You are on page 1of 31

Chapter 13

Comparative
International Auditing
and Corporate
Governance

McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Comparative International Auditing and
Corporate Governance
Chapter Topics
 Recent trends in international corporate governance.
 International diversity in external auditing.
 Harmonization of international external auditing.
 Auditor liability and independence.
 Audit committees.
 International internal auditing.
 Audit regulation.

13-2
Comparative International Auditing and
Corporate Governance
Learning Objectives
1. Define corporate governance and discuss the
circumstances that caused it to receive worldwide
attention in recent years.
2. Explain the link between auditing and corporate
governance in an international context.
3. Examine international diversity in external auditing.
4. Explain the steps take toward international
harmonization of auditing standards.

13-3
Comparative International Auditing and
Corporate Governance
Learning Objectives
5. Demonstrate an understanding of the issues concerning
auditor liability and auditor independence.
6. Explain the role of audit committees.
7. Discuss internal auditing issues in an international
context.
8. Discuss the provisions in the Sarbanes-Oxley Act of
2002 in relation to auditing issues.

13-4
International Trends in Corporate
Governance
 Recent accounting scandals, particularly those in the
U.S. (e.g., Enron, WorldCom) have led to increased
focus on corporate governance.
 The Sarbanes-Oxley Act of 2002 was a direct response
to these scandals.
 This act includes new rules pertaining to corporate
governance and auditing.
 These events in the U.S. are consistent with a worldwide
movement to improve corporate governance and
auditing.

Learning Objective 1 13-5


International Auditing and Corporate
Governance
OECD guidance
 Principles of Corporate Governance (1999) provide
guidance to help governments improve corporate
governance within their borders.
 Corporate governance, “…involves a set of relationships
between a company’s management, its board, its
shareholders, and other stakeholders.”
 These principles also make clear that the board of
directors has ultimate responsibility for governance.

Learning Objective 2 13-6


International Auditing and Corporate
Governance
OECD guidance
 In 2004, revisions to the corporate governance code
point out that external auditors should answer to
shareholders.
 These revisions also highlight the board of directors
responsibility for overseeing financial reporting.
 These revisions also strengthen shareholder rights in
most OECD member countries.

Learning Objective 2 13-7


International Auditing and Corporate
Governance
Sarbanes-Oxley Act of 2002
 Public Company Accounting Oversight Board (PCAOB)
was created to oversee the accounting profession.
 Certification of financial statements by CEOs and CFOs.
 External auditors to report directly to audit committee.
 Restriction on allowable non-audit work for auditors.
 Increased penalties for financial statement fraud.
 The NYSE followed suit by introducing additional listing
requirements related to corporate governance.

Learning Objective 2 13-8


International Diversity in External
Auditing
Background
 Globalization is leading to increased importance of
auditing internationally.
 Significant international diversity exists in various
aspects of auditing.
 The purpose of external audits varies between countries.
 The environment in which auditing takes place varies.
 Regulation of the audit function varies.
 The content of audit reports also varies.

Learning Objective 3 13-9


International Diversity in External
Auditing
Purpose of auditing
 In the U.S. and UK, the purpose of the external audit is
to provide assurance that the financial statements are
fairly presented.
 In the U.S., Sarbanes-Oxley also requires audits of
internal controls.
 Such a report provides assurance about the process of
financial statement preparation.
 In Germany, auditors are also responsible for evaluating
the report of management.

Learning Objective 3 13-10


International Diversity in External
Auditing
Purpose of auditing
 International variation in the purpose of audits seems to
be related to differences in corporate governance
structure.
 The supervisory board in Germany has essentially
equivalent responsibilities to a U.S. board of directors.
 German law includes specific regulations about the
composition of the supervisory board.
 German supervisory boards are more broadly
representative than their U.S. equivalent.

Learning Objective 3 13-11


International Diversity in External
Auditing
Environment of auditing – Culture and history
 Cultures that value saving face and societal harmony are
less accepting of the questioning inherent in auditing.
 Collectivist cultures often distrust outside auditors.
 Recent Chinese history of state-owned enterprises is
related to explicit limits regarding application of lower-of-
cost-or-market and allowance for bad debts.
 All of these factors can surprise auditors from a western
perspective.

Learning Objective 3 13-12


International Diversity in External
Auditing
Environment of auditing
 Countries with less developed financial infrastructure
would need less sophisticated auditing.
 When banks or families are the primary source of
financing, there is less demand for auditing.
 Common law countries tend to have a more influential
auditing profession relative to code law countries.
 Audit quality and independence are likely to be
influenced by level of rigor to join the profession and by
the extent of legal liability assigned to auditors.

Learning Objective 3 13-13


International Diversity in External
Auditing
Audit regulation
 Auditing in Anglo-Saxon countries has historically been
self-regulated
 However, recent scandals have led to increased
government oversight.
 In many other countries (e.g., Germany, China)
government exercises much more control.
 Auditor qualifications vary significantly from country to
country.

Learning Objective 3 13-14


International Diversity in External
Auditing
Audit reports
 The content of audit reports varies significantly between
countries, and sometimes between companies in the
same country.
 For example, audit reports sometimes refer to local audit
standards, non-local audit standards, multiple sets of
audit standards, or are addressed to different audiences.
 The Sarbanes-Oxley Act in the U.S. includes a
requirement to provide assurance on the internal
controls.

Learning Objective 3 13-15


International Harmonization of Auditing
Standards
 International auditing has historically received less
attention than international accounting.
 Recently, globalization has increased the importance of
cross-national understanding of audit reports.
 Harmonization of international auditing standards will
help increase consistency of auditing worldwide.
 The increased level of assurance on financial statements
should result in more efficient global capital markets.
 The International Federation of Accountants (IFAC)
develops international auditing standards.

Learning Objective 4 13-16


International Harmonization of Auditing
Standards
IFAC
 The International Auditing and Assurance Standards
Board (IIASB) is the entity that develops international
auditing standards.
 IFAC’s Forum of Firms and Compliance committee deal
with international regulation and compliance.
 IFAC’s efforts at harmonization are supported by the
International Organization of Securities Commissions
(IOSCO).

Learning Objective 4 13-17


International Harmonization of Auditing
Standards
IFAC pronouncements
 A set of International Standards on Auditing consisting of
nine sections have been published.
 Section 200 covers auditor responsibilities in conducting
an audit.
 Section 500 deals with audit evidence.
 Section 700 covers audit reports.
 Sections 800 and 900 deal with engagements other than
a standard audit.

Learning Objective 4 13-18


Auditor Liability and Independence

Auditor liability -- Background


 Auditors are subject to civil liability, criminal liability, and
professional sanctions.
 Civil liability can result from breach of contract or civil
duty (e.g., negligence).
 Criminal liability can result from criminal conduct (e.g.,
fraud).
 Professional sanctions can result from violation of the
rules of a professional body.
 The potential for legal liability varies internationally and is
highly significant in some countries (e.g., the U.S.).

Learning Objective 5 13-19


Auditor Liability and Independence

Auditor liability – Recent events


 Andersen, a big five firm, was effectively put out of
business by a criminal conviction, later overturned, in
connection with its Enron audit.
 One remaining big four firm, PricewaterhouseCoopers,
suggested to UK authorities that auditors are in a legally
untenable position.
 A 1998 German court decision resulted in auditors being
liable to third parties for the first time in that country.

Learning Objective 5 13-20


Auditor Liability and Independence

Auditor liability – Possible reforms


 Several solutions to limiting auditor liability exist in order
to limit potential damage to firms.
 Change of ownership structure to limit or eliminate joint
and several liability.
 Proportionate liability that limits auditor liability to the
proportion for which they are deemed responsible.
 Statutory caps to limit damages.
 Disclaimer of liability to avoid unintended liability. Some
UK auditors use these, the U.S. SEC rejects them as
invalid.

Learning Objective 5 13-21


Auditor Liability and Independence

Auditor Independence -- Background


 Independence is a fundamental principle of auditing.
 Auditors in the U.S. are required to adhere to a detailed
set of independence rules.
 The SEC has additional rules for auditors of public
companies.
 An SEC report in 2000 cited numerous violations by big
five auditors.
 Auditor independence is a subject of intense debate
internationally as well as in the U.S.

Learning Objective 5 13-22


Auditor Liability and Independence

Proposals to strengthen auditor independence


 Involvement of stockholders in auditor appointment.
 Restrictions or prohibitions of certain consulting
activities.
 Increased regulatory oversight.
 Increased involvement by the board of directors and
audit committee.
 Mandatory rotation of audit firms or engagement
partners.

Learning Objective 5 13-23


Auditor Liability and Independence

Proposals to strengthen auditor independence


 Separating consulting operations from the auditing
practice.
 Increasing the stringency of admission criteria to the
profession.
 A principles-based approach to auditor independence, in
contrast to a lengthy set of “bright-line” rules. This
approach maintains some specific rules.
 A conceptual approach similar to the above but that
includes no list of specific prohibitions.

Learning Objective 5 13-24


Audit Committees

Audit committees – United States


 The audit committee is a committee of the board of
directors responsible for financial reporting oversight.
 Beginning in the 1990s, increased attention has been
paid to this topic.
 In the U.S., the Blue Ribbon Committee made a series of
recommendations to enhance the role of the audit
committee.
 Sarbanes-Oxley includes specific provisions related to
audit committees.

Learning Objective 6 13-25


Audit Committees

Audit committees – Internationally


 Audit committees are increasingly being seen as an
important component of corporate governance.
 There is wide acceptance globally that the auditor works
for the audit committee.
 Australia, for example, requires listed companies to have
audit committees composed completely of outside
directors.
 Audit committees are also no required for listed
companies in Malaysia and Singapore.

Learning Objective 6 13-26


Internal Auditing

Internal auditing -- Background


 Internal auditing is “an independent, objective assurance
and consulting activity designed to add value and
improve an organization’s operations.”
 The SEC requires an internal audit function of public
companies.
 Internal audit can enhance the effectiveness of internal
controls over financial reporting.

Learning Objective 7 13-27


Internal Auditing

Internal auditing -- Background


 The clearest difference between external and internal
auditing is the consulting function of the latter,
particularly risk management.
 Given their complexity, multinational corporations
(MNCs) are increasingly demanding risk management
consulting.
 Internal auditors also commonly perform compliance
audits, and effectiveness and efficiency audits.

Learning Objective 7 13-28


Internal Auditing

The Foreign Corrupt Practices Act


 Foreign Corrupt Practices Act of 1977 (FCPA) requires
companies to maintain effective internal controls and not
pay bribes.
 The logic is that effective internal controls over financial
reporting will mitigate the risk of bribe payments.
 This legislation was a reaction to the discovery, in the
1970s, that many U.S. companies did pay bribes.
 Enforcement of the FCPA has resulted in large fines
against major U.S. companies.

Learning Objective 7 13-29


Sarbanes-Oxley and the Future of
Auditing
 Sarbanes-Oxley is the most significant legislation
pertaining to financial reporting, and auditing, since the
establishment of the SEC in the 1930s.
 The act has had an observable impact on business, one
example of which is the increase in financial expertise on
audit committees.
 Companies have spent significant resources enhancing
internal controls.
 On a more negative note, many financial executives are
experiencing increased stress due to Sarbanes-Oxley.

Learning Objective 8 13-30


Sarbanes-Oxley and the Future of
Auditing
Other international audit issues
 There is increased demand for internet-based financial
reporting and the related assurance.
 Continuous assurance on real-time information.
 Increased competition in the audit market.
 Increased exposure of international audit firms.
 The risk that increases in litigation will lead to more of a
checklist approach to auditing.
 The enhanced partnership between external auditors,
internal auditors, and audit committees.

Learning Objective 8 13-31

You might also like