Comparative
International Auditing
and Corporate
Governance
PROGRAM STUDI AKUNTANSI FAKULTAS EKONOMI DAN BISNIS
UNIVERSITAS ESA UNGGUL
EBA 604
AKUNTANSI INTERNASIONAL
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.
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.
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.
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.
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.
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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.
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.
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.
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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.
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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.
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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.
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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.
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.
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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.
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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.
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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).
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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.
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.).
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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.
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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.
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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.
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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.
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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.
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.
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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.
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.
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.
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.
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.
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.