CHAPTER 1 | Regulation in a Global

Economy

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Table of content

1.The Need for Regulation ...................................................................................................................... 9

2.Assurance Engagements ...................................................................................................................... 9
2.1. What is an Assurance Engagement? .............................................................................................. 9
2.2.The Three party Relationship ....................................................................................................... 10
2.3.What is an External Audit?.............................................................................................................. 10
3.Regulatory Framework ...................................................................................................................... 11
3.1 What is the International Federation of Accountants (IFAC)? ....................................................... 12
a. OECD Principles of Corporate Governance ....................................................................................... 14
b.Responsibilities of the Board ............................................................................................................. 15
a.Good Corporate Governance ............................................................................................................. 15
b.Requirements.16
4.Audit Committees17

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1. The Need for Regulation

Corporate failures - Failures of businesses over the years have increased the need
for regulation in order to ensure consistent and high quality audits. Well known
failures include Enron, Parmalat and Lehman Brothers.

Public confidence - Independent audit and assurance has a key role to play in
providing confidence in financial information issued by companies and hence
facilitate the decision making of investors and the smooth functioning of the markets.

Risk management - Regulation enables the users of financial statements to make

better decisions based on the risks.

Globalisation / Harmonisation - Increasingly businesses operate across borders

and are thus exposed to more complex legal, tax and accounting issues. Regulation
is necessary to deal with this complexity, and harmonizing regulations across the
world would go a long way to simplifying matters.

Shareholder Management relationship - In larger organizations the owners and

the managers are different persons giving rise to agency costs. They therefore need
assurance that the organization is being run in their best interests.

Stability in world economy - Governments want to smooth out the fluctuations in

the economy and hence eliminate events triggered from corporate failures.

2. Assurance Engagements
2.1. What is an Assurance Engagement?

DEFINITION

An engagement in which a practitioner expresses a conclusion designed to

enhance the degree of confidence of the intended users other than the
responsible party about the outcome of the evaluation or measurement of a
subject matter against criteria.

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The objective of an AE is for a professional accountant to evaluate a subject matter which

is the responsibility of another party against identified suitable criteria and to express a
conclusion that provides the intended user with assurance about that subject matter.

2.2.

The Three party Relationship

RESPONSIBLE
PARTY
(management)
Prepares
SUBJECT MATTER
(financial statements)

Evaluates

Assures

Practitioner
(auditor)

INTENDED
USER
(shareholders)

2.3.

What is an External Audit?

DEFINITION

An External Audit is an Assurance Engagement ISA200 states that the

objective of an audit of FS is to enable the auditor to express an opinion on
whether the FS are prepared, in all material aspects, in accordance with the
financial reporting framework

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An external audit (or statutory audit) is defined as a reasonable assurance

engagement

Other assurance engagements may give a lower level of assurance , called limited
assurance

Responsible party Company Directors

Intended users Shareholders (as a body)
Practitioner Independent auditor
Subject matter Financial Statements
Criteria Accounting Standards, legal requirements

3. Regulatory Framework
The conduct of audits is governed by three sets of rules:

Auditing Standards (ISAs)

Rules of Professional Conduct

Codes of Ethics

The Regulatory
Framework of Auditing

International
Standards on Auditing
(ISAs)

Rules of Professional
Conduct

Code of Ethics for

professional
accountants

Issued by the IFAC

Issued by the ACCA

Issued by the IFAC

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3.1 What is the International Federation of Accountants (IFAC)?

The global organization for the accountancy profession

Formed in 1977, based in NY
160 member bodies (including ACCA), 120 countries, 2.5 million accountants
Its mission:
to serve the public interest
strengthen the accounting profession
contribute to the development of strong economies via establishing
high quality standards

DEFINITIONS

Professional Accountant - is a member of the IFAC member Body

(Auditor or Practitioner Accountant in public practice) who has to
observe the Fundamental Principles of the IFAC code of Ethics

Professional Accountant in Public Practice Accountants offering

professional services (e.g. audit firms)

Employed Professional Accountant Accountants working in the

industry, commerce, government or education sectors

The IFAC consists of several sub-committees including:

International Auditing and Assurance Standards Board (IAASB)

The IAASB works to improve the uniformity of auditing practices and related services
throughout the world. This is done by issuing pronouncements on a variety of audit and
assurance functions and by promoting their acceptance worldwide.

It is the body responsible for promoting ISAs and other assurance standards.
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 International Ethics Standards Board for Accountants (IESBA)

Develops guidance on professional ethics and promotes its understanding and acceptance
by member bodies. The committee continually monitors and stimulates debate on a wide
range of ethical issues to ensure that its guidance is responsive to the expectations and
challenges of individuals, businesses, financial institutions and others relying on
accountant's work.

It is the body responsible for promoting the IFAC Code of Ethics.

Transnational Auditors Committee (TAC)

It is the executive committee of the Forum of Firms (FoF) and a committee of IFAC.
Membership to FoF is open to all firms performing or wishing to perform transnational audits.
Member firms will be expected, among other things, to conform to the FoF Quality
standards. This is more fully explained in Chapter 10 Group Audits.

Is the IFAC independent?

Matters to consider:

IFAC is financed by the accountancy body

Different arguments (approaches) from different countries on the implementation of
international standards
Large professional firms dominate the authority/power of the body

4. Corporate Governance
Incorporated businesses are usually owned by one group of people (the owners or
shareholders) whilst being run by another group of people (the management or the
directors). This separation of ownership from management creates an issue of trust (also
called Agency Cost).

The management have to be trusted to run the company in the interest of the shareholders
and other stakeholders.

Good corporate governance means governing the corporation in such a way that the
interests of the shareholders are protected whilst ensuring that the other stakeholders
requirements are fulfilled as far as possible.
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a. OECD Principles of Corporate Governance

OECD Organisation for Economic Co-operation and Development

Principles issued in order to:

Assist governments in their efforts to evaluate legal, institutional and regulatory

framework for corporate governance in their countries
Provide guidance and suggestions to stock exchanges, investors and other parties
that have role in developing good corporate governance

Principles:

1. Ensuring the basis for an effective CG framework

The CG framework should promote transparent & efficient markets, be consistent with
the rule of law and articulate the division of responsibilities among different supervisory,
regulatory and enforcement authorities.

2. The rights of shareholders and key ownership functions

The framework should protect and facilitate the exercise of shareholder rights (from
directors not acting for the shareholders best interests).

3. The equitable treatment of shareholders

The framework should ensure equitable treatment of ALL s/h including minority interest
and foreign s/h. All s/h should have the opportunity to obtain effective redress for
violation of their rights.

4. The role of stakeholders in CG

The framework should recognise the rights of stakeholders established by law or through
mutual agreements & encourage active cooperation between corporations &
stakeholders in creating wealth, jobs, and the sustainability of financially sound
enterprise.

5. Disclosure and transparency

The framework should ensure that timely and accurate disclosure is made in all material
matters regarding the corporation (including financial situation, performance, ownership
and governance of the company).

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6. The Responsibilities of the BoD

Ensure the strategic guidance of the company, the effective monitoring of management
by the board, and the boards accountability to the company and the shareholders
(introduction of audit committee and NED).

b. Responsibilities of the Board

Monitor the effectiveness of corporate governance practices and make changes as

needed
Review corporate strategy, planning, budgeting, implementation (risk policy, budgets)
Select executives and monitor their performance and remuneration
Monitor conflicts of interest of management (agency theory, including misuse of
assets, abuse in related party transactions)
Ensure integrity of accounting & financial reporting systems (including independent
internal audit, risk management systems)
Oversee process of disclosure and communications

a. Good Corporate Governance

Follow the corporate governance framework guidelines

Establish Audit, Remuneration and Nomination committees
Risk management
Internal audit review the need for one on an annual basis
Segregation of duties - best practice suggests that the role of Chairman (NE) and
that of Chief Executive Officer should be held by different individuals (to avoid
unrestricted power by one person for decision making & conflict of interest)
Annual review of the internal control system by directors and reporting to members
Directors/auditors should state their respective responsibility for preparing /auditing
FS
Directors should be subject to re-election on an annual basis
Directors can obtain independent professional advice to better perform their duties at
the company's expense
The board should have a formal agenda for decisions

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b. Requirements
Corporate Governance is not a legal requirement there are no legal consequences if
the guidance is not followed.

It is a requirement for listed companies in many countries to follow Corporate Governance

guidance and to report on an exception basis should any of the provisions not be met.

Management responsibility

The directors have to disclose, in a narrative

statement in the annual report, how they have
applied the Code principles.

The statement should mention whether they

have complied throughout the year with the
Code Provisions, and if they have not, they
should describe and explain why not.

Auditor responsibility

Read the statement (not an audit)

If it is misstated then ask directors to

amend. Otherwise seek legal advice
(depending on country of operations).

Audit procedures to review the statement

Review board minutes

Review supporting documents prepared by the board of directors
Make enquiries of the directors and the company secretary
Attend meetings of the audit committee (or other committees)
Obtain Management Representation letter

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4. Audit Committees
The Audit Committee should consist of at least 3 non-executive directors with pre-defined
duties and responsibilities (terms of reference).

Objectives

Increasing public confidence in published FS

Assisting executive directors in their duties (esp. financial reporting)
Strengthening the position of the external auditor (and internal auditors)
Functions

Monitor the integrity of the FS

Review internal control procedures
Review internal audit function
Review of companys accounting policies
Review of regular management information
Review of annual FS presented to S/H
Review external auditors findings
Recommend nomination and remuneration of external auditors
Advantages:

improve quality of management accounting

better communication between auditors/directors
helps to avoid conflicts between management/auditors
enhances independence of internal/external auditors
Disadvantages

fear that their purpose is to catch management out

non-executive directors dealing with details (may not have in-depth knowledge of the
business)
expensive to maintain
may not be given adequate power/responsibilities
Relationship with Internal Audit

The audit committee acts as the intermediary between the BoD and the Internal Audit
department. Internal audit reports to the Audit Committee which then reports to the BoD.

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Ensures that the internal audit department has direct access to board chairman and
the BoD
Reviews and assesses the annual internal audit work plan
Receives periodic reports on the results of internal audit work
Reviews managements responsiveness to the internal auditors findings and
recommendations
Meets the external auditor at least once a year without the presence of management
Monitors and assesses the effectiveness of internal audit in the overall context of the
companys risk management system

EXAM TIP

A Common mistake made by students concerns

questions in the exam asking for the role/functions of
the Audit Committee, but the answer given consists of
advantages and disadvantages.

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