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Outent Trang 7 Answer 3 CORPORATE GOVERNANCE Memo From: Chief Internal Auditor To: Board of ZX Subject: Role of Audit Committee Date: dd/mm/yyyy a Areas where the internal audit depart
REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) Answer AUDITORS AND AUDITING STANDARDS (a) Development, role, and authority of ISAs ISAs set out the basic principles and essential procedures that auditors should follow in the conduct of an audit of financial statements Auditing Standards are in bold type The grey type found in ISAs provides guidance on the application of ISAs Each Standard contains objectives and requirements (“shall”) with related guidance (introductory, explanatory, application, definitions and other material, including appendices) The entire text of a Standard must be understood in order to apply the requirements of that Standard A current project is underway to redraft all ISAs – not to revise but to rewrite in plainer language and an improved structure The differentiation between bold and plain text has been removed The structure of the redrafted standard will show the objective and requirements of the standard and will be supported by application and other explanatory material – all of which should be considered as an integral part of the standard International Standards on Auditing are set by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC) The IAASB is made up of representatives (in practice, commerce, research and academic) of the profession who are members of IFAC ISAs and other documents issued by the IAASB are developed using a process of exposure and consultation in order to obtain consensus and wide-spread acceptance of standards Consultation is with interested parties outside the profession, as well as within the profession itself 1001 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK Project is proposed and input sought If approved, project assigned to a Task Force Research carried out and Exposure Draft prepared ED placed on IFAC website and widely distributed for comment to member bodies, interested parties and general public Comments received are considered, ED revised and re-issued if substantive changes made Revised ED approved and issued as a Standard 1002 Projects are identified by the members of the IAASB, the Consultancy Advisory Group, the Forum of Firms, national auditing standard setting bodies and IFAC members The Consultancy Advisory Group gives representatives of the business community and international organisations the opportunity to contribute to the development of international auditing guidance Members of the Group represent organisations that have an interest in international auditing The Task Force carries out the basic research and development of an Exposure Draft (ED) This may be done as a joint project with a national auditing standard setting body ISAs apply to all audits of financial statements that are expressed in “true and fair”, “fair presentation”, or similar terms Each of the objectives within a Standard must be considered within the context of the overall objective of the audit as a whole If an objective cannot be achieved, the auditor must use their judgement to evaluate the impact on their ability to achieve the overall audit objective By their very nature, ISAs require auditors to use their professional judgement when applying them In exceptional circumstances, a professional accountant may judge it necessary to depart from a basic principle or essential procedure of a Standard (and Practice Statement) to achieve more effectively the objective of the engagement When such a situation arises, the professional accountant should be prepared to justify the departure REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) (b) The role of the ACCA in the regulation of auditors Auditors are regulated differently in different countries In some countries governments regulate auditors directly, or through government organisations (eg the Public Accounting Oversight Board in the USA established by the Sarbannes-Oxley Act) In other countries the profession is self-regulating In most cases, there is some combination of self-regulation and government regulation In the UK, the monitoring of the quality of the audit function carried out by listed company auditors is conducted by the Professional Oversight Board for Accountancy (POBA) of the Financial Reporting Council (FRC) The FRC is the UK’s independent regulator for corporate reporting and governance and is responsible for: (c) setting, monitoring and enforcing accounting and auditing standards statutory oversight and regulation of auditors overseeing the regulatory activities of the professional accountancy bodies promoting high standards of corporate governance operating an independent investigation and discipline scheme for public interest (eg listed) cases Inspection of auditors under the monitoring of the POBA is carried out by the Audit Inspection Unit (AIU) Such inspection incorporates a very thorough quality control review including reviews of audit working papers and audit procedures The regulation and inspection of auditors for non-listed companies is carried out directly by the professional bodies, eg the ACCA Professional bodies such as the ACCA, seek to uphold professional standards, to investigate complaints against auditors, and to assist auditors in the performance of their duties They have both investigative powers and sanctions against auditors who not comply with professional standards These include fines, exclusion from membership, and the withdrawal of the licence to audit (audit registration) Members of the ACCA are bound by its “Rules of Professional Conduct” The ACCA encourages high professional standards by setting academic requirements for those wishing to study for the examinations, by setting the examinations and by requiring additional experience of those who wish to practice as auditors This includes passing both Auditing papers (F8 and P7) in the ACCA examinations In addition, all members of the IFAC (this includes the ACCA) are required to continue their development throughout their careers (CPD) How ISAs and national standards influence each other In a global market-place it is increasingly important that Auditing Standards are harmonised across the world, particularly for multinational companies It is also important that Auditing Standards are applied consistently Over the last ten years, standard setters in those countries where the profession is mature have sought to harmonise their own standards with International Standards, and to influence International Standards 1003 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK In many countries, all new national Auditing Standards contain a statement to the effect that compliance with the national standard will ensure compliance with the relevant International Standard in all material respects, if that is the case, or it will explain the difference(s) The requirements of the Standards not override local regulations governing audit and assurance in a particular country If local regulations have been followed and ISAs (and Practice Statements) that are applicable to the engagement have not been applied in their entirety, then compliance with ISAs cannot be stated as fact It is not always possible for local Auditing Standards to be the same as International Standards because of local legal requirements Nevertheless, a number of countries have accepted International Standards in their entirety, or have accepted them subject to some minor local variations International Standards are thus extremely useful for countries where the profession is not strong and where government does not seek to detail Auditing Standards, and where there are few resources to develop local standards Standard setters in countries where the profession is mature make a significant contribution to the development of ISAs by providing representatives to sit on IFAC Committees and working parties and by providing the resource to help draft standards National standard setters comment on consultation papers and exposure drafts issued by the IAPC and help summarise responses on certain projects ISAs only have force internationally if they have the support of those countries who lead the profession internationally It is therefore essential for both national standard setters and international standard setters to take account of each other’s work Answer JUMPER & CO Memo From: To: Subject: Date: A Manager, Tela & Co Jumper & Co Corporate Governance in the SGCC Company dd/mm/yyyy As requested, I write to explain where your client SGCC does not appear to be following appropriate corporate governance codes and to recommend changes to ensure that the principles of good corporate governance are being followed Chief Executive Officer (CEO) and Chairman Mr Sheppard is both CEO and chairman of SGCC Corporate governance indicates that the person responsible for running the company (the CEO) and the person responsible for controlling the board (the chairman) should be different people This is to ensure that no one individual has unrestricted powers of decision I recommend that Mr Sheppard is either the CEO or the chairman and that a second individual is appointed to the other post to ensure that Mr Sheppard does not have too much power in SGCC Composition of board The current board ratio of executive to non-executive directors is 5:2 This means that the executive directors can dominate the board proceedings Corporate governance codes suggest that there should be 1004 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) a balance of executive and non-executive directors so this cannot happen A minimum of three nonexecutive directors are also normally recommended, although reports such as Cadbury note this may be difficult to achieve I recommend that the number of executive and non-executive directors is equal to help ensure no one group dominates the board This will mean appointing more non-executive directors to SGCC Director appointment At present, Mr Sheppard appoints directors to the board, giving him absolute authority over who is appointed This makes the appointment procedure and qualities directors are being appointed against difficult to determine Corporate governance suggests that appointment procedures should be transparent so that the suitability of directors for board positions can be clearly seen I recommend that an appointments committee is established comprising three non-executive directors to ensure there is no bias in board appointments Formal job descriptions should also be published making the appointment process more transparent Review of board performance It is correct that the performance of senior managers is reviewed, but this principle should also be applied to the board While Mr Sheppard may undertake some review, this is not transparent and it is not clear what targets the board either met or did not meet I recommend that performance targets are set for each director and actual performance assessed against these on a regular basis Reasons for underperformance should also be ascertained and where appropriate, changes made to the composition of the board Board pay At present, board members’ pay is set by Mr Sheppard This process breaches principles of good governance because the remuneration structure is not transparent and Mr Sheppard sets his own pay Mr Sheppard could easily be setting remuneration levels based on his own judgements without any objective criteria I recommend that a remuneration committee is established comprising three non-executive directors They will set remuneration levels for the board, taking into account current salary levels and the performance of board members Remuneration should also be linked to performance, to encourage a high standard of work Internal control The system of internal control in SGCC does not appear to be reviewed correctly While external auditors will review the control system, this review is based on their audit requirement and cannot be relied on to test the overall effectiveness of the system The system may therefore still contain weaknesses and errors I recommend that some more formal review of internal control is carried out, perhaps by establishing an internal audit department, as noted below The relationship with the company’s auditors must also be reviewed so that the work of the board and the auditors regarding internal control is understood by both parties 1005 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK Internal audit SGCC does not have an internal audit department Given the lack of formal review of internal control in the company, this is surprising Good corporate governance implies that the control system is monitored and that an internal audit department is established to carry out this task I recommend that an internal audit department is established, reporting initially to the audit committee who will monitor internal control and then summarise reports for the board Financial statements There appears to be acceptable disclosure in the financial statements regarding the past results of the company However, the board should also provide an indication of how the company will perform in the future, by a forecast review of operations or similar statement This is partly to enable investors to assess the value of their investment in the company I therefore recommend that the annual accounts of SGCC include some indication of the future operations of the company Audit committee There is no mention in the report of an audit committee Good corporate governance implies that there is some formal method of monitoring external auditors as well as checking that the reports from the external auditors are given appropriate attention in the company I recommend that an audit committee is established – made up from non-executive directors The committee will receive reports from the external and internal auditors (as mentioned above) and ensure that the board takes appropriate action on these reports I hope this information is useful Please contact me again if you require any further assistance Sincerely Ann C Outent Note to candidates: An alternative and allowable answer format was to answer sections (a), (b) and (c) of the question separately Taking this approach would also allow other valid points in part (b) such as inability to obtain a stock exchange listing 1006 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) Answer CORPORATE GOVERNANCE Memo From: To: Subject: Date: Chief Internal Auditor Board of ZX Role of Audit Committee dd/mm/yyyy (a) Areas where the internal audit department can assist the directors with the implementation of good corporate governance in an organisation include: Board reports Reviewing reports to the board and reports produced by the board to ensure that they present a balanced and understandable assessment of the company’s position and prospects The internal audit department will have good knowledge of the operations of the company as well as access to accounting information The department can effectively “audit” board reports to ensure they are accurate and understandable Internal controls The board need to maintain a sound system of internal control The internal audit department will be able to review existing controls and recommend improvements to ensure this objective is met Application of ISA and IFRS The board need to have a policy for applying appropriate International Statements on Auditing (ISA) and International Financial Reporting Standards (IFRS) to the organisation Internal audit will certainly be aware of new auditing standards and will have the technical expertise (especially where internal auditors are professionally qualified) to identify changes required by accounting standards Amendments to control systems for new auditing standards and financial accounting systems for new accounting standards can therefore be recommended Communication with external auditors Under corporate governance regulations, communications with external auditors will normally be via the audit committee, although the board must maintain an appropriate relationship with the external auditors However, internal and external auditors can also work together to ensure that the internal control system is sufficient; possibly by external audit delegating work to internal audit, and each auditor reviewing the work of the other auditor The board will therefore receive reports from both sets of auditors which will be accurate because they have been properly checked Communication to the board The internal auditor can also check that appropriate information is provided to the board from the external auditor ISA 260 Communications of audit matters with those charged with governance provides a list of matters which should be communicated to the board and the internal auditor can work with the external auditor to ensure that this information is provided 1007 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK (b) The advantages of an audit committee include: Public confidence Providing increasing public confidence in the creditability and objectivity of published financial information This will be particularly important for ZX if listing arrangements go ahead While an internal audit department is not normally necessary for incorporated companies, the provision of that department will provide additional confidence in the accuracy of the financial statements and hopefully make ZX an attractive investment Financial reporting Supports the directors in fulfilling their financial reporting obligations The directors have to prepare financial statements for ZX The committee can assist by checking the financial statements to ensure that they comply with appropriate reporting requirements This is especially important where the board not have detailed knowledge of accounting requirements Communication Enhancing the role of ZX’s external auditors by providing an appropriate channel of communication Use of the audit committee will enable the external auditor to discuss issues with the financial statements with the internal auditor, prior to providing a final summary of key points to the board “Friend” of the Board The audit committee may also act as a “critical friend” to the board by monitoring the work of the board and providing helpful guidance, where corporate governance requirements not appear to be being met The audit committee should have detailed knowledge of corporate governance as part of its monitoring function of the company and can share this with the board who may not have the time to obtain detailed information The disadvantages of an audit committee include: Lack of understanding of function As the directors in ZX not have much knowledge of corporate governance, they may see the additional involvement of the audit committee as a threat to their authority or taking away some of their responsibilities This memo has hopefully outlined the advantages of an audit committee in supporting the work of the directors, removing this as a problem Role of non-executive directors As the audit committee will be made up mainly from non-executive directors, the board may see this as a means of decreasing their power and possibly letting other people run the company Again, the audit committee must be seen as fulfilling a supporting role for the main board It will utilise the special knowledge of account production and internal controls from the external auditor and business non-executives to provide appropriate review of information being given to the board Cost The audit committee will increase the expenditure of the company as the non-executive directors will require some remuneration due to their additional responsibilities While this cannot be avoided, the benefits of the committee in terms of providing assistance to the board and raising the profile of ZX ready for possible listing must not be forgotten 1008 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) Answer FRAUD AND COMPLIANCE SEMINAR (a) Missing share certificates The auditors must treat this matter as extremely serious Not only has a senior executive perpetrated an illegal act, he has also been guilty of deliberately attempting to mislead the auditors The auditors must report the matter immediately to the audit committee, if there is one, or otherwise to the full board of directors (ISA 240) A criminal offence has been committed in the theft of the shares and in attempting to mislead the auditors The auditors would expect appropriate action to be taken Any further course of action depends on the action taken by the directors If the directors not take appropriate action, such as reporting the matter to the police, the auditors must consider the desirability of continued association with the company Failure to take action would make the directors a party to the wrongdoing involving, as it does, money for which they have a responsibility to the shareholders In most jurisdictions the auditors not normally have any responsibility for reporting the matter to third parties except in the public interest or where there is some direct legal duty imposed on auditors Their duty of confidentiality prevents their taking further action However, on resigning, they can take the opportunity to reveal their concerns in any communication accompanying their resignation They may also respond appropriately to professional enquiries from auditors nominated to replace them However, they need to obtain legal advice on the form of such communication to avoid the risk of action for breach of confidence by the company or even defamation by the finance director If the directors take appropriate action, the auditors must consider their position with respect to the current audit engagement The finance director is a key person with respect to representations on which the auditors would have relied Now that the credibility of that officer is in doubt, the necessary level of professional scepticism becomes much greater Such an official has the authority to override almost any control and is in a position to conceal such actions The control environment must be regarded as being wholly ineffective and inherent risk assessed as high Extended substantive procedures will now need to be performed in all areas that could have been manipulated by the chief financial officer Providing sufficient appropriate evidence is available then there would be no effect on the auditors’ report It is possible, under the circumstances, that the auditors may be unable to reassure themselves that further misstatements are not present In this case they would need to issue an “except for – scope limitation” qualified auditors’ report (b) Product safety The auditors have no duty to search for all instances of non-compliance with all applicable laws and regulations However, in addition to laws and regulations directly pertaining to financial reporting, the auditors also have a duty (ISA 250) to become familiar with any particular laws and regulations breaches of which might result in the company no longer being a going concern Moreover, in this case, they have already become aware of the possible breach Their suspicions are aroused and they are under a duty to investigate the matter further 1009 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK The finance director may be right in claiming the matter is of no consequence, but the fact of attempting to conceal the evidence from the proper authorities must arouse suspicions that the matter is serious The auditors need to obtain independent expert advice on the implications of the matter If the company denies access to an independent expert the auditors may consider, at the very least, issuing an “except for – scope limitation” qualified auditors’ report If the expert confirms suspicions and the effect is potentially material, at the very least the auditors would require full provision to be made, failing which an “except for – disagreement” qualified auditors’ report would be necessary (ISA 250) If the auditors’ suspicions are confirmed and the effect is material, the auditors would normally report the matter to the board of directors and to the audit committee, if the company has one In this case, however, the board is implicated in the attempt to cover up the evidence, so the auditors would report solely to the audit committee Again legal advice needs to be sought on whether the actions of the board are illegal If so, then they may consider it desirable to resign from the audit Moreover, consideration must be given to the consequences of the continued supply of unsafe goods It is likely the auditors have a case for alerting the appropriate authorities in the public interest which overrides their duty of confidentiality to the client – legal advice must be sought before doing so (c) Understatement of royalties This suspected fraud differs in being perpetrated by the company and not by employees against the company The auditors’ duty of confidentiality to the company prevents them from communicating their suspicions to the authors However, the company has a liability under the terms of the royalty agreements which must be provided for until extinguished by the statute of limitations or other limitation on the rights of creditors to sue for amounts due The auditors would possibly seek legal advice on whether the company’s action was illegal, such as a conspiracy to defraud the authors or false accounting to obtain a pecuniary advantage If the directors’ actions are illegal the auditors would expect the directors to pay the amounts due in full If the directors refuse, the auditors should consider resigning If the action is not illegal, it is certainly unethical, and the audit will be affected in two ways Firstly, if the amounts are material and the company fails to make adequate provisions within the financial statements, the auditors must issue an “except for – disagreement” qualified auditors’ report (ISA 240) Secondly, the auditors will need to revise their assessment of inherent risk at the entity level They would need to increase the tolerable level of detection risk and perform a higher level of substantive procedures than previously would have been considered necessary (ISA 240) (d) Unclaimed wages If there is no immediately apparent explanation, such as an employee on long-term sick leave, the circumstances arouse suspicions that the employee is fictitious – possibly a former employee whose resignation the supervisor has deliberately withheld from the personnel department If the amount is wholly immaterial, the auditor has no duty to investigate the matter further However, the auditor does have a duty to communicate suspicions promptly to an appropriate level of management and to see that the matter is properly investigated (ISA 240) If the auditor is not satisfied that a proper investigation is performed, it is possible that the level of management to which the suspicions are communicated is also implicated in the fraud The matter becomes more serious and must be reported to the audit committee or board of directors 1010