Lecture 6: Corporate Governance and Financial Reporting Quality Flashcards
What is the definition of Corporate Governance?
It is a mechanism or system which directs & control companies.
How is corporate governance applied?
Shareholders employ the BODs and auditors to assure the appropriateness of governance.
What are the responsibilities of BODs, directors and auditors?
BODs: supervise the management of co. & report to shareholders on their supervision
Directors: control & monitor how managers govern the firm
Auditors: check the F.S. independently for shareholders
Why is Agency Theory?
It is the separation of ownership & management. Managers might be motivated to make fraud against owners to increase their own wealth. When there’s no effective monitoring system, managers might behave in a way which the interest of shareholders will deviate.
What are the benefits of the Corporate Governance Mechanism then?
It addresses beneficial procedures that may restrict the managers’ power to deviate the benefit of shareholders.
What does the Corporate Governance Mechanism consists of?
- independent BOD
- sub-committees
- internal auditors
- external auditors
Role: to prepare more assurance & protection to the shareholders’ interest
What does it mean by Earnings Management?
It is a purposeful intervention in the external financial reporting process w/ the intent of obtaining some private gain. The alteration of financial reports by structuring the transaction to either mislead a no. of stakeholders or to control contractual outcome.
NOTE: Earnings management involves choosing accounting methods & estimates that are compliant w/ GAAP, they’re not like frauds.
What are Earnings Management driven by?
- the desire to increase firm’s share price to boost managerial compensation (ie: bonuses, incentives & stock prices)
What are some of the actions taken by management for the purpose of earnings management?
- management using accrual-based techniques to manage a firm’s earnings as this provides flexibility over selection of accounting methods, which has no direct effect on cash flows.
- discretionary accruals are more visible in the co. where remuneration of top management is linked w/ the stock value of co., especially when options are applicable.
What are the roles of Audit Committee?
They play an essential role in corporate governance as they can bring independent & transparency judgement in overseeing the F.S. reporting process.
- oversee & monitor the financial reporting process
- identify & discuss any significant accounting policies
- review the significant issues in financial reports
Is it true that a larger size of audit committee is more likely to uncover & resolve potential problem in the process of financial reporting.
Yes, it’s true. This is because, they provide the necessary strength & diversity views to ensure an effective monitoring in the org.
What do audit committee need to know?
They require specialized experience & accounting knowledge so that they’re able to identify & ask questions that challenges management & external auditors, thus improving the financial reporting quality.
What do audit committee need to know?
They require specialized experience & accounting knowledge so that they’re able to identify & ask questions that challenges management & external auditors, thus improving the financial reporting quality.
Will the frequency of audit committee meeting affect its earnings quality?
Yes, as it indicate the activity level of committee members. Inactive audit committees are less likely to oversee & monitor the financial reporting process effectively.
What are the functions of Internal Auditors?
They’ll help the org. to achieve its objectives by assessing & enhancing the effectiveness of governance, internal control & risk management.
- It helps in reducing the level of discretionary acruals & improve earnings quality
- the larger the size of internal audit function, the more competent personnel to establish financial reporting controls, and reducing the weaknesses.
What does the increasing size of internal audit function indicates?
It indicates a greater resources allocated to recruit & retain competent skilled personnel.
Are outsourced internal auditors more likely to be independent in carrying out its duties & able to fulfill the monitoring role better than i house internal audit function.
Yes, because they’re more likely to be independent in carrying out their duties & able to fulfill the monitoring role better than in house internal audit function.
What are the roles of external auditor?
- they contribute to the achievement of accurate & reliable financial info
- they express an opinion on whether the F.S. of co. are prepared in accordance to the financial reporting framework
- one of the most effective governance mechanism that enhance financial reporting quality and mitigate the conflict between shareholders & management
How can external auditors be assessed?
- size of audit firm
- audit fees
- industry specialised auditor
- auditor tenure (occupancy)
Why do large audit firms have more to lose?
Due to reputation loss and litigation risk when an audit failure occurs, ths they may provide higher audit quality.
What is the effect of charging high audit fees?
- It’d lead to an increase in audit effort by external auditors
- industry specialized auditors should be able to carry out higher quality audit work due to deeper knowledge & greater experience in the industry
- auditor tenure have a -ve effect towards audit quality as their independence will decrease as the length of tenure increases
