International Journal of Auditing 1(1), 3–12 (1997)

Auditing and Corporate Governance

—a Look Forward into the 21st
Century*
J. P. Percy
Department of Accountancy, University of Aberdeen, UK

Auditors will be expected to disclose whether the accounts are true

and fair, whether the company will fail, whether it is managed
competently, whether it is run in accordance with the law, free of
fraud, and whether it is adopting a responsible attitude to
environmental and societal issues. Corporate governance devel-
opments, broader ranges of stakeholders for auditors to serve,
requirements for assurance on softer, non-financial measurements
and developments in technological corporate reporting, are all
demanding new forms of audit assurance services and of audit
reporting. This in turn poses important challenges for interna-
tional audit standard setters and for audit educators alike. While
developments in global business and global capital markets have
given international dimensions to many of the developments in

#
corporate governance, there is not a complete consensus across the
world. 1997 by John Wiley Sons, Ltd. Int. J. Audit. 1(1), 3–12
(1997)

(No. of Figures: 0 No. of Tables: 0 No. of Refs: 12)

Key words: auditing; standards; information technology; behaviour;

stakeholders.

SUMMARY pectations are growing. The public believes audi-

While auditors are nervous in a litigious environ-
ment, they should not bemoan that the public
misunderstands their position. Developments in
international standards, which anticipate expecta-
tions, are important. Standards are needed on
prospective information, sensitivities and risks—
which is often soft, opinionated and non-financial
in format. Legislatures must improve the law to
alleviate auditor liability.
Dynamic auditing will maintain societal confi-
dence—in directors, managements and auditors.
Currently, the annual report is relied upon by all
who have an interest in the company’s success. Ex-
* This paper was prepared at the request of the International
Auditing Practices Committee to stimulate debate on the
future of auditing.
tors have a responsibility as watchdogs of the
integrity of business. Shareholders expect the
company to be safe until the next annual report,
so auditors need to look at least to the next
reporting date.
Auditors are expected to be free of commercial
influence, objective and competent; they must
avoid concurring with artistic impressions of
management’s desire rather than realistic state-
ments. Marketing other services to management
suggests that auditors are in their pocket; but
banning auditors from these services might deprive
businesses of quality advice. Audit partners should
not market other services and should be assessed
for robustness rather than fee generation. Auditing
and marketing behaviour are different: the stress
should be on the former. The engagement partner’s

Received August 1996

#
CCC 1090–6738/97/010003-10 $17.50 Revised September 1996
1997 by John Wiley & Sons, Ltd. Accepted September 1996
4 J. P. Percy
name on the audit opinion would strengthen
objectivity.
Auditors should advise audit committees on the
conservatism underlying the financials. Boards of
assessors might oversee audit and board regularity.
Corporate governance developments, more in-
quisitive stakeholders, assurance requirements on
non-financial measurements and developments in
technological corporate reporting, demand new
forms of audit. Negative assurance reporting,
which neither adds value nor communicates
clearly, is inadequate. There will be more informal
audit reports to directors on business conduct, and
audit reports may become discursive as they serve
special purposes. Financial reports are less histor-
ical, more an expression of resources utilization
and value. Many assets of companies are not on the
balance sheet: the public sector’s non-financial
measurements of service standards may be applic-
able. Auditors must reassure on sections of the
annual report, such as the directors’ report, chair-
man’s statement and management review.
Real-time reporting needs real time auditing
grounded more on assurance on inputs, process
and databases, less on outputs. Internal auditing
will be important in corporate governance with
INTRODUCTION
The capital markets will continue to require a
strong dynamic auditing profession as an integral
part of corporate governance in the 21st century. I
have been invited by the International Auditing
Practices Committee (IAPC) to prepare this paper
to provoke debate at this important time in the
development of international auditing standards. I
examine a number of changes which are taking
place in the environment that surrounds the
auditing profession now and into the next century.
I submit that our purpose as the IAPC is to assist
the auditing profession, to develop its agenda for
issuing standards and guidance that will be
appropriate to meet growing public expectations
whilst maintaining its deserved reputation and
status.
The International Federation of Accountants,
through IAPC and other committees, has done a
first class job over the past 20 years in establishing a
recognized core of standards which meet today’s
needs. It is now time to look to tomorrow’s agenda,
given the globalization of financial markets and the
interests of IOSCO and international stock ex-
changes in capital markets. IAPC has an important
# 1997 by John Wiley Sons, Ltd.
external auditors assessing its quality to obtain
assurance
on the database and the quality of information.
There will be new emphasis on auditing to
identify and minimize fraud. While auditors
cannot ensure that companies are run legally, they
must be alert to material effects on financial
reserves. The public expects auditors to find
material fraud: standards must ensure that auditors
cannot largely ignore internal control. Auditors,
reporting on system robustness to minimize fraud
and error, must discover how to give the degree of
assurance which meets expectations.
Auditors should develop skills to reassure on
non-financial measurements and so stay assessors
of measures of accountability. Auditors must study
behaviour to understand the signals of fraud and
manipulation. Directors, managements and audi-
tors all need the skills to follow the governance
principles of openness, accountability and integ-
rity.
Governance structures have been strengthened
worldwide. The auditor’s corporate watchdog role
is still poorly defined. Society will demand auditors
report on certain governance statements. How and
to whom is to be determined. In some countries
role in developing the agenda for the leadership of
our audit profession.
OBJECTIVES AND REFERENCE
MATERIAL
The views in this paper are my own and should not
be attributed to any body or company with which I
am involved. They are presented to provoke debate
and are drawn from a study of a number of papers
published in recent times.
In particular, the views are drawn from a
number of publications: the report of the advisory
panel on auditor independence entitled ‘Strength-
ening the professionalism of the independent
auditor’, Chaired by Donald Kirk of the Public
Oversight Board in the USA and their own paper
entitled, ‘Allies in protecting shareholder interest’.
In Europe, the Federation Des Experts Comptables
Europeens (FEE) have recently published their
paper on ‘The role of position and liability of the
statutory auditor in the European Union’ and in
July 1996 the European Commission published its
own Green paper for debate on the subject. In the
United Kingdom the Auditing Practices Board
International Journal of Auditing, 1(1), 3–12 (1997)
Auditing and Corporate Governance
(APB) published ‘The Audit Agenda’ in 1994,
following the APB’s paper on ‘The future develop-
ment of auditing’, published in 1992 and the
research paper on ‘Auditing into the twenty-first
century’ published by the Institute of Chartered
Accountants of Scotland. The most recent publica-
tions are ‘The Auditor’s Code’ (APB, 1996), setting
out the nine fundamental principles of auditing for
the use of directors of companies, as well as
auditors, ‘The Audit Agenda— next steps’ proposals
(APB, 1996) and ‘The Research Agenda’ (APB, 1996)
in the UK.
In recent times there has been an increasing
interest in corporate governance around the world
and I draw some issues from, ‘Who holds the
reins’, published by the International Capital
Markets Group (1996), of which I had the pleasure
of chairing the Task Force and the honour of
working with Al Sommer, Chairman of the Public
Oversight Board in the United States of America.
‘Who holds the reins’ is a comparative study of
corporate governance in Japan, Germany, France,
Canada, the USA and the UK.
I am all too conscious of the saying by
Confucius—‘he who foretells the future, lies’. But
unless one has a vision of the future, the develop-
ment of new ways of anticipating and meeting
expectations and demands is fraught with dangers.
I examine the current state of auditing within the
corporate governance framework, the expectations
of users of financial statements both in terms of
auditing and corporate governance together with
developments in the pipeline, and hopefully lift
our sights as to possible developments in corporate
reporting and the challenges which developments
in technology may bring to new forms of audit
assurance and reporting.
THE CURRENT STATE OF AUDITING
WITHIN THE GOVERNANCE
FRAMEWORK
Auditing is a critical aspect of corporate govern-
ance. The word audit derives from the Latin word
meaning ‘to hear’, it is about upholding the
integrity of financial reporting and business con-
duct and is about seeking the truth. The role of the
audit is critical in our society for maintaining
confidence in business operations, the capital
markets and the public sector. In recent times
auditing has concentrated on the public reporting
of financial statements, in accordance with gener-
ally accepted accounting principles. Informally, in
International Journal of Auditing, 1(1), 3–12 (1997)
5
certain cases, auditors report to directors on
business conduct. The litigious environment has
caused auditors, quite understandably, to concen-
trate on the financial reporting objective and the
accounting and auditing standard setters have
done much to provide a core set of standards in
this regard. However, there emerges through the
most recent developments in corporate governance
a challenge to auditors in the future to be a
watchdog of company behaviour.
In simple corporate governance terms, auditors
(respected for their objectivity, robustness, scepti-
cism, fairness and above all, integrity, and broad
business knowledge), are appointed by one party,
the shareholders, to report to them primarily on the
integrity of the financial information of another
party, normally management appointed by the
shareholders to operate the company with the
shareholders’ resources. Note the distinction that
the auditors are appointed by one party to report
on another party and not by one party to report on
itself. I appreciate that, in reality, shareholders
leave it to directors to make appointments but such
a weakness in the system should not be matched by
the auditor mistaking who is the client. The public,
in the shape of shareholders and other stake-
holders, I believe take comfort from the fact that
this watchdog is overseeing the integrity of busi-
ness through the process of reporting on financial
information. There lies a gap of understanding
between what the auditor presently provides and
what many expect.
The auditing profession needs not only to deliver
in the public interest what is practical and cost
effective, but needs to manage expectations. If not,
then confidence in our profession falls away and
society is the loser. Furthermore, our capital markets
and businesses would find it difficult to operate
without society’s confidence, which looks to audi-
tors to provide an important check and balance
within the traditional corporate governance frame-
work.
I contend that the issue of corporate governance
is not only an issue for independent directors or
supervisory boards but also for auditors. Directors
work with management to ensure that the com-
pany resources are used efficiently and in a manner
that ensures the achievement of the company’s
objectives and its ability to contribute to the
common good. Audits are perceived to have some
watchdog role as yet poorly defined.
Good corporate governance ensures that enter-
prises can be dynamic and progressive. Answers to
the question, ‘Who holds the reins’, whether it be
# 1997 by John Wiley & Sons, Ltd
6 J. P. Percy
by directors and auditors working individually or
collectively, are not intended to restrict such
dynamism, but rather to give it direction. Good
governance is behavioural by nature and mini-
mizes the risk of unscrupulous people harnessing
resources for their personal purpose or to mask the
incompetence and poor judgement of management.
The hallmarks of good corporate governance
behaviour are generally accepted to be integrity,
openness and accountability, and in my view audit
has an important role in the future to highlight
when such principles are missing.
PUBLIC EXPECTATIONS
It is not surprising that the profession comes under
enormous attack when things go wrong. The public
in my view wish to rely on auditors and believe
that auditors have a broader responsibility than just
reporting on the annual financial statements. When
scandals take place, auditors understandably say it
is not their fault, but in doing so sometimes
misread the high expectations by the public of the
external auditor as an independent assessor.
The auditing profession may not have done itself
justice in the 1980s by bemoaning that the public
does not understand its problems, that the public
does not understand the scope of audit, or the
complexities of its litigious position and may have
contributed to the damage of its own reputation
and objectivity by the aggressive marketing of
services to management from whom they are
supposed to be independent and for being the
advocates of creative accounting instead of the
independent assessors of appropriate accounting.
The profession has done much to arrest the
position in the 1990s, through constructive public
debate, standard setting, not least with the codifi-
cation of international auditing standards, and with
improved quality procedures of firms. Its aim must
be to enhance public confidence and find ways of
delivering the objective services that the public
demands in order to re-establish the confidence
which society needs. Much progress has been
achieved in the last five years, and such confidence
is returning. However, there is no room for
complacency.
In the early 1990s, faced with criticism of the
auditing profession, the Research Committee of the
Institute of Chartered Accountants of Scotland
under my chairmanship decided to examine the
growing public expectations of auditing and
possible new ways forward for auditors in the
# 1997 by John Wiley Sons, Ltd.
21st century. We examined the expectations by
talking to a wide range of people and recording
responses in layman’s language. These can be
summarized as follows: the accounts are correct—
the company will not fail—it will be managed
competently—run in accordance with the law—
free of fraud—and will adopt a responsible attitude
to environmental and societal issues providing an
annual report which can be relied upon by all its
stakeholders and those who have an interest in its
success and welfare. In addition, we ascertained
that the public expects company auditors to be
independent, professionally competent and to
behave in a professionally objective manner free
of commercial influence.
In parallel, the Auditing Practices Board of the
UK examined similar issues and published a paper
for public debate entitled, ‘The future development
of auditing’ (APB, 1992). Importantly, both these
documents I refer to were written by a combination
of practitioners and users of the audit process. The
ideas in those papers and the public response were
drawn together in ‘The audit agenda’ (APB, 1994).
It is clear in my mind that the growing public
expectation of auditors is developing hand in hand
with the growing public expectations of directors
and management. Hence there is now an increased
focus on corporate governance. What is interesting
in these developments is not only the expectation
of quality corporate reporting and auditing but
quality behaviour by directors and management
ensuring that governance principles of openness,
accountability and integrity are followed.
The following is an examination of expectations
in terms of users of financial reports.
FINANCIAL STATEMENTS ARE
CORRECT
Of course the public understand that correct does
not mean absolute accuracy. But correct means that
they can be relied on for investment and business
decisions. Should I invest? Should I do business
with them? Should I work with them? Will they
add harm or do damage to the community
surrounding them?
The 1980s saw an industry where not all, but
some, auditors found clever ways to advise
management on the use of accounting methods
which would legally fall within the concept of truth
and fairness and the law and allow management to
show the results in the best possible light. It could
be said that a company’s financial results were an
International Journal of Auditing, 1(1), 3–12 (1997)
Auditing and Corporate Governance
artistic impression of management’s desire rather
than a realistic statement of actual results—a clear
indication of the auditor conveniently forgetting
that his client was the shareholder or company and
not management. Auditing to management rather
than of management.
Much has been done around the world to enforce
the proper spirit of accounting standards in the last
five years and I was encouraged by the report of the
Public Oversight Board recommending that audi-
tors in future meet with audit committees not only
to advise them as to whether the accounting policies
used are within the wide constraints of fair
presentation, but whether they are the most appro-
priate accounting policies to be used and also to
advise on the clarity of the financial disclosures and
the degree of conservatism or aggressiveness
underlying management’s accounting estimates
and accounting principles. Such a proposal identi-
fies the public expectation that auditors will be a
watchdog for shareholders and the company
ensuring that the accounts do show a true and fair
view, no matter how painful that may be to
management.
THE COMPANY WILL NOT FAIL
In any capital market companies will fail. The issue
is that shareholders do not like surprises. The
concept of openness means that accounts should
show sensitivities and risks which the company
may from time to time be under and certainly in the
foreseeable future. The accounting standard setters
have not yet concluded on this issue. On going
concern, accounting standards are written on the
basis that directors will make a black and white
decision as to whether their financial statements
should be prepared on a going concern or liquida-
tion basis. This ignores the fact that most situations
in real life are grey and not black and white. Often
directors, particularly of highly geared growth
companies realize that they are under-capitalized,
that they are dependent on bankers and major
customers, and that one strong puff of wind at an
unexpected time may blow their company away.
Surely an investor or employee would be better
served if they were aware of the risks and
uncertainties, understanding that management,
together with motivated employees, will work
towards strengthening the company, rather than
letting it die or get into financial difficulty. Often
investors in the knowledge of such a situation will
invest more money, not less, as most desire a
International Journal of Auditing, 1(1), 3–12 (1997)
7
company to win rather than fail.
The events of the 1980s have proved that
investors expect auditors or management to warn
them of problems. In the United Kingdom, the
Stock Exchange requirements require directors to
report on risks and uncertainties where there is
substantial doubt as to the going concern nature of
the company in the foreseeable future, and if the
directors do not disclose such in the accounts the
auditors are expected to draw attention to it. The
public expectation in my view is that shareholders
can rely on financial statements and will expect the
company to be reasonably safe until they receive
their next annual report, unless they are made
aware of difficulties on the horizon. It is not
sufficient in my opinion for auditors or directors
therefore only to look at the next year end, which
may be only a few months away, but to look
beyond the end of their nose until at least the next
reporting date. I note this view is also put forward
for debate by the European Commission’s Green
paper. Such a course requires the auditor to look at
prospective information, and indeed the whole
issue of the auditor’s role with respect to Prospec-
tive Financial Information is an issue in its own
right and one which IAPC is expecting to issue a
paper on shortly. A paper on going concern will
also be published to update the present statement
in the light of public expectations.
Accounting Standard Setters need now to devel-
op disclosure standards for this important issue
and auditors can make judgements as to the
adequacy of such disclosures in the shareholders’
interest. Present proposals are encouraging, I
appreciate auditors are nervous in a litigious
environment, but that does not lessen the public
expectation, especially when such expectations can
be met largely through appropriate disclosures.
THE COMPANY IS COMPETENTLY
MANAGED
This is an expectation that needs to be fulfilled by
directors and, in particular, those who are non-
executive. It is a corporate governance issue and it
is the directors’ role to hire competent management
and fire incompetent management. The scandals of
the 1980s caused a number of countries around the
world to re-examine corporate governance issues
and a comparison of the position in certain
countries is developed in ‘Who holds the reins’
(ICMG, 1996). Throughout the world, governance
structures have been strengthened in recent years,
# 1997 by John Wiley & Sons, Ltd
8 J. P. Percy
and whilst there is some convergence of methods, it
is recommended that country cultures be respected
on the basis that none are any better nor any worse
than each other; just different.
In countries such as Germany and the Nether-
lands, we see the use of the Supervisory Board. In
the United Kingdom, USA, Canada, Australia,
South Africa and France we see the development
of the role of independent non executive directors,
and in countries such as Italy and Japan the
emergence of a Board of Statutory Auditors to
monitor the regularity of management behaviour
and to act as a check and balance.
There is a growing demand for annual reports to
include statements about the governance process
used by a company, and in some countries, the
additional need for auditors to report on the
appropriateness of certain governance statements.
My enquiries in this research told me that in some
countries there is no urge for auditor involvement.
This arises because some industrialists believe that
auditors will not add value in performing those
functions given their lack of experience of govern-
ance issues and because of cost. Other countries
take a different view and can see the benefit of
auditors performing a reporting role and it is a
challenge to our profession to prove the doubters
wrong.
For the future, I believe that society will demand
that auditors find ways of reporting on governance
issues, particularly when they observe weaknesses.
The urge for auditors to report on going concern
issues and internal controls is the tip of this iceberg.
In the UK we are developing guidance on how
auditors can report at least in the first instance to
audit committees, now quite common across the
world with non-executive directors who, it can be
argued, are the shareholder representatives on the
board. Much work is required internationally to
establish guidance on how auditors communicate
these issues to directors and, if need be, share-
holders and those relying on the governance of the
company. Communication is a current topic on the
IAPC agenda. The quality of corporate behaviour is
a critical issue in terms of the competence of
management and is often the subject that the media
highlight when companies fail.
THE COMPANY WILL BE RUN IN
ACCORDANCE WITH THE LAW
It is interesting to note the developments in
international and domestic standards to give
# 1997 by John Wiley Sons, Ltd.
guidance on this issue and the resolve in the report
issued by FEE with regard to this matter. Whilst
auditors are not lawyers and cannot give assurance
on such aspects, they will be expected to have a
watchdog role and require to be alert to issues that
could have a material effect on future financial
reserves. The European Commission’s paper sug-
gests a positive role for auditors reporting on this
issue.
THE COMPANY IS FREE OF FRAUD
This is a burning issue throughout the world and
quite rightly auditors make the point forcibly that it
is management’s responsibility to have systems in
place to minimize the risk of fraud and I agree with
that. However, whether we like it or not, the public
expectation is that auditors will find material fraud.
We all know the difficulties of trying to unearth
complex fraud by senior management working in
collusion with third parties to manipulate informa-
tion. Much has been done to strengthen auditing
standards on this issue, and in particular audit
reports are clearer as to the inherent limitations of
the audit process. However, further steps could be
taken and the European Commission encourages
debate on these.
First, I do not believe it is now any longer tenable
for auditors to rely purely on substantive auditing,
largely ignoring systems of internal control, and I
would expect alterations to auditing standards
dealing with the issue. The United Kingdom is in
the process of examining the issues surrounding
the proposal for guidance that auditors should
report to directors on the robustness of the systems
to minimize the risk of fraud or error. Also, much
work is being done by the accountancy profession
throughout the world to develop guidance or
standards for auditors to report on the effectiveness
of internal control systems or at least the adequacy
of the process of governance to minimize fraud and
error and ensure proper financial information.
Needless to say, the issue is wrought by the
litigation issue in that auditors are not keen in
present circumstances to make such reports in case
something should go wrong after the event. The
example of Barings brings this into sharp relief. The
challenge for auditors is to find ways of giving the
degree of reasonable assurance necessary to meet
shareholder and public expectations. The challenge
for legislatures is to improve the law to alleviate the
liability issue.
I believe that we need to examine our education
International Journal of Auditing, 1(1), 3–12 (1997)
Auditing and Corporate Governance
and training to prepare auditors to study beha-
vioural techniques in people and to understand the
warning signs of fraud and particularly manipula-
tion activity. It is said that a fraudster is a person
who enjoys fast women and slow horses and whose
ego is matched by the size of his or her incompe-
tence. Usually such people are, of course, highly
plausible and can seduce the unsuspecting auditor
away from uncovering their misdemeanours.
There is also a need to examine the financial
penalties that should apply in law for any employ-
ees giving auditors misleading information, as
clever fraudsters usually perpetrate fraud through
the manipulation of others in their employment,
urging them to alter records and to suppress
information.
The issue of fraud, a virus in today’s society,
needs continuing professional interest. It will never
be removed but can be minimized through im-
proved education and vigilance by auditors and
directors.
THE COMPANY ADOPTS A
RESPONSIBLE ATTITUDE TO
ENVIRONMENTAL AND SOCIETAL
ISSUES
This is a key subject on which the IAPC is working
and IFAC published a most useful discussion paper
on this in 1995. We are, of course, indebted
particularly to the Netherlands and Canada who
have carried out significant work in this area and
note the interest by the European Commission on
this subject. There are two issues, first the respon-
sibility of auditors to identify environmental issues
which have an effect on financial statements, and
secondly to report on environmental reports pre-
pared by management for stakeholders. Progress
and results in this important area are necessary if
auditors are to meet public expectations and
particularly the expectations of other stakeholders
in tomorrow’s company. Auditors will need to
work closely with other experts in a multi-
disciplinary profession.
THE COMPANY’S ANNUAL REPORT
CAN BE RELIED ON BY ALL
STAKEHOLDERS
This leads me to the expectation that the company’s
annual report can be relied on by all stakeholders.
It can be argued that since financial statements are
International Journal of Auditing, 1(1), 3–12 (1997)
9
prepared in a format for the purposes of share-
holders, the auditor should only report to them.
However, as we know, many others have an
interest in the company—creditors, employees
and the community. Those people treat the audit
report as an all-encompassing statement in the
annual report, that all is well and indeed, through
domestic laws, many annual reports now contain
information for such other parties. Indeed, in many
countries the legal requirement is that the financial
statements are on public record which implies in
itself a general role.
This is not a simple issue and considerable
research has to be carried out into the form of
information which is necessary for different stake-
holder purposes. Employees, for instance, are
interested in the health of the company from the
point of view of future employment and income,
creditors are interested in its ability to pay its debts,
and the community is interested in its survival and
environmental behaviour as it affects the popula-
tion surrounding it, whilst shareholders are inter-
ested in the value of their investment, its likelihood
for growth and the potential dividend stream.
The second aspect is that shareholders believe
that the auditor, whilst he or she has only reported
on the financial statements, will have also exam-
ined other sections of the report, such as the
director’s report, chairman’ statement, manage-
ment review and analysis or operational review.
The auditing profession needs to find ways of
giving appropriate reassurance on those issues and
certainly should not allow their names to be
associated with misleading information. Our new
auditor’s code in the UK addresses this last point.
The reaction of industry on the auditor’s involve-
ment with other information is that formal audit
reporting could stifle and fossilize information
which readers prefer to have in a discursive form,
and a general belief in any event that auditors
examine such information without explicitly re-
porting on it.
The challenge for the standard setter is to find
new ways of managing expectations by commu-
nicating appropriate reassurance on statements
which are soft, opinionated and not in a financial
format without fossilizing the information itself.
THE AUDITORS ARE INDEPENDENT,
PROFESSIONALLY COMPETENT, AND
WILL BEHAVE IN A PROFESSIONAL
MANNER, FREE OF COMMERCIAL
# 1997 by John Wiley & Sons, Ltd
10
INFLUENCE
Whilst in 99% of cases this is true, public percep-
tion is different. The public hears of cases of low
balling, cost cutting the audit in order to gain
lucrative consultancy work, being put under
pressure by management with the threat of beauty
parades and opinion shopping. The public per-
ceives that the auditors are paid for by manage-
ment and indeed aggressively sell services to
management. It is perhaps not surprising that
auditors are sometimes thought to be in the pocket
of management.
Studies in Europe and America that I have
mentioned all place emphasis on this issue,
recommending that independent directors should
be involved in the appointment of auditors and
their remuneration. The Audit Agenda (APB, 1994)
suggested that independent directors assess the
quantum of consultancy services delivered to
management to ensure that audit independence is
not impaired. Some, of course, would like to see
auditors totally banned from the provision of non-
audit services, but real life is not that simple and
there would not seem to be a trend in that direction
mainly because shareholders and directors value
the quality of independent advice that is necessary
for the creation of wealth.
Much of the problem can be solved by the
auditing firms themselves ensuring that audit
partners are not held responsible for marketing
other services to management and that audit
partners are assessed on their robustness rather
than their ability to create fees. The behavioural
aspects of an auditor and a marketeer are different.
The first is a sceptic who asks the question why?
and has the ability to say no. The second asks the
question what do you want? and usually likes to
say yes. The clearer identification of the objectivity
of the audit process and judgement by the firm to
the public will assist in this task. The practice of the
engagement partner signing the firm’s opinion by
name helps, in my view, to strengthen objectivity, a
practice followed in certain countries and being
examined in the United Kingdom.
On the question of auditor independence, the
study, ‘Auditing into the twenty-first century’
The concept was not supported in the UK as
industry saw this in terms of an additional cost and
bureaucratic burden. However, it is interesting to
note that in Japan and Italy there is a Board of
Statutory Auditors to oversee the regularity of the
board. In other countries the roles of non-executive
directors and audit committees are being devel-
# 1997 by John Wiley Sons, Ltd.
J. P. Percy
oped. However, non-executive directors at the end
of the day are not independent of management,
particularly when they sit on a unitary board and
they are chosen quite properly not for regularity,
but for their ability to contribute to the strategy and
governance of the company. Also, where there are
dominant executives or chairmen their position is
also fragile. The issue of independence of the
auditor is important and I believe they should be
selected by a body independent of those whom
they audit. Whilst the growing role of audit
committee involvement in appointment is a step
to be welcomed, it is argued by some to be still not
the ideal solution.
I wonder, with the developing interest in
corporate governance, whether after the next
recession and wave of scandals such as we saw in
the 1980s, there will not be a renewed interest in
this concept and that legislators might find the
Japanese and Italian models attractive as a con-
cept—creating a board of assessors, with a mixture
of accountants and executives experienced in
auditing and business life as a panel of three or
five people to oversee the regularity of the
governance of the company, and appointing ex-
ternal auditors to assist them in that process and,
when necessary, to effect changes in the boards of
companies when the need arises. Such a panel
would also be available to non-executive directors
who wish to discuss matters particularly when they
find themselves in a fragile situation. Such a
mechanism may be necessary to protect confidence
in capital markets.
At present such an overlay is not necessary if the
external auditors meet public expectations, the new
governance structures of companies around the
world work and shareholders demand information
on the governance process as a means of safe-
guarding their financial interest and its ability to
grow.
EMERGING DEVELOPMENTS
Having dealt with public expectations let me turn
to examine ideas on developments in corporate
reporting and technology which may change the
nature of auditing in the future.
Corporate Reporting
On the subject of corporate reporting, it is now
clear that financial reports are moving away from
being a historical record of the intromissions of the
International Journal of Auditing, 1(1), 3–12 (1997)
Auditing and Corporate Governance
directors to being a means of not only satisfying
shareholders that the resources of the company
have been wisely utilized and used for the creation
of wealth and dividends, but also of indicating
value. The demand for value-based accounting and
information based on judgements of the future is
now demanded by investors who are not satisfied
with merely a record of the past, but wish to know
more about the company’s worth and its future
potential.
Let us lift our eyes and examine some assets of a
company. Imagine for a moment what is valuable
in a company—its know how—experience of
management—its research and development into
new products and services—the integrity of its
governance—the experience and objectivity of its
directors—its plans—the motivation and education
of its work force—its share of its market and its
ability to maintain that share or to move into new
markets and, finally, the quality of its customer
base and their satisfaction. None of these items
appear in the balance sheet at present and, if they
do, we try and put mathematical figures around
them.
In the public sector we are learning not to
measure everything in financial terms, but to
measure standards of service with non-financial
measurements. We should be able to transfer these
techniques to the private sector. Shareholders are
not only interested in historical cashflows, but in
forecasts so that they have some concept of future
dividend flows and how they will be sustained and
improved and whether the company can afford
them at the same time as ploughing back sufficient
for investment, not into bricks and mortar, but into
training, research and development and people.
We have assumed as a profession that the word
accounting is about financial measurement, but
indeed it is the measure of accountability. In future
we will have to develop our skills to give
reassurance on non-financial measurements if we
are to maintain our position as the assessors of
measures of accountability.
It could be argued that whilst the profession
concentrates on reporting on annual financial
reports at the present time, it will eventually
become a small part of the auditor’s work. I still
foresee an annual financial report being prepared
in accordance with accounting standards on an
annual basis, but that such a report will be mainly
used by regulators and analysts. Shareholders will
find more useful the management and analysis
type statements made by directors, probably not
only on an annual basis, but at least on a quarterly
International Journal of Auditing, 1(1), 3–12 (1997)
11
basis and they are likely to be in a screen-based
format, at least for the sophisticated investor.
Technology
The technological revolution continues apace. For
the listed companies of the world, one can foresee
detailed financial information being available by
electronic means, possibly on the Internet. An
investor will be able to access information relevant
to his or her needs by the touch of a button, straight
from the company’s database. Such information is
unlikely to be accompanied by a long form audit
report, nor is it likely to be produced some months
afterwards but be in real-time. Investors will use
such information to match performance against
forecast benchmarks developed by themselves and
to track performance against expectation. There
will therefore be a need for real time auditing and,
can I suggest that, in the future, assurance will have
to be provided on the process and the databases
being used and on the inputs to that database
rather than only on the outputs.
Even in the smaller company, gone are the days of
manual accounting records. Given the number of
computer software packages which owner managers
can use, not only to keep their financial records, but
to give them up to date information on their
business, they will have the ability to compare their
performance with others in the same industry. Audit
routines are also being driven by software capability,
identifying unusual trends and issues for the auditor
to make intelligent enquiries of management and on
which to use his or her judgement. It is now
becoming cost effective to audit whole populations
by computer rather than relying on sampling.
These corporate reporting and technology devel-
opments will challenge external auditors to find
new forms of reporting and will also challenge
auditors to provide a whole host of new assurance
services.
CONCLUSIONS
In conclusion, therefore, I see a number of
challenges for the standard setters and educators
of the world and for those providing an audit
service in its wider dimension to meet the expecta-
tions of the future.
Standard setters and accountancy firms and their
professional bodies along with other governance
groups need to find new ways of protecting auditor
objectivity in the public interest if society is to have
# 1997 by John Wiley & Sons, Ltd
12
ongoing confidence in the operation of business
and capital markets.
As a profession we need to find new forms of
assurance services to meet the technological corpo-
rate reporting and governance demands which are
upon us and, in particular, to give assurance on
non-financial measurements.
Added to these is the challenge of clear unequi-
vocal reporting. We are too accustomed to use
hierarchic language that only we, as a profession,
truly understand. The advancement of negative
reporting I hope will cease as it is difficult to
believe that negative assurance adds value and
clearly communicates the assurance that is being
given. My own view is that we will be challenged
to move away from standard forms of report to
more discursive reporting, indicating clearly in
layman’s language the quality and extent of
assurance or reassurance being given.
The demand by other stakeholders to rely on
information will expand and, as such, will require
specific forms of information on which auditors
will have to give special purpose reports.
The challenge of technology will demand more
real-time activity and the need for quality corporate
governance will increase the industry of internal
auditing as an important aspect of the governance
process, with the external auditors assessing its
quality as a means of giving assurance on the
company’s database and its ability to provide
information that is reliable and has integrity.
There is the continual challenge of taking fraud
seriously. The future of auditing will place an
increased emphasis on developing improved tech-
niques for the identification of fraud, for advising
directors on the robustness of their systems to
minimize the risk of fraud and error and to ensure
that the company’s resources are harnessed for the
benefit of the company rather than for the benefit of
others.
Reporting on corporate governance behaviour,
environmental and societal issues, prospective
financial information and non-financial measure-
ment, will demand new skills in our successors, not
necessarily at the moment engrained through
education and training. In addition we need to
educate our auditors in the behavioural aspects of
people, not least to assist in the fight against fraud.
I have been privileged to have been invited to
prepare this paper and to have been involved in so
much standard setting activity over the last 20
years. I now see auditors from the perspective of a
director and regulator and am convinced that, for
the benefit of society, auditors must not be
# 1997 by John Wiley Sons, Ltd.
J. P. Percy
complacent, but truly examine the means by which
they can enhance confidence in the governance of
business for the needs of society and enhance
confidence in the capital markets as a whole.
REFERENCES
Auditing Practices Board (1992) The future development
of auditing—a paper for public debate. Milton Keynes:
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Auditing Practices Board (1994) The Audit Agenda. Milton
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Auditing Practices Board (1996) The Audit Agenda—Next
Steps. Milton Keynes: Accountancy Books.
Auditing Practices Board (1996) The Audit Research
Agenda. Milton Keynes: Accountancy Books.
Auditing Practices Board (1996) The Auditor’s Code.
Milton Keynes: Accountancy Books.
European Commission (1996) The Green Paper for public
discussion: the role, position and liability of statutory
auditors. Brussels: European Commission.
FEE (1996) The role, position and liability of the statutory
auditor in the European Union. Brussels: Federation
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ICMG (1996) Who holds the reins—a paper by the
International Task Force on Corporate Governance.
London: International Capital Markets c=o Interna-
tional Bar Association.
McInnes, W. M. (1993) Auditing into the twenty-first
century—a research paper of The Institute of Chartered
Accountants of Scotland, Edinburgh.
Percy, J. P. (1995) The relevance of research in the
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In Accountancy training for the future—the need to develop
interpersonal skills. Amsterdam: NIVRA.
Public Oversight Board AICPA—Advisory Panel on
Auditor Independence (1994) Strengthening the pro-
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Public Oversight Board AICPA (1995) Allies in Protecting
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AUTHOR PROFILE
Ian Percy is an Honorary Professor of Account-
ing at Aberdeen University, Chairman of the
Accounts Commission for Scotland, a director of a
number of companies, formerly senior partner of
Grant Thornton and President of the Institute of
Chartered Accountants of Scotland in 1990–91. He is
Vice Chairman of the UK Auditing Practices Board,
a member of IAPC and Chairman of the ICMG Task
Force on Corporate Governance. He chaired the
debate which culminated in the publication of
Auditing into the Twenty First Century, The Audit
Agenda, Audit Agenda—Next Steps, The Research
Agenda, Auditor’s Code and Who Holds the Reins.
International Journal of Auditing, 1(1), 3–12 (1997)