The Role of Auditor

IPASJ International Journal of Management (IIJM) Web Site: http://www.ipasj.org/IIJM/IIJM.htm Email: [email protected] ISSN 2321-645X

A Publisher for Research Motivation........

Volume 1, Issue 2, July 2013

Corporate Governance: Role of auditor and auditing committee Prof Hetal Pandya / Vyas GLS institute of Computer Technology, Gujarat Technical University, Ahmedabad -380006. Gujarat

ABSTRACT: The recent fall of the company SATYAM and the role played by its Auditor and auditing committee, has buzzed an alarm in the Indian capital market. It has resulted into shaking the confidence of the public investing in the stock market. It has led to drastic declines in share prices and substantial financial losses to minor shareholders. Both public and experts have acknowledged primary cause of these scandals as failure of corporate governance. This article tries to highlight the significant responsibilities of an auditor and auditing committee for protecting the interest of shareholders and investing community.

Key words: Auditor, Auditing committee, corporate governance and investing community

1. Introduction: “Doing right things and doing them in the right way is the essence of Corporate Governance” – Anonymous Corporate governance refers to the relationship that exists between the different participants and defining the intention and implementation of a corporate firm. The bodies like the CEO i.e. the management, the board of directors, the shareholders and the auditors and audit committee work together and mutually run an organization for interest of all the stakeholders. Excellent corporate governance needs to include effective internal control systems, policies, procedures and group to direct management to serve needs of all stakeholders. Corporate governance concentrates on management as well as on shareholder’s wellbeing. Internal as well as external corporate governance helps organization in board culture, their share price in market, future need for raising capital and the most important is to gain shareholders trust. Corporate governance means acceptance of management as trustees on behalf of the shareholders and to secure their rights as the true owners of corporation. It is about maintaining commitments to code and conduct, ethics and values in organization, as corporate governance is nothing but ethics and moral duties.

2. Literature Review As per the Organization for Economic corporation and development (OECD) documents (1999), Corporate Governance (CG) is the system by which organization are directed and controlled. Corporate governance designed to keep intact and disclose to shareholders in manner truly reflect the position of corporate. Milton friedman (1962) suggested that corporate governance is to carry out the business in accordance with owners (promoters) and shareholder’s aspiration, which generally will be to make as such money as possible, while in compliance to the fundamental rules of the society embodied in law and local customs. He talked about shareholders capitalism. Corporate governance means doing the whole thing superior, to get better relation between companies and their shareholders, full disclosure of information to all stakeholders and to monitor executive management properly in the interest of shareholders. Cadbury Committee Report (1992) defines Corporate Governance as “the system by which companies are intended for and restricted”. It is generally understood as the framework of rules, regulations, relationships, system and processes within and by which authority is exercised and controlled in corporations. Kumar Mangalam Birla Committee Report (1999) mentioned that corporate governance is essential intention to enhance long – term shareholders value and to protect interest of other stakeholders. Aravanan (2001) suggested that CG is basically system of making directors accountable to the stakeholders for effective management of the companies, with concerns of ethics and value. This is related to Board of directors who are members of auditing committee too, whose role is to check transparency, integrity and accountability of the management toward shareholders and investing community. Shareholder’s value is enhanced by honest and transparent board of Directors. (Vepa Kamesam, 2006). Jyothi Dhawan identifies the role of board of directors in CG, which inculcate a sense of accountability towards all stakeholders. The audit committee would search for the integrity and reliability of financial statement and reassure shareholders. (AICPA, 1967; Auerbach, 1973 and FCCG, 1999).


Page 1

IPASJ International Journal of Management (IIJM) A Publisher for Research Motivation........


Web Site: http://www.ipasj.org/IIJM/IIJM.htm Email: [email protected] ISSN 2321-645X

The responsibility of audit committee in the area of corporate governance is to provide assurance that the corporation is in rational compliance with relevant laws and regulations, is conducting its affairs fairly, and is maintaining effective controls against employee conflict of interest and fraud.(Muhammad Faisal Siddiqui) An audit committee consisting independent directors can have control over management and thereby acting as a sort of assurance to the shareholders that they will have full disclosure of correct information. To have good corporate governance, audit committee needs resource persons to act as independent director on whose shoulder lies the responsibility to take the company in the right path, demand for more disclosures, transparency and accountability and performance standards for investors and lender and protection for shareholders. (Abhas) The shareholders of the company place very high trust on the auditor’s report, which apparently shows the true and fair view of the accounts of the company. The auditor should perform their duties with extreme care and vigilance to ensure that there is no illegal or improper transaction. (Harsh Gargani and Ritika Jhurani, 2009). Auditor independence would be safeguarded if audit committee were made up of a majority of independent and non – executive directors, and this might signify that their independent status would contribute to auditor’s independence through bridging communication network. (Zulkarnain Bin Muhamad Sori, Shamsher Mohamad and Mohd Saad. (2008). Knapp (1987) found that an audit committee if is more likely to support the auditor rather than the management in audit differences and the level of support is steady across members of the audit committee which will secure interest of shareholders too. Department of Company affairs guidelines (2000) have recommended proper disclosure to the shareholders and investing community, which is done by role and influence of auditing committee only. The problem in Indian Corporate Sector is that of controlling the leading shareholders and safe guarding interest of minor shareholders, which can be solved by board of directors who are accountable to all stakeholders; it would make governance more easy (Jayant Rama Varma, 1997).

3. Objectives: This article focuses on the role of auditor and auditing committee in corporate governance and securing interest of shareholders and investing community. The assessment of what these two forces should do under statutory framework for shareholders and what actually they are doing. The article discusses both above mentioned point by studying case of Enron and the company SATYAM.

Source: Financial Management for Managers, the ICFAI University, November 2006

4. Audit Committee Composition: Blue Ribbon Committee (2000) has recommended that audit committee should be independent, minimum in size and members should be financially expert. Audit committee should have communication to auditor and shareholders too. Chairman of SEC Levitt (1998) has stated “Qualified, committed independent and though-minded audit committees represent the most reliable guardians of the public interest”. The Surbanes – Oxely Act (2000), also provides that all the members of the audit committee must be independent directors. Under the provision of Companies Act 1956, an audit committee must consist atleast 3 members from the Board of which 2/3rd members will be independent directors. As per Clause 49 of the listing agreement, such members must have financial knowledge in terms of corporate clients and expert in accounting aspects It has been supposed that audit committee can function effectively if its members are more independent. (Abbott et al, 2001; and Klein, 2002). The independent directors are liable to give a free and fair view which can add independence to auditor (Anwar 2003). Right blend of audit committee members is the most significant decision to execute corporate governance successfully. Committee with qualified and committed members from all walks of life with knowledge on hand of the company’s business will be able to execute its tasks successfully. The capability of the audit committee to perform independently and raise questions to management will stimulate auditor to work efficiently and their fair performance will facilitate good corporate governance. (Zulkarnain Bin Muhamad Sori, Shamsher Mohamad, Mohd Sadd, 2008)


Page 2




5. Audit committee: Roles and responsibilities The duties of directors may be classified into four categories – fiduciary duties, duties of care, statutory duties and other duties. Worldwide the company laws classify two important duties of the directors –the duty of loyalty and duty of care. It is observed that majority of corporate fraud have occurred on account of breach of these primary duties by directors. However, present-day discussion is more on conflict on duties – loyalty to the company and accountability to the investing community. As far as the India is concerned, the Security Exchange Board of India (SEBI) has been very serious about introducing new rules intensifying the audit committee so as to guard the interests of the investors in a better manner than before. In May 1999, the SEBI adopted several new rules based on the suggestion of the report submitted by Kumar Mangalam Birla committee on improving the efficacy of audit committee. The audit committee as per these new rules was supposed to perform following roles:

6. Role of Audit Committee  Oversight of companies financial reporting process  To recommend statutory auditor to Board, their appointment, re-appointment, substitution or elimination, terms and amount of audit fees , approval for payment for any other services rendered by statutory auditors.  To review quarterly and annual financial statement with the management before put forwarded to the board for sanction, with particular reference to : o Matters required to be included in the Director’s responsibility Statement to be included in the Board’s reports in terms of clause(2AA) of the section 217 of the Companies Act, 1956 o Changes, if any, in accounting policies and practices and reasons for the same. o Major accounting entries involving entries based on the exercise of judgment by management. o Significant adjustment made in financial statement arising out of the audit findings. o Compliance in listing and other legal requirement relating to financial statement o Disclosure of any party transactions o Qualifications in draft audit report  To review the statement of uses/ application of funds rose through any issue and IPO proceedings.  To review performance of statutory and internal auditor and the adequacy of internal control system and function  Discussion with the internal auditor and any momentous conclusion and follow up there on and review finding of any internal investigations by internal auditors where fraud and irregularity is suspected.

7. Audit Committee and Auditor: By performing all above mentioned roles, auditing committee will be able to exercise power over management which will give independence to the auditor and that will result into authentic financial reporting. This will meet the expectation of all the stakeholders and mainly shareholders. But as per Jawaher Al- Madhaki and P L Joshi (2004), concept of an auditing committee is not new in India but their development is slow and their constitution lacks independence. Auditing Committee functions are still intense in the traditional areas of accounting and their role is not varying fast enough to make the corporate governance more effective. Lam (1976) initiated that the manifestation of independence of the committee would boost auditors’ independence and improves transparency in financial reporting. The study shows that an audit committee with independent non – executive director strongly influences auditor’s sovereignty (Beattie et al.1999). Independent directors of audit committees are anticipated to boost the quality of monitoring because they are not associated with the company either as bureaucrats or human resources; thus they would act as the shareholders watchdog. Dezoort and Salterio (2001) and Raghunandan et al. (2001) revealed that audit committee that consist of qualified independent directors are better able to contribute towards auditor’s independence and audit will give true and correct picture of an organization which will guide shareholders and investing community.

8. Responsibilities of an auditor The statutory responsibilities of the auditor fundamentally require the following: 1. Duty to make certain inquiries 2. Duty to make a report to the company on the accounts examined 3. Duty to make a proclamation in terms of the provisions set. 4. Detection and Prevention of Fraud 5. Duty to report fraud 6. Duty as to substantial precision


Page 3




Code of corporate governance enhances the effectiveness of audit in the interests of stockholders and stakeholders and that is why they are relying on auditor heavily. Auditor has power to detect wrongdoer in management and report on the company objectively. An independent auditor can play his role effectively and maintain good governance. They can also remove bias from company’s financial reports. But on the availability and effectiveness of quality auditors, some argue that East Asian auditors lack expertise or willingness to supply quality audits. There is also some concern that auditors’ monitoring role may be in conflict with their consulting activities with client firms, an issue not unique to Asia. Also, the disciplinary mechanisms for auditors may be poor, which may have diluted the independence of auditors in Asia. Furthermore, initiatives have been taken by drawing up the Code in ensuring that the Board of Directors is responsible and accountable. So the independent directors in auditing committee can encourage auditor to perform his role diligently and honestly. Much more stress is placed on auditors in the perspective of corporate governance because in most of cases, auditors will be the first person to spot corporate abuse. This is due to the nature of auditing function and the purpose of auditing company accounts. It can also be a case of the only person who is aware of the misuse besides the wrongdoers. Thus, in many cases the auditors prefer to fall short to discover the wrongdoing at the expense of their duties and obligations. Auditor has to be bold enough to bring forth all the facts in his report and there should be no hesitation on his part in disclosing the defects, defaults, irregularities, discrepancies etc., even if the management of the company is involved in the same. He must perform his duties in right earnest and honestly. For the same, audit committee should monitor auditor’s performance. The audit committee should discuss various matters with the auditor related to their independence and what audit committee expects from auditor in interest of shareholders and other stakeholders except management. But it is not only expected from auditor to do his duties diligently but also audit committee should have guts to ask questions to management regarding any matter which is related to shareholders and investing community.

9. Governance in today’s Parlance Contrary to the legal status and various compliances to be followed for adherence of corporate governance, nationally and internationally, there real spirit of this concept in current parlance is quiet difference. The study made on compliance of forming Audit Committee by listed companies by Jawaher Al-Madhaki and P L Joshi (2002) reveals that to the context of only 56% of companies formed Audit Committee, although it has been made compulsory to have AC. Out of nearly 2/3rd companies are having either 3 to 6 members) as required 1/3rd of Board members). The study also reveals that surprisingly, only 14% of such companies have independent non – executive directors. This shows a lack of on independent representation on the committee. The criteria for selection of member should be familiarity and knowledge of business, experience of holding similar positions and accounting and finance proficiency. But usually in India, board members are not selected but invited by corporate so that they can influence their decisions. The independent directors, who are playing role of guardians for shareholders and stakeholders, are in true sense not independent for any decision. Truly most of the independent directors are family members, friends, relatives or closely known so that they can negotiate and compromise with management. In case of Enron, Texas based energy company, the independence of Enron Board of Directors were negotiated by financial ties between company and certain board members. Two directors have invested more than US $ 1 million each in Enron stock and had a strong financial incentive to ensure that the company does not collapse. Even they did not prevent them from doing along with Enron’s management on many issues where they should have resisted. Auditors are appointed by board of directors (auditing committee) with an intention to carry out auditing in an impersonal, intentionally and professional manner. Auditor should be independent to secure interest of shareholders and stakeholders but when board of directors is not independent then how they can ensure auditor’s independence. Auditor’s independence is compromised due to close relationship between him and management. Many time management obliged auditors by extending non- audit services and earned their favor in presenting false financial statement. In case of Enron, Board of Directors was not independent and that’s why auditor failed to do his duties. Though Arthur Anderson was external auditor of Enron, board permits him to be internal auditor and to provide consultancy services. In 2001, Arthur Anderson earned US$ 55 million for non-audit service. Here, the duties of auditor and audit committee are questionable. Auditor has to depend on management for their livelihood and they keep good relations with management. If they qualify the report or manage to spot the wrong doings of the management, it is doubtful that they will be appointed by the management in the future.


Page 4




In Enron, Anderson was making report on the company’s account and they did not report fraud to the shareholders and stakeholders because it was committed by management. If auditors have reported, then perhaps they will not be appointed in succeeding years. They made sure that they were in management’s good book. Auditors of SATYAM (PwC) were paid heavy amount by Raju (CEO), Srinivas Vadlamani (CFO) and other directors for window dressing the company’s account, and hiding frauds and lured the investors to invest their hard earned money by manipulating facts and figures. By keeping himself into management’s good book, PwC worked as SATYAM’s auditor from 2000 to 2008.

10. Conclusion: The role of audit committee and auditors in current scenario become very crucial. Stakeholders expect loyalty and trust from auditor and auditing committee while resolving financial facts and exposing at all fraud and fault in organization. The audit committee member’s experience, relevant exposures, qualification background and in depth knowledge need to be highlighted and confirmed because if directors are experts, experienced, qualified, financial wizards, then they can have vision and foresightedness to protect stakeholders. If a company has an active and strong audit committee then independent auditors’ working will be supported. Further the system of selection and appointment of auditor on their quality and experience need to be explored. Over and above laws and regulations, being responsible professionals and representatives of shareholders and investing community, Auditing committee and auditor should perform their role diligently and ethically to secure interest of not only company and investors but all stakeholders. This is possible when independent directors will have their own weight and right to ask questions to management, which in turn will give strength to auditor to be ethical.

References: [1.] Abhas “Role of Auditing committee in Corporate Governance” retrieved from www.companylawonline.com/search/articles [2.] Adhukia Rajakumar S (2009), “Corporate Governance and Role of Chartered accountants”, retrieved http://www.caclubindia.com/forum/files/33_corpgov31122008.pdf [3.] Ahmad Tabrez, Bhatnagar Aman, Mayank Kumar and Mahapatra Sandeep, 2009, 15th August, “Corporate Governance as a Determinant of External Finance in Transition Economies: A Case Study of India”, retrieved http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1452889# [4.] AICPA {American Institute of Certified public Accountants} (1967),” Executive Committee Statement on Audit Committees of the Board of Directors”, Journal of Accountancy, (September), p.10. [5.] Arvana S (201), “Corporate Governance: A Three Dimensional Network”, Corporate Governance, Excel books, pp. 114 -120, New Delhi. [6.] Bashyakar M and Mohandas J Menon, (2009), “Shareholders and Corporate Governance”, Personal Finance magazine by ICFAI university Press, Issue November 2009 [7.] Bhuiyan Md. Hamid Ullah, Biswas Pallab Kumar, (2007), “Corporate Governance and Reporting: An Empirical study of the Listed Companies in Bagladesh”, Journal of Business studies, Vol XXXVIII. No. 1 June 2007, retrieved http://www.scribd.com/doc/21894690 [8.] Chakrabarti Rajesh (2005), “Corporate Governance in India: Evolution and challenges”, The ICFAI Journal of Corporate Governance, Issue October 2005 [9.] “Comments on ‘Governance, supervision and Market Discipline: Lessons from Enron’ and the Author’s response”, Journal of the Indian School of Political Economy October – December 2002. [10.] Dhawan Jyothi (2006), “Board of Directors and corporate governance in Large Listed Firms in India”, The ICFAI journal of Corporate Governance, Vol 5, No 3, pp 39-61 [11.] “Financial Management for Managers” (2006), the ICFAI University, ICFAI university press. [12.] “Fraud and the Responsibilities of the Audit Committee: An Overview” (2005), the AICPA Audit Committee Toolkit, the American Institute of Certified Public Accountants, Inc., New York, New York [13.] Gagrani Harsh and Jurani ritika , (2008), “Role of auditor in light of Satyam Scam” retrieved http://www.indlawnews.com/Newsdisplay.aspx?uid=a250d304-88f6-477a-962f-2b2f3a3639a6&type=1 [14.] Gajra Rajesh, 2009 08 August, “Stock Markets: Initial Public Optimism”, Business Standard, retrieved www.businessworld.in/index.php/In-The-News/ [15.] Geiger Marshall A, Raghunandan, Rama D .V, (October 1998), “Going-concern audit report recipients before and after SAS No. 59”, retrieved http://findarticles.com/p/articles/mi_m4325/is_n8_v42/ai_n25025147/ [16.] Giridharan P T, (2004), “An Audit committee: Global Perspective “, retrieved http://docs.google.com/viewer [17.] Jickling Mark, (2002, 28th March) “The Enron Collapse: An Overview of Financial Issues”, Congressional Research Service, The Library of Congress, retrieved http://fpc.state.gov/documents/organization/9267.pdf


Page 5




[18.] Kajola, Sunday O, (2008), “Corporate Governance and Firm Performance: The Case of Nigerian Listed Firms”, European Journal of Economics, Finance and Administrative Sciences, ISSN 1450-2887 Issue 14. [19.] Kamath Vinay, R Ravikumar and T. Murrali, 2009 January 12, “Satyam saga may have wider impact”, Business line retrieved http://www.thehindubusinessline.com/manager/2009/01/12/stories/2009011251061000.htm [20.] Kamesam Vepa (2006), “ Corporate best Practices: recommendation for Directors”, IRDA Journal, March, pp, 2629 [21.] Kaplan, Richard L., “The Mother of All Conflicts: Auditors and Their Clients” (June 14, 2004). Illinois Public Law Research Paper No. 04-13. Available at SSRN: http://ssrn.com/abstract=556623 or doi:10.2139/ssrn.556623 [22.] Knapp M C (1987), “An Empirical Study of Audit Committee Support for Auditors Involved in Technical Disputes with Client Management”, the Accounting Review, Vol. 62, No. 3. pp. 578 – 588. [23.] Meara Kelly Patricia, (2002, 19th August), “Enron Board accused by U S Senate panel: a Senate subcommittee conclude that Enron’s board of directors knowingly gave its blessing to outrageous business practices that led directly to the company’s downfall”, Insight on the news, retrieved http://findarticles.com/p/articles/mi_m1571/is_30_18/ai_90753047/ [24.] Mehenna Yakhou, Vernon P. Dorweiler (2005) , “Corporate governance reform: impact on accounting and auditing”, Corporate Governance , Vol 5, issue 1, page 39-44, publisher Emerald Group Publishing Limited, retrieved http://www.emeraldinsight.com/Insight/viewContentItem.do?contentType=Article&hdAction=lnkhtml&contentId= 1464946 [25.] Mehta K S, (2009, 31st January),” Audit lessons from Satyam”, retrieved http://www.cainindia.org/news/1_2009/k_s_mehta_audit_lessons_from_satyam.html [26.] Prasanna Krishna (2006), “Independent Directors and Expectations and gaps : An Empirical Analysis”, The ICFAI journal of Corporate Governance, Vol 5, No 2, pp 56-72 [27.] Rao Sadhalaxmi Vivek , “ The economic consequence of ‘SEBI’ regulation on corporate governance on Indian stock market”, retrieved http:// iimcal.ac.in/programme/../ThesisAbstract/thesisabstractsadha.doc [28.] .Siddiqui Muhammad Faisal, ( ), “ A Role of Auditor and Auditing committee”, Institute of Cost of Management Accountants of Pakistan retrieved from www.icmap.com.pk [29.] S Subramaninan and S Swaminathan, (2008), “Corporate governance in India: A Survey of the Literature”, The ICFAI Journal of Corporate Governance, Issue July 2008 [30.] Theodore Stanley (2009, 26th January),” PwC auditors admit to fraud in Satyam case”, the statesman, asianewsnet, retrieved http://www.asianewsnet.net/news.php?sec=2&id=361 [31.] Varma Jaynath Rama, (1997), “Corporate Governance in India: Discipline the Dominant Shareholders”, IIMB Management Review, The Journal of Indian Institute of Management, Bangalore. [32.] Varma Jayanth R (2002), “Governance, supervision and Market Discipline: Lesson from Enron”, Journal of the School of Political Economy. Reproduced with the permission of the Journal of the Indian School of Political Economy in which the paper was first published (October-December 2002), Volume 14 Number 4, 559-632), retrieved http://www.iimahd.ernet.in/~jrvarma/papers/Enron_paper.pdf [33.] Wallace Yvette A, “Finding the right director”, by Keithley Lake & Associates, retrieved http://www.anguillaattorney.com/files/Finding_the_Right_Director.pdf [34.] Zabihollah Rezaee, 1995, “ What the COSO report means for internal auditors”, Managerial Auditing Journal, Vol. 10 , Issue 6, Pg. 5-9, Publisher: MCB UP Ltd , retrieved http://www.emeraldinsight.com/Insight/viewContentItem.do?contentType=Article&hdAction=lnkhtml&contentId= 868252 [35.] Zulkarnain Bin Muhamad Sori, Shamsher Mohamad and Siti Shaharatufazzah Mohd. Saad (2008), “ Audit committee Support and Auditor Independence”, the ICFAI Journal of Corporate Governance, Vol VII, No 1, pg 51-65. [36.] http://satyammatyas.blogspot.com/2009_02_01_archive.html [37.] http://www.economicexpert.com/a/Enron:corporation.htm [38.] en.wikipedia.org/wiki/corporate governance [39.] www.papers.ssrn.com/sol3/Delivery.../SSRN_ID876410_code400207.pdf?...1 [40.] www.papers.ssrn.com/sol3/Delivery.../SSRN_ID1031075_code400207.pdf?...1 [41.] www.papers.ssrn.com/sol3/Delivery.../SSRN_ID444724_code400207.pdf?...1 [42.] www.emeraldinsight.com/Insight/ViewCOntentServlet?Filename...html [43.] www.companylawonline.com/search/articles/?c036cb75-ec65... [44.] www.syndicatebank.in/Downloads/QRREPCL49-31122009.doc [45.] www.papers.ssrn.com/... /SSRN_ID1031075_code400207.pdf? abstractid...


Page 6




[46.] www.papers.ssrn.com/sol3/.../SSRN_ID1031075_code400207.pdf?...1 [47.] www.news.findlaw.com/hdcos/docs/enron/senpsi70802rpt.pdf

AUTHOR Hetal Pandya / Vyas is Assistance Professor at GLS Institute of Computer Technology and research scholar at Nirma University, Ahmedabad, Gujarat. She has received B.com and M, com degree from Gujarat University. Her research interest areas are Corporate Governance, Corporate Social responsibility and Behaviour finance.


Page 7

The Role of Auditor

Recommend Documents