereavement, learning difficulties,
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The prize guys: award winners Brendan McGing and Peter Franklin with Kath Haines of CABA

language barriers, financial hardship and caring for a partner or relative while training. The 2011 winners are Peter Franklin, from a small practice in Plymouth, who was diagnosed with a rare form of bone cancer and overcame life-threatening setbacks; Brendan McGing, from KPMG Manchester, who has a degenerative visual condition called Lebers Optic Atrophy; Laura Nyogeri, from PwC Bristol, who is making a success of her career in the profession despite a history of illness; Rachael Wraith, who overcame personal adversity battling with Crohns disease; and Ai Kim Wong, from Malaysia, who fought chronic joint pain and is now making a full recovery after an operation to remove a tumour in the pituitary gland. PQ
PQ Magazine August 2011

ACCA examiners conference PQ

he pass rates for the past four sittings of F8 have been 34%, 40%, 36% and 38%, and thats nothing short of disappointing, according to the F8 Audit & Assurance examiner Pami Bahl. She admits she is not sure why sitters do better in December: Maybe there are more retakes, she wondered.

Theres no Plan B
There are things that students do well despite the low pass rates, and she came out with a list: 1 Ethics students like these. 2 Report to management deficiencies/ implications. Recently, students were asked to write a covering letter. Just writing the letter was worth two presentation marks, and some students still couldnt manage this. It is astonishing that they dont know how to do it, said Bahl. 3 Going concern indictors but they cant explain what they are! 4 Internal audit/external audit relationship candidates do well with factual questions. 5 Audit committees students come up with some good points. 6 Evidence again, PQs are good at the theory, but they struggle with critical evaluation. 7 Tackling all five questions with the exception of December 2010. There were more scripts in the last sitting where students left big parts out. But Bahl believes this isnt about time pressure. 8 Ratios those who brought a calculator to the exam hall did well. There were five marks available for 10 rates.

WHAT IS DONE WELL..

PQs Graham Hambly spent two days locked up with ACCA examiners in Nottingham. Heres what the F8 examiner had to say
receives no marks. I want audit risks not business risks, she stressed. 3 Substantive versus test of controls another important area. Students should have ways to come up with examples. 4 Substantive procedures a core part of the syllabus. 5 Assertions candidates know the list of assertions, but dont understand them or what they relate to. 6 Audit reports Bahl has sympathy here for students who dont see audit reports. 7 F3 knowledge its not F7 you need its F3. 8 Definitions why, she asked, do students give them when they are not required? 9 Final review a Q5 topic with audit reports, which Bahl believes students should spend more time on.

2 Not reading the question requirement carefully even if you spend just 30 seconds thinking it would be better, pleaded Bahl. 3 Providing too many points even when a specific number is requested. After some discussion it was felt that if six were asked for then it would be natural to give seven, but the best suggestions should be the earlier ones. 4 Q1 left until last this is for 30 marks, and those who leave it to the end often dont give themselves enough time to do themselves justice. I would prefer that they do it earlier, she said. 5 Too much detail given for 10 marks it should be a two or three page answer! 6 Requirement verbs not understood if you see the words state, list or identify then she is not asking for a lot of writing. From a student perspective, Bahl stressed that F8 wasnt one of the papers with a big syllabus. Students have to understand that she likes to test their application skills. All exam sitters must take time to read the requirements carefully and question practice. Bahl explained that looking at the question and looking at the solution is not question practice. PQs also need to work harder on those presentation skills. Students also need to learn from other peoples mistakes. She puts a lot of effort into her exam reports, so please read them! There are some minor tweaks to the syllabus, but the big news is that UK stream sitters now need IFRS knowledge. The Clarified International Standards Auditing (ISA) have also been in the syllabus since 2010 and we are testing the new ones. Watch out for more feedback in next months issue. PQ Pami Bahl became the Audit and Assurance examiner from June 2010. An accounting & finance graduate, she worked for PwC as an auditor, leaving to join BPP as an accountancy and audit tutor. Now a freelance lecturer, she specialises in financial reporting

WHAT LESSONS LEARNED .

The list for what students dont do well is longer! She started with the problem topic areas: 1 Assurance. 2 Audit risk Bahl has tested this twice and both times the resulting answers have been poor. She stressed that business risk is off-syllabus and hence

WHAT IS NOT DONE WELL (TOPICS).

1 Layout of answers columns/ headings/paragraphs. Anything you can do to improve the layout is a plus. Think about the markers who open a page filled top to bottom with no breaks or paragraphs.

WHAT IS NOT DONE WELL . (TECHNICAL).

PQ Magazine April 2011

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PQ ICAEW focus

Ryan Hill explains the importance of the engagement letter and explains what they should include

Rules of engagement
WRITTEN REPRESENTATION LETTER ISA 580 Written Representations, requires the auditor to obtain written representations from management. These representations should support other evidence obtained and are not evidence in their own right. They are written by the auditor, printed on client headed paper, signed by management and dated prior to the audit report being dated. They confirm: Information that is confined to management, such as the existence of subsequent events, provisions, related party transactions. Matters of management judgement or opinion, such as their depreciation policies, NRV of inventory, going concern of the company. Other matters the directors confirm: Their responsibility to prepare the financial statements. They have provided all relevant information to the auditor. That all transactions are recorded in the financial statements. MANAGEMENT LETTER ISA 260 Communication to those Charged with Governance, often referred to as a management letter, requires a letter to be set to those charged with governance exploring matters that came to the auditors attention during the audit. Such matters would include: Significant findings from the audit. Written representations the auditor is requesting. The auditors views about the entitys accounting practices, including accounting policies, accounting estimates and disclosure notes. Significant difficulties encountered during the audit. Explanations surrounding any audit report modifications. ISA 265 Communicating Deficiencies in Internal Controls to those charged with governance, requires the auditor to report on deficiencies in the internal controls encountered. The management letter includes a description of the deficiencies and the potential effects of each deficiency. The standard gives examples of matters that the auditor may consider in determining whether deficiencies are significant. These examples include: The likelihood of the deficiencies leading to material misstatements or fraud. The volume of activity exposed to the deficiency. The frequency of the deficiency. By highlighting these issues future audits should be more efficient and effective. PQ Ryan Hill, First Intuition Reading

SA 210 Agreeing the Terms of Audit Engagements highlights the use and content of the engagement letter. The letter creates a contract between the auditor and the client and should be sent to the client before audit work begins. The letter should cover the following matters:

The objective and scope of the audit The objective will confirm that the auditor is conducting a reasonable assurance engagement and providing a positive opinion on the financial statements. The scope will make reference to the criteria the auditor will be using to evaluate the financial statements, ie IFRS. Managements responsibilities Confirms their responsibility to: Produce the financial statements following appropriate standards (IFRS). Implement internal controls. Make available all books and records to the auditor. Provide written representations. Auditors responsibilities Confirms their responsibility to: Produce an audit report expressing their opinion on the financial statements. Produce a management letter to those charged with governance. Conduct the engagement following ISAs and the limitations of the audit. Other matters The report may also include arrangements relating to planning, liaising with internal audit and the basis of the fee.

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PQ Magazine July 2012