Topic A-3 The Regulatory Environment and Corporate Governance

1. The regulatory frameworkAn area of significant change in recent yearsIncreasing emphasis on corporate governance and importance of internal auditTypes of regulatory influences include:Corporate governance requirementsNational legislationIndustry specific regulationsCommon regulations affecting all activities （e.g. Health and Safety）Industry specific regulationsInternational regulationsStatutory framework for internal auditing involves three key areas:Corporate governanceInternational accounting standardsPublic sector requirementsCorporate governanceCOSO Report –Internal Control –Integrated Framework, Committee of Sponsoring Organizations defines internal control as a process, effected by directors, management and other personnel, to provide reasonable assurance regarding the achievement of objectives.The objectives include:Effectiveness and efficiency of operationsReliability of financial reportingCompliance with laws and regulationsThe main areas of the model are as follows:Control environmentRisk assessmentControl activitiesInformation and communicationMonitoringThe latest UK requirements （Listing rules）are set out in the UK Stock Exchange combined Code, with guidance on meeting these requirements set out in the Turnbull report. Turnbull requires that listed companies （i.e. public companies whose shares are listed on the London Stock Exchange）‘be required to confirm that there is an ongoing process for identifying, evaluati ng and managing the company’s key risks and that it is regularly reviewed by the board and accords with the guidance’.2. Auditing and company legislationMost audit work involves companies incorporated under national legislation. Over time the purpose of audit has developed.In the 19th century, auditors were expected to prevent or detect fraud and error.In the early 20th century attention shifted to the certifying of accuracy in financial statements.End of 20th century sees a return to the prevention/detection role as the expectations gap is addressed.Company law often does not address the problem of setting auditing standards – this task is delegated to the profession.N.B.The ‘expectations gap’ is the term used to describe the gap be tween what the auditor actually does and whatusers of financial statements believe he does or should do. The auditor believes his job is to gather sufficient appropriate audit evidence to form his audit opinion; users often believe that detection of fraud is a key audit objective. Closing this gap is one of the profession’s most pressing priorities.（A- Q3/J2006）Corporate Governance3. You are the audit manager of Tela &Co, a medium sized firm of accountants. Your firm has just been asked for internationally recognized codes on corporate governance and Jumper & Co has a number of clients where the codes are not being followed. One example of this, from SGCC, a listed company, is shown below. As your country already has appropriate corporate governance codes in place, Jumper & Co have asked for your advice regarding the changes necessary in SGCC to achieve appropriate compliance with corporate governance codes.Extract from financial statements regarding corporate governanceMr Sheppard is the Chief Executive Officer and board chairman of GCC. He appoints and maintains a board of five executive and two non-executive directors. While the board sets performance targets for the senior managers in the company, no formal targets ofr review of board policies is carried out. Board salaries are therefore set and paid by Mr Sheppard based on his assessment of all the board members, including himself, and not their actual performance. Internal controls in the company are monitored by the senior accountant, although detailed review is assumed to be carried out by the external auditors; SGCC does not have an internal audit department.Annual financial statements are produced, providing detailed information on past performance.Required:Write a memo to Jumper & Co which:（a）Explains why SGCC does not meet international codes of corporate governance（b）Explains why not meeting the international codes may cause a problem for SGCC, and（c）Recommends any changes necessary to implement those codes in the company.（20marks）[答疑编号10103101：针对该题提问]Memo3Fsrom: A Manager, Tela & CoTo :Jumper & CoSubject: Corporate Governance in the SGCC CompanyDate: 13 June 2006As requested,I write to explain where your client SGCC does not appear to be following appropriate corporate governance codes and to recommend changes to ensure that the principles of good corporate governance are being followed.Chief Executive Officer （CEO）and ChairmanMr Sheppard is both CEO and chairman of SGCC. Corporate governance indicates that the person responsible for running the company （the CEO）and the person responsible for controlling the board （the chairman）should be different people. This is to ensure that no one individual has unrestricted powers of decision.I recommend that Mr Sheppard is either the CEO or the chairman and that a second individual is appointed to the other post to ensure that Mr Sheppard does not have too much power in SGCC.Composition of boardThe current board ratio of executive to non-executive directors is 5:2. this means that the executive directors can dominate the board proceedings. Corporate governance codes suggest that there should be a balance of executive and non-executive directors so this cannot happen. A minimum of three non-executive directors are also normally recommended, although reports such as Cadbury note this may be difficult to achieve.I recommend that the number of executive and non-executive directors is equal to help ensure no one groupdominates the board. This will mean appointing more non-executive directors to SGCC.Director appointmentAt present, Mr Sheppard appoints directors to the board, giving him absolute authority over who is appointed. This makes the appointment procedure and qualities directors are being appointed against difficult to determine. Corporate governance suggests that appointment procedures should be transparent so that the suitability of directors for board positions can be clearly seen.I recommend that an appointments committee is established comprising three noon-executive directors to ensure there is no bias in board appointments. Formal job descriptions should also be published making the appointment process more transparent.Review of board performanceIt is correct that the performance of senior managers is reviewed, but this principle should also be applied to the board. While Mr Sheppard may undertake some review, this is not transparent and it is not clear what targets the board either met or did not meet.I recommend that performance targets are set for each director and actual performance assessed against these on a regular basis. Reasons for underperformance should also be ascertained and where appropriate, changes made to the composition of the board.Board payAt present, board members’ pay is set by Mr Sheppard. This process breaches principles of good govemance because the remuneration structure is not transparent and Mr Sheppard sets his own pay. Mr Sheppard could easily be setting remuneration levels based on his own judgements without any objective criteria.I recommend that a remuneration committee is established comprising three non-executive directors. They will set remuneration levels for the board, taking into account current salary levels and the performance of board members, remuneration should also be linked to performance, to encourage a high standard of work.Internal controlThe system of intemal control in SGCC does not appear to be reviewed correctly. While extemal auditors will review the control system, this review is based on their audit requirement and cannot be relied on to test overall effectiveness of the system. The system may therefore sill contain weaknesses and errors.I recommend that some more formal review of internal control is carried out, perhaps by establishing an internal audit department, as noted below. The relationship with the company’s auditors must also be reviewed so that the work of the board and the auditors regarding intemal control is understood by both parties.Internal auditSGCC does not have an liternal audit department. Given the lack of formal review of internal control in the company, this is surprising. Good corporate governance implies that the control system is monitored and that and internal audit department is established to carry out this task.I recommend that an internal audit department is established, reporting initially to the audit committee who will monitor internal control and then summarise reports for the board.Financial statementsThere appears to acceptable disclosure in the financial statements regarding the past results of the company. However, the board should also provide an indication of how the company will perform in the future, by a forecast review of operations or similar statement. This is partly to enable investors to assess the value of their investment in the company.I therefore recommend that the annual accounts off SGCC include some indication of the future operations of the company.Audit committeeThere is no mention in the report of an audit committee. Good corporate governance implies that there is some formal method of monitoring external auditors as well as checking that the reports from the extemal auditors are given appropriate attention in the company.I recommend that an audit committee is established-made up from non-executive directors. The committee will receive reports from the external and internal auditors （as mentioned above）and ensure that the board takes appropriate action on these reports.I hope this information is useful. Please contact me again if you require any further assistance.SincerelyAnn C.OutentNote to candidates: An alternative and allowable answer format was to answer sections（a ）, （b）and （c）of the question separately. Taking this approach would also allow other valid points in part（b）such as inability to obtain a stock exchange listing.（B6/J2006）IAASB & ISA6 international Standards on Auditing （ISAs）are produced by the international Audit and Assurance Standards Board （IAASB）, which is a technical committee of the international Federation of Accountants （IFAC）. In recent years, there has been a trend for more countries to implement the ISAs rather than produce their own auditing standards.A school friend who you have not seen for a number of years is considering joining ACCA as a trainee accountant. However, she is concerned about the extent of regulations which auditors have to follow and does not understand why ISAs have to be used in your country.Required:Write a letter to your friend explaining the regulatory framework which applies to auditors.Your letter should cover the following points:（a）The due process of the IAASB involved in producing an ISA.（4marks）（b）The overall authority of ISAs and how they are applied in individual countries.（8marks）（c）The extent to which an auditor must follow ISAs. （4marks）（d）The extent to which ISAs apply to small entities. （4marks）（20marks）[答疑编号10103102：针对该题提问]6Flat SG1Community GardensLong RoadAnytown17 June 2006Dear JayneI am pleased you are also thinking about accountancy as a career and understand your concern regarding the use of auditing standards. I will try and explain the need for standards in this letter.The working procedure of the IAASB to produce an ISAThe start of the process of producing an international Standard on Auditing （ISA）is for a subcommittee of the international Audit and Assurance Standard Board（IAASB）to determine appropriate areas for an ISA, or to note where existing ISAs need amendment.The subcommittee produces an exposure draft on that subject, initially for consideration by the IAASBapprove the exposure draft, then it is circulated to the member bodies of the international Federation of Accountants （IFAC）and any other organisations that have an interest in auditing standards and published on the IAASB website.These bodies make comments on the exposure draft. Comments are sent back to the IAASB and the exposure draft is amended as necessary. Finally the exposure draft is re-issued as an ISA or an international Auditing Practice Statement （IAPS）.The whole process can take between one and two years.The overall authority of ISAs and how ISAs are applied in individual countriesISAs are designed to be applied in the audit of financial statements and may be applied to the audit of other historical financial information.Each ISA contains the basic principles and procedures to apply to that ISA （identified by bold type in the ISA itself）. Other text in the ISA provides guidance on the implementation of the principles. In the words, to apply the ISA, the whole of the text, not simply the parts in bold type, must be read and understood.ISAs are not designed to override the requirements for the audit of entities in individual countries. So if our country did not require and audit of specific entities, then the ISAs would not overrule that requirement.Regarding the detailed requirements of an audit, such as the nature of testing or the issuing of an engagement letter, where our country requirements meet those of the ISA, then the ISA will be sued. It is therefore unlikely that our country would issue a separate auditing standard; the ISA would be sufficient.Where our local codes on audit differ from the ISA, then the local requirements are used. However, we are encouraged to introduce changes in our country so that the requirements of the ISA are met. For example, our country may require an engagement letter to be signed every five years, but the ISA requires one every year. In this case, local change is needed to comply with the ISA.The extent to which an auditor must follow ISAsAn auditor should follow the ISA wherever pollible. However, in some situations an auditor may consider it necessary to depart from the ISA so that the objectives of the audit can be achieved more efficiently. In this situation, the auditor can depart from the ISA, but he or she must be prepared to justify the departure. It is expected that departure from any ISA will be the exception rather than the rule.The extent to which ISAs apply to small entitiesTo be clear, ISAs are meant to be applicable to the audit of any entity, no matter what its size. However, in small entities, the auditor may have to amend the audit approach to fit the circumstances of that business. For example, these will be greater reliance on substantive testing and management representations. However, the appropriate ISAs should be followed.ConclusionI hope that this clarifies your understanding of ISAs. Please let me know if I can be of further assistance to you in your accountancy career.Yours sincerely,Rajit Gry。