ISSN 0268-6902 Managerial Auditing Journal Volume 17, Number 3, 2002 Critical perspectives on accounting and finance This issue is part of a comprehensive multiple access information service comprising: Paper format Managerial Auditing Journal includes nine issues in traditional paper format The contents of this issue are detailed below Contents 110 Access to Managerial Auditing Journal online 111 Abstracts & keywords 113 Accounting and auditing requirements of the Sudan Companies Act 1925: time for change John A Brierley, Hussein M El-Nafabi and David R Gwilliam 117 Re-engineering recruitment to the accounting profession Malcolm Smith and Christopher Graves 122 A critical evaluation of the effect of participation in budget target setting on motivation Pamela Reid 130 An assessment of the newly defined internal audit function Albert L Nagy and William J Cenker 138 Auditing the indirect consequences of rework in construction: a case based approach Peter E.D Love 147 Corporate governance: communications from internal and external auditors Janet L Colbert 153 Slack in public administration: conceptual and methodological issues Tor Busch Internet Online Publishing with Archive, Active Reference Linking, Emerald WIRE, Key Readings, Institution-wide Licence, E-mail Alerting Service, and Usage Statistics Access via the Emerald Web site: http://www.emeraldinsight.com/ft See overleaf for full details of subscriber entitlements Managerial Auditing Journal online An advanced knowledge resource for the entire organization Access via the Emerald Web site – http://www.emeraldinsight.com/ft Subscribers to this journal benefit from access to a fully searchable knowledge resource stretching far beyond the current volume and issue Managerial Auditing Journal online is enhanced with a wealth of features to meet the need for fast, effortless, and instant access to the core body of knowledge Furthermore, this user-friendly electronic library may be networked throughout the 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log on either from the journal homepage or direct through the Emerald Web site Emerald Customer Support Services For customer service and technical help, contact: E-mail: support@emeraldinsight.com Telephone: (44) 1274 785278 Fax: (44) 1274 785204 Abstracts & keywords Accounting and auditing requirements of the Sudan Companies Act 1925: time for change John A Brierley, Hussein M El-Nafabi and David R Gwilliam Keywords The Sudan, Legal matters, Balance sheets, Profit and loss, Accounting The Sudan Companies Act 1925 is outdated There is a need for substantial revision to the Act either in accordance with, for example, current UK legislation, or a framework more directly suited to the economic and legal environment of the Sudan At a general level this should include the preparation of a profit and loss account, specific formats for the profit and loss account and balance sheet, notes to the accounts and an auditor’s report stating whether or not the accounts give a true and fair view of the state of a company’s affairs Re-engineering recruitment to the accounting profession Malcolm Smith and Christopher Graves Keywords Recruitment, Biodata, Forecasting, Performance, Modelling There can be few personnel techniques so lowly regarded as the recruitment interview Yet we persevere with the use of the technique despite the overwhelming evidence of its deficiencies The accountancy and auditing professions are as guilty as most in this regard, and suffer from rates of attrition and job turnover, which should be an embarrassment But there are alternatives available, and this paper reports on the development of revolutionary techniques which might have a significant impact on recruitment to the accounting and auditing professions in the UK A critical evaluation of the effect of participation in budget target setting on motivation Pamela Reid Keywords Accounting, Theory, Target setting, Participation, Performance Managerial Auditing Journal 17/3 [2002] Abstracts & keywords # MCB UP Limited [ISSN 0268-6902] This paper critically evaluates the effect of participation in budget target setting in an effort to increase the probability of an organisation’s goals being achieved and, in so doing, considers some of the numerous theories of motivation Such theories include Maslow through to equity and expectancy theories However, given that there are a multiplicity of variables at work here, the author concludes that the effect of participation is situation specific and dependent upon such variables: there is no ‘‘perfect’’ budgeting system An assessment of the newly defined internal audit function Albert L Nagy and William J Cenker Keywords Internal audit, Committees, Risk management, Corporate governance, Competences The new definition of internal auditing defines the function as an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations The purpose of this paper is to summarize an assessment of this new definition obtained through structured interviews from 11 internal audit directors of large publicly traded companies The responses from the directors indicate that there are wide differences in viewpoints and objectives; but a definite shift has occurred in the overall scope of internal audit towards operational activities While most of the interviewees are in conceptual agreement with the new internal audit definition, an underlying warning is vocalized: ‘‘Don’t throw out the franchise’’ That is, the traditional role of the internal auditor should not be completely abandoned These, along with other responses pertaining to related issues and suggestions for future research, are summarized throughout the paper Auditing the indirect consequences of rework in construction: a case based approach Peter E.D Love Keywords Construction industry, Indirect costs, Contract, Defective premises There is little known about the indirect consequences of rework in construction projects, especially the financial costs Therefore, this paper uses examples from a case study to demonstrate the potential indirect consequences and costs that are associated with undertaking rework in building construction projects A novel taxonomy for categorising the indirect consequences at an individual level, organisational level and project level is presented Based on the findings from examples derived from the case study, it is suggested that the incidence of rework can have a multiplier effect of up to six times the actual (direct) cost of rectification To reduce these costs it is concluded that design and construction organisations must improve their quality management systems by including a quality system for continuously auditing, analysing and presenting direct as well as indirect rework costs [ 111 ] Abstracts & keywords Managerial Auditing Journal 17/3 [2002] 111–112 Corporate governance: communications from internal and external auditors Janet L Colbert Keywords Corporate governance, Auditors, Communication, Finance International Standards on Auditing (ISAs) require external auditors to communicate with the client’s governance body regarding significant matters which came to the auditors’ attention during the engagement Similarly, the authoritative Practice Advisories (PAs), issued by the Institute of Internal Auditors (IIA), mandate that internal auditors discuss certain items with the board Thus, the governance body/board should be receiving information from two groups of auditors Compares and contrasts the requirements of the ISAs and PAs with regard to communications with the governance body/board The differences in the communications to the governance body/ board by the external and internal auditors derive mainly from the focus of each group The external auditors serve those users external to the organization; in contrast, internal auditors serve the board, which is responsible for the internal aspects of the entity Besides communication on financial issues, the board also desires information on operational and compliance matters The comparison of the international external auditing and the internal auditing standards shows that some information received by the governance body/board is similar However, much is unique Both groups of auditors aid the governance body/board in achieving its objective of guiding the entity to carry out its mission effectively and efficiently [ 112 ] Slack in public administration: conceptual and methodological issues Tor Busch Keywords Costs, Management, Efficiency, Public administration Ever since its introduction, the concept of organisational slack has constituted the basis for a considerable body of research within behavioural science A great deal of this research has concentrated on budgetary slack, and within the field of public administration the focus has been on the slack- or budget-maximising bureaucrat As the reduction of slack is the purpose of many of the techniques which are part of the new public management, there is a need to focus on how to measure changes in the level of slack The objective of this paper is to discuss the relationship between three central concepts within the research on slack: organizational slack, budgetary slack, and the discretionary budget; to assess whether these concepts are suitable for public organizations; and to discuss problems of measurement Accounting and auditing requirements of the Sudan Companies Act 1925: time for change John A Brierley Sheffield University Management School, The University of Sheffield, Sheffield, UK Hussein M El-Nafabi Al-Madina Al-Munawarah College, Al-Madina Al-Munawarah, Saudi Arabia David R Gwilliam School of Management and Business, University of Wales Aberystwyth, Aberystwyth, UK Keywords The Sudan, Legal matters, Balance sheets, Profit and loss, Accounting Abstract The Sudan Companies Act 1925 is outdated There is a need for substantial revision to the Act either in accordance with, for example, current UK legislation, or a framework more directly suited to the economic and legal environment of the Sudan At a general level this should include the preparation of a profit and loss account, specific formats for the profit and loss account and balance sheet, notes to the accounts and an auditor’s report stating whether or not the accounts give a true and fair view of the state of a company’s affairs Managerial Auditing Journal 17/3 [2002] 113–116 # MCB UP Limited [ISSN 0268-6902] [DOI 10.1108/02686900210419886] Introduction The Sudan Companies Act 1925 (hereafter the Act) was modelled on the UK Companies Act 1908 Despite the Sudan gaining independence from the UK in 1956 it has not been amended One of the reasons for this has been the distraction of the Sudanese civil war which broke out in 1955 and, except for ten years of peace following the 1972 Addis Ababa Agreement, has continued ever since This has been exacerbated by seven different regimes (three civilian and three military) which have governed the country since independence The common features shared by these regimes have been frequent changes of government, continuous cabinet reshuffles and high ministerial turnover For example the Ministry of Economic Planning, which plays a major role in the management of the economy, has been led by 32 ministers since independence The last multiparty democratic government, which came to office in 1986, saw four ministerial reshuffles in its three years in office with some ministerial offices changing hands on four occasions These frequent cabinet reshuffles led to a lack of continuity in government which has been exacerbated by the lack of clear descriptions of ministerial posts, and of agreed policies or manifestos to be followed by the appointed ministers Indeed, the lack of clear policies and strategies has made it the general norm in the Sudanese government’s history that every new minister starts his job by scrapping the policies adopted by his predecessor This government instability affects the environment in which accounting and auditing operate and has contributed to the fact that no amendments have been made to the Act Similarly, other acts established under British colonial rule have not been subsequently amended, these include the Bills of Exchange Act 1917 and the Insolvency Act 1929 Furthermore, it has been argued that the establishment of a professional accounting body in the Sudan was necessary to develop accounting and auditing practice To this end individuals who were members of professional accounting bodies outside the Sudan, notably the Institute of Chartered Accountants in England and Wales and the Association of Chartered Certified Accountants in the UK, made several attempts in the early 1980s with the government to establish a professional accounting body in the Sudan Due to the rapid changes in the political system during the 1980s these efforts did not come to fruition until the Certified Accountants Act 1988, which established the Sudanese Association of Certified Accountants (SACA) Article of the 1988 Act sets out the functions of the council of the SACA, which includes the enhancement of the role of accounts in the commercial environment This has not led, however, to any changes in the Act Thus government instability and the lack of influence of the accounting profession has meant that the Companies Act 1925 has never been amended The Act was introduced to assist the formation of private and public limited liability companies, and provide rules for the governance of their operations and financial affairs, but today it is out of date The objective of this paper is to illustrate the outdated nature of the Act’s provisions relating to accounting and auditing and offer suggestions for updating the legislation The paper is divided into three sections The first section discusses the Act’s accounting provisions, the second section discusses the Act’s auditing provisions, and the third section provides a brief discussion of necessary changes to the Act Accounting provisions The current issue and full text archive of this journal is available at http://www.emeraldinsight.com/0268-6902.htm Section 123(1) of the Act requires that every company shall keep proper books of account [ 113 ] John A Brierley, Hussein M El-Nafabi and David R Gwilliam Accounting and auditing requirements of the Sudan Companies Act 1925: time for change Managerial Auditing Journal 17/3 [2002] 113–116 in which there shall be full, true and complete accounts of the transactions and affairs of the company Section 124(1) states that every company has to prepare a balance sheet at least once a year and at intervals of not more than 15 months Further, section 124(2) requires that the balance sheet has to be audited by the auditor of the company, and the auditor’s report should be attached to the balance sheet, or there should be inserted at the foot of the balance sheet a reference to the report The auditor’s report should be read out at the general meeting and should be open to inspection by any member of the company Section 125(1) requires that the balance sheet contains a summary of the property and assets, and the capital and liabilities of the company Although no indication is provided as to the amount of disclosure, details should be provided of the ‘‘general nature’’ of assets and liabilities and ‘‘how the value of fixed assets has been arrived at’’ Details about the content of the balance sheet are stated in the Third Schedule Form C of the Act (see Appendix) There is no requirement to disclose comparative figures on the face of the balance sheet; hence it is not possible to make comparisons of amounts disclosed in the balance sheet with the previous year The balance sheet does not require separate disclosure of the accounting policies used or further disclosure of items in the form of a note to the balance sheet The balance sheet does not provide separate disclosure of a number of items, such as investments, like government securities, shares and debentures Nor is there a requirement for a breakdown of stocks and work-in-progress and debtors (Tyagi, 1982) There is no detailed breakdown of liabilities, for example, Tyagi (1982) notes that disclosure is not required of proposed dividends and of the security for any loans received There is no requirement to prepare a profit and loss account The only requirement is to disclose the profit for the financial year on the face of the balance sheet, although this requirement does not apply if a separate profit and loss account is prepared If a profit and loss account is prepared it does not have to follow any specific format, which may lead to difficulties when making comparisons between companies Auditing provisions Section 138 of the Act specifies the powers and duties of auditors Section 138(1) states that auditors have the right of access at all [ 114 ] times to the books, records and accounts of a company and are entitled to receive from the directors and officers of the company such information and explanations as may be necessary to carry out their work as auditors Auditors are required to report on: whether or not they have obtained all the information and explanations they require; whether in their opinion the balance sheet has been drawn up in conformity with the law (presumably the Act); and whether or not the balance sheet exhibits a ‘‘true and correct view of the state of the company’s affairs according to the best of their information and explanations given to them, and as shown by the books of the company’’ (emphasis added) The requirement to show a true and correct view is contrary to the concept of ‘‘true and fair view’’ in the UK According to Tyagi (1982), the auditor is unable to certify whether the financial statements exhibit a ‘‘correct’’ view because the auditor is not connected with the management of the company He argues that because the balance sheet is a summary statement of the activities of the whole company it is more appropriate for the auditor to assess whether the balance sheet shows a true and fair view The Act does not require the auditor to state whether or not the profit and loss account, if prepared, gives a true and fair view of the profit (or loss) for the period, nor whether or not the accounts have been prepared properly in accordance with the provisions of the Act Section 137 of the Act specifies the requirements regarding the qualifications and appointment of auditors The Act does not specify the necessary qualifications of persons who are eligible to act as company auditors, although in order to preserve auditor independence section 137(5) does prevent certain persons from acting as auditors These include: a director or officer of the company; a partner of such a director or officer; and any person in the employment of a director or officer Section 137(1) requires that an auditor should hold a certificate issued by the Minister of Finance and National Economy Usually the auditor is appointed at the annual general meeting until the next such meeting If for some reason an auditor is not appointed at the annual general meeting, section 137(4) states that the court may, following the application of any member of the company, appoint an auditor and fix their remuneration for the current year John A Brierley, Hussein M El-Nafabi and David R Gwilliam Accounting and auditing requirements of the Sudan Companies Act 1925: time for change Managerial Auditing Journal 17/3 [2002] 113–116 Discussion The 1925 Companies Act is outdated and does not reflect the changes and the worldwide developments in the areas of accounting and auditing practice There is clearly a need for substantial revision of the Act either in accordance with, for example, current UK legislation or, perhaps more appropriately, in line with a framework more directly suited to the economic and legal environment of the Sudan At a general level this should include the preparation of a profit and loss account, specific formats for the profit and loss account and balance sheet, notes to the accounts and an auditor’s report stating whether or not the accounts give a true and fair view of the state of a company’s affairs Reference Tyagi, C.L (1982), ‘‘Balance sheet reform needed’’, Sudanow, Vol No 11, p 29 Appendix Third Schedule Form C of the Sudan Companies Act 1925 Limited Balance-sheet As at 19 Capital and liabilities Capital LS m/ms Authorized capital shares of LS each Issued capital shares of LS each Subscribed capital shares of LS each Amount called up at LS per share Less calls unpaid Add – forfeited shares (amount paid-up) Reserve fund or development fund Any sinking fund Any other fund created out of net profits Any pension or insurance fund Provision for bad and doubtful debts Loans on mortgage or mortgage debenture bonds Loans otherwise secured (stating the nature of security) Loans unsecured Interest Accrued on mortgages, debentures of other secured loans Unclaimed dividends Liabilities For goods supplied For expenses For acceptances For other finance Advanced payments and unexpired discounts (For the portion of which value has still to be given, e.g in the case of the the following classes of companies: Newspaper, fire insurance, theatre, club, banking, steamship companies, etc.) [ 115 ] John A Brierley, Hussein M El-Nafabi and David R Gwilliam Accounting and auditing requirements of the Sudan Companies Act 1925: time for change Profit and loss LS m/ms Balance brought forward Managerial Auditing Journal 17/3 [2002] 113–116 Profit since last balance-sheet Balance as per previous balance-sheet Less – appropriation thereof (N.B – These details need not to be given if the same be contained in a profit and loss account attached to the balance-sheet.) Contingent liabilities – claims against the company not acknowledged as debts Money for which the company is contingently liable Arrears of cumulative preference dividends Property and assets Fixed capital expenditure (Distinguishing as far as possible between expenditure upon goodwill, land, buildings, leaseholds, railway sidings, plant, machinery, furniture, development of property, patents, trade marks and designs, interest paid out of capital during construction, etc., and stating in every case the original cost and the total depreciation written off under each head) Preliminary expenses Commission or brokerage (Commission or brokerage paid for underwriting or placing shares or debentures until written off) Stores and spare gear Loose tools Live stock (Stating mode of valuation, e.g cost or market value.) Bills of exchange Book debts (Distinguishing in the case of a bank between those considered good and in respect of which the bank holds no security other than the debtor’s personal security, and distinguishing in all cases between debts considered goods and debts considered doubtful or bad Debts due by directors or other officers of the company or any of them either severally or jointly with any other persons to be separately stated in all cases.) Advances (Recoverable in cash or in kind or for value to be received, e.g rates, taxes, insurance, etc.) Investments (Nature of investment and mode of valuation, e.g cost or market value.) Interest accrued on investments Cash and other balances Amount in hand Balances with agents and bankers (in detail, showing whether on deposit or current etc.) Profit and loss (giving in the case of a debit balance details as far as possible as in the case of a credit balance) [ 116 ] Re-engineering recruitment to the accounting profession Malcolm Smith School of Accounting and Information Systems, University of South Australia, Adelaide, Australia Christopher Graves School of Accounting and Information Systems, University of South Australia, Adelaide, Australia Keywords Recruitment, Biodata, Forecasting, Performance, Modelling Abstract There can be few personnel techniques so lowly regarded as the recruitment interview Yet we persevere with the use of the technique despite the overwhelming evidence of its deficiencies The accountancy and auditing professions are as guilty as most in this regard, and suffer from rates of attrition and job turnover, which should be an embarrassment But there are alternatives available, and this paper reports on the development of revolutionary techniques which might have a significant impact on recruitment to the accounting and auditing professions in the UK During this decade, dramatic changes have occurred in the business environment In order to remain competitive, accountancy firms now need to provide a diverse range of services to their clients, at low cost To meet these challenges, it is critical that accountancy firms select their employees carefully, as failure to select the right staff can be costly Some of the costs associated with poor recruitment decisions include: lower productivity and competitiveness, potential loss of clients, training costs, advertising costs, recruitment fees and redundancy packages The US Department of Labour estimates that a poor recruitment decision can cost the employer an amount equal to 30 percent of the employee’s first year’s potential earnings (Hacker, 1997) KPMG state that ‘‘the current estimate of investment per student is £100,000’’ (KPMG-UK, n.d.) Recruiters face a difficult task as they need to make a decision that predicts the contribution that an individual will make to the organisation in the future based on the factual and personal information available now As a result, any recruitment selection procedure adopted by the accounting profession will be an imprecise selection tool Essentially, there is no real substitute for observing the performance of individuals in the field, hence the popularity of intern relationships However, these may not always be available Practical tests conducted at interview may be a less than satisfactory alternative, but are still not universally adopted Conventional approaches to recruitment Managerial Auditing Journal 17/3 [2002] 117–121 # MCB UP Limited [ISSN 0268-6902] [DOI 10.1108/02686900210419895] Most frequently, recruiters adopt a two-stage procedure: The current issue and full text archive of this journal is available at http://www.emeraldinsight.com/0268-6902.htm Select (or not) candidates for interview based on the contents of their application form requiring biographical information (biodata) Make a final employment decision based on a personal interview; this itself may be a two-stage procedure if applicants are first used to draw up a short-list of potential appointees Dipboye et al (1984) suggest that ‘‘no other personnel technique is held in such low esteem in the research literature as the interview’’, yet despite its demonstrable lack of reliability and validity, the unstructured interview remains the prime assessment mechanism in graduate recruitment This is despite the fact that, before the interview, applicants complete a form containing historic and verifiable information about the individual which would permit the development of scoring systems and the construction of models with potentially high predictive ability of eventual success In the UK, around 30 percent of graduates entering the profession ultimately fail to qualify as accountants, a statistic which Harvey-Cook and Taffler (1987) attribute to failures of recruitment procedures Harvey-Cook et al (1998) and Gammie (1999) demonstrate that selection models using biographical data have value to recruiters and outperform conventional approaches; they suggest that significant benefits can be accrued by the accountancy profession through the adoption of formal statistical procedures at the selection stage Emerging recruitment techniques Harvey-Cook et al (1998) Holland (1976) finds that people with similar background characteristics form six vocational types: realistic, social, investigative, creative, conventional and enterprising Accountants are generally of the ‘‘conventional’’ type Biographical data [ 117 ] Malcolm Smith and Christopher Graves Re-engineering recruitment to the accounting profession Managerial Auditing Journal 17/3 [2002] 117–121 on personal characteristics and previous academic performance have been shown to be the best predictor of employee turnover (Gable et al., 1989), job performance (Hunter and Hunter, 1984) and voluntary withdrawal during training (Drakeley et al., 1988) In the UK, the most common cause of withdrawal from the profession during training is examination failure As a result, Harvey-Cook et al (1998) first developed a model for success in the professional examinations (Model 1) and then a model for ‘‘success’’ which incorporated both progress in examinations and good work performance (Model 2) Both of these models were constructed based on applicants to the profession employed by second-tier accounting firms (i.e not the then Big 6) The models The two models are described as follows: Model 1: to predict examination success Six significant variables were identified in trainee application forms that contributed to examination success In descending order of importance: number of grade As at ‘‘O’’ level; a good first degree (first or upper second class); number of arts or language ‘‘A’’ levels (a negative variable); first degree in science or mathematics; head boy or girl at school; independent school background The model’s overall probability of correct classification is 74 percent, with 78 percent of ‘‘pass’’ predictions correct and 69 percent of ‘‘fail’’ predictions correct in a sample of 229 applicants taking the professional examinations (see Table I) Model 2: to predict good work performance Again six significant variables were identified In descending order of importance: number of ‘‘A’’ levels in science subjects; head boy or girl at school; number of teams and societies at school; exemption from the graduate conversion course specifically designed for non-accounting graduates; degree class for first degree; Table I Model 1: to predict examination success Predicted pass Actual pass Actual fail Overall [ 118 ] Predicted fail Correct (%) 29 68 97 78 69 74 131 98 229 These two models were confirmed by applying them to a second group of applicants three years later Relevance to the accounting and auditing professions As both models are based on UK data, the important variables in each of the models provides a fair reflection of what might be important characteristics in a UK environment: ‘‘O’’ level (now GCSE) grades are the most important feature in predicting examination success These exams are undertaken at age 16 and provide the basic evidence of performance ability for university selection interviews in the following year Although ‘‘A’’ levels are completed at age 18, in most cases these will only determine the particular university destination; with minimal performance at ‘‘A’’ levels, the ‘‘O’’ level performance may determine university entrance Students who choose electives in mathematics and science at school are likely to fare better than those choosing arts and languages Students who choose an accounting degree at university, and who are therefore not subjected to a graduate conversion course, or equivalent, should better in the profession Interpersonal skills and social activities undertaken at school are important and positive – e.g school dux, sports colours and team participation The opposite appears to be true at university, where extra-curricula activities appear to have a negative effect The class of first degree awarded is significant, so the achievement of First Class Honours or a ranking in the top percent of graduating students would be positively regarded This study showed that an independent school background was a positive factor, though one less important than the other factors Total 102 30 132 size of social interaction groups at university (a negative variable) The model’s overall probability of correct classification is 75 percent, with 75 percent of the ‘‘successful’’ predictions correct, and 76 percent of the ‘‘unsuccessful’’ predictions correct (see Table II) Gammie (1999) Gammie (1999) constructed similar models for predicting success in the professional examinations However, this study extends Peter E.D Love Auditing the indirect consequences of rework in construction: a case based approach Managerial Auditing Journal 17/3 [2002] 138–146 improvement results in cost improvement Simply paying higher fees to design consultants will not reduce rework per se, as designing and constructing a facility right first time will always cost less Solving problems by identifying their causes and eliminating them can result in measurable savings and improved processes Thus, if construction organisations are to capitalise upon these savings they must implement a quality management system, which is supported with a quality cost system Only when organisations begin to measure (and hence appreciate) their rework costs, will they really understand the economics of quality Conclusion To date there has been limited research that has sought to determine the indirect consequences of rework events While the research presented in this paper has been exploratory in nature, it has demonstrated that the indirect costs of rework are significant as they can have a cost multiplier effect of three to six times the costs of actual rectification and therefore should not be ignored Such costs can lead to an organisation experiencing reduced profits and competitiveness in their respective marketplace A taxonomy of indirect costs that were experienced in the two examples presented were identified These costs, which could not be assigned any monetary value, occurred at the individual (e.g stress, fatigue, de-motivation) organisational (e.g inter-organisational conflict, loss of future work, reduced profit) and project levels (e.g work inactivity, end-user dissatisfaction) The findings presented in this paper, however, highlight the importance of ‘‘getting things right the first time’’, and that construction organisations, particularly design consultants, should use a quality management concept to audit the costs associated with having to undertake rework Once an organisation knows how rework is influencing its ‘‘bottom line’’ it can then implement the appropriate process improvement strategies to eliminate these costs Until construction organisations take responsibility for their own actions, and improve the quality of service they provide then rework will remain an endemic feature in construction projects References Abdul-Hamid, T.K and Madnick, S.E (1991), Software Project Dynamics An Integrated Approach, Prentice-Hall, Englewood Cliffs, NJ Abdul-Rahman, H (1995), ‘‘The cost of nonconformance during a highway project: a case study’’, Construction Management and Economics, Vol 13, pp 23-32 Ashford, J.L (1992), The Management of Quality in Construction, E & F Spon, London Barber, P., Graves, A., Hall, M., Sheath, D and Tomkins, C (2000), ‘‘Quality failure costs in civil engineering projects’’, International Journal of Quality and Reliability Management, Vol 17 No 4/5, pp 479-92 Building Research Establishment (BRE) (1982), Quality in Traditional Housing – An Investigation into Faults and Their Avoidance, BRE, Garston Burati, J.L, Farrington, J.J and Ledbetter, W.B (1992), ‘‘Causes of quality deviations in design and construction’’, ASCE Journal of Construction Engineering and Management, Vol 118 No 1, pp 34-49 Campanella, J (1990), Principles of Quality Costs: Principles, Implementation and Use, ASQC Quality Press, Milwaukee, WI Chan, D.W.M and Kumaraswamy, M.M (1997), ‘‘A comparative study of causes of time overruns in Hong Kong construction projects’’, International Journal of Project Management, Vol 15 No 1, pp 55-63 Chapman, R.J (1999), ‘‘The likelihood and impact of changes of key project personnel on the design process’’, Construction Management and Economics, Vol 17, pp 99-106 Construction Industry Development Agency (CIDA) (1995), Measuring up or Muddling through: Best Practice in the Australian Nonresidential Construction Industry, CIDA and Masters Builders Australia, Sydney, pp 59-63 Cooper, K.G (1993), ‘‘The rework cycle: benchmarks for the project manager’’, Project Management Journal, Vol 24 No 1, pp 17-21 Cox, I.D., Morris, J., Rogerson, J.H and Jared, G.E (1999), ‘‘A quantitative study of post contract award design changes in construction’’, Construction Management and Economics, Vol 17 No Crawshaw, D.T (1976), Co-ordinating Working Drawings, Building Research Establishment, Current Paper CP 60/76, Watford Dalty, C.D and Crawshaw, D.T (1973), Working Drawings in Use, Building Research Establishment, Current Paper CP 18/73, Watford Davis, K., Ledbetter, W.B and Burati, J.L (1989), ‘‘Measuring design and construction quality costs’’, ASCE Journal of Construction Engineering and Management, Vol 115, pp 389-400 Department of Industry, Science and Tourism (DIST) (1998), Building for Growth A Draft Strategy for the Building and Construction Industry, DIST, Commonwealth of Australia Publication, Canberra, February Edwards, D., Holt, G.D and Harris, F.C (1998), Maintenance Management of Heavy Duty [ 145 ] Peter E.D Love Auditing the indirect consequences of rework in construction: a case based approach Managerial Auditing Journal 17/3 [2002] 138–146 [ 146 ] Construction Plant and Equipment, Chandos Publishing, Oxford Hakim, C (1987), Research Design: Strategies and Choice in the Design of Social Research, Allen and Unwin, London Hammarlund, Y and Josephson, P.E (1991), ‘‘Sources of quality failures in building’’, Proceedings of the European Symposium on Management, Quality and Economics in Housing and other Building Sectors, Lisbon, 30 September-4 October, pp 671-9 Holt, G.D., Love, P.E.D and Li, H (2000), ‘‘The learning organisation: a paradigm for mutually beneficial strategic construction alliances’’, International Journal of Project Management, Vol 18 No 6, pp 415-23 Hoxley, M (2000), ‘‘Are competitive fee tendering and construction professional service quality mutually exclusive?’’, Construction Management and Economics, Vol 18, pp 599-605 Jick, T.D (1979), ‘‘Mixing qualitative and quantitative methods: triangulation in accumulation’’, Administrative Science Quarterly, Vol 24, pp 602-11 Josephson, P.-E and Hammarlund, Y (1999), ‘‘The causes and costs of defects in construction A study of seven building projects’’, Automation in Construction, Vol No 6, pp 681-42 Knocke, J (1993), Post Construction Liability and Insurance, E & F Spon, London Love, P.E.D (2001), ‘‘The influence of project type and procurement method on rework costs in construction projects’’, ASCE Journal of Construction Engineering and Management Love, P.E.D and Holt, G.D (2000), ‘‘Construction business performance measurement: the SPM alternative’’, Business Process Management Journal, Vol No 5, pp 408-16 Love, P.E.D and Li, H (2000a), ‘‘Quantifying the causes and costs of rework in construction’’, Construction Management and Economics, Vol 18 No 4, pp 479-90 Love, P.E.D and Li, H (2000b), ‘‘Overcoming the problems associated with quality certification’’, Construction Management and Economics, Vol 18 No 2, pp 139-49 Love, P.E.D., Mandal, P., Smith, J and Li, H (2000), ‘‘Modelling the dynamics of design error induced rework in construction’’, Construction Management and Economics, Vol 18 No 5, pp 575-86 Moselhi, O., Leonard, C and Fazio, P (1991), ‘‘Impact of change orders on construction productivity’’, Canadian Journal of Civil Engineering, Vol 18, pp 484-92 National Economic Development Office (NEDO) (1987), Achieving Quality on Building Sites, NEDO, pp 18-19 Nesan, L.J and Holt, G.D (1999), Empowerment in Construction Organisations: The Way Forward for Performance Improvement, Research Studies Press, Somerset Nylen, K.-O (1996), ‘‘Cost of failure in a major ´ civil engineering project’’, Licentiate thesis, Division of Construction Management and Economics, Department of Real Estate and Construction Management, Royal Institute of Technology, Stockholm Yin, R.K (1989), ‘‘Case study research – design and methods’’, Applied Social Research Method Series, Vol 34, Sage Publications, Newbury Park, CA Zeitoun, A.A and Oberlander, G.D (1993), Early Warning Signs of Project Changes, Source Document 91, Construction Industry Institute, The University of Texas at Austin, Austin, TX Further reading Building Research Establishment (BRE) (1981), Quality Control on Building Sites, Current Paper 7/81, HMSO, London Hammarlund, Y., Jacobsson, S and Josephson, P (1990), ‘‘Quality failure costs in building construction’’, Proceedings of the CIB W55/ W65 Joint Symposium, International Council for Building Research Studies and Documentation, Sydney, pp 77-89 Corporate governance: communications from internal and external auditors Janet L Colbert Department of Accounting, Gordon Ford College of Business, Bowling Green, Kentucky, USA Keywords Corporate governance, Auditors, Communication, Finance Abstract International Standards on Auditing (ISAs) require external auditors to communicate with the client’s governance body regarding significant matters which came to the auditors’ attention during the engagement Similarly, the authoritative Practice Advisories (PAs), issued by the Institute of Internal Auditors (IIA), mandate that internal auditors discuss certain items with the board Thus, the governance body/board should be receiving information from two groups of auditors Compares and contrasts the requirements of the ISAs and PAs with regard to communications with the governance body/board The differences in the communications to the governance body/board by the external and internal auditors derive mainly from the focus of each group The external auditors serve those users external to the organization; in contrast, internal auditors serve the board, which is responsible for the internal aspects of the entity Besides communication on financial issues, the board also desires information on operational and compliance matters The comparison of the international external auditing and the internal auditing standards shows that some information received by the governance body/ board is similar However, much is unique Both groups of auditors aid the governance body/board in achieving its objective of guiding the entity to carry out its mission effectively and efficiently Managerial Auditing Journal 17/3 [2002] 147–152 # MCB UP Limited [ISSN 0268-6902] [DOI 10.1108/02686900210419930] Introduction Under International Standards on Auditing (ISAs), external auditors have a responsibility to communicate certain matters discovered during the financial statement audit with those persons charged with governance of the entity Similarly, the authoritative Practice Advisories (PA), issued by the Institute of Internal Auditors (IIA), require internal auditors to share observations and recommendations with those charged with oversight responsibilities, typically, the board of directors Thus, the governance body/board should be receiving information from two sets of auditors Does the communication from one set of auditors complement or supplement the insights gleaned from the other? Or, is this reporting by the two groups a duplication of effort and information? After briefly reviewing significant publications regarding corporate governance and the supporting roles of internal and external auditors, this article summarizes the requirements of the international external auditing standards and the internal auditing standards related to auditor communications with the governance body/ board The article then goes on to compare and contrast the standards Significant publications In recent years, corporate governance has received increased attention in the accounting and auditing literature See, for example, the Panel on Audit Effectiveness Report and Recommendations (Panel on Audit Effectiveness of the Public Oversight Board, 2000) and the Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, 1999) Both Cadbury (1992) and The current issue and full text archive of this journal is available at http://www.emeraldinsight.com/0268-6902.htm COSO (1992) published reports related to controls and corporate governance in 1992 Still earlier, the Treadway Commission (National Commission on Fraudulent Financial Reporting, 1987) and the Cohen Commission (AICPA, 1978) addressed governance issues Also, various Web sites deal with such topics; some which are of interest are shown in Table I While these reports and others address, in varying degrees, corporate governance and internal and external audit issues, very little, if anything, has been written which specifically focuses on requirements for both internal and external auditors to communicate with the governance body/ board and what the governance body/board can expect This article helps to fill that gap International auditing standards International Standards Auditing section 260 (ISA 260), ‘‘Communications of audit matters with those charged with governance’’ (International Federation of Accountants, 2000)[1], provides guidance in communicating matters which may be of interest to the governance body of an entity The Standard applies to external auditors The persons and body which should receive the communication as well as the matters to be included are addressed in the Standard Also, the timing and form of the communication is covered Finally, the Standard’s discussion encompasses confidentiality issues as well as matters related to applicable laws and regulations Relevant persons and governance body The external auditor must determine the persons or body entrusted with the governance of the entity The relevant persons, and the body they make up, should be those responsible for supervising, controlling, and directing the entity, as well as for achieving its objectives The governance body is also accountable for appropriate financial reporting and for reporting other matters to interested parties The title and structure of the governance [ 147 ] Janet L Colbert Corporate governance: communications from internal and external auditors Managerial Auditing Journal 17/3 [2002] 147–152 Table I Relevant Web sites URL Organization www.cbc.to/ CBC (Commonwealth Business Encourages best practices in Council) corporate governance ECGN (European Corporate Research into corporate governance Governance Network) issues IIA (Institution of Internal Auditors) ‘‘Tone at the Top’’ newsletter for audit committees, boards and executive management OECD (Organization for Economic Principles of corporate governance Co-operation and Development) www.ecgn.ulb.ac.be/ecgn/ www.theiia.org/ecm/newsletters cfm?doc_id=739 www.oecd.org/daf/governance/ principles.htm body may vary across countries, according to legal and cultural norms Regardless of the composition and name of the governance body, the external auditors should identify it and establish a working relationship with the members Brief description documentation should be included in the working papers The documentation might consist of minutes of the governance body’s meeting or a confirmation sent to that group by the external auditor Confidentiality, laws and regulations Matters to be communicated The matters which the external auditor must communicate to the governance body are those which are discovered during the financial statement audit and which the external auditor believe are significant and relevant to that group The external auditor is under no obligation to specifically search for matters of governance interest, but may locate such items in the normal course of the engagement ISA 260 notes some of the matters which might come to the attention of the external auditor and which may be of interest to the governance body in fulfilling its oversight role These are: the scope of the audit; management’s selection of, or changes in, significant accounting policies; significant risks and exposures with a potential financial statement effect; proposed and booked audit adjustments; material uncertainties which may impact the going concern assumption; disagreements with management; expected modifications to the standard audit report; material weaknesses in internal control; management integrity; fraud Timing and form of communication The communication of matters to the governance body should be done in a timely fashion Prompt reporting enables the body to take appropriate action The form of the communication to the governance body is not regulated by the ISA; either oral or written communication is allowed If the external auditor chooses to relay matters orally, appropriate [ 148 ] ISA 260 notes that the confidentiality rules of accounting licensing bodies or legal requirements may restrict the external auditor’s communication with the governance body Thus, the external auditor’s ethical responsibilities to communicate with the group may differ from its legal ones Conversely, the Standard observes that accounting licensing bodies or legal requirements may mandate specific communication with governance bodies To sort out these differing perspectives, the external auditor may wish to consult with an attorney The ISA does not address the requirements of these licensing bodies or legal authorities Internal auditing standards Like ISA 260, guidance in the IIA’s Practice Advisories[2], discusses the auditor’s responsibilities in communicating with the governing body of an organization However, the PAs apply to internal auditors rather than their external colleagues The guidance in the PAs addresses the appropriate body which internal auditors are to communicate with and the communications to be made to that group Also, a charter, internal audit plans, and activity reports are discussed in the advisories Finally, the PAs cover coordination of the work of the internal auditors with that of their external colleagues Governing body and direct communication The PAs note that the chief audit executive (CAE) should report to the audit committee, the board of directors, or other governing authority Regardless of its name, the Janet L Colbert Corporate governance: communications from internal and external auditors Managerial Auditing Journal 17/3 [2002] 147–152 appropriate body for internal auditors to report to is the one with oversight responsibility for auditing, financial reporting, organizational governance, and control The CAE should have direct and regular contact with the board Such contact helps to ensure that the board and the CAE communicate regarding matters which are relevant to both Charter, plans and activity reports The PAs specify that every internal audit department should have a charter The document validates the unit’s position in the entity, authorizes internal audit access to records, and defines the scope of its work The charter should be approved by senior management and accepted by the board Periodically, the CAE should assess whether the charter is still adequate and communicate the assessment to senior management and the board The CAE should also submit to senior management and the board a summary of plans for work for the upcoming year The summary should be approved by senior management and tendered to the board for informational purposes Such information helps the board ascertain if the work of internal auditing supports the objectives and plans of the entity After completing the work, the internal audit department should present reports of its activities to senior management and the board Significant engagement observations and recommendations are included in the report The reporting should be undertaken at least annually Below are those items which the PAs suggest might constitute significant engagement observations and therefore, should be communicated to the board: irregularities; illegal acts; errors; waste; inefficiency; ineffectiveness; conflicts of interest; control weaknesses While it is the internal auditor’s responsibility to report significant engagement observations, it is management’s duty to resolve those issues Management may decide to act by implementing recommendations made by the internal auditors or by making other changes Alternatively, management may decide not to take action, thereby accepting whatever risk the internal auditors have identified in the current situation Regardless of which course management chooses, the internal auditor is then responsible for informing the board as to management’s actions or decisions External auditors The PAs note that, to ensure appropriate audit coverage and to minimize duplication of work, internal and external audit coverage should be coordinated The CAE should periodically evaluate the coordination of the work of the two sets of auditors and communicate the results of the evaluation to the board The PAs recognize that external auditors are required to communicate directly with the board regarding certain issues The CAE should be prepared for questions from the board and have an understanding of those matters which the external professionals will discuss Thus, in advance of the external auditors’ meeting with the board, the internal group should request information from their external colleagues regarding the issues to be presented Compare and contrast Some of the information provided to the governance body/board by the international external and the internal auditors will be similar, while much may be unique to one or the other sets of auditors The comparison of the international external and internal audit guidance regarding communications with the governance body/board is summarized in Table II To comprehend the similarities and differences in the information the two groups proffer, it is helpful to begin by understanding the sources of both the demand for the external audit and the authority for the internal audit function Authority/demand The demand for the external audit derives from the users of financial statements and their representatives and advisors These parties are aided in their decision making regarding financial matters by the added credibility which an independent audit provides Another factor which impacts on the demand for external audits is the legal and regulatory climate Specific laws or regulations in various countries may require entities to submit audited financial statements Whether the demand for an engagement emanates from added credibility and/or laws and regulations, the external auditor’s focus is to protect third party or public interests [ 149 ] Janet L Colbert Corporate governance: communications from internal and external auditors Managerial Auditing Journal 17/3 [2002] 147–152 Table II Comparison of ISAs and PAs regarding communication with governance body/board Topic ISAs PAs Authority/demand External focus Aid users by adding credibility Mandated by laws/regulations Protect the public interest Gather evidence to support opinion on financial statements Not required to plan procedures to locate matters to communicate Report matters which may have come to attention of external auditor; no requirement to search for matters Matters are generally limited to those financial in nature No obligation to follow up on findings Generally report at or near end of engagement Allows coordination with internal auditors Requires external auditors to consider work of internal auditor; does not require communication regarding that consideration Internal focus Derived from definition/charter Serves the board Planning, scope Reporting responsibilities Coordination with other auditors Because of this perspective, that auditor’s communication with the governance body centers on information garnered during the work performed in this role In contrast to that of the external auditor, the internal auditor’s focus derives from the definition of internal auditing and from language in the department’s charter The definition of internal auditing is: 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 management, control, and governance processes[3] This definition emphasizes internal audit’s role in aiding the entity to achieve its objectives The internal audit function’s charter should reinforce this view Because the board is ultimately responsible for the entity’s accomplishment of its objectives, the internal auditor’s focus is on providing information to that group Both external and internal auditors communicate with the governance body/ board However, the external auditors are ultimately attempting to protect the public interest – an external focus – while the internal auditors serve the board – an internal focus [ 150 ] Plans approved by senior management, summary presented to board Restrictions on scope reported to board Submit plans for coming period Present activity report of work performed Matters may be operational, compliance, or financial in nature Mandate to follow up on significant engagement observations and recommendations Allows coordination with external auditors Requires communication to the board regarding coordination of the two sets of auditors Planning and scope In planning the engagement and determining its scope, the external auditor’s main objective is to gather evidence to support giving an opinion on the financial statements Secondarily, and as a product of the audit, the composition of the governance body and what matters are to be communicated to it are considered ISA 260 notes that the form of the governance body may vary across jurisdictions In some countries, two boards exist; one is typically a supervisory, nonexecutive body and the other is a management, or executive, board Other countries may embrace the single board model Regardless of which structure the country and entity utilize, the external auditor should plan to report to the body which supervises, controls, and directs the entity This group is accountable for ensuring that the entity’s objectives are achieved and that financial results and other information are reported to interested parties When planning the engagement, the external auditor is not required to design procedures specifically to gather information to report to the governance body Rather, matters to be communicated are those which come to the auditor’s attention in the course of the engagement and which the auditor deems to be significant and relevant to the governance body To make clear the scope of Janet L Colbert Corporate governance: communications from internal and external auditors Managerial Auditing Journal 17/3 [2002] 147–152 the work and their responsibilities regarding communication, the external auditors may elect to include this information in an engagement letter Because the demand for, and objectives of, internal audit are distinct from those of external audit, the planning and scope of the two types of engagements also vary Internal auditors typically plan engagements which are different in nature and much broader in scope than those of their external colleagues While external engagements focus on the financial statement audit, internal audit work typically encompasses compliance and operational engagements, as well as financial work The PAs indicate that the CAE should annually prepare a summary of the planned work and staffing requirements, as well as a budget Senior management should give approval to this overall plan For informational purposes, the board should be presented with a summary of the plan The summary should be detailed enough to allow the board to ascertain if the work of internal audit bolsters the objectives of the entity and the board As the internal auditors perform engagements during the year, they may encounter scope limitations Such restrictions arise when the internal audit activity is prevented from carrying out its plans and meeting its objectives For example, a scope limitation may arise when access to locations, records, or employees is limited, the internal auditors are not able to perform necessary procedures, or the planned work is restricted The board should be informed, preferably in writing, of these challenges and their possible impact Reporting responsibilities In communicating with the governance body, the external auditor covers those matters already listed When discussing the items noted, the external auditors should make clear that the financial statement audit is not designed to locate all matters which may be relevant to the governing body Rather, only those which came to the external auditor’s attention when performing the engagement are included Unless requested by the governing body, no special work is performed to search for such matters The external audit’s communication with the governing body should be completed in a timely fashion Generally, at or near the completion of the audit is sufficient However, if critical items are found, meeting with the governing body before the end of the engagement may be warranted In comparison to that of the external auditors, the internal auditor’s communications with the board are generally more detailed Also, internal auditors are likely to communicate more frequently than their external colleagues Besides submitting plans for the coming year’s work, internal auditors also prepare activity reports covering those items already listed The activity reports, emphasizing significant observations and recommendations, may be prepared as the work is being performed or after it has been completed The CAE presents these activity reports to senior management and the board at least annually However, the CAE is likely to communicate with the board much more often, perhaps several times a year In studying the list of matters to be communicated, it is apparent that the external auditor relays matters with either a direct financial statement impact or which were unearthed during the financial statement audit In contrast, the list of engagement observations shows that the significant audit observations found by the internal auditor are much broader in scope than the external audit findings The internal audit observations follow from the activity’s coverage of operational and compliance, as well as financial statement, issues Besides the breadth of the observations, recommendations, and findings, the auditor’s treatment of the entity’s responses to them differs between the external and internal groups The external auditors have no obligation to follow up with the governing body or management to ascertain if action has been taken (Of course, during the next year’s audit, the issues may surface again.) In contrast to their external colleagues, internal auditors are under a mandate to follow up on significant engagement observations and recommendations The internal group is to ascertain if appropriate action has been taken, or if not, if management has accepted the related risks Management is not required to implement the recommendations of the internal audit activity or to make any changes at all However, the changes implemented, or management’s acceptance of the risks, should be reported back to the board Coordination with other auditors Because members of the governance body/ board will be hearing from both the external and internal auditors, they may naturally have queries regarding the two groups working together The internal audit literature addresses the coordination of work with the external auditors in PA 2050-1, ‘‘Coordination.’’ ISA 610, ‘‘Considering the Work of Internal Auditing,’’ focuses on this issue in the international external audit standards (International Federation of Accountants, 2000) [ 151 ] Janet L Colbert Corporate governance: communications from internal and external auditors Managerial Auditing Journal 17/3 [2002] 147–152 Both the ISA 610 and PA 2050-1 allow coordination of the work of the external and internal audit groups However, neither standard goes so far as to require coordination The international external audit standard directs the auditor to consider the activities of the internal audit function and to determine if that function’s activities might impact on the external engagement However, the ISA does not require the external auditor to communicate the results of the consideration with the governance body In contrast, the PA mandates that the director of internal audit evaluate the coordination of the two sets of auditors and then communicate the assessment to senior management and the board Also, the director of internal audit may choose to communicate regarding the performance of the external auditor The internal audit standard goes on to indicate that the internal auditor should anticipate that the external auditor will communicate with the board regarding various issues The internal auditor is advised to be prepared by having an understanding of the topics Similar advice is not present in the international external auditing standard Conclusion Both the ISAs and the PAs address the communication of the respective auditors with the governance body/board Significantly, both sets of standards require such communication Also, both the ISAs and the PAs allow, but not require, coordination with the other group of auditors The differences in the communications of the external and internal auditors with the governance body/board derive from the focus of each group While the demand for the external audit arises from external users’ desire for credible financial statements, the need for the internal audit function arises from the board’s wish for information useful in fulfilling its duty to aid in achieving the entity’s objectives Thus, the scope of the external audit is limited to matters related to the financial statements while the work of internal audit encompasses operational and compliance, as well as financial issues Other differences between the external and internal audit communications relate to follow-up on the auditor’s observations, recommendations, and findings and notification regarding coordination with the other set of auditors From the comparison of the international external auditing and the internal auditing standards regarding communications with the governance body/board, it can be seen [ 152 ] that some information received by the body from the two sets of auditors is similar However, the objectives of an external audit and an internal audit differ Therefore, the information and perspective the two sets of auditors offer to the governance body/board are distinct Both groups of auditors aid the governance body/board in its role of guiding the entity in effectively and efficiently carrying out its mission Notes Effective for audits of financial statements for periods ending on or after 31 December 2000 The IIA Practice Advisories referenced in this article are: 1000-1: Internal audit charter; 1110-1: Organizational independence; 1130-1: Impairments to independence or objectivity; 2020-1: Communication and approval; 2050-1: Coordination; 2060-1: Reporting to board and senior management; 2410-1: Communication criteria www.theiia.org, Professional Practices Framework, approved June 1999, effective January 2002 References AICPA (1978), The Commission on Auditors’ Responsibilities: Report, Conclusions, and Recommendation, The Cohen Commission Report, AICPA, New York, NY Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (1999), Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, National Association of Securities Dealers (NASB) and New York Stock Exchange (NYSE), February Cadbury, Sir A (1992), Financial Report of the Committee on the Financial Aspects of Corporate Governance, Financial Reporting Council, London Stock Exchange, London (Cadbury Report), December Committee on Sponsoring Organizations (COSO) of the Treadway Commission (1992), Internal Control – Integrated Framework, AICPA, New York, NY International Federation of Accountants (IFAC) (2000), IFAC 2000 Technical Pronouncements, IFAC, New York, NY National Commission on Fraudulent Financial Reporting (Treadway Commission) (1987), Report of the National Commission on Fraudulent Financial Reporting, National Commission on Fraudulent Financial Reporting Panel on Audit Effectiveness of the Public Oversight Board (2000), The Panel on Audit Effectiveness Report and Recommendations August 31, 2000, Public Oversight Board, Stamford, CT, available at www.pobauditpanel.org Slack in public administration: conceptual and methodological issues Tor Busch Sør Trøndelag College, Trondheim Business School, Trondheim, Norway Keywords Costs, Management, Efficiency, Public administration Abstract Ever since its introduction, the concept of organisational slack has constituted the basis for a considerable body of research within behavioural science A great deal of this research has concentrated on budgetary slack, and within the field of public administration the focus has been on the slack- or budgetmaximising bureaucrat As the reduction of slack is the purpose of many of the techniques which are part of the new public management, there is a need to focus on how to measure changes in the level of slack The objective of this paper is to discuss the relationship between three central concepts within the research on slack: organizational slack, budgetary slack, and the discretionary budget; to assess whether these concepts are suitable for public organizations; and to discuss problems of measurement Managerial Auditing Journal 17/3 [2002] 153–159 # MCB UP Limited [ISSN 0268-6902] [DOI 10.1108/02686900210419949] Over the past few decades a wide range of reforms and management techniques have been introduced in public administration to improve productivity and efficiency – management by objectives, total quality management, performance measurement, zero-base budgeting, etc This movement is described as the ‘‘new public management’’, which, according to Jackson (1994, p 121), puts the emphasis on ‘‘the importance of financial devolution; explicit standards of measuring performance; clear relationship between inputs and outputs; increased accountability; the superiority of private sector management practises and styles; the efficiency of competition and contracting out; and efficiency of parsimony’’ Critics have seen the new public management as a marked-based ideology invading the public sector, while others regard it as a management hybrid with a strong emphasis on core public values In connection with this development there is a need to assess whether new techniques, management information systems, and organizational forms lead to increased productivity, efficiency, and quality Because of the complexity of public administration, this may be difficult In this context the concept of slack may be useful Ever since Cyert and March (1963) introduced organizational slack as a significant concept in their theory of the firm, the level of slack has been used as an indicator of productivity Even if a certain level of slack is necessary in order for an organization to be able to carry out its tasks in a satisfactory manner, a high level of slack may be an indication of poor utilisation of resources The objective of this paper is to discuss the relationship between three central concepts within the research on slack: organizational slack, budgetary slack, and the discretionary budget; to assess whether these concepts are The current issue and full text archive of this journal is available at http://www.emeraldinsight.com/0268-6902.htm suitable for public organizations; and to discuss problems of measurement Organizational slack Cyert and March (1963, p 36) associate organizational slack with an understanding of the firm as a coalition of stakeholders They define organizational slack as ‘‘[the] disparity between the resources available to the organization and the payments required to maintain the coalition’’ Using their contribution as a starting point, the research on organizational slack has taken several directions Bourgeois (1981), Bourgeois and Singh (1983), and Sharfman et al (1988) have analysed organizational slack from a behavioural perspective, discussing both theoretical models and problems of measurement in empirical research Bourgeois (1981) emphasises that organizational slack forms a basis of resources which enables the organization to adapt to internal and external pressures, as well as to initiate any strategic changes required He thus indicates that organizational slack is needed in all organizations Wayne and Rubinstein (1992) apply the concept in a game-theory analysis of decision-making situations with particular emphasis on relations of co-operation and conflict Leibenstein (1966, 1978, 1980), in particular, has discussed the concept from a micro-economic perspective Through his concept of X-efficiency he analyses the degree to which an organization possesses an unutilised potential for improving its efficiency Williamson (1963, 1964) discusses the concept based on the manager’s possibility for using organizational slack to his own advantage Within public administration, this research has been further developed, particularly by Mique and Belanger (1974); Niskanen (1975), ´ ´ Breton and Wintrobe (1982), Wyckoff (1990), and Duizendstraal and Nentjes (1994) According to Cyert and March (1963), organizational slack exists in two shapes – [ 153 ] Tor Busch Slack in public administration: conceptual and methodological issues Managerial Auditing Journal 17/3 [2002] 153–159 [ 154 ] either as additional inducements for the stakeholders, or as a reserve accumulated by the management to which they can resort for resources during difficult times In order to accumulate a reserve the management can regulate the amount of input/output which is transferred between the stakeholders and the organization By supplying the organization with greater amounts of input than necessary to maintain a certain level of production, i.e by keeping the productivity at a lower level than that which is ultimately possible to achieve, the level of organizational slack will increase Likewise, the management may reduce the amount of output which is transferred to the customers, i.e keep the volume of sales at a lower level than that which is actually possible, and thus create another form of potential slack An interesting question in this context is whether it makes sense to apply the concept of organizational slack, given its definition, to the public sector and non-profit organizations as opposed to private enterprises: the stakeholders have a different composition; they are connected to the organization through different forms of contracts; and the management has fewer possibilities for influencing the basis of income The relationship to the customers or the users of public services is of particular importance In private businesses a normal market contract exists between the firm and the customer, and the overall demand governs the supply – at least in the long run Provided that the firm does not have problems supplying the goods, the amount purchased by a customer is not in itself part of the inducements For the public services, which are usually not financed through direct payment from the users, the level of production needs to be regulated through budgetary restrictions This implies that the output of public services may in itself constitute an important part of the users’ inducements Besides, the users of some public services have no alternative suppliers at hand As Cyert and March’s definition of organizational slack presupposes that the stakeholders may leave the coalition, it is difficult to define what proportion of the slack is at the disposal of the users in these organizations Another difference between private and public organizations is that public sector managers cannot establish a slack reserve by keeping the sales volume at a lower level than that which is realistically achievable in the market In reality, therefore, the picture is very complex As a conclusion we may say that it should be possible to apply the concept of organizational slack to public agencies However, Cyert and March’s definition is unsuitable as a way of grasping all the forms of slack which may exist within the public sector Budgetary slack Most researchers who have concerned themselves with budgetary slack position themselves in relation to Cyert and March (1963), but the relationship between organizational slack and budgetary slack has not been addressed or clarified to any significant degree Although the basis for the concept of budgetary slack lies in the theory of organizational slack, budgetary slack is normally defined as the difference between the stated budget and an honest budgetary prediction (Kirby et al., 1991; Lukka, 1988; Ueno and Sekaran, 1992; Waller, 1988) Lowe and Shaw (1968) and Lukka (1988) use the concept ‘‘budgetary bias’’ in order to distinguish between, on the one hand, slack as an overestimate of the costs and underestimate of the income, and on the other hand, what is termed ‘‘upward bias’’, i.e a conscious bias of the budget in the opposite direction A distinction is also made between budgetary slack based on a conscious action by the budget manager; and an unintended misjudgement or an actual change in productivity or efficiency (Anderson, 1974; Demski, 1967; Lukka, 1988; Otley, 1985) According to these views, budgetary slack in public administration can be defined as a conscious overestimate of the costs ex ante A large proportion of the research on budgetary slack has been conducted with the aim of identifying the factors which influence the development of this type of slack There are strong indications that participation is a necessary, although not sufficient, precondition for the establishment of budgetary slack (Dunk, 1990, 1993; Govindarajan, 1986; Leavins et al., 1995; Young, 1985) Research also shows that budgetary slack co-varies with budgetary emphasis (Dunk, 1993; Leavin et al., 1995); with asymmetrical information (Ueno and Sekaran, 1992); technology (Merchant, 1985); commitment and job involvement (Nouri, 1994); as well as with linkages between the budget and reward systems (Chow et al., 1991; Dunk, 1990; Kirby et al., 1991; Leavins et al., 1995; Waller, 1988) Within this research, budgetary slack is measured partly by means of composite variables taking as their starting point management attitudes toward budgetary slack; partly by means of financial Tor Busch Slack in public administration: conceptual and methodological issues Managerial Auditing Journal 17/3 [2002] 153–159 key figures; and in experiments on the difference between an honest budgetary prediction and the stated budget proposal The difference between organizational slack and budgetary slack is, first, that budgetary slack is defined ex ante, while organizational slack is defined ex post Second, budgetary slack is tied to the assessment of the budget manager as to what represents the minimum cost at which a specified amount of goods/services can be produced Any budget manager acts as a principal towards her or his subordinates, and if we presuppose asymmetrical information and the existence of opportunistic behaviour, the honest assessments of this manager will be flawed in various ways The concept of organizational slack is defined and applied on the assumption that full information is available Third, the time scope is limited in the context of the budget This means that organizational slack which has accumulated within the organization and which cannot be dissolved within the budget period in question, is unlikely to be considered as slack by the budget manager The conclusion must be, therefore, that according to the dominating definitions, organizational slack and budgetary slack are indeed two independent concepts, each with its separate content Discretionary budget In terms of slack in public administration, the most fundamental contribution was made by Niskanen (1971) He works within the public choice tradition, and his main thesis from 1971 is that bureaucrats will seek to maximise the budget of their bureau This is based on the supposition that there exists a positive co-variation between the size of the budget and the utility that can be obtained by the bureaucrat Niskanen claims that a range of variables will be included in the bureaucrat’s utility function: pay, fringe benefits, power, reputation, security, production volume, and the amount of energy needed in order to manage and change one’s own department Mique and ´ Belanger (1974) suggested an extension of the ´ model and argue that bureaucrats act to maximise their discretionary budget, defined as the difference between the total budget and the minimum cost of producing the output expected by the political authorities This modification implies that the model will predict low productivity rather than ‘‘budget maximisation’’ in public administration Niskanen (1991) accepts this as the general model and claims that his original model, predicting budget maximisation, constitutes a special case Many critical voices have been raised against the model of the slack-maximising bureaucrat, and empirical investigations designed to test out the validity of the model have proven difficult Several studies have been conducted in order to examine whether public organizations are less productive than private ones – with ambiguous results (Borcherding et al., 1982; Downs and Larkey, 1986; Mueller, 1989; Savas, 1982) After going through the relevant research, Blais and Dion (1991), however, claim that the hypotheses of the bureaucrat’s tendency to maximise his or her own budget or the discretionary budget should still constitute a central basis in any theory on bureaucratic behaviour The discretionary budget has not been theoretically defined either in relation to organizational or budgetary slack According to the definition, political authorities will have certain expectations in terms of the volume that should be produced by a public organization In the model is embedded an assumption that there exists a minimum cost which is necessary in order for the production to remain at this level The difference between this minimum cost and the stated budget is defined as the discretionary budget The concept is thus very similar to budgetary slack, but there is a significant difference in the sense that the discretionary budget is not based on the perception of the budget manager as to what minimum cost is achievable in real terms within the budget period in question Furthermore, there is no indication in Mique ´ and Belanger’s model (1974) that additional ´ inducements to the stakeholders are drawn in as a variable in the definition of minimum cost However, Niskanen (1991) indicates that the discretionary budget may, among other things, be used for additional inducements in the shape of perquisites to the management and/or the employees Another portion of it will be spent in ways that serve the interests of the political review authorities According to Niskanen, negotiations will take place with the purpose of distributing the discretionary budget among uses which serve the interests of the bureau and the interests of the political review authorities respectively As the discretionary budget may be used to meet the interests of the political review authorities, this may also, directly or indirectly, benefit the population The corresponding condition applies in the special case of the management of a bureau having preferences in relation to the [ 155 ] Tor Busch Slack in public administration: conceptual and methodological issues Managerial Auditing Journal 17/3 [2002] 153–159 maximisation of output The additional inducements for the users of public services are thus better defined than was the case when the concept of organizational slack was applied The relation between the discretionary budget and organizational slack is therefore somewhat unclear Both concepts include the reserve which the management may establish in order to keep the productivity at a lower level than that which is realistically speaking achievable, both are defined ex post, and both are applied on the condition of full information The difference is primarily found in the fact that while organizational slack is defined in terms of what inducements are necessary in order to keep the stakeholders within the coalition, the discretionary budget does not have a clear definition of what inducements should be included in the model On the basis of this, the relationship between the three concepts of slack may be described as in Table I Measuring slack Even though organizational slack has proved to be an important concept in analyses, great problems are associated with measuring the phenomenon empirically Bourgeois (1981) suggests a method in which each group of stakeholders is asked how big a reduction in the inducements they are willing to accept in the event of the organization being plunged into a crisis This method has also been described by Barnard (1938), March and Simon (1958), and Cyert and March (1963), and is used by Nohria and Gulati (1996) in studying the correlation between innovation and organizational slack In the public agencies where important stakeholders have no real alternatives, this method cannot easily be applied For reasons of validity and reliability, Bourgeois (1981) and Bourgeois and Singh (1983) suggest as an alternative that relative changes in the slack level can be measured by using data from the accounts as a basis They recommend that an indicator variable be developed, building on retained earnings; dividend pay-outs; general and administrative expenses; working capital as a percentage of sales; debt as a percentage of equity; credit rating; short-term loan interest compared to prime rate; and price/earnings ratio Furthermore, they introduce the dimension ‘‘ease-of-recovery’’ – using the three categories available slack, recoverable slack, and potential slack Cheng and Kesner (1997) used this method when they analysed organizational slack and responses to environmental change Sharfman et al (1988) operate according to the same guidelines, although their operationalisation is somewhat simpler: they regard slack as the physical resources available in an organization Williamson (1964) and Schiff and Lewin (1968) found that when pressure arose to reduce organizational slack, the focus was primarily directed toward selling, general, and administrative expenses According to Wolf (1971, cited in Leavins et al., 1995), these costs are non-repetitive, which means that they can function as a barometer for changes in slack Miller et al (1996) used selling, general and administrative expenses as a percentage of total costs as a measure of the slack absorbed within the organization Using figures from the accounts to measure organizational slack is generally a problematic approach, and it is particularly problematic in relation to public administration First, the accounts not offer any impression of what inducement the stakeholders would have accepted in a crisis situation, and second, it is extremely difficult to uncover what, in real terms, would be the highest achievable productivity Thus, it is not possible to uncover the level of slack by Table I The relationship between organizational slack, budgetary slack and discretionary budget Organizational slack Budgetary slack Defined ex post Additional inducements to the management, employees or the customers Reserve built up by the management by keeping productivity and sales volume at lower levels than those which are actually obtainable [ 156 ] Discretionary budget Defined ex post Inducements to the stakeholders beyond what is necessary to secure their participation in the coalition Reserve built up by the management by keeping productivity at a lower level than what is actually obtainable Defined ex ante The share of the inducements which the manager assumes can be freed through negotiations with the stakeholders during the budget period The share of the reserves of which the management has conscious knowledge, and which it assumes can be dissolved in the course of the budget period Tor Busch Slack in public administration: conceptual and methodological issues Managerial Auditing Journal 17/3 [2002] 153–159 studying the accounts of a public bureau Is it, then, feasible to develop an indicator variable which depicts relative changes in the level of slack? The greatest problem is probably one of distinguishing between changes in the level of slack and a redistribution of slack between the stakeholders The distribution of slack is not random, but tied to decisions made by the dominating coalition (Cyert and March, 1963) In some organizations, the employees may, through a strong bargaining position, have attracted slack in the form of high pay; in others, dominating customers may have secured particularly good conditions for themselves This means that the distribution of slack is influenced by the relations of power and the composition of the dominating coalition If we accept without reservation the accounts as our starting point, it is difficult, not to say impossible, to know whether registered changes are associated with a change in the level of slack, or with a redistribution of it Stable contracts, especially with regard to the dominating coalition, are therefore a prerequisite for measuring relative changes in slack by means of figures from the accounts This means that it may be difficult to find a single indicator with sufficient validity for all situations In order to solve this dilemma, indicators measuring relative changes with respect to the most important stakeholders may be developed In terms of the employees, indicators may be constructed which build on inducements which are by nature shortterm, and can easily be changed; in terms of the users of the public goods/services, the indicator may build on the level of quality; and in terms of the management, the indicator may build on the productivity development The slack at each stakeholder’s disposal is determined by the contracts entered into with the coalition The type of contract, the contract costs, relations of power, and the time-span of the contracts, as well as the degree of transaction-specific investments, are important factors which influence both the distribution of slack between the stakeholders, and the slack’s degree of solubility As many public agencies have the same purpose, task structure, and organization, the analyses may be extended to a comparison between the bureaus This may give an indication both of level of slack as well as of changes over a period of time In the existing research on the slackmaximising bureaucrat, very little attention has been paid to methods for measuring the level of slack The aim of this research has primarily been directed towards verifying the model, and/or towards developing the model with respect to the number of variables and relations In terms of measuring the discretionary budget, we encounter a new problem in that the model contains a special case in assuming that some bureaucrats have a special preference for maximising the output of the bureau In this case it is very difficult to measure the total amount of slack In terms of low productivity and extra inducements for the stakeholders, we come up against the same problems of measurement as the ones associated with measuring organizational slack The accounts are not likely to provide a basis for measuring the total level of slack, but by studying selected entries and comparing these with those of corresponding bureaus, it may be possible to obtain indications of relative changes The great volume of empirical research shows that it is easier to find operational measures for budgetary slack than for organizational slack Particularly in experiments, budgetary slack has often been directly measured (Chow et al., 1991; Waller, 1988; Wayne and Rubinstein, 1992) This research has provided us with valuable insight into the connections between budgetary slack and other behavioural concepts Such measurements are more difficult to conduct in field studies The respondents have reservations about giving information on budgetary slack within their own fields of authority, and unless they are very conscious of their own behaviour, their assessments may be flawed in numerous ways The method which is most frequently applied, according to their reports, was developed by Onsi (1973) However, methods of measurement have also been developed by Daley et al (1985), and by Dunk (1993) Onsi’s instrument consists of four items and emerges as consistent with regard to measuring attitudes to budgetary slack Onsi (1973) does not report any reliability analyses, but Merchant (1985) estimated the Cronbach’s alpha to be 0.70 for this instrument Two of the items have an affective basis, while the remaining two have a cognitive foundation Those who have applied Onsi’s method in their research have treated it as an indicator of behaviour directed towards establishing slack (Ueno and Sekaran, 1992), or of propensity towards establishing slack (Merchant, 1985; Nouri, 1994; Govindarajan, 1986) Dunk’s method also consists of four items, and Dunk (1993) reports an Alpha-coefficient of 0.68 The distinction between Dunk’s method and Onsi’s method is that the former only has a cognitive foundation, and that it focuses on [ 157 ] Tor Busch Slack in public administration: conceptual and methodological issues Managerial Auditing Journal 17/3 [2002] 153–159 the degree of difficulty in attaining the budgetary goals It is implicitly presupposed that if the respondents perceive the budget goals as easily attainable, they will have established a large degree of slack in the budget, and conversely, if they perceive them as difficult, there is little budgetary slack Attitudes to slack are so far only measured in connection with budgetary slack The reason for this is that budgetary slack builds on the budget manager’s estimate as to which resources are required in order to produce the volume budgeted for Based on the problems of measuring organizational slack and the discretionary budget, the possibility of measuring the attitudes to accumulating this type of slack should also be considered The processes of change which the public sector is currently undergoing have made it particularly important to find good instruments with a broad application and the capacity to register indications of changes in the level of slack Summary Many of the changes which are now being effected in the public sector seek to improve productivity, and efficiency, as well as quality, and in many contexts the intermediary variable is constituted by different forms of slack Often, a change in the level of slack or the distribution of slack is therefore necessary in order to meet the goals of developing a public sector which runs more smoothly In future research, it is, therefore, necessary to develop new methods of measurement which are adapted to the public sector and suitable for a comprehensive assessment of new initiatives This applies both to methods which build on quantitative data from the accounts/production as well as to instruments which measure attitudes to slack The latter have a broad area of application, and would make it easier to compare the development in different sectors and to conduct comparative 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El-Nafabi and David R Gwilliam Accounting and auditing requirements of the Sudan Companies Act 1925: time for change Managerial Auditing Journal 17/3 [2002] 113–116 in which there shall be full,... El-Nafabi and David R Gwilliam Accounting and auditing requirements of the Sudan Companies Act 1925: time for change Managerial Auditing Journal 17/3 [2002] 113–116 Discussion The 1925 Companies