External Auditors and their role in the Corporate Governance Framework

outer Auditors and their procedure in the somatic presidential term Frame manoeuvreExternal Auditors check social clubs accounts and storey to the company based on the accounts. Basic each(prenominal)y, the occupy is how orthogonal attendants life these duties effectively. Legislations, such as The Companies Act 1965, obligate made bulky efforts to look into exterior visitors conduct their duties and obligations effectively. The Code of collective boldness in 2001 and the amendment in 2007 have further enhanced the force of analyse in the interests of stockholders and sh beholders. In light of the recent scandals involving outside(a) listeners in the world, thither is a growing concern for incorporated regime glob tout ensembley as there is increased reliance by the stockholders and sh atomic number 18owners on impertinent attendants.This field of view examines the role of outside size upors in the corporate g everywherening body framework. The study then reviews the pecuniary scandals involving auditors occurred in the world and investigate the role of external auditor in the collapse of the companies.IntroductionCorporate political science is a central and dynamic aspect of business. It is very important for corporate victor and social welf are. In the wake of Enron, HIH insurance policy and opposite similar cases, countries nigh the world have reacted quickly by pre-examining similar events domestically. As a speedy response to these corporate failures, the USA issued the Sarbanes-Oxly Act in July 2002, and in UK, the Higgs Report and the Smith Report were published in January 2003 (Solomon, 2007).Nowadays corporate governance is a globally debated topic with many characteristics (Nobel, 1998). However, the concern is whether auditors diarrhea an important role in the framework of corporate governance.Corporate nerveCorporate governance is the relationship among various participants in determining the steerage and p erformance of corporations. The main participants are the shareholders, the solicitude and the advance of directors.Corporate governance is the process whereby directors of a company are monitored and controlled. There are two areas considered to be thorough to corporate governance, one is supervision and monitoring of management performance and the other is ensuring accountability of management to shareholders and other stakeholders (Marianne, 2009).Till now, likely the two most important basic elements of good corporate governance have been full disclosure and the presence of independent directors and auditors, who each has their stimulate ways to confirm that the information provided by the corporation are verit able-bodied and fairly fixd. The contents of full disclosure are listed out in regulatory demands and professional pronouncements, and companies are expected to fully comply. The independence of the outside director and external auditor means the directors and au ditors willing have to hold themselves considerably to assure shareholders that they have conducted their tasks (Bavly, 2004).Role of External Auditors in Corporate GovernanceExternal auditors play a key role in the corporate governance framework. They conduct one of the most important corporate governance checks that help to monitor managements activities. The audit of fiscal statement fathers disclosures to a greater extent current, thus increasing confidence in the companys transparency.The role of external auditors is to put forward sure that senesce of Directors and the management are acting responsibly towards the shareholders coronation interests. By keeping objectivity, the external auditors can add value to shareholders by ensuring that the companys inside controls are strong and effective. And by working with the audit commissioning and liaising with internal auditors, external auditors can help to facilitate a more(prenominal) than effective oversight of the fi scal account process by the Board of Directors (Hassan, 2004).However, the audit expectations gap needs to be acknowledged, as the audit component part can only do so much on the taradiddle. The external auditor can not be expected to find any fraud and error during an audit. In accordance with the Cadbury Report, it is important to know that the external auditors role is not to prepare the monetary statements, nor to provide assurance that the data in the financial statements are correct, nor to guarantee that the company will hold out as a going concern, entirely the external auditors have to state in the annual report that the financial statements show a avowedly and fair view. The Cadbury Report highlighted that there was no doubt on whether there should be an audit but rather how the audit could be ensured to conduct effectively and objectively by the external auditors (Solomon, 2007).Auditor IndependenceExternal auditors are expected to be independent of the company an d report on the company objectively. Actually, auditors can only play their role effectively if they are independent (Peel ODonnell, 1995). They have to conduct their tasks in the most independent and reliable manner to provide investing public with the level of assurance to make their decisions based on the financial statements.According to the Cadbury Report, auditor independence could be mended collectable to the finis relationship amidst auditors and company managers and due to the auditors intention to develop a constructive relationship with their clients. There are a subroutine of menaces to auditor independence, one of which is to provide non-audit work since non-audit services are lucrative. Auditors can obtain the contracts for non-audit services only if they maintain a good relationship with the management.The Cadbury Report stressed that a labyrinthine sense is inevitable to be achieved in such way that external auditors will work with, not against, company man agement, but in doing so they need to march shareholders. This is a difficult path. The easiest way to ensure this balance being bring base the bacon is suggested to establish audit committees and develop effective score system standards.The Cadbury Report recommended all companies to establish audit committees. Audit committees serve as representative of shareholder interests. They are not only responsible for monitoring financial reporting process to support good corporate governance, they are in like manner considered to be able to ensure an appropriate relationship exists between the external auditor and the management whose financial statements are being audited (Hassan, 2004). The Smith Report issued in 2003 highlighted that the audit committee needs to be proactive and raise the concern with directors rather than brush them under the carpet. The Report too stressed that all members of audit committee should be independent non-executive directors. Companys annual report s should disclose detailed information on the role and responsibilities of their audit committee.Lessons from Financial Scandals4.1 Collapse of EnronEnron, the zippo trading company based on Texas is the first scandal quiver up the auditing profession. It has led to a crisis to the confidence on auditors and the reliability of financial reporting (Holm Laursen, 2007). The audit quality and the independence of external auditors were headwayed. In this case, Enrons audit and accounting function were fraudulent. Arthur Andersen, the auditor of Enron, has been involved in Enrons fraudulent accounting and auditing. Failure of the audit function is one of the key factors contributing to the companys collapse.Enron created The Raptors, iv limited purpose entities (SPEs). SPEs are naturalized in order that a company can form a joint venture with other interested parties to conduct a specific transaction. This transaction will not subject the other parties to the assays more general ly associated with the companys operations. U.S commandly Accepted business relationship Principles (GAPP) consent tos companies to record the gains and losses of SPEs without reporting their assets and liabilities in certain instances. In this way, Enron avoided adding more than $1 billion debt to its balance sheet without consolidating certain SPEs (Jenkins, 2003). But the problems are, when the losses of these entities quickly rose into billions of dollars, these entities were brought into the core financial statements. It then became clear that Enron itself had great losses. The corporations stock price dropped sharply, and the company went into bankruptcy in December 2001 (Brown, 2005).Examples of Enrons shifty accounting exist widely in the corporation. The company recorded profits, for example, from a joint venture with Blockbuster Video that was never materialized (The Economist, 7 February 2002). In 2002, Enron restated its accounts, which is actually a process that re duced reported profits by $600 meg (The Economist, 6 December 2001). In fact, the process resulted in a cumulative profit decrease of $591 million and a rise in debt of $628 million for the financial statements from 1997 to 2000. The difference between the profit figures was in general attributed to the front omission of three off-balance sheet entities. Such profit inflation enabled the company to raise its earnings per share (EPS).The company not only manipulated the accounting figures to inflate the earnings, but it also was undercoat to remove substantial amounts of debt from its accounts by setting up a number of off-balance sheet entities. Such special purpose entities can be used to hide a companys liabilities from the balance sheet, in order to make the financial statements look much go against than they really are (The Economist, 2 May 2002). It means substantial number of liabilities did not have to be disclosed on Enrons financial statements, because they were mainly attributed to another legal entity.All these issues raise the question, why did Enrons auditor allow this type of activity? This is because the contravenes of interest exist between the external auditor and the management.Conflicts of InterestConflicts of interest are a frequent problem in the audit profession. Although independent appointment of external auditors by companys shareholders is regularly replaced by subjective appointment by the company management, the auditor is all besides often appreciated to the companys senior management.Further, conflicts of interest arise from interactive functions of audit and consultancy. Arthur Andersen has been blamed to apply loose standards in their audits because of conflict of interest over the subatantial consulting fees collected from Enron. In 2000, Andersen collected $25 million for auditing Enrons books in appurtenance to $27 million for consulting services. In 2001, Arthur Anderson earned US$55 million for provision of non-audi t services (Brown, 2005). Although Arthur Andersen reported on the companys accounts, they did not report fraud to the shareholders. This is because the fraud was committed by the management. Kenneth Lay, the Chief Executive Officer (CEO) from Feb 1986 until Feb 2001, took home US$ 152 million although the company was facing a loss. If Andersen were to report, they probably will not be appointed in the undermentioned old age or be engaged in non-audit services (Krishnan, L, 2009).Especially, close relationships are established over cartridge holder between companies and their external auditors. It can again affect independent judgment and impact on the auditing function. In this case, there are regular exchanges of employees within Enron from Arthur Anderson. Such conflicts of interest affect the corporate governance function.Serious conflicts of interest have also arisen among members of Enrons internal audit committee, which causes the internal audit committee did not perform i ts functions of internal control and of checking the external auditing function. For example, Lord Wakeham, a member of the audit committee, was at the same time having a consulting contract with Enron (The Economist, 7February2002). This shows that people in responsible positions should have observe fraudulent activities if they were independent. Enrons board of directors was composed of a number of members who have been shown to be willing to conduct fraudulent activity. It is also because the non-executive directors were compromised by conflicts of interest.4.2 Collapse of HIH InsuranceIn Australia, the collapse of HIH Insurance Ltd was observed as the beginning of the observance into external auditors role. HIH is one of Australias biggest insurers, comprising several separate government-licensed insurance companies, including HIH Casualty oecumenical Insurance Ltd, FAI General Insurance Ltd, CIC Insurance Ltd and World Marine General Insurances Ltd. On 15 March 2001, HIH w ent into provisional liquidation with losses of A$ 800 million (Peursem, Zhou, Flood Buttimore, 2007).HIH is one of the largest corporate collapses in Australian history. kindred issues arise as in the Enron case. HIH is claimed to mislead investors by providing incorrect financial reports to the market and HIHs auditor, Arthur Andersen, may have played a part in its collapse. Andersen conducted the external audits for HIH from 1971 until its collapse in 2001. Their contribution to the failure of HIH is considered in the following sectionsAudit PracticesAs part of audit process, auditors will conduct a risk assessment to determine the structure and plan of the audit. Andersen assessed the risk of HIH and deemed it a maximum risk client, however, the engagement team of Andersen had not prepared the risk management plan and therefore the senior management team at Anderson did not review and approve the plan (Peursem, Zhou, Flood Buttimore, 2007).At the end, the auditor simply drew the wrong conclusions. Andersen signed off HIHs annual report for the 30th June 2000 and stated that it was a going concern with net assets of $939 million. guild months later, HIH collapsed with debts of $5.3 billion (Peursem, Zhou, Flood Buttimore, 2007). Andersen used HIH management reports and forecasts and did not obtain fitted evidence to get the conclusions they did. The liquidator could not find the documentation on the reasons for considering HIH as a going concern. This implies that Anderson failed to produce sufficient working document to prove that the audit actually is conducted.Auditor IndependenceAndersen had a close relationship with HIH. By the time of liquidation, three former Anderson partners who had conducted HIH financial audit work held positions on the HIH board of directors. This obvious lack of independence between the board of directors and the auditors indicated that the best interests of HIH may have not always be a priority. Andersons failure in pro ducing adequate working papers or in obtaining adequate evidence to support their findings have serious concerns on the quality of the audit they did.A significant independence issue is also reflected in the form of Andersons payment to HIH Chairman, Geoffrey Cohen for consultancy fees. These fees totaled $190,887 in nine years and included the use of Andersons office and secretary. These fees were not disclosed to the remaining board members in the annual general meetings (Peursem, Zhou, Flood Buttimore, 2007). The close and complicated financial relationship between the auditors and HIH chairman raise further questions in this case.Finally, the threat to auditor independence is that Andersen provided both audit and non-audit services to HIH. It raises a question on how can an auditor provide an independent opinion on the financial statements when he may play a role in guiding the preparation of the statements?The Royal Commission in Australia, which investigates the collapse of H IH, has found that the largest corporate collapse in Australia was not due to fraud but the result of attempting to cover the cracks on the overpriced acquisition. Andersons role in it appeared to be substantial.Modern Approach to External Auditors Role in Corporate GovernanceExternal auditors now have to take a much stricter admission to their clients (Bourne, 1995). There is an increasing view to support that external auditors should take on a more proactive role (Baxt, 1970).The Companies Act has set the presumption on appointment, eligibility, qualification, disqualification and removal of external auditors (Davies Prentice, 2003). The intention is to ensure that auditors are able to carry out audit in an impersonal, objective and professional way. It is also to ensure that auditors are independent of the company. The reason for such emphasis is to ensure the external auditors are not in a position of conflict of interests.When there is conflict of interest, disclosure musti ness be made to shareholders and stakeholders. Alternatively, there should be prohibition to the provision of non-audit services to the company where they act as auditors. To ensure auditors are truly independent and not in a conflict of interest, auditors should be rotated every year. Thereafter there should be a gap of five years before the same auditors are appointed by the company.ConclusionExternal auditors have an essential role in corporate governance through their involvement and their examination of financial statements. The external auditors role in corporate governance is a fundamental complement to achieve the desired objective of corporate governance. Therefore, the duties and obligations of external auditors must be expanded for the rights and interests of shareholders and stakeholders. There must be a modern approach to the auditors role in the corporate governance framework.