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

2005 Peter Walton and Walter Aerts

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


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
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
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 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)
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 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)