Corporate Governance Principles Of Auditing: An .

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Slide 14.1Corporate GovernancePrinciples of Auditing: An Introductionto International Standards on Auditing- Ch 14Rick Stephan Hayes,Roger Dassen, Arnold Schilder,Philip Wallage[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.2Corporate GovernanceDefined Corporate Governance is the process andstructure used to direct and manage the businessand affairs of the corporations with the objectiveof enhancing shareholder value, which includesensuring the financial viability of the business.– The process and structure define the division ofpower and establish mechanisms for achievingaccountability among shareholders, the board andmanagement. Cadbury Committee: Corporate governance isthe system by which companies are directed andcontrolled.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.3Stakeholders Corporate governance has theobjective of enhancingshareholder value. But it alsotake into account the impact ofdecisions on other stakeholders.– Stakeholders are the community,the general public, consumergroups, etc. The stakeholder relationshipsinclude a relationship betweenthe community and the firm,between governments and firms,and between community andgovernments.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.4Transparency Transparency forms the backbone of goodcorporate governance and requires asophisticated system of accounting. Such asystem should:– allow investors to assess the magnitude andtiming of future cash flows to be generatedby a business– encourage efficient operations andmaximization of results;– provide an early warning of problems inmeeting objectives of the firm;– lead to quick corrective action wheneverthings go bad.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.5Corporate Governance DiscussionFour causes of the current corporategovernance discussion:1) bankruptcies, fraud, and mismanagement2) the influence of public, customers andmedia,3) globalization of capital markets, and4) developments in information technology (IT).[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.6Corporate Governance StructuresTwo types:(1) Market corporate governance structure and(2) Network corporate governance structure– Market oriented countries are more aggressiveand confrontation seeking, while network culturesseek consensus instead of conflict.– In Market countries, shares are widely distributedamong individuals. In network countries, banks,insurance companies and other institutionsmainly hold shares. As a consequence, stockexchanges play a more important role in marketoriented countries.– Another major difference is the two-tierseparation between the board of managementand the supervisory board in the networkstructure vs. one board in the market system.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.7[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.8The Sarbanes Oxley Act consists of 11SectionsI – Public Company Accounting Oversight BoardII – Auditor independenceIII – Corporate ResponsibilityIV – Enhanced Financial DisclosuresV – Analyst Conflicts of InterestVI – Commission Resources and AuthorityVII – Studies and ReportsVIII – Corporate and Criminal Fraud Accountability Act of2002IX – White-Collar Crime Penalty EnhancementsX – Corporate Tax ReturnsXI – Corporate Fraud and Accountability[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.9EU LawsThe EU Action Plan for Company Law, paysattention to the need for regulator response atthe European level.A 2001 comparative study concluded that theEU should not devote time and effort for thedevelopment of a European corporategovernance code.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.10EU and CompanyManagementThe EU is strengthening management of companiesduring the period 2003 - 2009 along the followinglines:– Modernizing the board of directors– Board composition (independent non executives orsupervisory directors and creation of specificcommittees)– Director’s remuneration (both ex ante and ex post)– Directors’ responsibilities (special investigation right,wrongful trading rule, directors’ disqualification).[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.11Best Practice from a Global PerspectiveFour elements of governance:I. Managing including boardresponsibilityII. SupervisionIII. Internal controlIV. Transparency.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.12I. Managing Best PracticeAn important element of governance is“managing” which includes the concepts ofmission, strategy, objectives, andcompatibility with societal objectives.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.13Board ResponsibilityThe board defines the company’s strategy,appoints the corporate officers responsiblefor managing the company andimplementing this strategy, overseesmanagement and ensures the quality ofinformation provided to shareholders andto financial markets through the financialstatements.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.14Certification of SEC reports by executives Chief executive and financial officers of US listedcompanies have to certify annual and quarterly reportsfiled with the SEC. Certification means that these executives reviewed thereports and based on their knowledge there are no untruestatement or omission of material fact, and the statementsfairly present the Company’s financial condition. Signing officers also certify that they evaluated theeffectiveness of disclosure controls and procedures. By signing they also confirm that disclosures have beenmade to auditors and audit committee of all significantdeficiencies in internal control or any fraud that involvesemployees with significant role in internal control.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.15II. Supervising Best Practice Good corporate governance requires a system ofindependent supervision and active oversight ofmanagement. A reduction on management influence over boards isgenerally achieved by rules that ensure the independenceof non-executive members of the board or, in continentalEuropean countries, supervisory board members. According to Anglo-Saxon best practice, the boardrepresents the shareholders – not other constituencies,although some countries hold that the board represents allstakeholders Appraisal of individual directors is a key element ofcorporate governance including designing and approvingappropriate remuneration scheme.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.16 Since 1978, the major American stockexchanges have required listed firms tohave audit committees comprised ofindependent, outside, directors who ownrelatively little stock in a firm and who arenot members of management. They have responsibilities for monitoringmanagement, corporate reporting, andrelations with the independent auditor. They meet with the internal and externalauditors, reviewing financial statementsbefore they are issued to the public, and, incertain circumstances, taking action toAuditcontrol management.Committees Audit committee members should notreceive fees other than for board serviceand should not be an “affiliated person” ofthe company or any subsidiary.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.17Audit CommitteeIndependent DirectorsAudit committee members should not receive feesother than for board service and should not be an“affiliated person” of the company.Financial ExpertAt least one member of its audit committee mustbe a "financial expert" (expertise in US GAAP).Auditor OversightResponsible for oversight of external reporting,internal controls and auditing, and theappointment and compensation of the auditor.Whistle-Blower CommunicationsConfidential and anonymous submissions byemployees.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.18SOx: Auditor Reports to Audit CommitteeAll critical accounting policies andpractices in use by the publiclylisted companyGAAP alternatives discussed withmanagement and any alternativepreferred by the audit firm.Other material writtencommunications such asmanagement letters andunadjusted audit differences.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.19III. Internal Control Best PracticeThe US Treadway CommissionRecommended that internal controls could prevent anddetect fraud and that guidelines be developed by COSO.The Cadbury Committee in the UKCode of Best Practice deals with internal controls as definedby COSO.Section 404 (SOX 404)Requires the annual report of issuers to containmanagement reports which state management responsibilityfor internal control structure and procedures and give anassessment of effectiveness.Internal Audit DepartmentCOSO says internal control component “monitoring” includesthe contribution of an internal audit department[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.20SOx: Auditor Report on Management’s AssertionAbout Internal ControlsSOx 404 requires management reports on theeffectiveness of internal controls and the auditorsattest to management’s assertions.PCAOB Audit Standard #2: auditor should: Obtain understanding of internal control andmanagement’s evaluation Evaluate design effectiveness of controls Test and evaluate the operating effectiveness ofcontrols Form an opinion[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.21Best Practice: Transparency Elements of transparency include timelydisclosure of reliable, adequate and relevantinformation for decision making. Investors want clear, reliable andinternationally comparable information aboutenterprises.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.22EU Corporate GovernanceDisclosureThe EU annual corporate governance statementshould at least include the following items: The operation of the shareholder meeting and itskey powers and the description of shareholderrights and how they can be exercised. The composition and operation of the board and itscommittees; The shareholders holding major holdings and theirvoting and control rights as well as keyagreements; The other direct and indirect relationships betweenthese major shareholders and the company; Any material transactions with other relatedparties; The existence and nature of risk managementsystems;[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.23Illustration 14.4[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.24Corporate Governance And The Role Of TheAuditorThe external auditor plays a central role in goodcorporate governance. Their core role is to audit financial statements and other (financial)reporting attest internal control statements, and review or attest of corporate governancestatements.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.25Combined Code provisions are as follows: The Board should have a formal schedule of mattersspecifically reserved to it for decision. The Board takes independent professional advice ifnecessary, at the company's expense. Non-executive directors should be appointed for specifiedterms subject to re-election All directors should be subject to election by shareholders. There should be a statement by the auditors about Boardreporting responsibilities. The directors should conduct a review of the effectiveness ofthe group's system of internal controls and should report toshareholders that they have done so. The board should establish an audit committee of at leastthree directors, all non-executive.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.26Duties of theare:Register public accounting firms that prepare auditreports for issuers.Establish or adopt rules: Auditing, Quality control,Ethics, Independence, as related to preparationof audit reportsConduct investigations of and disciplinaryproceedings involving registered publicaccounting firms.Establish auditing standardsEstablish quality control standards. Quality controlstandards could include rules to requiremonitoring professional ethics and independence[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.27EU Eighth Company LawDirective on Statutory Audits 2004 the Commission of the European Unionproposed a major revision of the 8th CompanyLaw Directive. It addresses: the duties of statutory auditors, theirindependence and ethics external quality assurance It creates an audit regulatory committee toensure public oversight over the audit profession. It mandates regulators in the country where anaudit firm is established take full responsibility forsupervising the audit process.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.28EU Eighth Directive: OtherProvisions The ownership and the management of audit firms will beopened to statutory auditors of all Member States Auditors and audit firms in all Member States will beregistered with the EU Basic principles of professional ethics and auditorindependence are described and are very closely relatedto IFAC’s. Member States will set rules for audit fees that ensureaudit quality and prevent "low-balling" Auditors must use ISAs for all EU statutory audits.Member States can only impose additional requirementsin certain defined circumstances.[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Slide 14.29Thank You for Your AttentionAny Questions?[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007

Corporate Governance And The Role Of The Auditor The external auditor plays a central role in good corporate governance. Their core role is to audit financial statements and other (financial) reporting attest internal control statements, and review or at

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