Chapter 1 Flashcards
The need for laws, regulations, standards and other guidance
- Trend for audit and accountancy firm passing national borders and operate as global firms.
- They go past the traditional role of auditing.
- Led to a great deal of re-examination of regulatory and standard-setting structures.
- Laws and regulations is the last resort to ensure that audits are in line with standards.
- Because laws are prescriptive and seen punitive in nature.
- Audit regulation sits in between the law and standards.
- International standards are principles-based, and are more flexible than statutory laws, allowing for ambiguity and judgement on the part of the auditor.
- They are not legally binding but which provide a starting point for the auditor in a given situation
Public Oversight Internationally
The Public Interest Oversight Board (PIOB) exists to exercise oversight for all of IFAC’s ‘public interest activities’ including its standard-setting bodies such as the IAASB.
Its work involves:
•Monitoring the standard-setting boards
•Overseeing the nomination process for membership of these boards
•Co-operation with national oversight authorities
Objective of PIOB: to increase confidence of the investors and others that the public interest activities of IFAC are properly responsive to the public interest.
Sarbanes-Oxley Act 2002
- In the US, the response to the breakdown of stock market trust caused by perceived inadequacies in corporate governance arrangements and the Enron scandal was the Sarbanes-Oxley Act 2002.
- The Act applies to all companies that are required to file periodic reports with the Securities and Exchange Commission (SEC).
- The Public Company Accounting Oversight Board (PCAOB) is a private sector body in the USA created by Sarbanes-Oxley. Its aim is to oversee the auditors of public companies. Its stated purpose is to ‘protect
- the interests of investors and further the public interest in the preparation of informative, fair and independent audit reports’.
- Its powers include setting auditing, quality control, ethics, independence and other standards relating to the preparation of audit reports by issuers. It also has the authority to regulate the non-audit services that audit firms can offer.
General Requirements of CG
• Set out the rights of shareholders, the importance of disclosure and transparency and the responsibilities of the board of directors.
Audit Committee and CG
- It is made up of NEDs, and are perceived to increase confidence in financial reports
- CG is a system with which corporates are directed and controlled in order to achieve corporate objectives
Provisions regarding Audit Committee in the UK CG Code
- Ensure integrity of financial reporting, and any formal announcements of company’s performance
- Review the Company’s internal financial controls, Risk Management and other internal controls.
- Monitor and review company’s internal audit function
- Provide the recommendations on appointment, reappointment and removal of external auditors to the shareholders. And approve the remuneration of the external auditors.
- To review and monitor the external auditor’s independence and objectivity and the effectiveness of the audit process, taking into consideration relevant UK professional and regulatory requirements
To report to the Board how it has discharged its responsibilities, including:
•– How it has addressed significant issues arising in the financial statements
•– How it has assessed the effectiveness of the audit process
•– How auditor objectivity and independence is safeguarded, where the auditor provides non-audit services.
Establishment of the Audit Committee
- Should be made up of NEDs
- Two NEDs in case of smaller companies.
- At least one member should be a financial expert
- Appointments are recommended by the nomination committee, and are for a maximum of three years, but this may be extended by a further two three-year periods (nine years in total).
- There should be a minimum of three meetings per year, but the precise number depends on the circumstances. No one who is not on the committee has a right to attend meetings (but they may be there if invited).
Relationship with the BoD
- The Board decides the role of the audit committee, and it is to the board that the audit committee reports. The audit committee should report to the board on how it has discharged its responsibilities.
- The committee’s terms of reference should be tailored to the circumstances, and should be reviewed at least annually.
Roles and Responsibilities of the Audit Committee
- Financial Reporting: review significant issues and judgements. BoD is responsible for FSs.
- Narrative reporting. If the board requests it to, the audit committee will review the annual report and advise on whether it is fair, balanced and understandable.
- Whistleblowing: it reviews the mechanism by which staff can report on improper financial reporting.
- Internal controls and risk management: Reviews and provide the statements made about them in the Annual Report. Responsibility for these systems vests with the Mgt.
- Internal Audit Function:
- Review and approve its annual plan
- Ensure IA has direct access to Chairmen of the BoD
- Review the Audit Reports
- Carries out EQAs
- Report on the performance of the IA to the
- Review and monitor Mgt.’s responses to the IA findings and recommendations
Communication with shareholders
The audit committee section of annual report should include the following.
• A summary of the role of the audit committee
• The names and qualifications of all members of the audit committee during the period
• The number of audit committee meetings
• The significant issues considered in relation to the financial statements and how these issues were addressed
• An explanation of how it has assessed the effectiveness of the external audit process and the approach taken to the appointment or reappointment of the external auditor, and information on the same.
Advantages of audit committees
- It will lead to increased confidence in the credibility and objectivity of financial reports.
- By specialising in the problems of financial reporting and thus, to some extent, fulfilling the directors’ responsibility in this area, it will allow the executive directors to devote their attention to management.
- In cases where interests of the Company, EDs and employees conflict, it acts as an impartial body for thee auditors to consult
Disadvantages of audit committees
- There may be difficulty selecting sufficient non-executive directors with the necessary competence in auditing matters for the committee to be really effective.
- The establishment of such a formalised reporting procedure may dissuade the auditors from raising matters of judgement and limit them to reporting only on matters of fact.
- Costs may be increased..
Importance of internal control and risk management
- The UK CG Code states that directors ‘should maintain sound risk management and internal control systems’ (Section C2).
- Internal control systems help a company to manage the risks that it takes in trying to achieve its strategic objectives. Internal control also helps to prevent and detect fraud, and to safeguard the company’s assets for the shareholders.
Directors’ Responsibilities regarding Internal Control
The ultimate responsibility for a company’s system of internal controls lies with the board of directors. The UK Corporate Governance Code requires directors to review the effectiveness of internal controls at least annually.
•Mgt. is responsible for designing and implementing internal control system that ensure the financial statements are prepared free from errors a and mistakes
- Implement an enterprise risk management system that ensure management of key risks to the organisation
- Obtain independence assurance on the internal controls and risk mgt.
Auditors’ Responsibility regarding Internal Control
- Assess the adequacy and effectiveness of the internal control system to produce Fss that are free from material misstatements either due to fraud or error ( ISA 215)
- However, the requirements of ISAs are much narrower than the review performed by the directors. This is the role of an Internal Audit function.
- ‘We are not required to consider whether the board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the company’s corporate governance procedures or its risk and control procedures.’
The auditors may report by exception if problems arise, such as:
•The board’s summary of the process of review of internal control effectiveness does not reflect the auditors’ understanding of that process.
- The processes that deal with material internal control aspects of significant problems do not reflect the auditors’ understanding of those processes.
- The board has not made an appropriate disclosure if it has failed to conduct an annual review, or the disclosure made is not consistent with the auditors’ understanding.
