COMPARATIVE INTERNATIONAL AUDITING

AND CORPORATE GOVERNANCE

Chapter 13

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Comparative International
Auditing and
Corporate
Chapter Topics
Governance
Recent trends in international corporate governance

International diversity in external auditing

Harmonization of international external auditing
Auditor liability and independence
Audit committees
International internal auditing
Audit regulation

13-2

Comparative International
Auditing and
Corporate
Learning Objectives
Governance
1. Define corporate governance and discuss the circumstances that
caused it to receive worldwide attention in recent years.
2. Explain the link between auditing and corporate governance in an
international context.
3. Examine international diversity in external auditing.
4. Explain the steps taken toward international harmonization of
auditing standards.

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Comparative International
Auditing and
Corporate
Learning Objectives
Governance
5. Demonstrate an understanding of the issues concerning auditor
liability and auditor independence.
6. Explain the role of audit committees.
7. Discuss internal auditing issues in an international context.
8. Discuss the provisions in the Sarbanes-Oxley Act of 2002 in
relation to auditing issues.

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International Trends in Corporate

Governance
Recent accounting scandals, particularly those in the U.S. (e.g.,

Enron, WorldCom) have led to increased focus on corporate

governance.
The Sarbanes-Oxley Act of 2002 was a direct response to these
scandals.
This act includes new rules pertaining to corporate governance and
auditing.
These events in the U.S. are consistent with a worldwide
movement to improve corporate governance and auditing.

Learning Objective 1

13-5

International Auditing and

Corporate
Governance

OECD guidance

Principles of Corporate Governance (1999) provide guidance to

help governments improve corporate governance within their
borders.
Corporate governance, involves a set of relationships between a
companys management, its board, its shareholders, and other
stakeholders.
These principles also make clear that the board of directors has
ultimate responsibility for governance.

Learning Objective 2

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International Auditing and

Corporate
Governance

OECD guidance

In 2004, revisions to the corporate governance code point out that

external auditors should answer to shareholders.
These revisions also highlight the board of directors responsibility
for overseeing financial reporting.
These revisions also strengthen shareholder rights in most OECD
member countries.

Learning Objective 2

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International Auditing and

Corporate
Governance

IFAC 2007 survey Financial Reporting Supply Chain

Current Perspectives and Directions
Positive areas include increased awareness that good corporate
governance counts, new codes and standard improvements in
board structure, and more transparency in reporting.
5 areas of concern:

Governance in name, but not spirit

Overregulation
Checklist mentality
Personal risk/liability for directors and senior management
Cost/benefit

Learning Objective 2

13-8

International Auditing and

Corporate
Governance

IFAC 2007 survey Financial Reporting Supply Chain

Current Perspectives and Directions
Proposed improvements:

Behavioral and cultural aspects of governance

Review of reactive rules
Quality of directors
Better relation of remuneration to performance
Expansion of view from compliance governance to business
governance

Learning Objective 2

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International Auditing and

Corporate
Governance

Sarbanes-Oxley Act of 2002

Public Company Accounting Oversight Board (PCAOB) was

created to oversee the accounting profession.
Certification of financial statements by CEOs and CFOs
External auditors to report directly to audit committee
Restriction on allowable non-audit work for auditors
Increased penalties for financial statement fraud
The NYSE followed suit by introducing additional listing
requirements related to corporate governance.

Learning Objective 2

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International Auditing and

Corporate
Governance

Financial Reporting Council (FRC) in the U.K.

published The Audit Quality Framework in 2008
which provides for the following key drivers of audit
quality:

The culture within an audit firm

Audit partners and staffs skills and personal qualities
Effectiveness of the audit process
Reliability and usefulness of audit reporting
Noncontrollable factors affecting audit quality

Learning Objective 2

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Background

International Diversity in External

Auditing

Globalization is leading to increased importance of auditing

internationally.
Significant international diversity exists in various aspects of
auditing.
The purpose of external audits varies between countries.
The environment in which auditing takes place varies.
Regulation of the audit function varies.
The content of audit reports also varies.

Learning Objective 3

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International Diversity in External

Auditing

Purpose of auditing

In the U.S. and U.K., the purpose of the external audit is to provide
assurance that the financial statements are fairly presented.
In the U.S., Sarbanes-Oxley also requires audits of internal
controls.
Such a report provides assurance about the process of financial
statement preparation.
In Germany, auditors are also responsible for evaluating the report
of management.

Learning Objective 3

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International Diversity in External

Auditing

Purpose of auditing

International variation in the purpose of audits seems to be related

to differences in corporate governance structure.
The supervisory board in Germany has essentially equivalent
responsibilities to a U.S. board of directors.
German law includes specific regulations about the composition of
the supervisory board.
German supervisory boards are more broadly representative than
their U.S. equivalent.

Learning Objective 3

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International Diversity in External

Auditing

Environment of auditing Culture and history

Cultures that value saving face and societal harmony are less
accepting of the questioning inherent in auditing.
Collectivist cultures often distrust outside auditors.
Recent Chinese history of state-owned enterprises is related to
explicit limits regarding application of lower-of-cost-or-market and
allowance for bad debts.
All of these factors can surprise auditors from a western
perspective.

Learning Objective 3

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International Diversity in External

Auditing

Environment of auditing

Countries with less developed financial infrastructure would need

less sophisticated auditing.
When banks or families are the primary source of financing, there is
less demand for auditing.
Common law countries tend to have a more influential auditing
profession relative to code law countries.
Audit quality and independence are likely to be influenced by level
of rigor to join the profession and by the extent of legal liability
assigned to auditors.
Learning Objective 3

13-16

International Diversity in External

Auditing

Audit regulation

Auditing in Anglo-Saxon countries has historically been selfregulated.

However, recent scandals have led to increased government
oversight.
In many other countries (e.g., Germany, China) government
exercises much more control.
Auditor qualifications vary significantly from country to country.

Learning Objective 3

13-17

International Diversity in External

Auditing

Audit reports

The content of audit reports varies significantly between countries,

and sometimes between companies in the same country.
For example, audit reports sometimes refer to local audit standards,
non-local audit standards, multiple sets of audit standards, or are
addressed to different audiences.
The Sarbanes-Oxley Act in the U.S. includes a requirement to
provide assurance on the internal controls.

Learning Objective 3

13-18

International Harmonization of
Standards
Auditing
International auditing has historically received less attention than

international accounting.
Recently, globalization has increased the importance of crossnational understanding of audit reports.
Harmonization of international auditing standards will help increase
consistency of auditing worldwide.
The increased level of assurance on financial statements should
result in more efficient global capital markets.
The International Federation of Accountants (IFAC) develops
international auditing standards.

Learning Objective 4

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International Harmonization of
Auditing
Standards

IFAC

The International Auditing and Assurance Standards Board (IAASB)

is the entity that develops international auditing standards.
IFACs Forum of Firms, as well as its Compliance Committee, deal
with international regulation and compliance.
IFACs efforts at harmonization are supported by the International
Organization of Securities Commissions (IOSCO).

Learning Objective 4

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International Harmonization of
Auditing
Standards
IFAC pronouncements
A set of International Standards on Auditing consisting of nine sections has
been published.
Section 200 covers auditor responsibilities in conducting an audit.
Section 500 deals with audit evidence.
Section 700 covers audit reports.
Sections 800 and 900 deal with engagements other than a standard audit.

PCAOB is proposing Rule 4012 where the board would place full
reliance on the inspection program of non-U.S. auditor oversight
entities.
Learning Objective 4

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Auditor Liability and Independence

Auditor liability -- Background
Auditors are subject to civil liability, criminal liability, and
professional sanctions.
Civil liability can result from breach of contract or civil duty (e.g.,
negligence).
Criminal liability can result from criminal conduct (e.g., fraud).
Professional sanctions can result from violation of the rules of a
professional body.
The potential for legal liability varies internationally and is highly
significant in some countries (e.g., the U.S.).
Learning Objective 5

13-22

Auditor Liability and Independence

Auditor liability Recent events
Andersen, a big five firm, was effectively put out of business by a
criminal conviction, later overturned, in connection with its Enron
audit.
One remaining big four firm, PricewaterhouseCoopers, suggested
to U.K. authorities that auditors are in a legally untenable position.
A 1998 German court decision resulted in auditors being liable to
third parties for the first time in that country.

Learning Objective 5

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Auditor Liability and Independence

Auditor liability Possible reforms
Several solutions to limiting auditor liability exist in order to limit
potential damage to firms.
Change of ownership structure to limit or eliminate joint and several
liability
Proportionate liability that limits auditor liability to the proportion for
which they are deemed responsible
Statutory caps to limit damages
Disclaimer of liability to avoid unintended liability. Some U.K.
auditors use these, but the U.S. SEC rejects them as invalid.
Learning Objective 5

13-24

Auditor Liability and Independence

Auditor Independence -- Background
Independence is a fundamental principle of auditing.
Auditors in the U.S. are required to adhere to a detailed set of
independence rules.
The SEC has additional rules for auditors of public companies.
An SEC report in 2000 cited numerous violations by big five
auditors.
Auditor independence is a subject of intense debate internationally
as well as in the U.S.

Learning Objective 5

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Auditor Liability and Independence

Proposals to strengthen auditor independence
Involvement of stockholders in auditor appointment
Restrictions or prohibitions of certain consulting activities
Increased regulatory oversight
Increased involvement by the board of directors and audit
committee
Mandatory rotation of audit firms or engagement partners

Learning Objective 5

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Auditor Liability and Independence

Proposals to strengthen auditor independence
Separating consulting operations from the auditing practice
Increasing the stringency of admission criteria to the profession
A principles-based approach to auditor independence, in contrast to
a lengthy set of bright-line rules, which would maintain some
specific rules
A conceptual approach similar to the above but that includes no list
of specific prohibitions

Learning Objective 5

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Audit Committees
Audit committees United States
The audit committee is a committee of the board of directors
responsible for financial reporting oversight.
Beginning in the 1990s, increased attention has been paid to this
topic.
In the U.S., the Blue Ribbon Committee made a series of
recommendations to enhance the role of the audit committee.
Sarbanes-Oxley includes specific provisions related to audit
committees.

Learning Objective 6

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Audit Committees
Audit committees Internationally
Audit committees are increasingly being seen as an important
component of corporate governance.
There is wide acceptance globally that the auditor works for the
audit committee.
Australia, for example, requires listed companies to have audit
committees composed completely of outside directors.
Audit committees are also now required for listed companies in
Malaysia and Singapore.

Learning Objective 6

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Internal Auditing
Internal auditing -- Background
Internal auditing is an independent, objective assurance and
consulting activity designed to add value and improve an
organizations operations.
The SEC requires an internal audit function of public companies.
Internal audit can enhance the effectiveness of internal controls
over financial reporting.

Learning Objective 7

13-30

Internal Auditing
Internal auditing -- Background
The clearest difference between external and internal auditing is the
consulting function of the latter, particularly in risk management.
Given their complexity, multinational corporations (MNCs) are increasingly
demanding risk management consulting.
Internal auditors also commonly perform compliance audits, and
effectiveness and efficiency audits.
PCAOBs Auditing Standard No. 5 An Audit of Internal Control Over
Financial Reporting implements Sections 103 and 404 of the SarbanesOxley Act. It must be used for all audits of internal controls no later than for
fiscal years ending on or after 11/15/07.
This standard applies a principles-based approach and eliminates
unnecessary procedures from the audit.
Learning Objective 7

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Internal Auditing
The Foreign Corrupt Practices Act
Foreign Corrupt Practices Act of 1977 (FCPA) requires companies
to maintain effective internal controls and not pay bribes.
The logic is that effective internal controls over financial reporting
will mitigate the risk of bribe payments.
This legislation was a reaction to the discovery, in the 1970s, that
many U.S. companies did pay bribes.
Enforcement of the FCPA has resulted in large fines against major
U.S. companies.

Learning Objective 7

13-32

Sarbanes-Oxley and the Future of

Auditing
Sarbanes-Oxley is the most significant legislation pertaining to

financial reporting and auditing since the establishment of the SEC

in the 1930s.
The act has had an observable impact on business, one example of
which is the increase in financial expertise on audit committees.
Companies have spent significant resources enhancing internal
controls.
On a more negative note, many financial executives are
experiencing increased stress due to Sarbanes-Oxley.

Learning Objective 8

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Sarbanes-Oxley and the Future of

Auditing

Other international audit issues

There is increased demand for internet-based financial reporting

and the related assurance.
Continuous assurance on real-time information
Increased competition in the audit market
Increased exposure of international audit firms
The risk that increases in litigation will lead to more of a checklist
approach to auditing
The enhanced partnership between external auditors, internal
auditors, and audit committees
Learning Objective 8

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