What Is the Function of Audit from a Corporate Governance Perspective - Assignment Example

Topic: Audit and corporate accountability 1. What is the function of audit from a corporate governance perspective? An effective audit function can play a significant role in demonstrating a company’s good corporate governance. It embraces varied concepts such as risk assessment, monitoring financial and operational controls and compliance. The auditor does not have direct corporate governance responsibility but rather provides a check on inappropriate accounting practices, inadequate internal controls, and ineffective corporate governance. The primary responsibility for ensuring effective governance rests with the board of directors. The board establishes the direction and values of an organization, oversees performance and protects shareholder interests. Corporate governance requires committed leadership, integrated planning, coordinated execution and constant monitoring. Good governance improves competitive position and contributes to long-term improved financial performance of the company. An important tool essential for the success of corporate governance is the efficiency and effective functioning of the audit committee. An audit committee is an operating committee of the Board of Directors formed with the purpose of assisting the management by supervising the activities of financial reporting and disclosure. Auditing the effectiveness of a company’s governance systems, practices and performance requires a rigorous methodology and comprehensive view of the company. The function of audit from a corporate governance perspective is discussed below: Audit and the Board of Directors: Effective corporate governance is the responsibility of the Board of Directors and Audit Committee assists the Board in discharging this function. The audit function ensures maintenance and regulation of: The efficiency and adequacy of the company’s internal control and risk management practices Compliance with regulations Integrity of financial statements and Financial reporting practices. Audit and Financial Disclosures: A company’s financial statements and reports should be clear, relevant, reliable and comparable. The financial information provided to shareholders should be complete, objective and timely for effective decision making. The audit function ensures: Inclusion of disclosure objectives, controls and procedures over financial reporting in the annual audit plan, In consultation with the independent auditor, internal auditors and management, review the integrity of the Company's financial reporting processes and the internal control structure. Audit and Risk Management: The company’s processes for managing business and financial risk needs to be assessed and reviewed constantly. This ensures effective risk management and improved performance. Audit provides recommendations that help Manage risk by identifying key risk areas and processes, Design, document and assess controls, Improve performance and enhance governance. Audit and Monitoring: In the face of increased regulatory scrutiny, monitoring adds significant value to the area of audit. As companies strive to strengthen controls and improve risk and performance management, the role of the auditor in the governance process increases. The objective of monitoring is to ascertain if the processes and controls are operating as intended. Audit ensures: Identification and understanding of the monitoring activity is taking place in the company for each of the other components of the governance framework. In case of discrepancies, timely performance monitoring helps the managements to take corrective action. Coordination and integration of monitoring functions enhances reporting capabilities, operations efficiencies and sustainability of corporate governance. Audit and Communication: Effective communication of legal requirements and governance practices is required as corporate governance is present in every area of the company. This results in efficient functioning of the various components of the governance framework. The audit function plays a pivotal role in communicating throughout the company by: Maintaining communication with audit committee members and board of directors Provide a channel of communication to the board for the outside auditor and internal auditors Include information about corporate governance in audit reports. Audit is an important tool essential for the practice and success of corporate governance initiatives. Thus, the scope of audit from a corporate governance perspective extends to monitoring financial and operational activities, financial disclosures, risk management and regulatory compliance. 2. What theoretical bases underpin its role? A good corporate governance structure is a working system for principled goal setting, effective decision-making and appropriate monitoring of compliance and performance. Through such an efficient structure, the management team and the board of directors can interact effectively and adapt to the changing circumstances, within a framework of solid corporate values, to provide enduring value to the stockholders who invest in the enterprise. Recent regulations, including emphases on anti-fraud and whistleblower provisions, have resulted in assigning audit function a more active role in corporate governance. Internal audit plays a pivotal role in any company in development of an integrated, well-planned and progressive governance program Internal auditing, according to the Institute of Internal Auditors definition, “helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes” Internal audit performs critical roles in implementation of corporate governance by: Supporting the audit committee in fulfilling its responsibilities Reviewing the effectiveness of the company’s code of conduct, ethics policies and whistleblower provisions Helping assess risks and measure performance across the company Monitoring corporate governance activities and compliance with the company's policies Facilitating and improving communications with the board. Auditing the effectiveness of an organization's corporate governance systems, practices and performance requires a reliable framework and methodology. For an audit process to be successful in its role, it is imperative that it will have to be independent and objective, yet be a part of the company. The auditing function requires business knowledge, decision making capacity and effective communications. The audit function should be able to assess opportunities where corporate governance can be strengthened and suggest corrective action if needed. It requires being aware of changes in regulations, access to policies and procedures, assessing risks that could cause hindrance in governance; periodic evaluation of governance activities and controls; and monitoring and providing reports to board of directors. The role of audit in corporate governance requires decision making, accountability, and monitoring. For decision making it is important that the information required is relevant and reliable. Accountability involves measuring, reporting, and transparency. Monitoring involves accessing the functioning of the systems and getting feedback. The board should receive relevant and reliable information with regard to the company’s financial and operational performance for effective decision making. Auditors should express the appropriateness and acceptability of the accounting principles used (or proposed to be used), and on the transparency and completeness of the disclosures in the financial statements based on audit evidence obtained by themselves. Financial misstatements could occur due to error or fraud and it is the auditor’s role to seek misstatements caused by either reasons. “Auditors must consider the possibility that financial statements may contain important, false representations the objective of which is to deceive the users of such statements or to conceal diversions of assets. Auditors must also keep in mind that illegal acts may have significant effects on financial statements.” The auditor is required to express an opinion on the fairness of financial statements in all material respects, the company’s financial position, results of operations, and cash flows in conformity with regulations. To be able to express such an opinion, the auditor must examine the financial statements and supporting records using sound auditing techniques. So, the primary role of audit would be to check if the financial information given to the stakeholders is reliable. All the stakeholders be it shareholders, employees, customers, lenders, vendors and the community rely on financial statements to make financial decisions. People outside the company perceive audit reduces uncertainty and risk. Audit provides confidence and adds value. To summarize, the role of audit is to assess and review the financial results and to ensure that financial statements are accurate, sufficient and credible. To perform this role adequately, it is necessary that the audit function is independent and objective. 3. In order to fulfill these functions, what are the crucial qualities/characteristics of audit? Audit is a core part of corporate governance and the need for audit should be emphasized within the company. With the recent focus on good corporate governance, the expectation from a company’s board, senior management and the audit department have been raised. The role of audit is to provide an independent review of a company’s operations and financial accounts. To meet those expectations, it is necessary to improve standards of reporting and provide transparency and disclosure standards by implementing accounting standards and strengthening the principles of corporate governance. Therefore, the audit function must be independent of the activities audited and independent from the every day internal control process. Independence is viewed as central to the ethics of the activity of auditing. The board should ensure that the independence of the audit function is maintained. The audit department thus, should not be involved in management or operational processes. The audit function should only support the management and must not have management responsibilities as the independence of the role could be compromised. The Institute of Internal Auditors (IIA) offers the following definition of internal auditing: “Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.” The audit committee should consider the independence of the outside auditor and should develop policies regarding the provision of non-audit services by the outside auditor. The provision of audit related and consulting services by the outside auditor may not be inconsistent with independence or the attestation function. The audit department should review the operations of the company, identify potential risks and ascertain the compliance of policies and procedures. It should have an audit plan documented which identifies the objectives and scope of audit. The plan should be reviewed regularly and areas in weakness of internal control identified. The progress against the plan is to be monitored regularly and reported to the board. The audit department monitors the operations of the company so that appropriate action is being taken in mitigating the risk and avoiding the possibility of loss. The audit departments should report to the board and audit committee updated with the issues and progress of audit. The reports to the managements should highlight the work performed; mention any issues requiring attention and state if the progress of work is in accordance to the plan. The efficiency of audit ultimately depends on its usefulness to the audit committee and board. Primary responsibility for the operations of the company, failures in financial reporting and misstatement of financial statements rests with top management. The management often depends on audit to find out the risks facing the company, weakness in its processes and offer its recommendations for improvement. For this the audit department should understand the controls in use for monitoring and managing risks. Thus the role of audit in corporate governance is: To plan the approach, scope of audit, observations of auditors, review of periodic financial statements and limitations of audit To ascertain that appropriate accounting policies and practices are implemented and any changes required reported to the audit committee and to the board. To reviewing the company’s financial and risk management policies and establish if it is significant to warrant disclosure To find out if there are weaknesses in accounting and internal control systems. To ensure there are no irregularities, fraud or non-compliance with law and regulations. To review legal compliance and assess the financial implications of litigations and claims against the company To ensure the applicability of going concern. To reviewing the adequacy of internal audit function, including the structure of the internal audit department, reporting structure coverage and frequency of internal audit. Reviewing the findings by the internal auditors in matters of suspected fraud or irregularity or a failure of internal control systems of a material nature, and reporting the matter to the board. The objective of audit is to assist corporate management and boards of directors in their individual efforts to implement best practices of corporate governance, and also to serve as guideposts for the public dialogue on evolving governance standards. References Institute of Directors, 2007, “The Combined Code on Corporate Governance: The audit committee” Abstract of “The Director's Handbook”, (online) Available at http://www.out-law.com/page-8219 Derek Broadley, 20 June 2006, ‘AUDITING AND ITS ROLE IN CORPORATE GOVERNANCE’, Deloitte Touche Tohmatsu, Hong Kong, (online) Available at http://www.oecd.org/dataoecd/50/6/37178451.pdf Martin Bariff, principal researcher, April 30, 2003, ‘Internal Audit Independence and Corporate Governance’, Institute of Internal Auditors-Research Foundation, (online) Available at http://www.theiia.org/iia/download.cfm?file=234 Fumio Naito, April 16, 2003, “About the Usefulness of the Accounting and Audit Function as a Method for Corporate Governance”, Kobe University, (online) Available at www.b.kobe-u.ac.jp/resource/br/pdf/No.49.pdf John F Laker, “THE ROLE OF INTERNAL AUDIT – A PRUDENTIAL PERSPECTIVE”, The Institute of Internal Auditors-Australia, (online) Available at www.apra.gov.au/Speeches/upload/The-Role-of-Internal-Audit-A-Prudential-Perspective.pdf Publication: Directors & Boards, June 22 2005, “Corporate governance: point of view (trends of internal auditing)”, (online) Available at http://goliath.ecnext.com/coms2/gi_0199-4634348/Corporate-governance-point-of-view.html Department of Business Ethics, IESE Business School - University of Navarra, ‘Ethics in Auditing and Corporate Reporting’, (online) Available at http://www.iese.edu/en/RCC/BusinessEthic/symposium/13Symposia/papers/AuditingandReporting/EthicsinAuditingandCorporateReporting.asp#8793 Read More