Governance and audit committees slide presentation

• Audit committees are an integral part of governance, and where used effectively can enhance governance... PART A – The need for corporate governance • Agency and stewardship theory • A

Governance and Audit

Committees

Dr AJ Purcell, FCPA , Chief Auditor, CPA Australia

aj.purcell@cpaaustralia.com.au

• CPA Australia is one of the world's largest accounting bodies with more

than 150,000 finance, accounting and business professionals in 121

countries

• Distinguishing feature of CPA Australia is ‘Business Strategy and

Leadership’

• 35,000 members in Asia

• 50 year presence in Asia

• Staffed offices since 1992

• Hanoi and Ho Chi Minh City since mid 2007

• Audit committees are an integral part of governance, and where used

effectively can enhance governance

PART A – The need for corporate governance

• Agency and stewardship theory

• Agency and agents act of behalf of the principals

• Stewardship – carefully look after the resources they have been

trusted with

• Two assumptions of Agency Theory

 Individuals act in their own self-interest

 Agents are in a position of power

• Berle and Means (1932) seminal work of the separation of rights and

responsibilities of shareholders, directors and management

• Corporate governance provides the context for:

 Ownership and control

 Exercise of power

 Accountability and responsibility

IFAC (2008)

• Berle and Means (1932) - “control lies in the hands of individuals/groups

who have actual power to select the board of directors”

Explanation of Governance Principles

• Financial aspects of corporate governance (Cadbury 1992)

• OECD (2004)

• Principles of Corporate Governance, the King Report on

Corporate Governance (King 2002)

• Principles of Corporate Governance and Best Practice

Recommendations (ASX 2007)

Justice Owen HIH Royal Commission (2003)

• “Danger with an overly prescriptive approach to systems and

structures is that it may unwittingly encourage a superficial

or ‘tick the box’ approach to the achievement of governance

objectives:

• “Systems and structures can provide an environment

conducive to good corporate governance … it is the acts or

the omissions of people … that will determine whether

governance objectives are in fact achieved”

IFAC (2008)

Anglo-American core duties and responsibilities from statute or case

law

• Avoid conflict of interest

• Act in the best interest of the company

• Exercise power for a proper purpose

• Retain discretionary powers

• Act with due skill and care

• Be informed of the company’s operations

• Prevent trading while insolvent

Conflict of interest

• Bribery, secret commissions

• Misuse of corporation’s funds for personal purposes

• Accepting corporate opportunities

• Confidential information to trade

• Competing with the company

• Misuse of position to secure a financial advantage

• Act in the company’s interests

 Action should always be in good faith, honestly and without collusion

• Exercise power for a proper purpose

 Act within power (ie Anti-competitive pricing would be illegal)

• Duty to retain discretion

 Directors remain responsible for power even if delegated

• Duty of care, skill and diligence

 Risks must not be reckless

 Test of a reasonable man

 Business judgement rule

• Key messages:

 Clear accountabilities and delegations

 Organisational structure to add value

 Sound risk management

• The power of the metaphor of the lighthouse is to ensure that

companies/directors/management:

 identify and respect stakeholders’ needs and expectations;

 are transparent, accountable, ethical

 accountability and responsibility

• Conformance and performance

• Seminal works on governance (Cadbury, King, OECD, ASX)

• Anglo-American core duties and responsibilities

• Metaphor of the lighthouse

Summary - Governance

PART B – Audit committees

• Audit committees can positively contribute to governance

• Committees of the board – finance, nomination/remuneration Advisory

committees – ethics, regulatory

• “7 S” Theory

 Strategy, structure, systems

 Staffing, skills, style

 Shared values

• Behavioural focused

 What are the enablers/disincentives to function?

• Groups at the Audit Committee

 Directors/independent directors/management

 Auditors (external/interest)

• Audit committees topical in the literature

• Audit committees can be a vehicle to assist directors and management

towards their mutual obligations of honest stewardship

• Audit committees can assist companies to establish and maintain reliable

systems of internal control

• In working with audit committees there can be negative and positive

behaviours

For example - government audit committee had:

 Critical information withheld

 Dominated members

 Manipulation of agendas

 Misinformation in relation to risk

• Better practice guidelines – risk of prescription

Effectiveness of and Audit Committee

To assess effectiveness, audit committees could consider the

following:

(1) quality of the financial reporting;

(2) risk management and internal control;

(3) compliance and ethics;

(4) oversight of management and internal audit;

(5) relationships with external auditors;

(6) resources and investigations;

(7) composition of the audit committee;

(8) training;

(9) frequency of meetings; and

(10) role and responsibilities of the audit committee (Bromilow and

Berlin, 2005)

Some of the Building Blocks of Audit Committee

Effectiveness

Audit Committees – Areas of Focus

• Independence, expertise and diligence

• Skills and expertise

• Support from management

• Skill and training of audit committee members

• Composition, authority and resources

• Leadership

• Adverse financial reporting

• Mechanisms for monitoring financial reporting

• Governance research predominately based on agency theory

• Financial reporting, internal controls and sustainability

Audit Committee Research

• Audit committee mechanisms to strengthen corporate governance

• Corporate law reforms aim to enhance accountability and integrity of

financial reporting

• Audit committee can enhance reporting and independence

• Monitor and protect the interest of the community

Do they add value and are they effective?

• Recurring themes of:

 accountability and transparency

 credibility of members

 independence

 advisory body

• Selection of the right things to do

• Appropriately skilled people

• Managing relationships

• Relevant questions

• Management of the ‘difficult issues’

Challenges of an Audit Committee

 Shareholders informed of audit fees, non-audit services and how audit

committee protects independence

• Oversight of internal control and risk management

• Other duties of audit committees

• Relevant skills

• Management attitudes – agency –v- stewardship

• Appointment of a chair

 Skills : emotional intelligence (social awareness, empathy,

self-awareness, self-management, relationship management)

• Audit committee members

 Skills/qualifications

 Independence

 Sufficient knowledge

 Rigour / knowledge

 Committed to integrity and transparency

Right people at the audit committee

• Relationship with directors and independent members

• External and internal auditors

• Preparation / diligence

• Work plan

• Relationships with subsidiaries

• Relationship with CEO/CFO critical

Relationship of the Audit Committee

• Key developments (service, infrastructure, performance)

• Legal and regulatory issues

Subject Matters

• Second opinions

• Management engaged in misconduct/fraud

• Errors in published accounts

• Whistle-blowing allegations

• Regulatory reviews

• Major non-compliance with legislation

• Fundamental internal control weakness

• Replacement of auditors

• Reprimanding management

• Resistance

• Incompetent members

Difficult issues for an audit committee

• Provides oversight of internal controls and integrity of reporting

• Independence regime for auditors

• Facilitates communication

• Forum for disagreement

• Keeps the board informed of accounting and audit issues

• Limitations of an audit committee

 Expectations gap

 Power to enforce recommendations

 Credibility and undermining of effectiveness

 Incompetency

 Mistrust

Summary

PART B

• Governance Failures

• OECD Principles

• Code of Ethics for Accountants

• CPA (2014) Survey of Governance in the Asia/Pacific

• GOVERNANCE FAILURES

 Unethical and risk taking culture

 Dominant and charismatic CEO

 Boards which failed to question

 Ineffective internal controls and risk management

 Aggressive earnings management

Enron – a catch phrase for a corporate collapse

Cruver (2002)

“Fear among competitors, suppliers, customers and even Enron’s employees…greed among those who dreamed of

colossal bonuses, millions in stock options and generous

campaign contributions Fear and greed…were radically and

permanently entrenched…throughout the culture, the people

and the industries that Enron touches”

• Financial crisis (GFC) – governance did act to safeguard against excessive

risk taking

• Information systems faulted

• Strategy and performance metrics

• Accounting and regulatory environments can lag

• Remuneration systems/rewards not linked to strategy and risk appetite

• Principles-based as compared to prescriptive

• Unintended consequences of behaviours (what is the minimum I have to do?)

• Six core principles of OECD

 Basis for an effective governance system

 Rights of shareholders

 Equitable treatment

 Stakeholders

Professional judgement

+ The framework of the Code requires the use of professional judgement

Autonomy/privilege + responsibility

+ Professional accountants face dilemmas that require professional judgement

• E.g.: The duty of confidentiality on one hand and disclosure of information to protect the

public interest on the other

• Dilemmas require consideration of which action creates the most good and least harm,

best serves the rights of others and promotes the public interest

+ The impact of a potential action on our character and integrity is also important,

as is the promotion of the credibility of the profession (required by the

fundamental principle of professional behaviour in the Code)

+ These considerations are not independent of each other; need to be examined

together

Our code and principles

+ The first paragraph of the Code of Ethics for

Professional Accountants states

‘A distinguishing mark of the accountancy profession is its

acceptance of the responsibility to act in the public interest

Therefore, a professional accountant's responsibility is not

exclusively to satisfy the needs of an individual client or

CPA (2014) SURVEY OF GOVERNANCE IN THE ASIA PACIFIC

• Vietnam

 Good governance was an enabler for economic growth

 Corporate governance improves when accountability and financial

transparency improves

 Potential opportunities in relation to:

 Integrity of financial reporting

 Corporate reporting

Summary of key findings as compared to other countries

• Political interference – less of a problem in Vietnam

• Accountability/transparency – more effective in Vietnam

• Corruption and fraud

Summary of presentation : Parts A/B/C