OBTAINING NEW AUDIT WORK The 2 most common ways of obtaining an audit engagement are: Recommendation (from existing

g clients and other professionals like bankers and solicitors). Tendering

TENDERING It is the process of quoting a fee for work before the work is carried out. RISKS ASSOCIATED WITH THE TENDER PROCESS In addition to the risk associated with any other new client the specific risks of being involved with the tender include: Wasted time if the audit tender is not accepted. Setting an uncommercially low fee in order to win the contract (lowballing). Making unrealistic claims or promises in order to win the contract. Prior to tendering, the auditor should establish the specific needs of the prospective client as well as an acceptable fee level for himself. The audit firm will therefore want the following information before drawing up its proposal: Precisely what does the co. expect from the auditors? What timetable does the client expect? By what date are the audited F/S required? What are the cos future plans e.g. public floatation, expansion etc What are the problems with the current auditors, if the co. is seeking to replace them?
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CONTENTS OF THE PROPORSAL The contents of the proposal should include: The fee and how it has been calculated. The nature, purpose and legal requirements of an audit (clients are often unclear about this) An assessment of the requirements of the client An outline of how the audit firm proposes to satisfy those requirements The audit methodology An outline of the firm and its personnel The ability of the firm to offer other services HOW WILL THE PROPOSAL BE JUDGED After audit firms have made their presentations, the co. makes its choice and it is usually based on the following criteria: Clarity Relevance Professionalism Timeliness of delivery Originality Range of other services Ability to deliver Reputation

CORPORATE GOVERNANCE It is the means by which a company is operated and controlled. It concerns such matters as: The responsibities of directors The appropriate composition of the board of directors The necessity for good internal control the necessity for an audit committee. Relationships with the external auditors. Corporate governance is about ensuring that co.s are run well in the interests of their SHs and the wider community. THE NEED FOR CG The need to improve CG came to prominence in the UK in the 1980s following the high profile collapses of a number of large companies (Maxwell, Polly Peck, BCCI, etc) Poor stds of CG had led to insufficient controls being in place to prevent wrongdoing in the US in the 1990s, as demonstrated by the collapses at ENRON and WORLDCOM. Good CG is particulary important for publicly traded co.s because large amounts of money are invested in them either by small SHs or from pension schemes and other financial institutions. Mgt.s abuse of trust usually takes 1 or 2 forms (although both can happen at the same time and in the same co.): The direct extraction from the co. of excessive benefits by Mgt. eg large salaries, pension entitlements, share options, use of co. assets eg jets, apartments etc

 Manipulation of the share price by misrepresenting the cos profitability, usually so that shares in the co. can be sold or options cashed in. The key to good and effective CG is to ensure that talented individuals are rewarded at appropriate levels for their effort and skill, whilst ensuring that they act in the best interests of the co. and its SHs. RESPONSIBILITIES It is the responsibility of those operating a co. (Mgt. and those appointed for the purpose of ensuring that a co. is well managed) to maintain satisfactory stds. Of CG. Auditors do not have the responsibility of stds. Of CG at audit clients, but have an interest in a cos attitude and approach to CG because: I. They are concerned with the risk that the cos FS might be misstated (will contain errors). If a co. has good stds. of CG and is well managed, the risk of errors in the FS is reduced.

II.

AUDITORS RESPONSIBILITY FOR REPORTING ON CG Listed co.s following the Combined Code in the UK, or other applicable guidance in respect of CG, must include a CG statement in the annual report. The auditors are not required to audit this statement but must review it for inconsistencies with other info. contained within the annual report. If inconsistencies are found, there may be an impact on the audit report in 2 ways: If its an error in the F/S and the directors refuse to amend the error, the auditor will issue a qualified report. If its an error or misleading info. in the CG statement, the auditor will add an emphasis of matter paragraph to their report (this is not a qualification but aimed at bringing the readers attention to the matter).

THE OECD PRINCIPLES OF CG In 1999 the Org. for Economic Co-operation and Development (OECD) issued principles of CG which were revised in 2004. Their focus is on publicly traded co.s. However, to the extent they are deemed applicable, they are a useful tool to improve CG in non-traded co.s These six principles are: i. The CG framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities. The CG framework should protect rights of SHs The CG framework should ensure the equitable treatment of all SHs. The CG framework should recognize the rights of stakeholders established by law or through mutual agreements. The CG framework should ensure that timely and accurate disclosure is made on all material maters regarding the corporation The CG framework should ensure the responsibilities of the board and its accountability.

ii. iii. iv.

v.

vi.

THE OECD PRINCIPLES & THE AUDIT The principles suggest that external audit, conducted to professional stds, helps to maintain stds of CG.

COMBINED CODE Cadbury report: General Greenbury report (1995): Directors pay and the role of the Remuneration Committee Hampel report (1998): Separation of roles of Chairman and CEO; composition of board. Turnbull report (1999): Internal controls and risk management. Higgs report (2003): Composition and accountability of board. Too harsh Go through library books and study the combined code. HOW ARE COS RUN? THE BOARD OF DIRECTORS Fundamentally, CG is about how a co. is run by its mgt. The board should be composed of executive directors (often referred to as mgt.) and non-executive directors. Oversight of mgt.s actions is by non-executive directors and by sub committees e.g audit committee and remuneration committee. NON EXECUTIVE DIRECTORS These are usually employed on a part time basis and do not take part in the routine executive mgt of the co. Their role is as follows: Participation at board meetings. To provide experience and business contacts which strengthen the board. Membership of sub committees e.g audit committee, which should be by independent and knowledgeable non executive directors.

ADVANTAGES OF PARTICIPATION BY NON EXECUTIVE DIRECTORS 1. Oversight of the whole board. 2. Often act as a corporate conscience. 3. They bring external expertise to the co. DISADVANTAGES 1. They may not be sufficiently well informed or technically competent 2. They may fail to report significant problems and may approve unjustified pay rises. Enrons audit committee proved incapable of preventing the wrongdoing of the executive directors. There are several aspects of CG which are regarded as crucial if public cos. are to be well run: Segregation between the roles of chairman and chief executive officer :( Hampel and Combined Code). One person assuming both roles results in a conflict of interest. In addition, a lot of power is vested in that one person. Such one person would be able to sway the decisions taken by the board ending up in decisions not being made in the interests of the SHs. Existence of audit committees Existence of other committees e.g nominations and remunerations. The need for risk mgt. The role of Internal audit.

THE CHAIRMANS ROLE 1. Non executive 2. Ensures full info. and full discussion at board meetings 3. Ensures satisfactory channels of communication with the external auditors 4. Runs the board of directors 5. Ensures the effective operation of sub-committees of the board THE C.E.OS ROLE 1. Ensures the effective operational functioning of the co. 2. Heads up the executive directors

BEST PRACTICE FOR LISTED COS Publicly traded cos. should have an audit committee of at least 3 non executive directors (or 2 for smaller cos). At least 1 member of the audit committee should have recent and relevant financial experience. OBJECTIVES OF THE AUDIT COMMITTEE i. Assisting directors (particularly executive directors) in meeting their responsibilities in respect of financial reporting. Strengthening the independent position of a co.s external auditor by providing an additional channel of communication. Increasing public confidence in the credibility and objectivity of published financial info. (including unaudited interim statements).

ii.

iii.

FUNCTIONS OF THE AUDIT COMMITTEE i. ii. iii. Monitoring the integrity of F/S Reviewing the co.s internal financial controls Monitoring and reviewing the effectiveness of the internal audit function. Making recommendations in relation to the appointment and removal of the external auditor and their remuneration. Reviewing and monitoring the external auditors independence and objectivity and the effectiveness of the audit process. Developing and implementing policy on the engagement of the external auditor to supply non-audit services Reviewing arrangements for confidential reporting by employees and investigation of possible improprieties

iv.

v.

vi.

vii.

THE AUDIT COMMITTEE & INTERNAL AUDIT It is important to establish an internal audit function in order to help the audit committee fulfill their responsibilities. Best practice is that the audit committee should: Ensure that the internal auditor has direct access to the board chairman and to the audit committee and is accountable to the audit committee. Review and assess the annual internal audit work plan. Receive periodic reports on the results of internal audit work. Review and monitor mgt.s responsiveness to the internal auditors findings and recommendations

 Meet with the head of internal audit at least once a year without the presence of mgt. Monitor and assess the effectiveness of internal audit in the overall context of the co.s risk mgt. system.

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