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chapter I

Role and context of modern auditing

Introduction Topic List

I Role of auditing 2 The audit process 3 Statutory audit requirement 4 Legal responsibilities 5 International standards on auditing 6 Quality control 7 Documentation

Summary and Self-test Technical reference Answers to Self-test Answers to Interactive questions

The Institute of Chartered Accountants in England and Wales, March 2009

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ROLE AND CONTEXT OF MODERN AUDITING

Role of auditing

1.1 Purpose of the audit Audits serve a fundamental purpose in helping to enforce accountability and promote confidence in financial reporting. Directors are delegated responsibility for managing the affairs of the company by the owners, in effect they act as trustees for the shareholders. The audit provides a mechanism for shareholders to help ensure that the directors are acting in the company's best interests and therefore plays a fundamental stewardship role.

BSA 200 Objective and General Prindples Governing an Audit of Financial Statements sets out the objectives of an audit as follows:

'The objective of an audit of financial statements is to enable the auditor to express an opinion as to whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.'

1.2 Part of the economic infrastructure The audit is also a vital function of economic activity. For that economic activity to continue to flourish there has to be trust. As the ICAEW Audit and Assurance Faculty publication Audit Quality states:

'An important contributor to trust and confidence is the independent audit of the information provided to shareholders. It is a vital component of efficient capital markets.'

While the audit has a crucial role to play in providing assurance to shareholders it cannot be seen in isolation. For example, the directors of the company have a role to play in the preparation of financial statements that show a true and fair view. The audit has to be seen in the context of a range of interwoven laws, regulations, and guidance, all of which promote good corporate governance. 0fVe will look at corporate governance in detail in Chapter 3).

1.3 The expectation gap The primary role of the auditor is to perform an independent examination of the financial statements and to form an opinion. You should be very familiar with this concept from your earlier studies. The audit opinion will provide reasonable assurance that the financial statements give a true and fair view; it does not provide a certificate that they are completely accurate and free from every error or fraud, no matter how small. BSA 200 explains that absolute assurance is not possible due to inherent limitations of the audit including those resulting from the following factors:

~ The use of testing ~ Inherent limitations of internal control ~ The fact that most evidence is persuasive rather than conclusive ~ The impracticability of examining all items within a class of transactions or account balance ~ The possibility of collusion or misrepresentation for fraudulent purposes ~ The fact that the work undertaken by the auditor is permeated by judgement

The Institute of Chartered Accountants in England and Wales, March 2009 3

Advanced Stage- Advanced Audit and Assurance

In some instances this 'expectation gap' can lead to difficulties arising from the difference between what shareholders expect an audit to achieve and what it is designed to achieve. The public increasingly expect the following types of questions to be answered:

~ Is the company a going concern? ~ Is the company managed effectively? ~ Is there an adequate system of controls? ~ Is the company susceptible to fraud? As Audit Quality states:

'A continuing challenge facing those with an interest in corporate governance and every auditor is communicating the purpose, ambit and limitations of the audit.'

1.4 The audit opinion The key judgement made by the auditor is whether the financial statements give a true and fair view. Whilst there is no legal definition for these terms, 'true' and 'fair' are normally taken to mean the following:

Definition True: The information in the financial statements is not false and conforms to reality.

In practical terms this means that the information is presented in accordance with accounting standards and law. The f1nancial statements have been correctly extracted from the underlying records and those records reflect the actual transactions which took place.

Definition Fair: The financial statements reflect the commercial substance of the company's underlying transactions and the information is free from bias.

You will have come across examples of the application of substance over form in your financial reporting studies e.g. the treatment of a finance lease.

The problem with making judgements such as these is that they can be called into question, particularly where others have the benefit of hindsight. The major defence that the auditor has in this situation is to show that the work was performed with due skill and care and that the judgements made about truth and fairness were reasonable based on the evidence available at the time. We will look at quality control in Section 6 of this chapter. Auditor liability is covered in Chapter I 0.

4 The Institute of Chartered Accountants in England and Wales, March 2009


2 The audit process

2.1 Overview You will have covered the audit process in you earlier studies. The following diagram summarises the key points you should be familiar with. Chapters 4 - 6 of this text cover the audit in more detail.

Point to note

BSA 200 requires that the audit should be planned and performed with an attitude of professional scepticism.

The Institute of Chartered Accountants in England and Wales, March 2009 S

Advanced Stage - Advanced Audit and Assurance

3 Statutory audit requirement

3.1 The audit requirement The basic principle is that all companies registered in Bangladesh should be audited.

4 Legal responsibilities

4.1 Companies Act 1994 The legal responsibilities regarding directors and auditors are currently contained in the Companies Act 1994 which has effectively replaced the provisions of the Companies Act 1913.

4.2 Directors' responsibilities These duties are as follows:

~ Fiduciary Duty Directors are fiduciaries and must, therefore, display the utmost good faith towards the company in their dealings with it or on its behalf. They must act bona fide, in what they believe to be the best interests of the company. They must exercise their powers for the particular purpose for which they were conferred and not for some extraneous purpose, even though they honestly believe that to be in the best interest of the company. But the most important feature of the fiduciary nature of their duties is that they must not fetter their discretion to exercise their powers from time to time in accordance with the foregoing rules. Also they must not, without the consent of the company, place themselves in a position in which there is a conflict between their duties and personal interests. Good faith must not only be done but must manifestly be seen to be done, and the law will not allow a person acting in a f1duciary capacity to place himself in a situation in which his judgment is likely to be biased. ~ Accounting records

A company is required to keep proper books of account, which are sufficient to show and explain the company's transactions. Failure to do so may render every officer of the company liable to a fine or imprisonment.

In addition to the statutory requirement, the directors have an overriding responsibility to ensure they have adequate information to enable them to fulfil their duty of managing the company's business.

~ Annual balance sheet

The board of directors of every company shall, at every annual general meeting held in pursuance of section 81, "lay before the company a balance sheet together with the profit and loss account." Board Report-- There shall be attached to every balance sheet laid before a company in general meeting a report by its board of directors, with respect to.-

(a) the state of the company's affairs; (b) the amount, if any, which the board proposes to carry to any reserve in such balance sheet;

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(c) the amount, if any, which the board recommends should be paid by way of dividend; {d) material changes and commitments, if any, affecting the financial position of the company which have occurred between the end to the financial year of the company of which the balance sheet related and the date of the report:

(2) The board's report shall, so far as is material for the appreciation of the state of company's affairs by its members, deal with any changes which have occurred during the financial year:-

{a) in the nature of the company's business; (b) in the company's subsidiaries or in the nature of the business carried on by them; and (c) generally in the classes of business in which the company has an interest. {3) The board shall also be bound to give the fullest information and explanations in its report aforesaid on every reservation, qualification or adverse remark contained in the auditor's report.

(4) The board's report and any addendum thereto shall be signed by its chairman if he is authorised in that behalf by the board, and, where he is not so authorised, shall be signed by such number of director as are required to sign the balance sheet and the profit and loss account or the income and expenditure account of the company.

~ Directors' and officers' insurance Generally a company cannot indemnify a director against a liability arising from an act of negligence,

'" default or breach of duty. However, this statutory provision does not prevent a company from buying and maintaining insurance against such a liability.

~ Safeguarding the assets Responsibilities to safeguard the assets of the company includes the prevention and detection of fraud. One of the main ways in which this duty can be carried out is to implement an effective system of controls.

4.3 Loans to Directors Section I 03 prohibits loans or guarantee or securities in favour of directors. This section follows section 860 of the Act of 1913 which was introduced in the company law of our country by the amending Act of 1936. A further amendment in 1938 extended the operation of the rule to loans to private companies in which any director of the lending company was a member. Section I 08 (I) (g) provides that the office of a director shall be vacated if a director or any firm of which he is a partner or any private company of which he is a director accepts a loan or guarantee from the company in contravention of section I 03.

A private company may give or guarantee a loan if the loan is sanctioned by the board and the general meeting and does not exceed fifty percent of the paid up value of the shares held by the director in his own name. A contravention of section I 03 may, in addition to the vacation of the office of the director, entail a fine of five thousand taka or a simple imprisonment for six months in lieu of fine for every person who is a

- party to such a contravention. Regulation 78 in the First Schedule to the Act also provides that the office of a director shall be vacated if the director accepts a loan from the company.

4.4 Auditors' responsibilities Under the Companies Act 1994, it is the external auditor's responsibility to form an independent opinion on the truth and fairness of the financial statements

The auditor will also report by exception on the following. Whether:

~ Proper returns, adequate for audit purposes, have been received from branches ~ The accounts agree with the underlying records

~ Adequate accounting records have been kept ~ All necessary information and explanations have been obtained


Advanced Stage -Advanced Audit and Assurance

The auditor also has a duty towards other information in documents containing audited financial statements in accordance with BSA 720 Other Information in Documents Containing Audited Financial Statements (see Chapter 6).

S International standards on auditing

5.1 Introduction You will have covered the regulatory framework affecting the issue of International Standards on Auditing (ISAs) including the role of the International Auditing and Assurance Standards Board (IAASB) in your Audit and Assurance studies at the professional level. This section therefore provides a brief summary of the key points.

5.2 Overview The system in Bangladesh currently works as follows:

IAASB Issues

I CAB Adopts

BSA as used by Bangladesh Auditors

5.3 International Auditing and Assurance Standards Board 5.3.1 Pronouncements

IAASB was set up by the International Federation of Accountants (IFAC), which nominates a majority of its members - others are nominated by the forum of firms -to issue professional standards. It issues the following standards:

~ International Standards on Auditing (ISAs) ~ International Standards on Assurance Engagements (ISAEs) (applicable to assurance

engagements which are not audits) ~ International Standards on Related Services (ISRSs) (applicable to other, non-assurance

engagements) ~ International Standards on Quality Control (ISQCs) (applicable to all engagements carried out

under any of the IAASB's standards)



~ International Standards on Review Engagements (ISREs) (are to be applied in the review of historical financial information)

It also issues the following practice statements:

~ International Audit Practice Statements (lAPS). lAPS provide interpretive guidance and practical assistance to professional accountants in implementing ISAs and to promote good practice.

~ International Review Engagement Practice Statements (IREPSs), International Assurance Engagement Practice Statements (IAEPSs), and International Related Services Practice Statements (IRSPSs) are issued to serve the same purpose for implementation of ISREs, ISAEs and ISRSs respectively.

5.3.2 Authority of ISAs ISAs are to be applied in the audit of historical financial information.

In exceptional circumstances, an auditor may judge it necessary to depart from an ISA in order to more effectively achieve the objective of an audit. When such a situation arises, the auditor should be prepared to justify the departure.

5.3.3 Working procedures The working procedures of the IAASB can be summarised as follows

~ Subjects selected for detailed study are reviewed by a subcommittee ~ The subcommittee prepares an exposure draft for consideration by the IAASB

~ Once approved the exposure draft is distributed to member bodies of IFAC (and other international organisations that have an interest in auditing standards) for comment ~ A revised exposure draft is issued after consideration of the comments received by the IAASB

~ If the revised draft is approved an ISA is issued.

5.4 ICAB Adoption Procedures 5.4.1 ICAB adoption of ISAs and BSAs

The process for adoption by I CAB of ISAs and BSAs is as follows:

~ Identification of the broad areas by the Technical and Research Committee (TRC) for formulating the Accounting/Auditing Standards ~ Constitution of the study groups by the TRC for preparing the preliminary drafts of the proposed

Accounting/ Auditing Standards ~ Consideration of the preliminary drafts prepared by the study groups by the TRC and revision, if any,

of the drafts on the basis of deliberations at the TRC ~ Consideration of the drafts Accounting/ Auditing Standards by the Councii-ICAB and if found

necessary, modification of the drafts in consultation with the TRC ~ The Accounting/ Auditing Standards, so finalised, are issued under the authority of the Councii-ICAB as

Bangladesh Accounting Standards (BAS), and Bangladesh Standards on Auditing (BSA)

5.4.2 Future harmonisation: Clarity Project The ongoing IAASB Clarity Project will also result in amendments being required to BSAs in due course.

5.5 Clarity Project The IAASB is in the middle of a clarity project, during which they are reissuing existing ISAs, with the aim of making the requirements within them clearer.

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Under this project, each ISA will have: ~ A stated overall objective ~ Clarified obligations, by use of the word 'shall' where a requirement of the ISA is set out ~ Eliminating ambiguity in ISAs ~ Improving the overall readability of ISAs

5.5.1 Revised and redrafted ISAs As at September 2008 the following ISAs have been revised and redrafted as part of the Clarity Project. ISA 260 (Revised and Redrafted) Communication with Those Charged with Governance (see Chapter 6) ISA 540 (Revised and Redrafted) Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures (see Chapters 5 and 12) ISA 550 (Revised and Redrafted) Related Parties (see Chapter 5) ISA 580 (Revised and Redrafted) Written Representations (see Chapter 5) ISA 600 (Revised and Redrafted) Special Considerations -Audit of Group Financial Statements (Including the Work of Component Auditors) (see Chapter 14)

5.5.2 Redrafted ISAs To date the following ISAs have been reissued in the clarity form. These new standards make no significant changes to the auditor's responsibilities but have been reworded in line with the aims of the Clarity Project.

ISA 230 (Redrafted) Audit Documentation ISA 240 (Redrafted) The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements ISA 250 (Redrafted) Consideration of Laws and Regulations in an Audit of Financial Statements ISA 260 (Redrafted) Communication with those charged with Governance ISA 300 (Redrafted) Planning an Audit of Financial Statements ISA 315 (Redrafted) Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment ISA 330 (Redrafted) The Auditor's Response to Assessed Risks ISA 51 0 (Redrafted) Initial Audit Engagements - Opening Balances ISA 560 (Redrafted) Subsequent Events ISA 570 (Redrafted) Going Concern ISA 720 (Redrafted) The Auditor's Responsibility in Relation to Other Information in Documents containing Audited Financial Statements

I 0 The Institute of Chartered Accountants in England and Wales, March 2009


6 Quality control

6.1 Principles and purpose Audit quality is not defined in law or through regulations, nor do auditing standards provide a simple definition.

Although each stakeholder in the audit will give a different meaning to audit quality, at its heart it is about delivering an appropriate professional opinion supported by the necessary evidence and objective judgements. Many principles contribute to audit quality including good leadership, experienced judgement, technical competence, ethical values and appropriate client relationships, proper working practices and effective quality control and monitoring review processes.

The standards on audit quality provide guidance to firms on how to achieve these principles.

6.2 Quality control at a firm level The fact that auditors follow BSAs provides a general quality control framework within which audits should be conducted. There are also specific quality control standards. BSQC I: Quality Control for Firms that Perform Audits and Reviews of Historical Finandallnformation and other Assurance and Related Service Engagements deals with quality control at a firm level. You have studied BSQC I in Audit and Assurance at the professional level. A summary of the key points is provided below.

6.2.1 Purpose of BSQC I The purpose of BSQC I is to ensure that firms establish a system of quality control designed to provide it with reasonable assurance that the firm and its personnel comply with professional standards and regulatory and legal requirements, and that reports issued by the firm or engagement partners are appropriate in the circumstances.

6.2.2 Elements of a system of Quality Control BSQC I identifies the following six elements of the firm's system of quality control: (I) Leadership responsibilities for quality within the firm

The standard requires that the firm implements policies such that the internal culture of the firm is one where quality is considered essential. Such a culture must be inspired by the leaders of the firm, who must sell this culture in their actions and messages. In other words, the entire business strategy of the audit firm should be driven by the need for quality in its operations.

The firm may appoint an individual or group of individuals to oversee quality in the firm. Such individuals must have:

~ The ability to carry out the job ~ The necessary authority to carry out the job

The Institute of Chartered Accountants in England and Wales, March 2009 I I


(2) Ethical requirements Policies and procedures should be designed to provide the firm with reasonable assurance that the firm and its personnel comply with relevant ethical requirements.

The policies and procedures should be in line with the fundamental principles, which should be reinforced by:

~ The leadership of the firm ~ Education and training ~ Monitoring

~ A process to deal with non-compliance At least annually, the firm should obtain written confirmation of compliance with its policies and procedures on independence from all firm personnel required to be independent by ethical requirements.

(3) Acceptance and continuance of client relationships and specific engagements A firm should only accept, or continue with, a client where:

It has considered the integrity of the client and does not have information that the client lacks integrity

~ Is competent to perform the engagement and has the necessary time and resources

~ Can comply with ethical requirements including appropriate independence from the client (4) Human resources

The firm's overriding desire for quality will necessitate policies and procedures on ensuring excellence in its staff, to provide the firm with 'reasonable assurance that it has sufficient personnel with the capabilities, competence, and commitment to ethical principles necessary to perform its engagements in accordance with professional standards and regulatory and legal requirements, and to enable the firm or engagement partners to issue reports that are appropriate in the circumstances'.

These will cover the following issues:

~ Recruitment ~ Performance evaluation

~ Capabilities ~ Competence ~ Career development ~ Promotion

~ Compensation ~ The estimation of personnel needs

The firm is responsible for the ongoing excellence of its staff, through continuing professional development, education, work experience and coaching by more experienced staff.

The assignment of engagement teams is an important matter in ensuring the quality of an individual assignment.

This responsibility is given to the audit engagement partner. The firm should have policies and procedures in place to ensure that

~ Key members of client staff and those charged with governance are aware of the identity of the audit engagement partner

~ The engagement partner has appropriate capabilities, competence, authority and time to perform the role

~ The engagement partner is aware of his/her responsibilities as engagement partner

The engagement partner should ensure that he assigns staff of sufficient capabilities, competence and time to individual assignments so that he will be able to issue an appropriate report.



(5) Engagement performance The firm should take steps to ensure that engagements are performed correctly, that is, in a~cordance with standards and guidance. Firms often produce a manual of standard engagement procedures to give to all staff so that they know the standards they are working towards. These may be electronic.

Ensuring good engagement performance involves a number of issues:

~ Direction ~ Supervision ~ Review ~ Consultation

~ Resolution of disputes Many of these issues will be discussed in the context of an individual audit assignment (see below). The firm should have policies and procedures to determine when a quality control reviewer will be necessary for an engagement. This will include all audits of financial statements for listed companies. When required, such a review must be completed before the report is signed.

The firm must also have standards as to what constitutes a suitable quality control review.

In particular the following issues must be addressed.

For listed companies in particular the review should include:

~ The engagement team's evaluation of the firm's independence in relation to the specific engagement

~ Significant risks identified during the engagement and the responses to those risks ~ Judgements made, particularly with respect to materiality and significant risks ~ Whether appropriate consultation has taken place on matters involving differences of opinion or

other difficult or contentious matters, and the conclusions arising from those consultations

The significance and disposition of corrected and uncorrected misstatements identified during the engagement

~ The matters to be communicated to management and those charged with governance and, where applicable, other parties such as regulatory bodies

~ Whether working papers selected for review reflect the work performed in relation to the significant judgements and support the conclusions reached ~ The appropriateness of the report to be issued

(6) Monitoring The standard states that firms must have policies in place to ensure that their quality control procedures are:

~ Relevant ~ Adequate ~ Operating effectively ~ Complied with

In other wqrds, they must monitor their system of quality control. Monitoring activity should be reported on to the management of the firm on an annual basis.

There are two types of monitoring activity, an ongoing evaluation of the system of quality control and period inspection of a selection of completed engagements. An ongoing evaluation might include such questions as, 'has it kept up to date with regulatory requirements?'

A period inspection cycle would usually fall over a period such as three years, in which time, at least one engagement per engagement partner would be reviewed.

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The people monitoring the system are required to evaluate the effect of any deficiencies found. These deficiencies might be one-offs. Monitors will be more concerned with systematic or repetitive deficiencies that require corrective action. When evidence is gathered that an inappropriate report might have been issued, the audit firm may want to take legal advice.

Corrective action

~ Remedial action with an individual ~ Communication of findings with the training department

~ Changes in the quality control policies and procedures ~ Disciplinary action, if necessary

Point to note

All quality control policies and procedures 'should be documented and communicated to the firm's personnel'

6.2.3 Practical application The ICAEW Audit and Assurance Faculty publication Quality Control in the Audit Environment: A practical guide for frrms on implementing ISQC I recommends that firms take the following key steps to give them confidence that they are compliant with ISQC I:

~ Document the operation of the quality control system ~ Lead from the top giving a consistent message on the importance of quality control

~ Always act ethically in accordance with relevant Standards and pronouncements ~ Focus on the right clients being matched by the right skills with emphasis on integrity and

competencies

~ Maintain capable and competent staff giving due attention to the firm's human resources policies and procedures

~ Deliver quality audits consulting when needed and meeting requirements for engagement quality control review

~ Monitor the firm's system of quality control and carry out a periodic objective inspection of a selection of completed audit engagements

6.3 Quality control on an individual audit You will have studied BSA 220 Quality Control for Audits of Historical Financial Information in the previous Audit and Assurance paper. A summary of the key points is provided below.

6.3.1 Policies and procedures It is the responsibility of the engagement team to implement quality control procedures with respect to individual audit engagements. The engagement partner is ultimately responsible for quality control on an individual engagement.

The policies and procedures for quality control on individual audits parallel those for the firm outlined above. In addition, however, of particular significance for individual audits are the procedures of direction, supervision and review.

~ Direction At the planning stage, but also during the audit, the engagement partner ensures that the members of the engagement team are informed of:

Their responsibilities The nature of the entity's business Risk issues Problems that may arise Detailed approach to the audit engagement



~ Supervision

Supervision includes:

Tracking the process of the audit engagement

Considering the capabilities of individual members of the engagement team and that they understand their instructions

Addressing issues that arise and modifying the audit approach if appropriate

Identifying matters for consultation or consideration by more senior members of the audit engagement.

~ Review

Reviewing concerns the inspection of work by engagement members by more senior members of the same engagement. This includes ensuring that:

The work has been carried out in accordance with professional and regulatory requirements Significant matters are given further consideration Appropriate consultations have taken place and have been documented Where appropriate the planned audit work is revised The work performed supports the conclusions The evidence obtained supports the audit opinion The objectives of the engagement have been achieved

6.3.2 Practical application The ICAEW Audit and Assurance Faculty publication Audit Quality identifies the following as major factors which drive audit quality:

~ Leadership

This involves:

Setting the strategies and objectives Recognising the commonality of commercial and professional approaches Ensuring the organisation will deliver the required quality Setting the right tone at the top Ensuring quality is consistently communicated

~ People

Audit quality is highly dependent on the quality of the people. Staff need to be both competent and motivated. Training and development must be an integral part of professional life.

~ Client relationships Managing client relationships involves:

Clearly defining the responsibilities of the auditor and management

Assessing whether the audit partner and the audit firm is objective and independent but still close enough to have a good understanding of the business

Managing communications with the client management and audit committee so that issues are dealt with on a regular and timely basis.

~ Working practices

Good working practices include:

A clear understanding of roles and responsibilities by all members of the audit team The application of sufficient thought at each stage of the audit Audit work should be performed with alertness of mind, professional scepticism and rigour Completion procedures must be performed and audit conclusions carefully considered

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~ Internal monitoring This essentially represents an 'internal audit' performed by staff independent of the audit team.

~ External monitoring

External monitoring is to be carried out through the ICAB QAD visit. Reports from the QAD visit provide independent feedback on a firm's quality review processes and provide an opportunity to measure them against good practice elsewhere.

6.4 Assuring the Quality of Professional Services International Professional Practice Statement I Assuring the Quality of Professional Services (IPPS I) issued by IFAC covers many of the issues dealt with by ISQC I and ISA 220 but addresses them largely from the perspective of the role of the professional bodies e.g. I CAB. In particular it makes the following points:

IFAC believes that the following objectives have worldwide applicability and that member bodies should strive to achieve them:

~ Member bodies should adopt or develop quality control standards and relevant guidance that require firms to establish quality control policies and procedures

~ Member bodies should develop quality review programs designed to evaluate whether firms have established and complied with appropriate quality control policies and procedures and are complying with those

~ Member bodies should require firms to make improvements in their quality control policies and procedures where improvement is required. Corrective action should be taken where the firm fails to comply with relevant professional standards. Educational or disciplinary measures may be necessary.

Interactive question I: Addystone Fish [Difficulty level: Intermediate] You are an audit senior working for the firm Addystone Fish. You are currently carrying out the audit of Wicker Ltd, a manufacturer of waste paper bins. You are unhappy with Wicker's inventory valuation policy and have raised the issue several times with the audit manager. He has dealt with the client for a number of years and does not see what you are making a fuss about. He has refused to meet you on site to discuss these issues.

The former engagement partner to Wicker retired two months ago. As the audit manager had dealt with Wicker for so many years, the other partners have decided to leave the audit of Wicker largely in his hands.

Requirement

Comment on the situation outlined above.

See Answer at the end of this chapter.



7 Documentation

7 .I Audit documentation Audit documentation is a key part of the overall quality control framework during the course of an audit. All audit work must be documented: the working papers are the tangible evidence of all work done in support of the audit opinion. BSA 230 Audit Documentation provides guidance on this issue.

In your previous studies, you have learnt the practical issues surrounding how audit papers should be completed. The key general rule concerning what to include on a working paper to remember, is:

'What would be necessary to provide an experienced auditor, with no previous connection with the audit, with an understanding of the nature, timing, and extent of the audit procedures performed to comply with the ISAs and applicable legal and regulatory requirements and the results of the audit procedures and the audit evidence obtained, and significant matters arising during the audit and the conclusions reached thereon.'

The key reason for having audit papers therefore is that they provide evidence of work done. They may be required in the event of litigation arising over the audit work and opinion given.

The BSA sets out certain requirements about what should be recorded, such as the identifying characteristics of the specific items being tested.

It also sets out points an auditor should record in relation to significant matters. These include:

~ Discussions undertaken with directors and

~ How the auditor addressed information that appeared to be inconsistent with his conclusions in relation to significant matters.

If an auditor felt it necessary to depart from customary audit work required by audit standards, he should document why, and how the different test achieved audit objectives. The BSA also contains details about how the audit file should be put together and actions in the event of audit work being added after the date of the audit report (for example, if subsequent events results in additional work being carried out}. You should be familiar with these points from your earlier studies.

7.2 R~view We shall briefly revise here the review of working papers. Review of working papers is important, as it allows a more senior auditor to evaluate the evidence obtained during the course of the audit for sufficiency and reliability, so that more evidence can be obtained to support the audit opinion, if required. lt. is an important quality control procedure.

Work performed by each assistant should be reviewed by personnel of appropriate experience to consider whether:

~ The work has been performed in accordance with the audit programme. ~ The work performed and the results obtained have been adequately documented. ~ Any significant matters have been resolved or are reflected in audit conclusions.

~ The objectives of the audit procedures have been achieved.



~ The conclusions expressed are consistent with the results of the work performed and support the audit opinion.

The following should be reviewed on a timely basis.

~ The overall audit strategy and the audit plan ~ The assessments of inherent and control risks

~ The results of control and substantive procedures and the conclusions drawn including the results of consultations

~ The financial statements, proposed audit adjustments and the proposed auditors' report In some cases, particularly in large complex audits, personnel not involved in the audit may be asked to review some or all of the audit work, the auditors' report etc. This is sometimes called a peer review or hot review.

Interactive question 2: Documentation (revision) [Difficulty level: Intermediate] Viewco is a manufacturer of TVs and video recorders. It carries out a full physical inventory count at its central warehouse every year on 31 December, its financial year-end. Finished goods are normally of the order of CU3 million, with components and work in progress normally approximately CUI million.

You are the audit senior responsible for the audit of Viewco for the year ending 31 December 20X I. Together with a junior member of staff, you will be attending Viewco's physical inventory count. Requirements

(a) Explain why it is necessary for an auditor to prepare working papers. (b) State, giving reasons, what information the working papers relating to this inventory count attendance

should contain.


Interactive question 3: TrucksToGo Ltd [Difficulty level: Intermediate] You are the audit senior on the audit ofTrucksToGo Ltd. You are supervising the work of a relatively inexperienced audit junior. The junior has been carrying out audit procedures on the assertions of completeness and existence of non-current assets. According to the junior, audit work has been completed and the memo below has been produced outlining some of the issues found during the audit.

Memo: Issues identified during audit ~ The directors have confirmed that there are no further non-current assets to include in the financial statements. This representation was received in a meeting with the Finance Director and recorded on the audit file at this time. I Part of the existence work on non-current assets included obtaining a sample of assets from the asset register and then physically verifying those assets. Unfortunately, a significant number of assets were not available for verification- the vehicles were in use by the company and therefore not on the premises. As an alternative, vehicles on the premises were agreed back to the asset register.

A number of vehicles were noted on the company premises in a poor state of repair; for example, engines missing. On enquiry, the vehicle manager confirmed that the vehicles were under repair. I am therefore happy that the vehicles belonged to the company and no further action is necessary.

I have reached the conclusion that all non-current assets are correctly stated and valued in the financial statements.



Requirement

Explain to the junior why the evidence collected is insufficient, and detail the action necessary to complete the audit procedures. Refer to your objectives in reviewing audit documentation as a format for your answer.




Summary and Self-test

Summary


chapter 2

Ethics


I Relevance of ethics 2 Ethical codes and standards 3 Making ethical judgements

Summary and Self-test Answers to Self-test Answers to Interactive questions Appendix I


ETHICS

Relevance of ethics

1.1 Introduction In general terms ethics is a set of moral principles and standards of correct behaviour. Far from being noble ideals which have little impact on real life they are essential for any society to operate and function effectively. Put simply, they help to differentiate between right and wrong, although their application often involves complex issues, judgement and decisions. Whilst ethical principles can be incorporated into law in many cases their application has to depend on the self-discipline of the individual. This principle can be seen to apply to society as a whole, the business community and the accounting profession.

Interactive question I: Ethical risl


1.2 Ethics in business Business life is a fruitful source of ethical dilemmas because its whole purpose is material gain, the making of profit. Success in business requires a constant search for potential advantage over others and business people are under pressure to do whatever yields such an advantage. As a result organisations have become increasingly under pressure to act and to be seen to be acting ethically. In recent years many have demonstrated this by publishing ethical codes, setting out their values and responsibilities towards stakeholders.

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are maintained but also provides protection for the professional providing a benchmark against which any alleged failings can be measured.

1.4 Ethics and the individual Whilst legislation and professional bodies have their part to play through issuing guidance, the importance of the integrity of the individual cannot be underestimated. Its ethical consequences are potentially very significant in deciding for example, whether to whistleblow on questionable practice at work, despite pressure from colleagues or superiors or negative consequences of doing so.

The devastating effect of the ethical choices of one individual can be seen in the following summary of the role played by Betty Vinson, an accountant at WorldCom.

Worked example: WorldCom WorldCom the US long-distance telephone carrier is 'credited' with being responsible for a fraud that created the largest bankruptcy in US history. This reportedly resulted in a fine of $500 million, which at the time was the largest fine ever imposed by the Securities and Exchange Commission (SEC). The problems began for WorldCom in mid-2000. Its operating costs were increasing sharply due to the fees which it had to pay to other companies for use of their telephone networks. Its Chief Executive Officer and Chief Financial Officer had had to inform Wall Street of lower than expected profits for the second half of the year and there was increasing pressure to improve results. Betty Vinson was working for WorldCom at this time as a senior manager in the corporate accounting division. She was asked by her boss to falsify the accounts in order to increase profits. This was achieved primarily by capitalising line costs rather than treating them as operating expenses. Whilst Betty Vinson considered resignation due to the pressure she was put under to falsify the results she continued to work for WorldCom until early 2002 and was promoted from senior manager to director with an increase in salary of $30,000. Over an 18 month period she had helped to falsify records at the request of her bosses increasing profits by $3.7 billion. By March 2002 questions were being asked by internal audit. Vinson decided to disclose the details of the falsified records to the FBI, the SEC and the US Attorney. She had hoped that her testimony could be exchanged for immunity from prosecution, however this was not the case. In October 2002 she pleaded guilty to two counts of conspiracy and securities fraud (carrying a maximum sentence of IS years) and in October 2003 she was charged with entering false information on company documents (carrying a maximum sentence of I 0 years).

Interactive question 2: Ethics and the individual [Difficulty level: Intermediate] List the factors which you think may have affected Betty Vinson's decision to make the fraudulent entries.

What other courses of action could she have taken?


2 Ethical codes and standards



2.1 Fundamental principles ~ The IFAC Code identifies five fundamental principles:

Integrity Objectivity Professional competence and due care Confidentiality Professional behaviour

2.2 Threats and safeguards ~ The IFAC Code is based on the principle that integrity, objectivity and independence are subject to

various threats and that safeguards must be in place to counter these.

~ The majority of threats fall into the following categories:

Self-interest threat Undue dependence on total fees from a client ----------------~-----------------------

Self-review threat Reporting on the operation of financial systems after being involved in their design or implementation

Advocacy threat Acting as an advocate on behalf of an assurance client in litigation or disputes with third parties

Familiarity or trust threat A member of the engagement team having a close or immediate family relationship with a director of the client

Intimidation threat Being threatened with dismissal or replacement in relation to a client engagement

~ The IFAC Code considers that there are two general categories of safeguard:

(I} Safeguards created by the profession, legislation or regulation Education, training and experience requirements for entry into the profession

Continuing professional development requirements

Corporate governance regulations (see Chapter 3} Professional standards (See Chapter I} Professional or regulatory monitoring and disciplinary procedures

External review by legally empowered third party of the reports, returns, communications or information produced by a professional accountant

(2} Safeguards within the work environment These may be:

Firm wide e.g. leadership of the firm that stresses the importance of compliance with fundamental principles

Engagement specific e.g. rotating senior assurance team personnel

~ Safeguards in the work environment may differ according to whether a professional accountant works in public practice, in business or in insolvency.

~ When evaluating safeguards what a reasonable and informed third party, having knowledge of all relevant information, including the significance of the threat and the safeguards applied, would conclude to be unacceptable should be considered.

I 3 8 The Institute of Chartered Accountants in England and Wales, March 2009

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2.3 Professional appointment ~ The following procedures are as per IFAC and ICAB Codes:

The prospective auditor should explain to the prospective client that they have a professional duty to communicate with the existing auditor

The client should be requested to confirm the proposed change to the existing auditor and to authorise the existing auditor to co-operate with the prospective auditor

Where this authorisation is received the prospective auditor should write to the existing auditor and request the disclosure of any information which might be relevant to the successor's decision to accept or decline the appointment

The prospective auditor should then consider whether to accept or decline the appointment in the light of the information received from the existing auditor

The existing auditor is required to respond within 14 days of receiving the requests for information

The prospective auditor is allowed to assume that silence implies that there are no adverse comments to be made. However the fact that no reply was received should be considered as part of the overall decision-making process.

2.4 Confidentiality ~ Information received in confidence should not be disclosed except in the following circumstances:

Where disclosure is permitted by law and is authorised by the client or the employer.

Where disclosure is required by law

Where there is a professional duty or right to disclose, when not prohibited by law.

This might include circumstances where an employee has committed a fraud and the management are in agreement that the police should be informed.

For example:

~ Production of documents or other provision of evidence in the course of legal proceedings

In this instance disclosure can be made if it is in the 'public interest' to do so.

~ Confidential information should not be used for personal advantage or the advantage of third parties e.g. insider trading

~ Applying this guidance will involve difficult judgements, particularly in making the decision as to whether disclosure is in the public interest. Other specific matters which may need to be considered include:

BSA 240 The Auditor's Responsibility to Consider Fraud in an Audit of Financial Statements (see Chapter I 0) BSA 250 Considerations of Laws and Regulations in an Audit of Financial Statements (see Chapter I 0)

2.5 Conflicts of interest ~ Conflicts of interest and confidentiality are related matters. Where a conflict of interest arises, one of

the key issues is whether it will be possible to keep information confidential.

~ Safeguards would include: Notifying the affected parties of the conflict of interest and obtaining permission to act/continue to act

Using separate engagement teams

.;..



Procedures to prevent access to information e.g. physical separation of teams and audit evidence

Clear guidelines for members of the engagement team on issues of security and confidentiality

The use of confidentiality agreements signed by employees

Regular reviews of the application of safeguards by a senior individual not involved with the relevant client engagement.

~ Where safeguards do not mitigate the risks sufficiently the professional accountant should not accept the engagement or should cease to act for one of the parties.

Interactive question 3: Stewart Brice [Difficulty level: Intermediate] You are the Engagement Partner at Stewart Brice, a firm of Chartered Accountants. The following situations exist.

Teresa is the audit manager assigned to the audit of Recreate, a large quoted company. The audit has been ongoing for one week. Yesterday, Teresa's husband inherited 1,000 shares in Recreate. Teresa's husband wants to hold on to the shares as an investment.

The Stewart Brice pension scheme, which is administered by Friends Benevolent, an unconnected company, owns shares in Tadpole Group, a listed company with a number of subsidiaries. Stewart Brice has recently been invited to tender for the audit of one of the subsidiary companies, Kermit Co.

Stewart Brice has been the auditor of Kripps Bros, a limited liability company, for a number of years. It is a requirement of Kripps Bros' constitution that the auditor owns a token CUI share in the company.

Requirement Comment on the ethical and other professional issues raised by the above matters.

Identify the ethical and professional issues Stewart Brice would need to consider.


3 Making ethical judgements

3.1 Resolving ethical conflicts Although there are a number of sources of ethical guidance, resolving ethical issues can be complex. As you have seen in your earlier studies (also see Appendix I) there are some specific rules which can be applied, but current IFAC ethical guidance is primarily principles based.

The application of these principles requires a degree of skill and the onus is placed on the integrity and judgement of the individual in weighing up the facts of the situation. In addition, it may mean that in certain circumstances there is more than one acceptable outcome.

The IFAC Code recognises that conflicts in the application of fundamental principles may need to be resolved. When providing a service the professional accountant must take into account:

~ The client's requirements and ~ The public interest.

Where these are in conflict the public interest should take priority.


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The ICAB Code sets out a framework that accountants can follow when faced with these issues, which may be set out as framework as follows, and you may find useful when considering ethical problems in the exam. The I CAB Code suggests that the resolution process should consider the following: -----------------------------------------------------------

Relevant facts

Relevant parties

This may involve:

~ Referring to the organisation's policy, procedures, code of conduct and previous history

~ Discussing the matter with trusted managers and employees.

These may include those directly affected e.g. shareholders, employees and employers but may also include the community at large.

---------------------- ---------------

Ethical issues involved

Fundamental principles related to the matter in question

Established internal procedures

Alternative courses of action

These include:

~ Professional ethical issues ~ Organisational ethical issues ~ Personal ethical issues

This will involve reference to the relevant ethical guidance e.g. ICAB Code

The professional accountant may find it useful to discuss ethical conflict issues with:

~ Immediate superior ~ The next level of management ~ A corporate governance body ~ Other departments e.g. legal, audit, human

resources

Consideration should also be given to the point at which help is sought from external sources e.g. I CAB. Generally it would be preferable for the conflict to be resolved without externa_l consultation.

The following should be considered:

~ The organisation's policies, procedures and guidelines ~ Applicable laws and regulations ~ Universal values and principles adopted by

society ~ Long and short-term consequences ~ Symbolic consequences ~ Private and public consequences

Where the conflict is significant and cannot be resolved the accountant would need to seek legal advice. After exhausting all other possibilities and depending on the nature of the conflict, the individual may conclude that withdrawal from the engagement team or resignation from the firm/employing organisation is appropriate.

Point to note

Withdrawal/resignation would be seen very much as a last resort.



3.2 Exam context Ethical issues will have been examined in the Knowledge and Application stage papers. However, at the Advanced stage you will be faced with more complex situations. More emphasis will be placed on your ability to use your judgement in the light of the facts provided, rather than testing your knowledge of the ethical codes and standards in detail. In some instances the correct action may be uncertain and it will be your ability to identify the range of possible outcomes which will be important rather than concluding on a single course of action.

You should also be aware that the term 'ethics' will be used in a much broader sense than it has been in the earlier Assurance and Audit and Assurance papers. It is likely to be combined with financial reporting, business and tax issues where you may be required to assess the ethical judgements made by others including management. You may also be asked to consider the issue from the point of view of the accountant in practice and the accountant in business.

The following Interactive question demonstrates these points.

Interactive question 4: Revenue recognition [Difficulty level: Exam standard] You are the auditor of Bellevue Ltd for the year ended 31 December 20X8. The company provides information to the financial services sector and is run by the managing director, Toby Stobbart. It has a venture capital investment of which part is in the form of a loan. The investment agreement details a covenant designed to protect the loan. This states an interest cover of 2 is required as a minimum i.e. the company must be able to cover interest and loan principal repayments with profits at least twice.

70% of the revenue of the business is subscription based and contracts are typically 3 years in duration. 30% of the revenue is for consultancy work which is billed on completion of the work. Consultancy projects are for a maximum of 2 months.

During the previous year the management performed a review of the subscription revenue and concluded that 40% of this represented consultancy work and should therefore be recognised in the first year of the contract rather than being recognised over the duration of the contract as had previously been the case. The audit file for 20X7 indicates that this treatment had been questioned vigorously by the audit manager but had been agreed with the audit partner, James Cowell. James Cowell subsequently left the firm abruptly.

You have received a copy of the 20X8 draft accounts which show an interest cover of 2.02 for 20X7 and 2.0 I for 20X8. You have also been told that a similar review of subscription income has been made for 20X8 with 40% being reclassified as consultancy work as in the previous year.

What are the issues that you as auditor would need to consider in this situation?



ETHICS

.. Summary and Self-test

Summary


chapter 3

Governance


I Relevance of corporate governance 2 Corporate governance concepts 3 The Code of Corporate Governance 4 Role of the board 5 Associated guidance 6 OECD principles of corporate governance 7 Sarbanes-Oxley 8 Evaluation of corporate governance mechanisms

Summary and Self-test Technical reference Answers to Self-test Answers to Interactive questions


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Relevance of corporate governance

1.1 Introduction

1.2

Corporate governance potentially covers a wide range of issues and disciplines from company secretarial and legal through business strategy, executive and non-executive management and investor relations to accounting and information systems.

Corporate governance issues came to prominence in the business world from the late 1980s. The main drivers associated with the increasing demand for developments in this area included the following:

~ Financial reporting

Issues concerning financial reporting were raised by many investors and were the focus of much debate and litigation. Shareholder confidence in what was being reported in many instances was eroded. Whilst corporate governance development is not just about better financial reporting requirements, the regulation of creative accounting practices, such as off-balance sheet financing, has led to greater transparency and a reduction in risks faced by investors.

Corporate scandals

The early 1990s saw an increasing number of high profile corporate scandals and collapses including Polly Peck International, BCCI, and Maxwell Communications Corporation. This prompted the development of governance codes in the early 1990s. However, the scandals since then, including En ron, have raised questions about further measures that may be necessary.

~ Excessive directors' remuneration

Directors being paid excessive salaries and bonuses has been seen as one of the major corporate issues for a number of years. Whilst CEOs have argued that their packages reflect the global market, shareholders and employees are concerned that these are often out of step with the remuneration of other employees and do not reflect the performance of the company.

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Definition Corporate governance: The system by which organisations are directed and controlled.

An alternative definition is:

Corporate governance: The set of processes, customs, policies, laws and institutions affecting the way in which an entity is directed, administered or controlled. Corporate governance serves the needs of shareholders, and other stakeholders, by directing and controlling management activities towards good business practices, objectivity and integrity in order to satisfy the objectives of the entity.

In essence corporate governance: ~ Involves the management and reduction of risk ~ Specifies the distribution rights and responsibilities among different participants in the

corporation, such as the board, managers, shareholders and other stakeholders ~ Spells out the rules and procedures for making decisions on corporate affairs ~ Provides the structure through which objectives are set

~ Provides the means of attaining the objectives and monitoring performance It can be argued that good corporate governance:

~ Provides a framework for an organisation to pursue its strategy in an ethical and effective way and offers safeguards against the misuse of resources, human, financial, physical or intellectual ~ Can attract new investment into companies, particularly in developing nations ~ Underpins capital market confidence in companies

1.3 Features of poor corporate governance The scandals over the last 25 years have highlighted the need for guidance to tackle the various risks and problems that can arise in organisations' systems of governance.

1.3.1 Domination by a single individual A feature of many corporate governance scandals has been boards dominated by a single senior executive with other board members merely acting as a rubber stamp. Sometimes the single individual may bypass the board to action his own interests. The report on the UK Guinness case suggested that the Chief Executive, Ernest Saunders, paid himself a CU3million reward without consulting the other directors.

Even if an organisation is not dominated by a single individual, there may be other weaknesses. The organisation may be run by a small group centred round the chief executive and chief financial officer, and appointments may be made by personal recommendation rather than a formal, objective process.

1.3.2 Lack of involvement of board Boards that meet irregularly or fail to consider systematically the organisation's activities and risks are clearly weak. Sometimes the failure to carry out proper oversight is due to a lack of information being provided.

1.3.3 Lack of adequate control function An obvious weakness is a lack of internal audit.

Another important control is lack of adequate technical knowledge in key roles, for example in the audit committee or in senior compliance positions. A rapid turnover of staff involved in accounting or control may suggest inadequate resourcing, and will make control more difficult because of Jack of continuity.


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1.3.4 Lack of supervision Employees who are not properly supervised can create large losses for the organisation through their own incompetence, negligence or fraudulent activity. The behaviour of Nick Leeson, the employee who caused the collapse of Barings bank was not challenged because he appeared to be successful, whereas he was using unauthorised accounts to cover up his large trading losses. Leeson was able to do this because he was in charge of dealing and settlement, a systems weakness or lack of segregation of key roles that was featured in other financial frauds.

1.3.5 Lack of independent scrutiny External auditors may not carry out the necessary questioning of senior management because of fears of losing the audit, and internal audit do not ask awkward questions because the chief financial officer determines their employment prospects. Often corporate collapses are followed by criticisms of external auditors; such as the Barlow Clowes affair where poorly planned and focused audit work failed to identify illegal use of client monies.

1.3.6 Lack of contact with shareholders

1.3.7

1.3.8

Often board members may have grown up with the company but lose touch with the interests and views of shareholders. One possible symptom of this is the payment of remuneration packages that do not appear to be warranted by results.

Emphasis on short-term profitability Emphasis on success or getting results can lead to the concealment of problems or errors, or manipulation of accounts to achieve desired results.

Misleading accounts and information Often misleading figures are symptomatic of other problems (or are designed to conceal other problems) but clearly poor quality accounting information is a major problem if markets are trying to make a fair assessment of the company's value. Giving out misleading information was a major issue in the UK's Eqwtable Life scandal where the company gave contradictory information to savers, independent advisers, media and regulators.

1.4 Risks of poor corporate governance Clearly the ultimate risk is of the organisation making such large losses that bankruptcy becomes inevitable. The organisation may also be closed down as a result of serious regulatory breaches, for example misapplying investors' monies.


Advanced Stage -Advanced Audit and Assurance

2 Corporate governance concepts

One view of governance is that it is based on a series of underlying concepts. These are important as good corporate governance depends on a willingness to apply the spirit of the guidance as well as the letter ofthe law.

2.1 Fairness The directors' deliberations and also the systems and values that underlie the company must be balanced by taking into account everyone who has a legitimate interest in the company, and respecting their rights and views. In many jurisdictions, corporate governance guidelines reinforce legal protection for certain groups, for example minority shareholders.

2.2 Openness/transparency In the context of corporate governance, transparency means corporate disclosure to stakeholders. Disclosure in this context obviously includes information in the financial statements, not just the numbers and notes to the accounts but also narrative statements such as the directors' report and the operating and financial review. It also includes all voluntary disclosure, that is disclosure above the minimum required by law or regulation. Voluntary corporate communications include:

~ Management forecasts ~ Analysts' presentations ~ Press releases ~ Information placed on websites ~ Other reports such as stand-alone environmental or social reports. The main reason why transparency is so important relates to the agency problem, that is the potential conflict between owners and managers. Without effective disclosure the position could be unfairly weighted towards managers, since they normally have far more knowledge of the company's activities and financial situation than owners/investors. Reducing this information asymmetry requires not only effective disclosure rules, but strong internal controls that ensure that the information that is disclosed is reliable.

2.3 Independence Independence is an important concept in relation to directors (as well as auditors). Corporate governance reports have increasingly stressed the importance of independent non-executive directors; directors who are not primarily employed by the company and who have very strictly controlled other links with it. They should be free from conflicts of interest and in a better position to promote the interests of


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shareholders and other stakeholders. Freed from pressures that could influence their activities, independent non-executive directors should be able to carry out effective monitoring of the company in conjunction with independent external auditors on behalf of shareholders and other stakeholders.

2.4 Probity/honesty Hopefully this should be the most self-evident of the principles, relating not only to telling the truth, but also not misleading shareholders and other stakeholders by presenting information in a biased way.

2.5 Responsibility For management to be held properly responsible, there must be a system in place that allows for corrective action and penalising mismanagement. Responsible management should do, when necessary, whatever it takes to set the company on the right path.

The board of directors must act responsively to, and with responsibility towards, all stakeholders of the company. However the responsibility of directors to other stakeholders, both in terms of to whom they are responsible and the extent of their responsibility, remains a key point of contention in corporate governance debates.

2.6 Accountability Corporate accountability refers to whether an organisation (and its directors) are answerable in some way for the consequences of their actions.

The UK Combined Code emphasises that boards of directors are accountable to shareholders. (See section 3). However, the Code stresses that making the accountability work is the responsibility of both parties. Directors, as we have seen, do so through the quality of information that they provide whereas shareholders do so through their willingness to exercise their responsibility as owners, which means using the available mechanisms to query and assess the actions of the board.

As with responsibility one of the biggest debates in corporate governance is the extent of management's accountability towards other stakeholders such as the community within which the organisation operates.

2. 7 Reputation In the same way directors' concern for an organisation's reputation will be demonstrated by the extent to which they fulfil the other principles of corporate governance. There are purely commercial reasons for promoting the organisation's reputation, that the price of publicly traded shares is often dependent on reputation and hence reputation is often a very valuable asset of the organisation.

2.8 judgement Judgement means the board making decisions that enhance the prosperity of the organisation. This means that board members must acquire a broad enough knowledge of the business and its environment to be able to provide meaningful direction to it. This has implications not only for the attention directors have to give to the organisation's affairs, but also the way the directors are recruited and trained.

The complexities of senior management mean that the directors have to bring multiple conceptual skills to management that aim to maximise long-term returns. This means that corporate governance can involve balancing many competing people and resource claims against each other.



2.9 Integrity The UK Combined Code provides the following definition:

Definition Integrity: Straightforward dealing and completeness. What is required of financial reporting is that it should be honest and that it should present a balanced picture of the state of the company's affairs. The integrity of reports depends on the integrity of those who prepare and present them.

Integrity can be taken as meaning someone of high moral character, who sticks to principles no matter the pressure to do otherwise. In working life this means adhering to principles of professionalism and probity. Straightforward dealing in relationships with the different people and constituencies whom you meet is particularly important; trust is vital in relationships and belief in the integrity of those with whom you are dealing underpins this.

The UK Combined Code definition highlights the need for personal honesty and integrity of preparers of accounts. This implies qualities beyond a mechanical adherence to accounting or ethical regulations or guidelines. At times accountants will have to use judgement or face financial situations which aren't covered by regulations or guidance, and on these occasions integrity is particularly important.

Integrity is an essential principle of the corporate governance relationship, particularly in relation to representing shareholder interests and exercising agency. As with financial reporting guidance, ethical codes don't cover all situations and therefore depend for their effectiveness on the qualities of the accountant. In addition we have seen that a key aim of corporate governance is to inspire confidence in participants in the market and this significantly depends upon a public perception of competence and integrity.

3 The Combined Code of Corporate Governance in Bangladesh

3.1 The Content of Corporate Governance in SEC notification The guidelines recommended by SEC, vide notification dated 20th February, 2006 on a "comply or explain" basis to enhance corporate governance for the listed .companies of Bangladesh are as follows:

3.1.1 Board of Directors: 3.1.1.1 Board's Size The number of the board members of the company should not be less than 5 (five) and more than 20 (twenty}:

Provided, however, that in the case of banks and non-bank financial institutions, insurance companies and statutory bodies for which separate primary regulators like Bangladesh Bank, Department of Insurance etc.


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exist, the Board of those companies should be constituted as may be prescribed by such primary regulators in so far as those prescriptions are not inconsistent with the aforesaid condition.

3.1.1.2 Independent Directors All companies should encourage effective representation of independent directors on their Board of Directors so that the Board, as a group, includes core competencies considered relevant in the context of each company. For this purpose, the companies should comply with the following:-

(i) At least one tenth ( 1/1 0) of the total number of the company's board of directors, subject to a minimum of one, should be independent directors. Explanation: For the purpose of this clause "independent director" means a director who does not hold any share in the company or who holds less than one percent (I%) shares of the total paid-up shares of the company, who is not connected with the company's promoters or directors or shareholder who holds one percent (I%) or more than one percent (I%) shares of the total paid-up shares of the company on the basis of family relationship; who does not have any other relationship, whether pecuniary or otherwise, with the company or its subsidiary/ associated companies, who is not a member, director or officer of any stock exchange, and who is not a shareholder, director or officer of any member of stock exchange or an intermediary of the capital market.

(ii) The independent director(s) should be appointed by the elected directors.

3.1.1.3 Chairman ofthe Board and Chief Executive The positions of the Chairman of the Board and the Chief Executive Officer of the companies should preferably be filled by different individuals. The Chairman of the company should be elected from among the directors of the company. The Board of Directors should clearly define respective roles and responsibilities of the Chairman and the Chief Executive Officer.

3.1.1 A The Directors' Report to Shareholders The directors of the companies should include following additional statements in the Directors' Report prepared under section 184 of the Companies Act, 1994:-

(a) The financial statements prepared by the management of the issuer company present fairly its state of affairs, the result of its operations, cash flows and changes in equity.

(b) Proper books of account of the issuer company have been maintained.

(c) Appropriate accounting policies have been consistently applied in preparation of the financial statements and that the accounting estimates are based on reasonable and prudent judgment.

(d) International Accounting Standards, as applicable in Bangladesh, have been followed in preparation of the financial statements and any departure therefrom has been adequately disclosed.

(e) The system of internal control is sound in design and has been effectively implemented and monitored.

(f) There are no significant doubts upon the issuer company's ability to continue as a going concern. If the issuer company is not considered to be a going concern, the fact along with reasons thereof should be disclosed.

(g) Significant deviations from last year in operating results of the issuer company should be highlighted and reasons thereof should be explained. (h) Key operating and financial data of at least preceding three years should be summarised.

(i) If the issuer company has not declared dividend (cash or stock) for the year, the reasons thereof should be given.



(j} The number of Board meetings held during the year and attendance by each director should be disclosed.

(k} The pattern of shareholding should be reported to disclose the aggregate number of shares (along with name wise details where stated below) held by:-

(i} Parent/Subsidiary/Associated companies and other related parties (name wise details); (ii} Directors, Chief Executive Officer, Company Secretary, Chief Financial Officer, Head of Internal Audit and their spouses and minor children (name wise details); (iii) Executives; and (iv) Shareholders holding ten percent (I 0%) or more voting interest in the company (name wise details).

Explanation: For the purpose of this clause, the expression "executive" means top five salaried employees of the company, other than the Directors, Chief Executive Officer, Company Secretary, Chief Financial Officer and Head of Internal Audit.

3.1.2 Chief Financial Officer (CFO), Head Of Internal Audit And Company Secretary: 3.1.2.1 Appointment The company should appoint a Chief Financial Officer (CFO), a Head of Internal Audit and a Company Secretary. The Board of Directors should clearly define respective roles, responsibilities and duties of the CFO, the Head of Internal Audit and the Company Secretary.

3.1.2.2 Requirement to Attend Board Meetings The CFO and the Company Secretary of the companies should attend meetings of the Board of Directors, provided that the CFO and/or the Company Secretary should not attend such part of a meeting of the Board of Directors which involves consideration of an agenda item relating to the CFO and/or the Company Secretary.

3.1.3 Audit Committee: The company should have an Audit Committee as a sub-committee of the Board of Directors. The Audit Committee should assist the Board of Directors in ensuring that the financial statements reflect true and fair view of the state of affairs of the company and in ensuring a good monitoring system within the business. The Audit Committee shall be responsible to the Board of Directors. The duties of the Audit Committee should be clearly set forth in writing.

3.1.3.1. Constitution of Audit Committee

(i) The Audit Committee should be composed of at least 3 (three) members.

(ii) The Board of Directors should appoint members of the Audit Committee who should be directors of the company and should include at least one independent director.

(iii) When the term of service of the Committee members expires or there is any circumstance causing any Committee member to be unable to hold office until expiration of the term of service, thus making the number of the Committee members to be lower than the prescribed number of 3 (three) persons, the Board of Directors should appoint the new Committee member(s) to fill up the vacancy(ies) immediately or not later than I (one) month from the date of vacancy(ies) in the Committee to ensure continuity of the performance of work of the Audit Committee.

3.1.3.2. Chairman of the Audit Committee

(i) The Board of Directors should select I (one) member of the Audit Committee to be Chairman of the Audit Committee.

7 4 The Institute of Chartered Accountants in England and Wales, March 2009

(ii) The Chairman of the audit committee should have a professional qualification or knowledge, understanding and experience in accounting or finance.

3.1.3.3. Reporting of the Audit Committee

3.1.3.3.1 Reporting to the Board of Directors

(i) The Audit Committee should report on its activities to the Board of Directors.

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(ii) The Audit Committee should immediately report to the Board of Directors on the following findings, if any:-

(a) Report on conflicts of interests; (b) Suspected or presumed fraud or irregularity or material defect in the internal control system; (c) Suspected infringement of laws, including securities related laws, rules and regulations; and (d) Any other matter which should be disclosed to the Board of Directors immediately.

3.1.3.3.2 Reporting to the Authorities

If the Audit Committee has reported to the Board of Directors about anything which has material impact on the financial condition and results of operation and has discussed with the

Board of Directors and the management that any rectification is necessary and if the Audit Committee finds that such rectification has been unreasonably ignored, the Audit Committee should report such finding to the Commission, upon reporting of such matters to the Board of Directors for three times or completion of a period of 9 (nine) months from the date of first reporting to the Board of Directors, whichever is earlier.

3.1.3.3.3. Reporting to the Shareholders and General Investors

Report on activities carried out by the Audit Committee, including any report made to the Board of Directors under condition 1.7.3.1 (ii) above during the year, should be signed by the Chairman of the Audit Committee and disclosed in the annual report of the issuer company.

3.1.4. External/Statutory Auditors

The issuer company should not engage its external/statutory auditors to perform the following services of the company; namely:-

(i) Appraisal or valuation services or fairness opinions; (ii) Financial information systems design and implementation; (iii) Book-keeping or other services related to the accounting records or financial statements; (iv) Broker-dealer services; (v) Actuarial services; (vi) Internal audit services; and (vii) Any other service that the Audit Committee determines.

3.1.5. Reporting the Compliance in the Director's Report

The directors of the company shall state, in accordance with the annexure attached, in the directors' report whether the company has complied with these conditions.



3.2 Bangladesh Bank Guidelines on Financial Institutions' Corporate Governance

3.2.1. Structure of the audit committee and qualification of its members As per BRPD circular 12 , the structure of the audit committee and the qualification of its members should be as under:

Organisational structure

The audit committee will comprise of 3 (three) members; Members of the committee will be nominated by the board of directors from the directors; Members may be appointed for a 3 (three) year terms of the office; Company Secretary of the bank will be the secretary of the audit committee.

Qualifications of the members

Integrity, dedication and opportunity to spare time for the committee will have to be considered while giving nomination to a director to the committee Each member should be capable of making valuable and effective contributions in the functioning of the committee;

To perform his or her role effectively each committee member should have adequate understanding of the detailed responsibilities of the committee membership as well as the bank's business, operations and its risks.

Duties and responsibilities of audit committee will be as follows:

Internal control

Evaluate whether management is setting the appropriate compliance culture by communicating the importance of internal control and the management of risk and ensuring that all employees have, understanding of their roles and responsibilities.

Review the arrangements made by the management for building a suitable management information system (MIS) including computerisation system and its applications

Consider whether internal control strategies recommended by internal and external auditors have been impleme