Why Ethics Is Important To Auditors
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Introduction
Sir Adrian Cadbury, who chaired
the U.K’s Committee on the Financial Aspects of Corporate Governance which
reported in 1992, stated that corporate governance was “ the system by which
companies are directed and controlled” (Cadbury Report 1992, page 15). This
definition is sufficient but clearly conveys the importance of controls in the
company. Corporate governance, the process whereby directors of a company are
monitored and controlled, involves decision making, accountability and
monitoring.
Two aspects which are considered
to be fundamental to corporate governance are:
Supervision and monitoring of
management performance (the enterprise aspect) and
Ensuring accountability of
management to shareholders and other stakeholders (the accountability aspect).
Enron, Parmalat, WorldCom, HIH –
these corporate failures and accounting scandals shook the foundations of
investor confidence in the transparency, integrity and accountability of
corporations and capital markets.
There has also been public
disquiet about the role professional auditors and audit firms have played in
these corporate scandals. There have been disastrous repercussions of the above,
many of which have assumed epic proportions: reputations both of key
individuals and organizations are in ruins, jobs have been lost, and pension
funds have been wiped out. The damage, both economic and social, has been
incalculable, and the implications are far-reaching for corporate management,
company directors, audit firms and the investing public.This
essay is an example of a student's work
An array of factors contributed to
these events, but one thing is for certain –the billions of dollars in corporate
value lost was due in significant part to unscrupulous management and boards of
directors that failed to meet their responsibilities. The accounting
profession, including auditors, also played a major role in these events. While
the story behind these corporate failures is always complex, a lack of ethical
behaviour by many individuals is a big part of it.
Role of auditors
For the audit profession, these
developments have again highlighted the gap between public expectations and the
reality of the role of the auditor. With Enron in particular, the public
perception was that the auditor should have acted as a control on unscrupulous
management practices. The conclusion reached by many members of the public (and
parliamentarians) was that the auditors failed in this responsibility because
their independence from the management of Enron was compromised. While it is by
no means as simple as that, the audit profession must acknowledge and address
these types of perceptions, or indeed facts, if it is to restore trust in both
the capital markets and itself.
Corporate governance involves
decision making, accountability, and monitoring.
Decisions require relevant and
reliable information.
Accountability involves measuring,
reporting, and transparency.
Monitoring involves systems and
feedback.
The auditor does not have direct
corporate governance responsibility but rather provides a check on the
information aspects of the governance system.
Three key themes have emerged from
lessons learned from various corporate collapses and these are:
emphasis on “substance of the
transaction” rather than legal form,transparency and the management of risk
Since the management of risk is
considered to have the greatest impact and significance in the fields of
regulation and corporate governance, auditors are to play a major play.
The financial audit remains an
important aspect of corporate governance that makes management accountable to
shareholders for its stewardship of a company.
“The quality of reported financial
information, however, is influenced not simply by the quality of accounting
standards, but also by other institutional factors [corporate governance, the
legal system, and the existence and enforcement of laws governing investor
protection and disclosure standards] that affect the demand for and the supply
of financial information
At this point it is pertinent to
mention that it is not the regulator alone who can bring about effective
corporate governance; the auditors play a key role in meeting the objective. In
order for audit committees to fulfill their role as watchdogs over the
financial reporting process, members of the audit committee need to receive
important information about the company's business activities and the proper
accounting for those activities. This implies that any good audit is a function
of good accounts and good accounts come from full disclosures which clearly
show the financial health of the company.
Auditor’s primary role is to check
whether the financial information given to investors is reliable. To meet its
obligations to shareholders, the Board must ensure that it receives relevant
and reliable information. Auditor assists the Board in achieving that goal.
There must be open and frank dialogue between the auditors and the board.
However, the role of auditors is
to ensure whether Board of Directors and the management are acting responsibly
towards the shareholders’ investment interests i.e. no leakages are taking
place on the investment side; no wastages on the expenditure side and is there
propriety of the expenditure or not.
The biggest challenge ahead for
auditors is to identify how ethical behaviour can be – and be seen to be –
restored, as it is this that will be the basis for the reconstruction of public
trust in the profession and in the practice of auditing. Regulators are
increasingly taking an interest in the activities of auditors evidenced by:
Regulation of the relationship
between the auditors and the company (independence and freedom from conflicts)
Public inspections of audit firms
(quality control systems within the firm and appropriateness of audit work
It is imperative that the auditor
is perceived to be independent of the client. For instance, SOX adopts a
rules-driven approach setting out prohibited services and requiring preapproval
by audit committee of non-audit services
Practical Illustration
Auditing and accounting rules have
evolved to a quantitative rule of thumb for materiality when the qualitative
factors often speak volumes about the financial condition of the company as
well as management's integrity. Ethical behaviour is not simply conforming to
legal and professional rules; it is a state of mind, the following of unwritten
principles, a culture of ‘doing the right thing’.
This essay is an example of a
student's work
Disclaimer
For e.g. Asian Financial Crisis in
the late 1990s revealed the vulnerability of economies to structural weaknesses
in governance systems. It has become evident that prudent management and sound
code of ethics could have prevented the economic meltdown in the Newly
Industrialized Countries (NICs)
Conclusion
The cost of accounting and audit
failures is immense in terms of skepticism about the auditors and the
companies, in terms of litigation against the auditors and the companies and in
terms of the survival of the auditors and the companies
Corporate governance, business
ethics and effective compliance management are increasingly critical to an
organization’s reputation and success. To regain public trust, safeguard
reputation and grow market share, all organizations need to embed ethics and
compliance into their culture and core business processes. They also need a
mechanism so that they can be seen by the public at large to have these
processes working effectively.
A framework and process for
corporate governance, business ethics and compliance management that weaves
together a ‘top-down’ approach to managing accountability with ‘bottom-up’
compliance processes is a large step in the right direction.
External auditors can impact the
risk taking incentives of management through an appropriate application of
accounting policies. However, it is also important to ensure that rules (in the
event of a breach of accounting polices) are correspondingly enforced. The
external auditor’s responsibilities and the audit committee’s role in corporate
governance are fundamental complements in helping to achieve the desired aims
of corporate governance. Safeguards are necessary to ensure that the external
auditor’s expertise is maximized. In conclusion, good corporate governance is
largely the result of a sound internal monitoring system, an effective
regulatory environment and adequate disclosure requirements. The significance
of mandatory compliance with laws and regulations through a strict monitoring
and regulatory system is crucial. Even though external auditors play a vital
role in corporate governance, through their involvement and their examination
of financial statement and accounting policies, it must be emphasized that they
alone cannot promote effective governance. The ultimate success or failure of
an organization’s code of conduct and business ethics program will rest upon
the values and culture created by the board of directors or leadership team,
and ultimately embraced by all its people
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