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Should Auditors Be Subjected To The Governance Standards They Preach?

Should Auditors Be Subjected To The Governance Standards They Preach?

The quality of corporate governance demonstrated by Malaysian companies is one of the factors which influence the competitiveness of our capital market. Many public listed companies (PLCs) and financial institutions (FIs) have gone beyond adopting the recommended principles and having the required structures but are competing to demonstrate that good governance is already part of their culture.

Apart from ensuring their auditors report are reliable, auditors and accounting firms have also been playing their part in promoting corporate governance in Malaysia. Their senior partners were involved at policy formulation and development stages and also participated in various events in sharing views and ideas with board members with the intention of helping the directors to enhance governance practises in the companies which they are responsible for.

Accounting firms are also in the frontline when it comes to the implementation of the International Financial Reporting Standards (IFRS). Whenever new and complicated standards are adopted, they would be called upon to assist management in ensuring their accounting systems and processes would lead towards financial statements which are in compliance with those standards. For example, the forthcoming adoption of IFRS 9 has created huge demand of their services to the extend that some firms have declined new engagements.

Not that different from companies which are required to demonstrate good corporate governance, audit quality and auditors independence are predicated upon the tone from the top and having systems and processes which are effective. Audit inspection reports from all over the world, however, revealed that accounting firms offering auditing services were criticised for significant failures in some of the audit engagement chosen during inspections by audit regulators.

While non of the major audit firms in Malaysia have been subjected to enforcement actions by the Audit Oversight Board (AOB), the concerns raised by the AOB regarding these firms cannot be taken lightly. They audit more than 90% of the PLCs and most of the FIs. One apparent weakness is the inability of these firms to maintain high audit quality across all their audit engagements, one of the major concerns of global audit regulators as well.

The Financial Reporting Council (FRC) in United Kingdom is one of the leading audit regulators which have moved ahead in requiring audit firms auditing 20 PLCs or more to comply with Audit Firm Governance Code (the Code) since 2007. The objectives of the Code are to promote audit quality, to ensure the reputation of the firms are secured and to reduce the risk of firm failure as FRC considers them as systemically significance.

The Code requires the relevant audit firms to:

Have a board or equivalent governance structure to oversee the activities of the management team;
Publish a Transparency Report covering, amongst others, how the governance structure and management operate and how the audit and other services of the firm are overseen;
The members of the governance structure and management should be subjected to formal periodical performance assessment and subjected to election.
Adopt the management and principles of the Code;
Appoint at least three independent non-executive to the governance structure and they should be the majority on any body which oversees public interest matters;
Audit firms must adopt compliance principles which must be oversee by the independent non-executives apart from adopting and implementing risk management, people and whistleblowing principles;
Published audited financial statements which comply with IFRS or the UK GAAP; and
Have dialogues with PLC shareholders and audit committees regarding matters with respect to the Code.
Since its adoption, the FRC noted some issues with respect to implementation of the Code. The Code itself is not visible, the role of the independent non-executive was not understood and the dialogue with stakeholders was not effective.

As a result, the FRC recently revised the Code by adding additional information in the Transparency Report including:

The work of the Board and the independent non-executive including their performance against pre-determined key performance indicators;
A separate report from the independent non-executive on how they have overseen public interest matters and whether they are satisfied that appropriate culture exist; and
Why the firm has chosen to position the independent non-executive the ways it has and how this serves public interest and improves audit quality.

Given the significance and the role of audit firms in the present corporate governance landscape, such measures could be considered in Malaysia. After all, they are not alien to the firms as all of them are advocators of good corporate governance. It would be also good for the public to know more about the firms structures and governance arrangements, as what we expect from our PLCs.

Why shouldn’t the audit firms be expected to comply with similar standards which they have been preaching given the downside risks of major audit failures which could lead towards firm failures as well?