The Role of the External Auditors in the Corporate Governance - Term Paper Example

 ‘The Role of External Auditing in the Corporate Governance Framework within the UK and Country of Choice Table of Contents Introduction 2 Conceptual Relevance of the Core Topics 4 Corporate Governance 4 External Audit 5 The Role of the External Audits in the Corporate Governance 5 Importance of the Role Played by the External Audit in Corporate Governance: Analysis of the Recent Financial Scandals 6 Role of External Audit in Corporate Governance in Malaysia 8 Role of External Auditors in Corporate Governance in the UK 12 Comparison between UK and Malaysia External Audit Practice in Corporate Governance 14 Conclusion 15 References 16 Introduction With the ever changing competitive world, it is essential for the trade organisations to act effectively and efficiently to gain the competitive advantages. According to the recent trends, the global organisations adopt several tactics to acquire a competitive position. To assess these tactics or for evaluating the way of gaining competitive advantages of the organisations, evolution of a mechanism was required. Corporate governance is such a mechanism which can satisfy the requirement. Corporate governance can be considered as the set of laws, policies, customs and processes that can influence the way corporations are directed, controlled and admired. In addition to these, corporate governance can also involve the relationships among the stakeholders of an organisation. Corporate governance mainly has four attributes and those are board of directors, management, internal and external auditors. In this paper, it has been decided to discuss one of the major parts of the corporate governance that is external auditing. The primary objective of this paper is to highlight the role of the external auditing in the corporate governance. It is evident that corporate governance framework is not same in all the countries. Based on the laws and regulations, different countries develop different corporate governance. Therefore, to throw light on the corporate governance framework, two countries have been selected. Those are the UK and Malaysia. In addition to the corporate governance framework, the role of the external auditors in the corporate governance of those countries will also be demonstrated. On the basis of the recent trends, it can be stated that several scams have occurred in the recent past. This fact has in certain way indicates the importance of the corporate governance and more specifically, it signifies the necessity of conducting external audit in the organisations. For accomplishing the research, simple methodology will be adopted. The entire research will be based upon the qualitative research. The data collection source is secondary. It has been intended to accumulate data from the previously accomplished research papers. Apart from that, audit report and corporate governance reports in several companies in the selected two countries will also be taken into consideration. Conceptual Relevance of the Core Topics Before discussing the role of the external auditors in the corporate governance in context to two countries, it is essential to develop an idea with the core concepts of this paper. The research work is mainly focused upon the concepts of corporate governance and external auditing. Hence, in this part conceptual relevance of the two topics will be exhibited. Corporate Governance Corporate governance is the set of customs, policies, processes, institutions and laws. It is the technique through which a company or an organisation is governed, managed and directed. To simplify the concept, it can be stated that corporate governance paves the path for carrying the business in a way through that stakeholders’ interest can be achieved. The concept is all about balancing the societal and individual goal as well as social and economical goals. The way corporate governance deals can ensure a fair return on the investment of the providers of finance. The mechanism is able to differentiate between the managers and the owners. In an organisation, the responsibility of taking decisions lies on the managers. It is evident that the task of the managers and owners should be clearly defined instead of harmonising. Corporate governance enables the management of an organisation to obtain efficient and effective strategic decisions through providing ultimate authority to the Board of Directors. Eventually, it can be stated that corporate governance poses a broad scope and encourages moral, trustworthy as well as ethical environment (Management Study Guide, 2011). External Audit An external audit program engages an independent auditor for executing a full-scope balance sheet statement, financial statement audit, an attestation of internal monitoring over the financial reporting. In this note, it is important to include that co-sourced and out-sourced internal audit is not a part of the external audit program. In this note, responsibilities of the external audit, needs to be included. An external auditor is an auditing as well as accounting expert, who especially works for the business advisory company or for the public accounting firms. The auditors engage themselves in reviewing the financial statements of a business to assess that whether the statements are prepared as per the accounting guidelines, principles and industry standards. The responsibility of ensuring the adequacy level of the internal procedures of an organisation also lies on the external auditors. The Role of the External Audits in the Corporate Governance According to Nobel (1998), corporate governance is the ‘internationally debated interdisciplinary’ concept. The main concern is if the auditors and most importantly external auditors play an important role in the context of corporate governance or not. The auditors are provided an enormous power of detecting the wrongdoings by the management. Hence, they are expected to be independent and report on the company objectively. In this note, view of the Peel and O’Donnell (1995) can be included. According to him, auditors need to be independent to play their role effectively. To build-up the relationship with the corporate governance and role of external auditor, outlook of the Carmichael (1977) can be adopted. He indicated that as regards to the presentation of the financial report external audit can be employed for discarding the biasness of the management. Even the external auditors can report the extent to which an organisation follows the corporate governance. Ali (1999) stated that external auditors are expected to play an important role in sustaining corporate governance. Anandarajah (2001) felt that external auditor should ensure that a good corporate governance practices have been adopted by the organisation and they need to act as guardian of the financial integrity of the company. Importance of the Role Played by the External Audit in Corporate Governance: Analysis of the Recent Financial Scandals There is a requirement to clarify the obligations and the responsibilities of the auditors because of the spate of recent financial scandals (Tomasic, 1992). According to Lee (2002), financial scandals have always been the root cause for bringing changes in the company law. However, it should not happen that organisations learn wrong lesson from the financial scandals. Each financial scandal indicates the declining level of the audit in the organisation. In this note, viewpoint of Dopuch (1988) can be mentioned. He stated that the auditors should be blamed for conducting an inferior audit, if the company fail within a limited timeframe after being audited. Few of the recent scandals worldwide can be discussed to understand the failures of the auditing process. Though there were several cases related to the auditors in the 18th century, the case of Texas based energy trading company, Enron, can be considered as the first scandal which trembled up the auditing profession. According to the Holm and Laursen (2007), in the company there was a crisis regarding the reliability of the financial reporting and the confidence in the auditors. After this scandal, independence of the auditors and audit quality both were at the stake. Brown (2005) has stated noteworthy information in this regard. According to him, Arthur Andersen, the auditor of Enron did not only receive fees for the audit work but also for the non-auditing services. US$55 million earned by Arthur Andersen for the non-audit service can be considered as the consultancy service. Collapse of an Australian company, HIH Insurance Ltd can be considered as the beginning of the reflection of the role, obligation and duties of the auditors. In this case the auditor has ignored a document that was dated July, 1998, in which it was shown that for many years the company had been substantially under reserve. In the viewpoint of Mackerras (2003), after creating a loss of AUS$5.3 billion, HIH collapsed in March, 2001. Another scandal in Australia can also be demonstrated in this context. One-Tel, an Australian mobile telecommunication company, collapsed incurring AUS$2.4 billion loss and debts (Robbins, 2006). The prime reason behind it was the erroneous judgments made by the auditors on the financial affairs of the company. Therefore, the auditors’ independence became questionable (Houghton & Jubb, 2003). Enhancing the quality of auditing service is the only way out for countering the financial scandals. Nevertheless, the regulatory, the legal and the corporate governance framework are not sufficient to protect the market because of the increasing number of the financial scandals that involves auditors. It is a recognised fact that corporate governance has been improved in the recent days but the duties and responsibilities of the auditors are shrouded in mystique and mystery as ever (Leek, 1996). It has been observed and experienced by several researchers in the international arena. Based on the above discussion, it can be stated that there is a lacuna in the existing legal framework that reposed the duties of an auditor as it was quite inadequate to counter the financial scandals. Role of External Audit in Corporate Governance in Malaysia In this section of the paper, financial scandals that occurred in the Malaysia and contribution of the auditors in it will be discussed. In addition to that, it will also be discussed that whether the present codes and conducts of the country are comprehensive and adequate in addressing the scandals or not. The part III of the Malaysian Code of Corporate Governance has undertaken the duties and the responsibilities of the auditors since 2000. The matter of concern is that though there is code, scandals are still occurring. Few of the instances can be provided as follows: Transmile Group Bhd, a Malaysian company has glimmered of concern regarding the duties and obligations of the auditors. Robert Kuok was monitoring the company. Several frauds and accounting irregularities had been detected in the company. The issue with the company was that the company had overstated its accounts. The reason behind doing that was the intension of showing profits of RM75 million and RM158 million in the year of 2005 and 2006 respectively. Whereas the actual financial statement of the company revealed that it made net loss of RM370 million and RM1256 million in the two consecutive years. The loss was not been detected, by the auditors of the company, Deloitte and Touche. It had been figured out by another audit team called Moores and Rowland that was specially appointed. Few initiatives have been taken to ensure that the board of directors is accountable and responsible through drawing up the codes. Remarkably, the codes have been revised in the year 2007. The purpose behind it was to strengthen the relationship between the audit committee and the auditors of a company and to specify the role of the auditors. The code, part I of D III, bestowed that the board of directors need to establish the transparent and formal measures for developing and maintaining appropriate relationship with the auditors of the company. Referring to this code, it can be argued that providing non-audit services by the auditors of an organisation become questionable. Even the relationship between the board of directors and the auditor become doubtful as it is expected to be a formal relationship but providing non-auditing service indicates beyond formal relationship. The code should have been drafted as follows: “The relationship between the Board of Directors and the auditors should be Formal” (Krishnan, n.d.). Moreover, the code needs to be transparent. In that case, the board of directors should disclose all the activities and commitments made between them and auditors for the non-auditing activities. In this scenario, the question arises that whether this kind of relationship is under the purview of the arrangements or not. It is true that, the relationship possess legal perception but ironically the duty to monitor this lies on the boards of directors. Hence, it is necessary to frame and maintain a code regarding non-activities service rendered by the external auditors to the organisations. Taking into consideration the recent scandals, it can be recommended that government intervention is substantially required as these scandals have immense negative effect upon the economical and social environment of an organisation. Therefore, while appointing external auditors a government authority needs to be there for closely monitoring the entire practices. Much emphasis required to be placed on the auditors in the corporate governance perspective as it has been found that auditors and most importantly external auditors are the first authority to spot corporate exploitation. Apart from this, external auditors are the only persons who can be well aware of the transgression besides the wrongdoers that is the management of an organisation. Thus, in several cases the external auditors are pointed out for failing to investigate the misconduct at the expense of their obligations and Duties (Krishnan, n.d.). Therefore, auditors are now obliged to adopt much stricter approach while conducting audit for their clients. In the ‘Companies Act’ of Malaysia, provisions have been enacted for the eligibility, appointment, removal and qualification as well as disqualification of the auditors (Davies & Prentice, 2003). Role of External Auditors in Corporate Governance in the UK Companies that are incorporated in the UK and listed in the UK Stock Exchange are considered under the purview of the Combined Code on Corporate Governance. Basically, the Combined Code in 2006 needs to be reviewed. The Financial Reporting Council (FRC) is an independent regulator in the UK which is mainly responsible for the combined Code on the corporate governance. It is also associated with the statutory regulation and is the monitor of the auditors as well as the actuarial and the professional accountancy bodies. The Companies Act of 2004 of the UK, which undertakes audit, investigations and community enterprises, place a statutory responsibility on the employees and officers to render the external auditors with explanation and information in respect of the accounts and audit of the company. Even the directors are also needed to make a statement that they have revealed all the required and relevant information to the auditors. The directors also have to make a statement that preparing false statement is subject to a criminal offence. To look into the instances of non-compliance of the corporate accounting, with the UK GAAP, Financial Reporting Review panel had been set up in the year 1990. It compels the board of directors and auditors to provide proper explanation with adequate documentation if the accounts and other reports are not able to satisfy the requirement of the relevant reporting standards. Though there is an exception with all the medium and small enterprises but apart from them all the organisations are subject to provide detailed disclosure of each and every non-audit services rendered by the external auditors (IT Governance, 2011). In these notes, it is important to mention that few of the scandals occurred in the UK. The case of Parmalat can be brought into the light. When the case begun to unfold, it had been assumed that the collapse of the company will definitely exemplify slightly more darken part of the Italian business. But once more details regarding the company had been disappearing; it has become evident that the case was not uniquely Italian affair. There was a letter in the heart of this scandal which had come from the Bank of America. It had been confirmed from the bank authority that Bonlat, which is the subsidiary of the Parmalat, had deposited of around €4 billion with the bank. One of the accused members, who had been the chief financial officers of the organisation, Eausto Tonna admitted to their prosecutors that he had been benefited from the funds of subsidiaries in Luxembourg. After the case also, Grant Thornton, the auditor of the firm did continue his job with Bonlat. For the evidences of the assets of the Parmalat subsidiary he relied upon the bank of America letter until, in the mid-December 2003 (The Economist Newspaper and The Economist Group, 2004). After explanation of the scandals it is necessary to understand the contribution of the corporate governance to check these financial issues. Few of the steps of the corporate governance in the UK, has already been discussed. In this part few discussions regarding few other reports can be included. In the year 1992, Cadbury report had been published which was previously known as ‘The Report of the Committee on the Financial Aspects of Corporate Governance’. The reasons behind the establishment of the committee was to take measures against the occurrence of the financial scandals in the year 1980’s that engages the listed companies of the UK. In 1998, Hampel Committee was established to revise and review the recommendations made by the Cadbury Committee. The report emphasised on the principles of good governance instead of taking care of the explicit rules for minimising the regulatory burden on the companies (Manifest, n.d.). Comparison between UK and Malaysia External Audit Practice in Corporate Governance From the overall analysis a comparison between the corporate governance framework and role of the external auditors in it can be comprehended. The matter of concern in Malaysia is that there is no such Ethics Standards Board such as the UK to prevent developing intimate and informal relationship between the auditors and the management of an organisation. Ethics Standards Board is the part of the UK Accountancy Regulator. This board ensures that external auditors should not render audit and non-audit service to the same client (Parker, 2002). Conclusion In this market-oriented economy, requirement of the corporate governance has arisen. In addition to that globalisation can also be considered as an aspect for advocating corporate governance. This mechanism is essential to build up added value for the stakeholders. With providing transparency, the mechanism is able to provide balanced and strong economic development. Also, it safeguards the interests of the shareholders. It tries to make it certain that all the stakeholders can fully exercise their rights and thus the organisation can fully recognise their rights. Recently businesses are collapsing and that have negative affects not only on the stakeholders but also to all the investors. Since, it is the magnitude of the accountability of the auditors, equal significance should be placed for the implementation of the corporate governance. The duties and responsibilities of the external auditors must be expanded and is required to be closely monitored because of the sake of stability of financial and economical sector, capital market and to preserve the interests and rights of the stakeholders. References Ali, R., 1999. The Rules of Good Corporate Governance: Methods of Efficient Implementation. Proceedings of the 12th Commonwealth Law Conference. Anandarajah, K., 2001. Corporate Governance: A Practical Approach, Butterworths Asia. Brown, R. E., 2005. Enron/Andersen: Crisis in U.S. Accounting and Lessons for Government. Public Budgeting and Finance, 25 (3), Pp. 20. Carmichael, D. R., 1977. The Auditor’s Role and Responsibilities. 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