Session 2 Practice Implication

Question 1

What are the practice implications of the audit committee hiring the external auditors?

Answer 1

There won’t be a good AC paired with bad external auditors or vice-versa, because a bad AC will hire bad auditors. Shareholders have little protection from weak governance.

Question 2

Weak governance is associated with an increased likelihood of adverse financial reporting outcomes

Answer 2

SOX is actually helping make better governance

Question 3

Boards and audit committees are primary mechanisms for the internal monitoring of top management’s financial reporting behavior, and the CEO and/or CFO is involved in most public company accounting frauds.

Answer 3

External auditors need to be very careful in their assessment of governance characteristics. Management knows far more about the company that the auditors, which makes it easier to hide stuff. Informal interactions let the auditor know what the board and AC are like.

Question 4

Auditor changes / dismissals are less problematic in the presence of good governance.

Answer 4

Regulators can use governance characteristics to decide if an auditor dismissal was legit or not.

Question 5

External auditors assess risk higher, and plan more audit hours, for firms with weak governance; however, whether auditors adequately adjust for weak governance has not been examined.

Answer 5

Auditors should see if their are truly adjusting enough to potential risks associated with weak governance.

Question 6

A number of studies have demonstrated the importance of accounting expertise, auditing expertise and industry expertise in an audit committee.

Answer 6

If there are no financial experts on an AC, the auditor should challenge the effectiveness of the AC.

Question 7

Audit committee compensation methods can influence audit committee members’ judgments and are associated with the risk of restatement and the handling of auditor adjustments

Answer 7

If AC are compensated with short-term incentive-based pay (short-term stock options), there may be conflicts of interest.

Question 8

Some audit committees appear to take their monitoring roles seriously, while others appear to be primarily ceremonial in nature.

Answer 8

Auditor’s should adjust their measurements of necessary work based on how effective the AC is at their job. Especially if AC is compromised by dominant CEO.

Question 9

There is severe reputational damage experienced by directors, especially audit committee members, in cases of financial reporting failure.

Answer 9

Permanent staff or consultants to AC may reduce impact of reputation risk.