Financial sector governance

Financial sector governance Financial Statements, Audit and Regulation December 6, 2002 José Monsalve Managing Partner – E&Y Chile

Financial Statements, Audit and Regulation Contents: • Corporate governance accountability II. Financial statement perception gap III. Audit expectations gap IV. Regulation V. Final comments

I. Corporate governance accountability • Issuers: • Establish effective external control systems • Apply adequate GAAP and disclose relevant events • Deliver reliable information to the market Corporate Governance • External Auditors: • Professional independence • Compliance with GAAS • Evaluate GAAP used • Regulators: • Dictate standards and regulations • Monitor compliance • Sanction deviations • Market: • Be adequately informed • Act responsibly • Praise/punish conduct

II. Financial statement perception gap What do the financial statements represent? • Main source of infomation on the company for the market • Fundamental tool for decision making • Used by investors, analists, management, regulators and the market in general. But, ......... What has been lost from sight? How do you explain the gap between the book values and market values of the companies? Is the problem with the accounting principles used or with errors in the prices established by the market?

II. Financial statement perception gap Source: The Economist – May 2002

II. Financial statement perception gap What has been lost from sight ? Limitations inherent to the financial statements: • Opportunity • Use of judgement and estimates that in time can differ • Accounting criteria alternatives for the same transaction • Chilean GAAP v/s US GAAP v/s IAS And what happens with GAAP ? • Complexity in basic accounting issues: • Recording and valuation of assets • Recognition of income • Adequate disclosures • It has not advanced at the required speed • Substance over form

III. Audit expectations gap What is an audit ? • It is a critical and sistematic review • Independent • Performed in accordance with audit standards • Performed on selective basis • It is performed under materiality concept • What is the objective of having an opinion on the reasonability of the financial statements But, ......... Does the market understand these concepts ? What has been done to close this expectiations gap? What is the responsibility in cases of fraud?

III. Audit expectations gap What has happened ?

III. Audit expectations gap What has failed? • Has the concept “in our opinion” been lost ? • Negligence problems ? • Independence problems ? • Lack of adequate expertise for current businesses? • Professional skepticism in fraud detection? What can be done so this does not happen again ? • Go from a “pass or fail” concept to a “risk rated opinion” in the use of GAAP • Improve “enforcement” • Regulate “real” conflicts of interest • Establish regulations to detect fraud

IV. Regulation Certain concepts: • Perception versus reality • All services should be approved by the Audit Committee, not only “non-audit services” – Achieve management independence • Ethics and integrity problems are not avoided with more regulations • A fair balance between regulation and self regulation – The market rewards, but it also punishes

“No client is more important than our integrity” “Our main asset is our reputation” Jim Turley – Chairman Ernst & Young October 2002 V. Final comments • Standardize accounting regulations worldwide • Modernize accounting regulations • Regulation of real conflicts of interest • Ethics and codes of conduct

Financial sector governance