Governance and Accountability

UMADHV-15-2

SU4: Audit and Corporate Governance

Rhian Dow

SU4 - Audit and CG 1

 Objectives
• Understand the role of audit as a tool of good corporate governance
– Discuss the purpose and composition of the audit committee

– Describe the nature and function of internal audit, and understand its
differences from external audit

– Evaluate the utility of external audit as a monitoring activity in the

agency relationship and appreciate its wider function in society

– Understand the role of, and discuss the future of, audit as a tool of
corporate governance

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 Where does auditor fit?
• The auditor does not have direct corporate governance
responsibility but rather provides a check on the information
aspects of the governance system.

• International Standard on Auditing (ISA) 260: “Communications of

Audit Matters with Those Charged with Governance”

• ISA 260 requires the auditor to determine those persons that

are charged with governance

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The Audit Committee

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 The Audit Committee

Board of
Directors

Risk Nominations Audit Remuneration

Committee Committee Committee Committee

Internal Audit External Audit

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Where does the auditor fit in?

Source: Deloitte (2005)

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 Audit and reliability of financial
statements
• Why might financial statements NOT present fairly? Two main
reasons:
– Error
– Fraud
• Auditor’s role is to look for misstatements caused by either reason.

• People rely on financial statements to make economic decisions.

– Audit provides confidence.

– Audit reduces uncertainty and risk.

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UK Code of Corporate Governance
The Audit Committee should:
• comprise at least 3 independent non-executive directors;
• monitor the integrity of the financial statements, reviewing significant
financial reporting judgements
• review the company’s internal controls;
• monitor and review the effectiveness of the company’s internal audit function;
• make recommendations in relation to the appointment, re-appointment and
removal and remuneration of the external auditor;
• review and monitor the external auditor’s independence and objectivity and
the effectiveness of the audit process;
• develop and implement policy on the engagement of the external auditor to
supply non-audit services;
• report to the board on how it has discharged its responsibilities.
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 Important points

Main Board

Audit
Committee

Internal External
audit audit

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Internal Audit

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 Internal Audit - factfile
• An appraisal or monitoring activity established by (or provided to) a
company.

• Functions include examining, evaluating and monitoring adequacy

and effectiveness of internal controls.

• Monitors company’s overall risk management.

• Employed by the company (in-house or outsourced).

• Do not have to be professionally qualified.

• Professional association – Inst. IA – with more than 185,000 members

worldwide.

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 Internal Audit – typical work
• IT systems reviews

• Control testing - inventory counts

• Customer service review - mystery shopper

• Compliance with law and regulation reviews

• Best Value audits – 4Cs

– Challenge
– Compare
– Consult
– Compete
• Fraud investigations
– Asset theft
– Control failures
– Fraudulent financial reporting
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Internal Audit - outsourcing

• The IA function may be outsourced to external providers, such as

accounting firms.

– What advantages/disadvantages are

there of doing this?

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 Differences between IA and EA
Internal External

Purpose Add value and improve Express an opinion on the FS

company’s operations
Employed Company Shareholders
by
Reports to Board of directors, via Shareholders
audit committee
Reports Private, restricted to Publicly available
are directors/management

Work Company’s operations Financial Statements

scope
Nature of Strategic, long-term, Risk-based, sufficient appropriate
work procedural. Evidence from evidence to support opinion as to
staff interviews, document truth and fairness of the FS
inspection.
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External Audit

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 External Audit
• ‘The annual audit is one of the cornerstones of corporate
governance…The audit provides an external and objective check on
the way in which the financial statements have been prepared and
presented.’ (Cadbury Report 1992)

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 Objective of External Audit
• The purpose of an audit is to enhance the degree of confidence of
intended users in the financial statements. This is achieved by the
expression of an opinion by the auditor on whether the financial
statements are prepared, in all material respects, in accordance with
an applicable financial reporting framework.

• ISA (UK AND IRELAND) 200 OVERALL OBJECTIVES OF THE

INDEPENDENT AUDITOR AND THE CONDUCT OF AN AUDIT IN
ACCORDANCE WITH INTERNATIONAL STANDARDS ON AUDITING

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 How do auditors do this?
• Auditing involves:

– Gathering and evaluating evidence

– Critically examining assertions made

– Assessing how closely these assertions conform to the ‘rules’

– Communicating the results in a written report

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 Assertions in the Audit of FS
Assertions relating to classes of transactions

• Occurrence : Transactions recognized in the financial statements

have occurred and relate to the entity

• Completeness: All transactions that were supposed to be recorded

have been recognized in the financial statements.

• Accuracy: Transactions have been recorded accurately at their

appropriate amounts.

• Cut-off: Transactions have been recognized in the correct

accounting periods.

• Classification: Transactions have been classified and presented

fairly in the financial statements
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https://accounting-simplified.com/audit/introduction/audit-assertions.html
Assertions relating to assets, liabilities and equity balances at the
period end
• Existence
• Completeness
• Rights & Obligations
• Valuation

Assertions relating to presentation and disclosures

• Occurrence
• Completeness
• Classification & Understandability
• Accuracy & Valuation

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 External Audit is expensive…
Company Auditor 2017 audit fee
Barclays KPMG $47 m
British Petroleum Deloitte $45 m
Royal Bank of EY $21 m
Scotland

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…it has some in-built limitations

Sampling
Limitations
Audit
of audit
judgement
report

Limitations Uncertain
Limitations
of control of auditing audit
systems evidence

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 …and it doesn’t always work
quite as intended

The FRC said it will examine why KPMG afforded HBOS a 'going
concern' status a year before the bank's catastrophic failure and
subsequent rescue by Lloyds TSB.

Accountancy Age 21 January 2016

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 So why bother?
• ‘trust engendering technology’ (Power, 1999) - monitoring
mechanism reducing agency risk

• Theories of audit
– Agency theory

– Information hypothesis

– Insurance hypothesis

• And also, of course, because it’s the law: Companies Act

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The role of audit in society
• Economic benefits of audit

• Access to capital markets

• Lower cost of capital

• Securing corporate accountability

• Deterrent to insufficiency and fraud

• Control and operation improvements

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 Workshop
• For workshop this week, please find and bring with you a recent
news story you find interesting relating to audit.

• Hint: try this link if you’re struggling

• http://www.accountancyage.com/category/audit

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