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Comparative

International Auditing

and Corporate

Governance

PROGRAM STUDI AKUNTANSI FAKULTAS EKONOMI DAN BISNIS

UNIVERSITAS ESA UNGGUL

EBA 604

AKUNTANSI INTERNASIONAL

(2)

13-2

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.

(3)

13-3

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)

13-4

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.

(5)

13-5

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.

(6)

13-6

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.

(7)

13-7

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.

(8)

13-8

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.

(9)

13-9

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.

(10)

13-10

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.

(11)

13-11

International Diversity in External

Auditing

Purpose of auditing

International variation in the purpose of audits

seems to be related to diferences 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.

(12)

13-12

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.

(13)

13-13

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

infuential auditing profession relative to code law countries.

Audit quality and independence are likely to be

infuenced by level of rigor to join the profession and by the extent of legal liability assigned to auditors.

(14)

13-14

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.

(15)

13-15

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 diferent audiences.

The Sarbanes-Oxley Act in the U.S. includes a

requirement to provide assurance on the internal controls.

(16)

13-16

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 efcient global capital markets.

The International Federation of Accountants (IFAC)

develops international auditing standards.

(17)

13-17

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 eforts at harmonization are supported by

the International Organization of Securities Commissions (IOSCO).

(18)

13-18

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.

(19)

13-19

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.).

(20)

13-20

Auditor Liability and

Independence

Auditor liability – Recent events

Andersen, a big five firm, was efectively 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.

(21)

13-21

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.

(22)

13-22

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.

(23)

13-23

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.

(24)

13-24

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.

(25)

13-25

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.

(26)

13-26

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.

(27)

13-27

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 efectiveness of

internal controls over financial reporting.

(28)

13-28

Internal Auditing

Internal auditing -- Background

The clearest diference 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 efectiveness and efciency audits.

(29)

13-29

Internal Auditing

The Foreign Corrupt Practices Act

Foreign Corrupt Practices Act of 1977 (FCPA)

requires companies to maintain efective internal controls and not pay bribes.

The logic is that efective 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.

(30)

13-30

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.

(31)

13-31

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.

(32)

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