THE AUDITOR AND THE COMPANIES ACT-Introduction
SUBSTANTIVE TESTING Notes
Principles of Good Corporate Governance
There are a number of principles essential for good corporate governance practices. The following have been identified as representative of critical foundations and virtues of good corporate governance practices.
a. Directors.
Every company should be headed by an effective board of directors to offer strategic guidance, lead and control the company and be accountable to shareholders.
The board of directors should discharge the following responsibilities regarding corporate governance.
- Define company mission, strategy, goals ad objectives.
- oversee the corporate management and operations, review management accounts, approve the company expenditures and review the performance of the organization.
- review on a regular basis the adequacy ad integrity of the company’s accounting and internal control system including compliance with applicable laws and regulations.
- Establish relevant committees and delegate mandates to run the affairs of the company. in addition, it should establish an audit committee.
- Director’s remuneration.
This should be sufficient to attract and retain directors to run the company efficiently and it should be approved by the shareholders. The executive director’s remuneration should be competitive and linked to performance.
- Board balance.
The board should be composed of a balance of diverse skill and expertise in order to ensure that no individual or group of individuals can dominate the board’s decision making process.
For listed companies, the board should have at least a third of independent non executive directors. an independent director is one who:
- Has not been employed by the company in an executive positioning in the last five years.
- is not associated with any advisor or consultant of the company or member of the company’s senior management or a significant customer or supplier of the company.
- has no personal service contract with the company or a member of the company’s senior management.
- He is not employed by a public limited company in which an executive officer of the company serves as a director.
- he is not a member of the immediate family of any person named above.
- Has not had any of the relationships described above with any affiliate of the company.
- Appointments to the board.
There should be a formal and transparent procedure in appointment of directors to the board. all persons offering themselves for appointment as directors should disclose any potential areas of conflict that may undermine their position in service as directors.
- Re-election of directors.
all directors except the managing director should be required to submit themselves for re-election at regular intervals or at least every three years. Executive directors should have a fixed service contract not exceeding five years with a provision for renewal subject to regular performance approval by the shareholders.
- Role of the chairman and the chief executive.
There should be a clear separation of roles and responsibilities of the chairman and the chief executive. This should ensure a balance of power and authority and provide checks and balances such that no individual should have unquestionable powers over decision making.
- Approval of major decisions by shareholders.
The shareholders should participate in major decisions of the company. The board should therefore provide shareholders with information such as major disposal of company assets, plant restructuring, mergers and acquisitions and organization plans.
Best practices in Audit Committees
an audit committee is an independent committee established by the board and mainly composed of at least three non executive independent directors with written terms of reference which deal clearly with its authority and duties.
Objectives of the audit committee
- Increasing public confidence and credibility and objectivity of published financial statements.
- Assisting directors in meeting their responsibilities in respect of financial reporting.
- Strengthening the independence position of a company’s external auditor by providing an additional channel of communication.
Attributes of audit committee members
- Members of the audit committee should have the following attributes; • broad business knowledge relevant to the company’s business operations.
- Keen awareness on the interests of the investing public.
- Familiarity with basic accounting principles.
- Objectivity in carrying out their mandate with no conflict of interest.
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Functions of an Audit Committee
- Act as an effective overseer of the financial reporting process and company internal control system. E.g. it should be involved in review of company’s internal control procedures.
- Reviews quarterly, semi-annually and yearly financial statements of the company focusing particularly on any changes in accounting practices, significant adjustments arising from the audit, the appropriateness of the going concern assumption adopted in preparation of the financial statements and whether the financial statements comply with IFRSs and other relevant regulations.
- Consider the appointment of the external auditor, the audit fees charged and any questions regarding resignation or dismissal of the external auditor.
- Discuss with the external auditor before the audit commences the nature and scope of the audit and ensure that the work is properly coordinated.
- review management evaluation of the factors related to independence of the external auditor. both the audit committee and the management should assist the external auditor in preserving his independence.
- Discuss problems and reservations arising from the audit and any matters that the external auditor may want to discuss.
- review any communication between the external auditor and management. Such communication should include management letter issued after the conclusion of the audit.
- The committee considers any related party transactions that may arise within the company and ensure that related party transactions are appropriately disclosed in the financial statements in accordance with iSa 24 related party Disclosures.
- Consider major findings of any internal investigations undertaken and the management’s response to the findings.
- The committee has exclusive authority to investigate any matter within its terms of reference and management must provide access to the necessary information and any resources required.
- Considers other issues as defined by the board of directors including regular reviews of the capacity and effectiveness of internal audit function.
The audit committee is established to give additional assurance to the various stakeholders on issues regarding the quality and reliability of financial information used by the board and financial statements issued by the company. The committee maintains a direct line of communication between the board of directors and the external auditor.
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Relationship between the audit committee and the internal audit function
The management of the organization should establish an internal audit function which should be independent of the activities that they audit as the internal audit work should be done with objectivity, proficiency and due professional care. The audit committee performs the following roles regarding the internal audit function;
- review of the scope, functions and resources of the internal audit function and ensures that it has the necessary resources and authority to carry out the work.
- review the internal audit function work programme and the internal audit report and where necessary ensure that appropriate action is taken on recommendations made.
- review any appraisal or assessment of the performance of the members of the internal audit function.
- approve any appointment or termination of senior staff members of the internal audit function.
- Ensure that the internal audit function is independent of the activities of the company and it operates with objectivity, skill and due care.
- Determine effectiveness of the internal audit function and undertake all steps possible to promote its independence.
Relationship between the audit committee and the board of directors
The board of directors establishes the audit committee. however this committee should be independent of the board to be able to exercise its responsibilities.
Some of the members of the board may be appointed members of the audit committee, usually non executive members.
The audit committee reviews or provides an oversight over some of the responsibilities exercised by the board. E.g. the audit committee could review significant accounting policies chosen by the board to ensure that such policies are appropriate to the organization and result to credible financial information.
The audit committee enhances and improves communication between the external auditor and the board and between the board and the internal audit function.
Advantages of the audit committee
- It contributes to improvement of quality of financial statements and credibility of the financial reporting process.
- Assists the directors meeting the responsibilities in respect to financial reporting.
- Strengthens independence position of the external auditor by providing additional channel of communication.
- promotes effectiveness of internal audit function by ensuring that the function has authority and resources t carry out its responsibilities and also ensures its recommendations to the management are implemented.
- Increases public confidence in credibility and objectivity of published financial information including audited interim financial statements.
- improves communication between directors, the eternal auditor and the management.
Disadvantages of the audit committee
- It leads to fear that its purpose is to catch the management out and by so doing, cause divisions in the board. all directors are equal and some should not be seen as supervising others. however, the audit committee acts on behalf of the main group of directors and reports to it.
- Non executive directors may be overburdened with detail and may get into management responsibilities and possibly cause conflict. There is a thin line between management and supervision.
- Audit committees are ineffective and powerless as they cannot enforce their recommendations or report directly to shareholders.
- Appointment of non executive directors is heavily influenced by the executive hence ‘yes men’ may be appointed.
- Audit committee incurs time and costs unless it is justified that the benefits outweigh costs.
- The committee may encourage prudence and risk aversion which can hamper initiative and executive flair.
- Non executive directors may lack the technical skills and the know-how and in turn be rendered incompetent.
