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After discussing briefly the primary role of a company auditor, consider why ethics is important to auditors. Evaluate how significant the contribution of auditors is to the effective corporate governance of large UK companies.
According to Porter, Simon & Hatherly (2008):
'Auditing is a systematic process of objectively gathering and evaluating evidence relating to assertions about economic actions and events in which the individual or organisation making the assertions has been engaged, to ascertain the degree of correspondence between those assertions and established criteria, and communicating the results to users of the reports in which the assertions are made.' (p9)
Audits may be classified as external audits and internal audits based on primary audit beneficiaries. Internal audits are performed for parties internal to the entity. The internal audit is conducted in accordance with managementï¿½ï¿½s requirements. External audits are an audit performed for parties external to the auditee. Experts, independent of the auditee and its personnel, conduct these audits in accordance with requirements which are defined by, or on behalf of, the parties for whose benefit the audit is conducted.
Both types of audits provide crucial information to those who needed. There is always a good director behind a nice movie ï¿½C in this case, the ï¿½ï¿½directorï¿½ï¿½ is an auditor. According to Wikipedia (Audit): 'Internal auditors of internal control are employed by the organisation they audit. Internal auditors perform various audit procedures, primarily related to procedures over the effectiveness of the company's internal controls over financial reporting. External auditor is an independent accounting firm engaged by the client subject to the audit, to express an opinion on whether the company's financial statements are free of material misstatements, whether due to fraud or error. '
Auditors are acting crucial roles in auditing process, and the independence of auditors has been referred to as the cornerstone of auditing. Independence is a key concept ï¿½C a characteristic that is essential for ensuring the credibility of auditorsï¿½ï¿½ work. They have to keep away from the temptation which may destroy their faith to be independent. These influences could impair their objectivity and impartiality. Porter, Simon & Hatherly (2008) had stated that there are three factors that might compromise auditorsï¿½ï¿½ independence:
ï¿½ï¿½A self-interest threat arises when the auditor has financial or other interests which might cause it to be reluctant or take actions that would be adverse to the interests of the audit firm or any individual in a position to influence the outcome of the audit.
A familiarity threat arises when the auditor is predisposed to accept or is insufficiently questioning of the audited entityï¿½ï¿½s point of view.
An intimidation threat arises when the auditorï¿½ï¿½s conduct is influenced by fear or threats.ï¿½ï¿½ (p56)
The audited entity might bribe the auditor in order to persuade him or her to do what the board need. For example, to ignore the fraud and misstatement.
Auditors are taking the responsibility of making the companies and even the economy better. The audit not only benefits the audited entity, audit firm and the third party organisation, it also benefits the public. A fair and accurate financial reporting might make people better off; in contrast, a misstatement or biased report might make somebody bankrupt. Auditors represent ï¿½ï¿½trustï¿½ï¿½, they are sent to evaluate and judge other peopleï¿½ï¿½s work. How can people trust them if misstatements are made? Therefore, ethics are of crucial importance to the audit function.
Corporate governance is the system by which organisations are directed and controlled by senior officers. There are several elements in corporate governance which have been stated in ACCA, 3rd Edition:
'Reduction of risk is fundamental.
Overall performance enhanced by good supervision and management within set best practice guidelines underpins most definitions.
Good governance provides a framework for an organisation to pursue its strategy in an ethical and effective way from the perspective of all stakeholder groups affected and offers safeguards against misuse of resources, physical or intellectual.
Good governance is not just about externally established codes, it also requires a willingness to apply the spirit as well as the letter of law
Accountability is generally a major theme in all governance frameworks. There is a free flow of information in the form of accounts and other reports. ' (p108)
Financial reporting is a crucial element necessary for the corporate governance system to function effectively. Accountants and auditors are the primary providers of information to capital market participants. The function of auditor's report has been defined: 'An auditorï¿½ï¿½s report is considered an essential tool when reporting financial information to users, particularly in business. Since many third-party users prefer, or even require financial information to be certified by an independent external auditor, many auditees rely on auditor reports to certify their information in order to attract investors, obtain loans, and improve public appearance.' (Wikipedia: Auditor's report)
For companies, the audit process culminates in the statutory report to shareholders. The report is the end product of the audit examination and communicates to shareholders. The statement shows the financial position and performance of the company, eventually the company would decide whether to compliant the financial reporting framework. Auditors definitely have the contribution to the strategy and governance of companies by providing different financial information.
In this case, I would look into the Severn Trent Plc to do a case study. Severn Trent Plc is a large group of companies employing more than 15,000 people across the UK, US and mainland Europe. And it is traded on the London Stock Exchange.
In Severn Trent Plc Annual Report and Accounts 2009, Governance, it states:
ï¿½ï¿½The Severn Trent Governance Framework has three key elements:
The way we assure our performance, management assurance is provided by a combination of effective management processes and embedded risk and compliance activities. Independent assurance is provided primarily by internal audit, by our independent external auditors and by other external bodies.ï¿½ï¿½ (p24)
The groupï¿½ï¿½s internal audit function reports to management on the effectiveness of the companyï¿½ï¿½s systems of internal controls, the adequacy of these systems to manage business risk and to safeguard the groupï¿½ï¿½s assets and resources.ï¿½ï¿½ (p27)
The board reviews the effectiveness of the system of internal control, including financial, operational, compliance and risk management, at least annuallyï¿½ï¿½ The internal audit department provides objective assurance and advice on risk management and control. The external auditors also report on significant control issues to this committee.ï¿½ï¿½ (p31)
The company maintains an independent perspective on the overall framework by obtaining confirmation that the governance structure is working properly. In Severn Trent, this is obtained primarily from the internal audit function and the external auditorï¿½ï¿½ Internal audit deliver an audit plan to confirm that key business risks are being mitigated. It also delivers specific, tested opinions on those areas for which it, as a function, is responsible.ï¿½ï¿½ (p32)
From the annual report, we can find out many functions that the external and internal auditors have. They provide effective management processes and embedded risk and compliance activities to enhance the overall performance ï¿½C a key element of corporate governance. They help the board to review the effectiveness of the system of internal controls and to safeguard the groupï¿½ï¿½s assets and resources. Internal audit also deliver an audit plan to confirm that key business risks are being mitigated. One of the auditorsï¿½ï¿½ jobs is to find out the risks and problems of the system and offer a method to erase them.
It is easy to find that the auditorsï¿½ï¿½ work is mostly connected with the performance, risk management and framework assurance of Severn Trent Plc. The report on business performance may affect the decisions regarding the governance, management strategy and regulation of the company. For example, if a loss is shown on the financial statement, the decision makers might change the strategy, auditors have to advice the board by analysing information collected, whether to maximise profit or maximise the market share. In addition, corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection. For example, to monitor managers' behaviour, the external auditor attests the accuracy of information provided by management to investors. An ideal control system should regulate both motivation and ability. Thus, the contribution of auditors to the effective corporate governance is essentially crucial.
However, although the auditor has significant effects on the corporate governance, they are still limit. Good financial reporting is not a sufficient condition for the effectiveness of corporate governance if users do not process it or not apply the advice the report offered as personal preference might affect the decisions from the board.
In the modern economy, age of privatisation, both internal and external auditors are acting more and more crucially. They are the image of expert and justice. Once the auditors fail to be independent, there would be a significant influence to their work. They have to avoid being attracted by any temptation from themselves or others. Therefore, ethics is essentially important to a good auditor. Auditors analyse information for the audited entity and report to the board of the company by providing the advice about internal controls, business performance and risk management, and also provide advice. External and internal auditors are essential to effective corporate governance. Anyway, the auditors ï¿½ï¿½holdï¿½ï¿½ the destiny of companies, to be a successful auditor, they have to achieve independent and professional.