Role of Various Agencies

in Ensuring Ethics in
Corporations
 Factors that ensure ethical practices in
companies
1) Public opinion
2) Role of auditors
3) Role of Board of Directors in Ensuring Ethical
Business
4) Media and business ethics
5) Role of Government Agencies in Ensuring Ethical
Practices
6) Role of judiciary
7) Role of SEBI
8) Role of whistle-blowing
1. Public Opinion

• In a democracy, public opinion is a strong instrument to bring about

ethical practices among corporations

• Public opinion can initiate new requirements, help crystallization

of policy initiatives and force public authorities to create an
ethically conducive environment.

• Greater transparency, better disclosure of financial & non financial

information has been made an absolute necessity among
corporations because of hardening public opinion

• Several companies in US & Europe were made to recall their

products due to public pressure

• In India Public opinion is now gaining momentum.

2. Role of auditors

Ethics & values get short shrift in business in two ways:

 By failure of management

 By failure of auditors

 Economies reveal that auditors failed to do what they were assigned to do.
They involved themselves in unethical practices & failed to whistle blow
when things went wrong in the organizations where they were engaged as
auditors

 Certain malpractices like window dressing, manipulation of profit & loss

accounts, resorting to continuous upward revaluation of assets to conceal
poor performance are adopted by companies with the help of obliging
auditing firms
Defining Auditor

• An auditor is defined as a person appointed by a company to perform

an audit. He is required to certify that the accounts produced by his
client companies have been prepared in accordance with normal
accounting standards and represent a true and fair view of the
company. Usually, Chartered Accountants are appointed as auditors.

• An auditor is a representative of the shareholders, forming a link

between the government agencies, stockholders, investors and
creditors.
Defining Audit

• The Institute of Chartered Accountants of India (ICAI) has defined

audit as, "...The independent examination of any entity, whether profit
oriented or not and irrespective of its size or legal form, when such an
examination is conducted with a view to expressing an opinion
thereon”.

• Auditing is the process by which a competent independent person

objectively obtains and evaluates evidence regarding assertions about
an economic activity or event for the purpose of forming an opinion
about and reporting on the degree to which the assertion conforms to
an identical set of standards.
Objectives of Audit:

“the objective of an audit of financial statements is

to enable an auditor to express an opinion on
financial statements which are prepared within a
framework of accounting policies & practices &
relevant statutory requirements”
There are three types of auditors:
Internal Auditors
• Internal auditors are employed by the organization for which
they perform audits.
• Their responsibilities vary and may include financial statement
audits, compliance audits and operational audits.
• They may assist the external auditors in completing the financial
statement audit or perform audits for use by management within
the entity.
• An organization may have a small or very large internal audit
staff.
Independent Auditors

• Independent auditors are usually referred to as CPA

(Certified Public Accountants) firms.

• The opinion of an independent auditor about financial

statements makes the statements more credible to
such users as investors, bankers, labour unions,
government agencies and the general public.
Government Auditors

• Government auditors work in various local, state and federal or

Central government agencies performing financial, compliance and
operational audits.

• Local and state governments, for example, employ auditors to

verify that businesses collect and remit sales taxes and excise
duties as required by law.
DUTIES OF AN AUDITOR

The duties of an auditor are defined under section 227 (1A) of the
Companies Act 1956.
It says that an auditor can enquire
1. whether loans and advances made by the company on the basis of
security have been properly secured ;
2. whether transactions of the company which are represented merely
by book entries are not prejudicial to the interests of the company ;
3. whether loans and advances made by the company have been
shown as deposits
RESPONSIBILITIES OF AUDITORS

As per the Standard Auditing Practices (2), the auditor

• Is responsible for forming and expressing his opinion on the
financial statements.
• He assesses the reliability and sufficiency of the information
contained in the accounting records
• Determines whether the relevant information is properly disclosed
in the financial statements by comparing the financial statements
with other source data to see whether they properly summarize the
transactions and events recorded.
RESPONSIBILITIES OF AUDITORS (contd.)

• Is not expected to perform duties which fall outside the

scope of his competence. For example, the professional
skill required of an auditor does not include that of a
technical expert for determining physical condition of
certain assets.
AUDIT FAILURES LEADING TO CORPORATE
SCAMS
The Enron debacle
• In December what is termed as the biggest bankruptcy in US
history, the Houston based trader of natural gas & power, Enron
Corporation, filed bankruptcy.
• the mega corporation’s auditor, Arthur Andersen, the fifth largest
audit & consultancy firm worldwide, also faced an investigation
by the Securities & Exchange Commission (SEC) for avoiding &
destroying official documents & for not being able to detect
accounting jugglery undertaken by Enron.
• However, Arthur Andersen blamed Enron for not providing
complete information
• The collapse of Enron led to the collapse of public confidence in
the process of examining a company’s heath by auditors because
audit firms are considered to be “watchdogs” of a company’s
financial & accounting practices & their signatures certify what is
considered to be the “true & fair value” of financial statements

• Though Andersen paid a heavy price for its deviant behavior,

investors confidence in the securities market was permanently lost
& their faith in the auditing profession was badly shaken.
Other Audit Failures

• In May 2001, Sunbeam Corporation collapsed for indulging in financial

fraud and fudging of accounts.

• In June 2001, Waste Management Inc. for false statements of accounts.

• Deloitte also landed in trouble in 2002 for applying a valuation model for
fast-food franchisees, which misled bankers into extending credit to
unworthy clients and incurring bad debt of $ 10 billion.

• In 1999, another reputed US based accounting firm, Ernst & Young paid $
335 million to a client to settle a lawsuit related to accounting
problems.
THE US LAW GOVERNING AUDITORS’
RESPONSIBILITIES
 Sarbanes Oxley Act (SOX) was passed by the US Congress in
2002 with an aim to protecting investors from the fraudulent
accounting practices of corporations.
 They created a new board consisting of five members of whom
only two will be CPA’s
 All accounting firms will have to register themselves with the
board & submit a list of its staff who participate in audit
 The Public Company Accounting Oversight Board (PCAOB) will
establish rules governing audit, ethics & the firm’s independence
INDIAN ATTEMPTS TO PREVENT FRADULUENT
AUDITING PRACTICES
 Till date, four committees played a vital role in framing the
responsibilities of the auditors and the audit committees:
 the R.D. Joshi Committee,
 the Kumar Mangalam Birla Committee,
 the Naryana Murthy Committee and
 the Naresh Chandra Committee.
• All these committees' recommendations focused mainly on the
following aspects of auditing: Formation of the audit committee,
their responsibilities, rotation of auditors, prohibition of non audit
services and the transparency of financial statement.
Audit Committee

• The act provides for a new improved audit committee.

• The committee is made up of independent directors.

• It is responsible for the appointment, fixing of fees and oversight

of the work of independent auditors.

• The committee is also responsible for establishing and reviewing

the procedures for the treatment of accounts, internal control and
audit complaints
Audit Committee (contd.)
The audit committee, should review the following information.
• Financial statements and draft audit reports, including quarterly/half-
yearly information;
• Management discussion and analysis of financial conditions and
the results of operations;
• Report relating to compliance with laws and risk management ;
• Management letters/letters of internal control
• Records of related pay transactions.
Audit Partner Rotation

• These committees have also recommended the mandatory rotation

of lead audit partner reviewing audit every five years.
Prohibition of Non-Audit Services

• Auditors are prohibited from providing non-audit services

concurrently with audit review services.

• Non-audit services include book-keeping, financial and

information system design, internal audit, HRD services,
investment advice, investment banking services, legal advice,
appraisal, valuation and actuarial services.
Disclosures

• Full disclosures of accounts and decisions of management

involving the funds of the company to all its stakeholders is a
characteristic of good corporate culture.
• The R.D. Joshi Committee has suggested the imposition of
responsibility on auditors to check and, report diversion, under
misappropriation of funds by companies.
• The Naresh Chandra Committee has recommended that the
auditors should disclose implications of contingent liabilities so
that the investors and shareholders have a clear picture of these
liabilities.
Penalties

• Under section 539 of the Companies Act 1956, if an auditor is

found to be involved in unethical practices, he will be punishable
with imprisonment for a term which may extend to seven years
and shall also be liable to a fine.

• Under Section 21 of the Chartered Accountants Act, it is said that

the auditor will be prevented from exercising his duty and his
license will be cancelled by ICAI.
 Summary
o Role of auditors in ensuring business ethics
o Defining auditor
o Defining audit
o Objectives of audit
o Types of Auditor
 Internal Auditor
 Independent Auditor
 Government Auditor
o Duties of an auditor
o Responsibilities of auditor
o Audit failures leading to Corporate Scams
o Establishment of Sarbanes Oxley Act & PCAOB
o Indian attempts to prevent fraudulent practices
 Audit Committee
 Audit partner rotation
 Prohibition of non audit services
o Disclosures
o Penalties
3.Role of Board of Directors in Ensuring Ethical
Business

 Role and responsibility of the director must be performed in a by

them in order to ensure corporate governance.
Media and Business ethics

 Social media and ethics in todays time

 Creating awareness raising voice
against unethical practices
Role of government agencies

 The regulatory role

 The promotional role
 The entrepreneurial role
 The planning role
Role of SEBI

 Refer Fernando Page 564

Role of whistle blowing

 Refer to whistle blowing ACT and rules

in India.