WEEK 2: GOVERNANCE AND THE AUDITOR
Key auditor interactions and relationship:
Governance
The exercise of economic and administrative authority to manage an entity’s affairs
Concerned with processes by which decisions are made and implemented, so that
the entity’s affairs are conducted properly and in accordance with the laws and other
applicable regulations
Applicable to all entities such as shareholder and stakeholder capitalism which are
responsible for healthcare and environment
“...characterised by participation, transparency, accountability, rule of law
effectiveness, equity... Good governance refers to the management of government
[governing body] in a manner that is essentially free of abuse and corruption, and
with due regard for the rule of law.” (OECD, 2017)
Agency structure :
- Separation of ownership and management
- Owners rely on management (agents)
- Agents conduct the business on behalf of owners
Authority of governing body underpinned by transparency and accountability
Independent auditor adds to the credibility of the agent’s conduct
Issues in governance
1. Risk management and internal control
Effective governance and accountability based on effective functioning of internal
control and risk management
Risk management is the culture, process and system established to manage
opportunities and minimise or control risks
2. Financial misstatements – earnings management (EM)
Discretionary accruals – EM used to meet or beat financial analysts’ expectations or
other incentives
Asset turnover and profit margin diagnostics
Classification shifting – misclassifies a core expense as a non-core specific item to
affect share performance
Restatements of accounts – existence of fraud
, Internal auditing : “provides independent, objective assurance and consulting services
designed to add value and improve an organisation’s operations...” (IIA 2016)
Internal audit encompasses examination and evaluation of :
- Adequacy and effectiveness of governance and internal control structure
- The quality of performance
- The procedures of risk identification and management
- Mechanisms to ensure regulatory compliance
Supplements the work of independent auditors
Internal auditors should :
- Review the reliability and integrity of financial and operating information
- Review the systems established to ensure compliance with policies, plans,
procedures, laws and regulations
- Assess risks within and outside the business
- Review the means of minimising risks
- Appraise the economy and efficiency of resources
- Review operations or programs
Assessing internal auditors
Criteria external auditors use to assess the performance of the internal auditor :
- Organisational status
- Scope of internal auditing
- Technical competence
- Due professional care
Operational auditing
Examines use of resources to evaluate whether they are being used in the most
efficient and effective manner
Three approaches:
- Risk-based audit approach
- Value-for-money approach
- Process audit approach
Audit committees – of the board of directors
be of sufficient size, independence and technical
expertise to discharge its mandate effectively
be made up of only independent directors
include members who are all financially literate
include at least one member with financial expertise
include some members who have an understanding of the industry
Key auditor interactions and relationship:
Governance
The exercise of economic and administrative authority to manage an entity’s affairs
Concerned with processes by which decisions are made and implemented, so that
the entity’s affairs are conducted properly and in accordance with the laws and other
applicable regulations
Applicable to all entities such as shareholder and stakeholder capitalism which are
responsible for healthcare and environment
“...characterised by participation, transparency, accountability, rule of law
effectiveness, equity... Good governance refers to the management of government
[governing body] in a manner that is essentially free of abuse and corruption, and
with due regard for the rule of law.” (OECD, 2017)
Agency structure :
- Separation of ownership and management
- Owners rely on management (agents)
- Agents conduct the business on behalf of owners
Authority of governing body underpinned by transparency and accountability
Independent auditor adds to the credibility of the agent’s conduct
Issues in governance
1. Risk management and internal control
Effective governance and accountability based on effective functioning of internal
control and risk management
Risk management is the culture, process and system established to manage
opportunities and minimise or control risks
2. Financial misstatements – earnings management (EM)
Discretionary accruals – EM used to meet or beat financial analysts’ expectations or
other incentives
Asset turnover and profit margin diagnostics
Classification shifting – misclassifies a core expense as a non-core specific item to
affect share performance
Restatements of accounts – existence of fraud
, Internal auditing : “provides independent, objective assurance and consulting services
designed to add value and improve an organisation’s operations...” (IIA 2016)
Internal audit encompasses examination and evaluation of :
- Adequacy and effectiveness of governance and internal control structure
- The quality of performance
- The procedures of risk identification and management
- Mechanisms to ensure regulatory compliance
Supplements the work of independent auditors
Internal auditors should :
- Review the reliability and integrity of financial and operating information
- Review the systems established to ensure compliance with policies, plans,
procedures, laws and regulations
- Assess risks within and outside the business
- Review the means of minimising risks
- Appraise the economy and efficiency of resources
- Review operations or programs
Assessing internal auditors
Criteria external auditors use to assess the performance of the internal auditor :
- Organisational status
- Scope of internal auditing
- Technical competence
- Due professional care
Operational auditing
Examines use of resources to evaluate whether they are being used in the most
efficient and effective manner
Three approaches:
- Risk-based audit approach
- Value-for-money approach
- Process audit approach
Audit committees – of the board of directors
be of sufficient size, independence and technical
expertise to discharge its mandate effectively
be made up of only independent directors
include members who are all financially literate
include at least one member with financial expertise
include some members who have an understanding of the industry
