Lecture 2 - CG Prof Ethics PDF

Advance Audit & Assurance Lecture 2 Lecture Two Regulatory Framework Corporate Governance Code of Professional Ethics Regulatory Framework Corporate Governance Corporate Governance DEFINITION ‘the system by which a company is directed and...

Advance Audit & Assurance Lecture 2 Lecture Two Regulatory Framework Corporate Governance Code of Professional Ethics Regulatory Framework Corporate Governance Corporate Governance DEFINITION ‘the system by which a company is directed and controlled’ ‘Cadburys 1992’ ‘Cadburys 1992’ Corporate Governance Why Corporate Governance? Why? Agency Theory The problem of corporate governance arises because often in companies (particularly larger ones) management and owners are not the same people The managers (stewards) of the company report to the owners Other people use that report to draw conclusions about the company This ‘report’ (the financial statements) is audited by auditors, who report on its truth and fairness (SOURCE BPP 2013) UK Corporate Governance Code UK Corporate Governance Code This looks at the following sections: 1. Board leadership & Company purpose 2. Division of Responsibilities 3. Composition, Succession and Evaluation 4. Audit, Risk and Internal Control 5. Remuneration (SOURCE: UKCG 2024) UKCG Code Formerly known as the ‘Combined Code’ Complusory for ALL listed companies Comply or explain E.g Stuart Rose - joint Chair & CEO of M&S 2009 Principles Based (Voluntary) not ‘Rules Based’ (compulsory) UKCG Code – Principles Based ADVANTAGES DISADVANTAGES Can be applied flexibly Insufficient protection Smaller entities can pick and choose Choice of non-compliance (BPP 2013) Does not create ‘burden of requirement’ UKCG Code – Main Elements The Board Meet regularly Chairman Balance of executive and non- Roles of Chairman and Chief Executive to executive directors be distinct (BPP 2013) Some non-execs to be independent Rigorous and transparent nomination process Directors to submit for re-election UKCG Code – Main Elements Internal controls and risk Board should maintain sound risk management and internal control systems management Audit committee Should be established Internal audit Consider the need for the internal audit function annually (BPP 2013) Remuneration Formal transparent process for setting reasonable remuneration Relations with shareholders Ensure satisfactory dialogue with shareholders Auditors FTSE 350 companies in the UK should put the external audit contract out to tender at least every 10 years(BPP 2013) UKCG Code – Main Elements Set up three committees at the minimum: i. Remuneration ii. Audit iii. Nomination R.A.N UKCG Code – EA Role provide independent Segregation of roles between check. Chairman and CEO to reduce the power of prominent people form an opinion on Chairman - is the head of non- whether directors have executive directors complied with CG regulations. CEO - ensures the effective operation of the company Non-Executive Directors (NEDs) A non-executive director is a part-time position which holds a seat on a business's board of directors and shares in the collective responsibility for the running of the company. Usually employed on a part time basis Do not make executive management decisions Participate at board meetings Assist the main board Members of sub committees Appoint Senior NED – intermediary between other directors and shareholders Non-Executive Directors (NEDs) Ineligibility Criteria: is or has been an employee of the company or group within the last five years; has, or has had within the last three years, a material business relationship with the company, either directly or as a partner, shareholder, director or senior employee of a body that has such a relationship with the company; has received or receives additional remuneration from the company apart from a director’s fee, participates in the company’s share option or a performance-related pay scheme, or is a member of the company’s pension scheme; has close family ties with any of the company’s advisers, directors or senior employees; holds cross-directorships or has significant links with other directors through involvement in other companies or bodies; represents a significant shareholder; or has served on the board for more than nine years from the date of their first appointment. NEDs – Audit Committee Composition General board should be made up of a minimum of 50% NEDs. AC is considered best practice for listed companies AC composed of a minimum of 3 NED’s At least one AC NEDs must have recent/relevant financial experience NEDs – Audit Committee: Objectives Increase public confidence in the credibility and objectivity of published financial information Assisting directors in meeting their obligations regarding financial reporting Strengthening the independent position of the external auditor NEDs – Audit Committee Role & Responsibilities I monitoring the integrity of the financial statements. providing advice (where requested by the board) on whether the annual report and accounts is true and fair. reviewing the company’s risk management and internal control framework. monitoring and reviewing the effectiveness of the company’s internal audit function.  Make recommendations in relation to the appointment and removal of the external auditors and remuneration NEDs – Audit Committee Role & Responsibilities II  Review and monitor the auditor’s independence and objectivity  Review and monitor the auditor’s independence and objectivity  Review the effectiveness of the audit process  Develop policy on the engagement of the external auditors supply of non-audit services  Review the arrangements for whistle blowers within the organisation NEDs – Audit Committee Advantages Increased confidence in credibility of reporting- HOW ? Frees executive directors to manage Reporting lines for the internal audit function and impartial link for external audit Creates culture opposed to fraud NEDs – Audit Committee Benefits i. Independent reporting mechanism ii. Ensure that the internal audit reports are considered and actioned uponShareholder and public confidence enhanced iii. Help executive directors fulfil their obligations iv. Help the business maintain appropriate IC’s v. Ensure better communication between the board and the external auditors – Strengthen the independence of the external audit function NEDs – Audit Committee Limitations 1. Selecting suitably independent NED’s can be difficult 2. Perception that they are there to catch management out 3. NED’s can be overburdened with detail - consequences 4. A two-tier board of directors 5. Cost Regulatory Framework Code of Professional Ethics This Code of Ethics establishes ethical requirements for professional accountants/auditors. A member’s objectivity must be beyond question if he or she is to report as an auditor. That can only be assured if the member is, and is seen to be, independent (BPP 2013) Professional Code of Ethics (IAASB) FIVE fundamental principles: 1. Professional behaviour Mnemonic Moment: 2. Professional Competence & due care Popular people chat in 3. Confidentiality the office 4. Integrity 5. Objectivity Professional Code of Ethics Professional behaviour Professional competence and due care Members have a continuing duty to maintain Members should professional knowledge and skill at a level required to comply with relevant ensure that a client or employer receives the advantage of laws and regulations competent professional service based on current developments in practice, legislation and techniques and should avoid any Members should act diligently and in accordance with action that discredits applicable technical and professional standards when the profession providing professional services (BPP 2013) Professional Code of Ethics Confidentiality: Voluntary or Obligatory Members should respect the confidentiality of information acquired as a result of professional or business relationships and should not disclose any such information to third parties without proper and specific authority (Voluntary) unless there is a legal or professional right or duty to disclose (Obligatory) Confidential information acquired as a result of professional and business relationships should not be used for the personal advantage of the professional accountant or third parties (SOURCE BPP) Professional Code of Ethics Integrity Objectivity Members should not allow Members should be bias, conflicts of interest or straightforward and honest undue influence of others in all business and to override professional or professional relationships business judgements Professional Code of Ethics (IAASB) Threats: situations that tempt an accountant to act in a way that goes against their code of ethics 1. Self – interest Mnemonic Moment: 2. Self – review Some Smart 3. Advocacy Auditors Find Important Mistakes 4. Familiarity 5. Intimidation 6. Management Professional Code of Ethics Threat Example Self – interest can arise where there are financial or other interests in a client. Self – review can arise when an audit firm reviews their own work. Advocacy where an audit firm promotes a position of an audit client to the point where subsequent objectivity is compromised. Example commenting publicly on the future events concerning the client. Familiarity having an audit client over a long period can cause this. Intimidation where an audit client threatens an auditor and the auditor is prevented from behaving objectively because of this threat Management the auditor making management decision making Professional Code of Ethics – ES1 Ethical Standard 1 (ES1)- ‘ auditors should conduct the audit of financial statements of an entity with integrity, objectivity and independence’ What is independence ? ‘freedom from situations and relationships which make it probable that a reasonable and informed third party would conclude that objectivity either is or could be impaired’ Practical Ethical Guides – ES1 A key risk to independence arises from the provision of other services to audit clients An auditor:  Must not assume a management responsibility  May not prepare accounts for a public interest entity  Must not review his own work  Cannot be an employee of an audit client Practical Ethical Guides – ES1 Advertising, publicity and obtaining professional work Members: Should not obtain or seek work in an unprofessional manner Can advertise, but should have regard to relevant advertising codes and standards Should not make disparaging references to or comparisons with the work of others Should not quote fees without great care not to mislead Should not offer fees, commission or reward to third parties for introducing clients (BPP 2013) Practical Ethical Guides – ES1 Audit fee The audit fee is a sensitive issue It is estimated according to charge out rates and work planned Lowballing is offering audit services at less than the market rate; undercutting others in a tender It can be an independence threat as such a fee is less than the work is worth However, audit does have a fluctuating market price and firms can reduce fees Fee Dependency – 15% Ltd / 10% PLC of annual audit practice annual revenue. Review within 5% of threshold. Non-audit services provided by an audit firm to no more than 70% of the average audit fees paid over the previous three consecutive financial years. Practical Ethical Guides – ES1 Confidentiality Exceptions to the prohibition on disclosure – voluntary Disclosure is reasonably necessary to protect the member’s interests Disclosure is compelled by process of law (say in an action where member must give evidence) It is in the public interest to disclose Some government bodies have statutory powers to compel disclosure Practical Ethical Guides – ES1 INDEPENDENCE Family & Personal relationships- immediate family members who are a director, employee of the client company – person should not be part of the audit team. Also close family members are included such as parent, child, brother, sister. Audit firm should regularly review this issue Close business relationships – should be avoided Financial interests IT Systems- not allowable Gifts & Hospitality – only allowable if the value is insignificant Professional Code of Ethics: Safeguards against loss of objectivity By:  Professional guidelines - Audit committee  The benefit of audit rotation is that loss of independence through familiarity is guarded against  In practice audit rotation is not popular because of the high recurring costs of first audits, loss of trust and experience built up  If an individual is a key audit partner for seven years for a public interest client, they must be rotated off the audit for two years (bpp 2013)  Workplace rules and policies – i.e. Quality control procedures  Self-awareness and improvement of professional knowledge – i.e. CPD