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Statutory Audit of Financial Statements; Who audits the auditor?

Statutory Audit of Financial Statements; Who audits the auditor?. Russian Corporate Governance Roundtable Meeting (OECD / Tacis). Geoffrey Townsend; Team Leader Moscow, 11 th November 2004. Introductory Comments Professional Bodies External Quality Assurance Public Oversight Summary.

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Statutory Audit of Financial Statements; Who audits the auditor?

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  1. Statutory Audit of Financial Statements; Who audits the auditor? Russian Corporate Governance Roundtable Meeting (OECD / Tacis) Geoffrey Townsend; Team Leader Moscow, 11th November 2004

  2. Introductory Comments Professional Bodies External Quality Assurance Public Oversight Summary

  3. Introductory Comments Caveat: - all views expressed are personal views. They are not: - the views of the European Commission, - the views of the consortium partners.

  4. Introductory Comments Who are the users of financial statements? Views differ broader definitions talk about stakeholders. In this presentation, I shall use a narrower definition. - Investors, by which I mean: current and future – Minority Shareholders Lenders.

  5. Introductory Comments What Users want: • A flow of useful, current and accurate information from the management. • Most of that information is unaudited; i.e. will be taken on the trust of management. • A part of that information is annual final statements. • Audit is an external, independent verification of those financial statements. • Audited financial statements are usually too late for many investment decisions. • If there are no surprises, they reinforce trust in management. • If there are surprises, they reduce trust in management

  6. Introductory Comments History of Audit: Audit has been a response to the possible problems arising from the division of management from ownership. Originally, auditors were a committee of shareholders independent of management. Increasingly, this task was transferred to outside experts; later this became a legal requirement.

  7. Introductory Comments History of the Audit profession: • Auditors began to form professional organisations, modelling themselves on medieval guilds. • These guilds represented the interest of their members, and simultaneously protected public interest. • Later, these guilds received legal privileges • Restriction of use of name • Exclusive right to certain types of business – e.g. statutory audits. • On the whole, the guilds worked well; but there were scandals. • Guilds have an inherent conflict of interest – members interest vs. public interest.

  8. Goods/services Contract Payment Customer Supplier Specific Problem of Audit Control - 1 “Normal” Contract Structure General • Normally subject to mutual agreement, i.e. freedom of contract • Normally, assume parties are equal and knowledgeable; each knows what he is doing; each protects himself Role of state • Contract law framework • Court system (last step in dispute resolution) • Protect “weak” customers • Standards (simplification of contract) • Protect third parties

  9. Specific Problem of Audit Control - 2 Auditing Enterprise Triangular Problem • User not enterprise, but 3rd party • User not interested in audit technique, only in result • Appointment of auditor • De jure – shareholder • De facto – management • Also users such as banks, not involved at all Role of state and SRAAs SRAAs are “experts”; detail is very technical • Represent users’ interests • Set legal framework • Ethical guidelines • Legalize standards (codification of service) • Minimum quality • Set barrier to entry • Ensure auditors “up-to-date” • Force enterprise to appoint auditors • Police quality Service Delivery Financial Statement Contract Fee Payment Election of Auditors User Auditor Auditor’s Report Lawsuit (??)

  10. Professional Bodies Membership Accountants? Auditors? Audit firms?

  11. Professional Bodies Activities Members’ interest: • Lobbying • Training • Conferences • Publications Public Interest: • Examinations (?) • CPE Monitoring • Compliance + Disciplinary • Inspection

  12. Regulation and Discipline Traditional “triggers” • Complaints • Scandals • Professional investigations • Government investigations • Legal Actions: - civil, - criminal. Problem Shutting the stable door after the horse has bolted.

  13. Regulation and Discipline Pre-emptive measures • Standards • Ethical code • Curriculum • Pre-qualification training - theoretical - practical • CPE monitoring and – increasingly • inspections

  14. External Quality Assurance Two triangles or one rhombus? Audit firm Professional Organisation Audit Assignment Auditor

  15. External Quality Assurance Inspect what? • Procedures • Independence • Specific audit assignments. Inspect whom? • Firms • Auditors Inspect how often? What to do with results of inspection?

  16. Public Oversight “Auditing too important to be left to auditors”. “Chaps controlling chaps”. Professional Organisations have a conflict of interest; they must represent interests of • Members (who pay their subscriptions and complain) • The Public (who only complain)

  17. Public Oversight Intrinsic problems The topics are very technical Meaningful inspection only possible by someone with at least the skills of the person being inspected. Boredom risk • Intrinsic boringness of subject • Night-watchman syndrome • Are results being taken seriously? Source and remuneration of inspectors. Parallel Problem (analogy) How can independent director monitor management?

  18. Public OversightHow it fits together Oversight Standard Setting etc. Professional Organizations yardstick Audit firms Users yardstick Audit Engagements Audit Board Chief Accountant Accountants

  19. Public oversight of Professional Bodies Members Public Representative Professional Organisation Oversight Public Interest Activities Member Interest Activities

  20. Who should be the focusof quality assurance? The problem: There are very many small firms and only a few big ones. This is not purely a Russian problem: AuditorsAudit firms Germany (WP only) 12.194 2.178 UK (ICAEW only) 29.947 16.010 But: the focus of POBA in the UK is FTSE 350. Big 4 – 97%!

  21. Summary Audit too important for auditors Public oversight essential to improve perception of auditors. Inspection of audit firms and audit engagements is an essential element. Done well, inspection can help improve standards; focus on recommendations and follow-up rather then disqualification. Thought must be given to the quality and training of inspectors Inspectors’ remuneration will be an issue. Prioritisation is important.

  22. Prioritization Who is to be inspected: • Important to cover auditors of public interest companies. • But for smaller audit firms, inspection could be a real help. What is to be inspected: Personal view: • In addition to a general programme tailored to the size of company inspected and complexity of clients. • I would suggest that MinFin publishes a lot of special concerns on which there should be focus. e.g. Related Parties Pocket auditors.

  23. Presenter’s contact detailsGeoffrey Townsendtel: 937 – 29 – 51e-mail: gtownsend@kpmg.ru

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