The UK System of Corporate Governance - Internal and External Audit Functions - Assignment Example

Corporate Governance Name Subject & Code Instructor Submission Date Introduction In the United Kingdom, the Cadbury Committee developed the initial version of the UK Corporate Governance Code in 1992. Paragraph 2.5 of the Code defines corporate governance refers to a set of rules and principles and a system of practices that define and direct how a company’s operations should be managed and controlled. It balances the interests of stakeholders to a company, including the board of directors, executive management, shareholders, suppliers, customers, government regulators, and financiers (Financial Reporting Council 2012). This paper discusses the UK system of corporate governance, and its key components and its objectives. It further explores the purposes and differences between internal and external audit activities and remits, as well as how the internal audit function complement the role of the external auditor. Lastly, it discusses the arguments for and against corporate engagement in social responsibility activities. Q4. The UK system of corporate governance, its key components, and its objectives The UK corporate governance system uses a market-based approach that permits the board to maintain flexibility in how it systematizes its functions and performs its responsibilities to ensure that it is effectively answerable to company shareholders. This approach is facilitated by the UK Corporate Governance Code, which operates on the strength of ‘comply or explain’ approach (Cronin & Murphy 2012). The UK Corporate Governance Code also has a range of key components intended to ensure the effective functioning of the board. This includes identification of good governance practices that relate to the board and board’s committees as well as internal control, and risk management. The components also include an effective board that provides leadership, prescribed structure, or remuneration to provide transparent procedures for executive remuneration and relationship with shareholders to ensure a link with shareholders (Financial Reporting Council 2010). Still, companies may select to use a different approach depending on whether it is highly suitable and applicable to their situation. Whenever companies do so, they have to give details of their reasons for doing so to the shareholders, who in turn have to make a decision on whether they approve the approach taken. The ‘comply or explain’ approach allows for decisions on the board’s duties and composition to be made depending on the company’s prevailing circumstances (Financial Reporting Council 2014). The UK approach has several objectives. It seeks to ensure that the board makes a business sustainable by developing a business strategy and business model. It seeks to ensure effective governance to improve the capacity of the board to oversee the operations of a company effectively. It also aims to ensure that corporate governance supports rather than restrains a company’s entrepreneurial leadership, while simultaneously making sure that risks are effectively managed. It ensures this by facilitating a considerable level of flexibility in the manner in which a company espouses and acclimatizes to governance practices (Financial Reporting Council 2010). Q5. How the internal audit function complements the role of the external auditor The internal audit distinctly differs from the external audit. However, it does serve some complementary function to the external auditor as it provides an assurance framework that shows the two have a potential to work in coordination to ensure effective corporate governance. Therefore, the two forms of the audit are crucial for an efficient governance of a company (CIMA 2010). Internal audit and external audit are different yet complement each other as they expose the adequacy of a company’s internal audit and expose the risks. Their different assurance provides an overall opinion that the company is being managed effectively. An effective internal audit can help in times of economic crisis as it may report on the competence of internal controls and the apparent risks a company is facing. Additionally, the external audits rely on internal audits to make their overall opinion. A company would expect important synergies when the external and internal auditors have established a strong relationship, as the external auditors rely on internal audit transaction testing to make their views. Essentially, while an internal audit is not by design intended to detect fraud or ineffective management teams and business models, it usually serves this function. However, it does complement an external audit firm by allowing and the audit firm to provide its valuable opinion on the accuracy, exactness, and credibility of financial statements. The internal audit provides the external audit with the data it needs to form its opinion on the accounts that a company’s managers and directors have prepared (CIMA 2010). Additionally, while the internal audit is seen to complement external audit, coordinating internal audit activities with those of external audit is crucial from the perspective of internal audit, as it guarantees a credible internal audit by providing critical information to assess risks control. From the external audit’s perspective, it allows the external auditors raise the efficiency of financial statements audit (Atanasiu & Bota-Avram 2008). Q6. The arguments for and against corporate engagement in social responsibility activities The concept of corporate social responsibility (CSR) is an approach designed to allow a company to contribute to sustainable development through the delivery of social, economic, and environmental benefits to stakeholders. There are some arguments in favour and against corporate engagement in social responsibility activities (Carrol & Shabana 2010). Corporate engagement in social responsibility activities is crucial as it protects stakeholders’ interests, based on the stakeholder theory. Lack of adherence to the social norms potentially attracts legislative restrictions or litigations (Tanuja 2016). For instance, companies that pollute the environment through poor waste management that in turn brings harm to the public may attract legislative restrictions or litigations, or heavy fines and in extreme circumstances closure. On the other hand, corporate engagement in social responsibility should be restricted because company’s business is essentially an economic activity, as its primary function is to seek for economic viability in all its business functions to increase its profitability. Based on the cost-benefit analysis, it could further be argued that any CSR activity that has initial costs that go beyond the anticipated benefits may make a company less profitable. Indeed, when quantified, corporate engagement in social responsibility is costly as it requires a company to commit capital resources to the social values. Hence, it has to ensure maximisation on long-term return on investment (ROI) of a company; otherwise, it would be useless (Wood 2009) . b) Comparison and contrast between the shareholder primacy approach with the stakeholder approach to managing a business. The shareholder primacy approach contends that the primary duty of a company’s management is to ensure that shareholder returns are maximised. On the other hand, stakeholder theory contends that directors are responsible to shareholders and non-shareholder stakeholders and work in their specific interests. Therefore, while shareholder primacy focuses on maximising shareholders’ interests, it overlooked the interests of non-shareholder stakeholders. The stakeholder approach also seems to contend that, it is not the shareholders alone who contribute to the success of a company. Stakeholders also make significant contributions. Purposes and differences between internal and external audit activities and remits The purpose of the external audit is to make sure that the reports from companies to shareholders are more credible and reliable by adding their opinion to the reports. On the other hand, the purpose of internal audit is to offer an assurance that can be used by the executive management and board members to discharge their duties and responsibilities (Chartered Institute of Internal Auditors 2015b). While external auditors offer assurance to the shareholders who are actually outside the company’s management boundary, internal auditors offer assurance within the company’s management boundary, particularly to the executive management, members of the board and the audit committee. Next, external and internal audit also has different rationale for providing their assurances. For instance, an opinion by the external audit in addition to the work performed by external auditors seeks to add corroboration, reliability, and trustworthiness to company’s reports meant for shareholders. In contrast, an assurance by the internal auditors serves to offer board members and the executive management a reassurance they can apply to undertake their duties to the company (CIMA 2015a). In addition, their timing and rate of recurrence of audit work also differ. Essentially, external audit is linked to the cycle for external financial reporting of the company and is intended to support the annual opinion of the external auditor on the company’s financial statements. Conversely, internal auditing is essentially a more lasting and is an ongoing process, as a majority of its tasks is based on engagements that have been planned beforehand. The nature of work designated to internal and external audit also differs. The external audit offers its view on financial statements in addition to other associated disclosures or types of reporting to shareholders in addition to financial reporting on risks as well as their management. On the other hand, internal audit encompasses many risks categories by identifying and responding to risks (CIMA 2015b). Conclusion The UK corporate governance system uses a market-based approach that permits the board to maintain flexibility in how it systematizes its functions. This approach is facilitated by the UK Corporate Governance Code, which operates on the strength of ‘comply or explain’ approach. Corporate engagement in social responsibility activities is crucial as it protects stakeholders’ interests. On the other hand, corporate engagement in social responsibility should be restricted on the basis that a company’s primary function is to seek for economic viability in all its business functions to increase its profitability. On the other, it is the government’s responsibility to fulfil the interests of the public. The purpose of the external audit is to make sure that the reports from companies to shareholders are more credible and reliable by adding their opinion to the reports. On the other hand, the purpose of internal audit is to offer an assurance that can be used by the executive management and board members to discharge their duties and responsibilities. While the internal audit distinctly differs from external audit, it does serve some complementary function to the external auditor. This is because it provides an assurance framework that shows the two have a potential to work in coordination to ensure effective corporate governance. 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