The Concept of Auditing and Corporate Governance - Essay Example

Internal Audit and Corporate Governance Report Presented to: Report Presented By: Table of Contents Introduction 1 Corporate Governance2 Internal Audit and Corporate Governance5 Conclusion8 Recommendations…………………………………………………………………………………………………………………………………………8 Bibliography……………………………………………………………………………………………………………………………………………………9 Auditing and Corporate Governance Introduction The growing number of financial scandals, the widening disparity in the pay and rewards and the changing form and style of management in large corporations has resulted in the public concern therefore as a result many countries have started to develop the rules and regulations for the corporate governance within these large originations.(Deaken&Hughes,1997). The growing liberalization of trade related matter has gradually reduced the government intervention into the affairs of the organizations and resulted also in weakening the labor and the powers of the corporate managers have grossly increased to unprecedented levels where their decisions might have had a greater impact on the larger good of the stakeholders i.e. Shareholders, general public, government etc. In the heat of competition the managers of these organizations take decisions which may not be in favor of internal as well as external customers of these organizations. This has therefore necessitated the more proactive role of the board of the directors of organizations in promoting good governance specially their role in ensuring the effectiveness of the internal controls of the organization is stressed upon a lot. An effective internal audit function can play an important role in helping Board of directors to discharge their responsibility of ensuring effective control. However before discharging this responsibility, an internal audit function within the organization need to be objective and proactive in nature with a mandate to conduct independent reviews and with the necessary organizational flexibility to report their findings to the highest authority within the organization so that not only independence is maintained but also the results are communicated to the platform where they can be executed and explored without any internal compromises and with an aim of safeguarding the interests of the shareholders by adding value to their investments. This essay will look into how the internal auditor and his role in corporate governance and how it can be performed to serve the issue of corporate governance. Corporate Governance Corporate governance has succeeded in attracting a good deal of public interest because of its apparent importance for the economic health of corporations and society in general. However, the concept of corporate governance is poorly defined because it potentially covers a large number of distinct economic phenomenon. As a result different people have come up with different definitions that basically reflect their special interest in the field. It is also believed that if the firm is nothing more than a legal fiction than its values must be driven by its stakeholders thus the companies values emerge as a result of internal conceptualization of the values of their stakeholders. Stakeholders can influence a company directly through market transactions and contracts without imposing their values on the company, but transaction costs and information problems set a limit to use of contractual mechanisms. Under incomplete contracting, non-market governance mechanisms must be used instead. (Thomsen, 2004). “Corporate governance is a field in economics that investigates how to secure/motivate efficient management of corporations by the use of incentive mechanisms, such as contracts, organizational designs and legislation. This is often limited to the question of improving financial performance, for example, how the corporate owners can secure/motivate that the corporate managers will deliver a competitive rate of return"(Mathesian,20002). The above definition suggest that the issue of the corporate governance is seen in the context of improving financial performance and a balance between the compensation of managers and the rate of return they generate for the shareholders of their organizations. The roots of the corporate governance can be traced back to the theory of agency cost which suggests that managers of the firm often adapt their own agenda and try to generate better and better compensation for them rather than increasing the shareholders’ value which is theoretically considered as their basic purpose. Due to this nature of the corporate governance United States and United Kingdom has responded to this challenge by implementing Higgs Report (2003), Smith Report (2003) and Sarbanes-Oxley Act (2002). (Solomon and Solomon). All these reports and act strongly advocated the effective role of internal audit function of the organizations in effectively ensuring as well implementing the corporate governance. In the wake of increasing trust being placed in the role of board of directors in ensuring corporate governance, following roles and responsibilities of the board may emerge (KPMG) 1) Making assessment of the scope and effectiveness of the internal control procedures of the organization. 2) Identify, evaluate and monitor various risks arising from organization’s activities. 3) Ensuring that the senior management maintains and establishes adequate and effective internal controls. 4) Monitoring and reviewing the effectiveness of the internal audit function. 5) Reviewing and assessing the internal audit plans and its progress. 6) Ensuring that internal audit function has adequate resources and have the required standing within the organization. 7) To consider the response of the management to various internal audit recommendations and monitoring their progress on it. 8) Approving the appointment and dismissal of the head of the internal audit department of the organization. The above responsibilities of the board of directors regarding their corporate governance duty strongly suggest a link between the internal audit and corporate governance as within the organization, it is only the function of internal audit which can effectively ensure that the corporate governance standards are implemented and that the shareholders’ value is effectively maintained and managed in the best interest of the enterprise as well as all the stakeholders in the organization. Internal Audit and Corporate governance As discussed above, the role of internal audit can be significant in ensuring and implementing the corporate government frameworks within the organizations potentially aimed to safeguarding the interests of the shareholders. The failure of external auditors in preventing the financial disasters like that of Enron and World Com has given a new and fresh outlook to the role of internal audit as the tool which effectively help board of directors with the corporate governance issues. Internal auditors unique full-time focus on risks and controls is vital to sound governance process -- and to sound financial reporting. According to recent statistics from international news and information organization Bloomberg News, in more than half of the 673 largest bankruptcies of public corporations since 1996, external auditors provided no cautions in annual financial statements in the months before bankruptcy. Five of the seven largest bankruptcies in history, including Enron, Global Crossing Ltd., and Kmart Corp., followed annual reports with clean audit opinions from the external auditors. These statistics demonstrate that the larger and more complex the company, the more difficult it is for external auditors, management, and boards to have an accurate picture of risks and controls. With our unique viewpoint as independent but inside observers, internal auditors play a vital role within governance processes by keeping the board, senior management, and external auditors aware of risk and control issues and by assessing the effectiveness of risk management. (Auditor). The available data on the corporate governance and internal audit suggest that there were incidences where the internal auditors have dug out some dubicious accounting practices but were silenced by the higher ups of the organization as in the case of World Com where an internal auditor has unearthed $3.8 billion susceptible accounting but was not allowed to present his findings to the audit committee. (Auditor). However despite this rising liability cost for the board of directors in terms of their responsibilities for corporate governance, neither firms and nor liability insurers are concentrating on the role of effective audit committees as well as proactive internal auditing function within the organization. (Auditor). The developments in the corporate governance at local as well as international level suggest that the internal audit play a key role in supporting the board in implementing the corporate governance. The key functions and roles which internal audit can perform are (KPMG) 1) The prime objective and role of internal audit is to support the board of directors in discharging their liability towards the shareholders of implanting and effective and legally compliant corporate governance system. 2) An objective evaluation of the existing risk and internal control framework. 3) Systematic analysis of the business processes and internal control framework. 4) Review of the existence and value of assets. 5) A source of major information on frauds and irregularities. 6) Review of the existing compliance framework and specific compliance issues. 7) Assessment of the accomplishment of the corporate goals and objectives. 8) Feedback on adherence to the organization’s values and code of conduct / ethics. It must also be noted that the internal auditors may find it hard to conduct above mentioned functions it is therefore often suggested that the internal audit should report their findings to either the Audit Committee or the board of the directors rather than to the higher management of the firm. It is also important to mention here the fact that though legally internal audit may not be binding to implement the internal audit function however as various legal acts of law like of Sarbanes- Oxley suggest a role board of directors in implementing the corporate governance therefore internal audit provide the necessary tool the board of directors to fulfill that legal responsibility. It is therefore necessary that an strategic fit is also determined between how the internal audit can provide a valued adding benefit to the organization while carrying out the implementation of the corporate governance. This can be achieved through the assessment of the critical success factors for an internal audit function which includes following: 1) The mission and role of internal auditor are widely defined within the governance parameters and its being effectively disseminated and communicated across the organization in fuller way. 2) Internal audit has the capability to deliver the desired results and if not than what can be done to upgrade the skill levels of those who are performing the internal audit function. 3) Its funding is made in such a way that it help them to promote the objectivity and consistency in the quality of the service they offer. 4) Finally internal audit must add value to the business. Internal audit thus can be proved as beneficial to the overall process of corporate governance implementation in the organization if its roles and duties are effectively demarcated and defined with objectivity and a certain degree of impartiality and independence is provided to the overall function of the internal audit. Conclusion The emergence of corporate governance on the stage of modern business is the result of some high profiled failures of giant companies like Enron. These failures brought into action the more dominating and proactive role of the board of directors of the organizations which ultimately look to the internal audit to execute and implement the corporate governance into the organization. However in order to help internal audit to perform that function in more independent and impartial way, it is necessary that the generalized audit function is separate from the main management of the firm. It is also important that the audit function should be in best with the organization to add value to it while remaining under the corporate governance framework. Recommendations Based on the review of available literature, data and information, I have come to the conclusion that internal audit function should be made separate from the management and its reporting lines should be separated from the current management and to be shifted to either audit committee or the board of directors besides developing a mechanism which must suggest how the information pointed out by the internal audit is interpreted and what lines of responsibilities be set in order to effectively manage the implementation of corporate governance in the company. References 1) Auditor, Internal. "Internal auditors: integral to good corporate governance." Aug 2002. Find Articles.com. 28 Jan 2008 . 2) KPMG. "Internal Audits role in modern corporate governance." Thought Leadership Series 2003. 3) Solomon, J. and Aris Solomon. Corporate Governance and Accountability. New York: Jhon Willey & Sons Ltd, 2004. 4) Deakin, Simon & Hughes, Alan, 1997 ‘Comparative Corporate Governance: An Interdisciplinary agenda, Journal of Law and Society, Vol 24, no.1, p 1-9 5) Mathesian, Henrik, 2000,’ Managerial Ownership and Financial Performance’Ph.D. dissertation, series 18.2002, Copenhagen Business School, Denmark. 6) Thomsen, Sheen, 2004, ‘Corporate values and corporate governance’. Corporate Governance, Vol 4, no.4, pp29-46. Read More