Chapter Two

AUDITING AND CORPORATE GOVERNANCE

Learning objectives
After studying this chapter, you should be able to:
 understand the concept of corporate governance and agency theory
 Explain the importance of corporate governance in auditing
 Understand the objectives and functions of audit committee in corporate financial
reporting and risk management
 Appreciate the advantages and disadvantages of audit committee in an
organization
 Explain the relationship between the audit committee, internal auditors and
external auditors
 Identify the regulatory institutions of audit practice in Ghana
 Understand why audit practice in Ghana and elsewhere should be regulated

2.0. Introduction
The considerable involvement of external auditors in internal control and reporting processes of
public companies is indicative of the sensitive relationship between boards of directors, auditors
and shareholders within organizations. For this reason, it is not surprising that following every
wave of corporate scandals, the auditing profession becomes the focus of criticism. These
criticisms are partly related to the high public expectations of the auditor’s role in an
organization and to the high standing and authority of the audit profession worldwide. Despite
the recent criticism of the performance of certain external auditors, most auditors are still
perceived as upholders of the integrity of financial reporting in the public interest.
It is essential to discuss the relationship between corporate governance and auditing, which has
become a very topical issue, as indicated by extensive debates in the financial community. To
understand how corporations and their internal control processes function, external auditors of
publicly listed companies are interested in the ways in which managers are made responsible to
boards of directors and how they in turn are made responsible to shareholders. The audit carried
out by the external auditors is a very important part of corporate governance, as it is an
independent check on what the directors are reporting to the shareholders.

1
2.1. CORPORATE GOVERNANCE
2.1.1 The meaning of corporate governance
A company is governed by its directors on behalf of the shareholders and the directors also
govern on behalf of other ‘stakeholders’ in the company, such as its employees. Corporate
governance is the system by which a company is directed and controlled. It concerned with
the structures, strategies and systems put in place control by which managers are held
accountable to those who have a legitimate stake in an organization. Board of directors (BoDs)
are responsible for governance of the company. The shareholders roles is to appoint the directors
and auditors and to satisfy themselves that an appropriate governance system is in place. The
responsibility of the board include setting the company’s strategic aims, providing the leadership
to put them into effective, supervising the management of the company and reporting to
shareholders on their stewardship. Corporate governance is therefore about what the boards of
company does, and how it sets the values of the company, and it is to be distinguished from the
day to day operational management of the company by fully time executives. The International
Standards on Auditing (ISA) 260, requires the auditor to determine those persons that are
charged with governance and Communicate Audit Matters with them.

In many countries, rules or guidelines on ‘best practice’ in corporate governance have been
developed. These are either applied on a voluntary basis or imposed by law. Depending on the
jurisdiction, different bodies may have responsibility for corporate governance: Board of
Directors, Audit Committee and Other supervisory committees.

An important aspect of corporate governance is the relationship between the owners of a

company (its equity shareholders) and its governors (the board of directors). The strength of the
relationship between owners and governors depends largely on the quality of the communication
between them. The most important method of communication is the annual financial statements
and accompanying reports (the ‘report and accounts’). To promote good corporate governance,
the financial statements should be reliable. This means that the directors should present reliable
and relevant information in the financial statements, and those financial statements should be
subject to independent audit to provide assurance to the shareholders.
The issue of corporate governance is important because, in companies of any size, those who
own the company (that is, the shareholders) are usually divorced from the day-to-day control of
the business. It has become an increasingly important issue for organizations for three main
reasons.
 The separation of ownership and management control of organizations means that
most organizations operate within a hierarchy, or chain, of governance. This chain
represents those groups that influence an organization through their involvement in either
ownership or management of an organization.
 Corporate scandals since the late 1990s have increased public debate about how
different parties in the governance chain should interact and influence each other. Most
notable here is the relationship between shareholders and the boards of businesses, but an
2
 equivalent issue in the public sector is the relationship between government or public
funding bodies and public sector organizations.
 Increased accountability to wider stakeholder interests has also come to be
increasingly advocated; in particular the argument that corporations need to be more
visibly accountable and/or responsive, not only to ‘owners’ and ‘managers’ in the
governance chain but to wider social interest.
In an organizational theory, the relationship that exist between various parties is being views as
agent’s relationship, and hence agency theory. The shareholders employ the directors to manage
the company for them, and employ employees to work for the success of the organization.
Therefore, the shareholders are principals and the directors are agents, and the directors are in
turn principals to the employees who are agents. Given this position, it may seem reasonable to
assume that the best interests of shareholders will guide the directors’ decisions. However, in
practice this does not always occur. The directors may be more concerned with pursuing their
own interests, such as increasing their pay and ‘perks’ (such as expensive motor cars, overseas
visits and so on) and improving their job security and status. As a result, a conflict can occur
between the interests of shareholders and the interests of directors. Again, the auditors submit
their report to the shareholders. However, the renewal or reappointment of the auditor’s
engagement is effectively in the hands of directors. They therefore have a potential conflict in
conducting the audit function and also be in good terms with the directors.
To avoid these agency relationship conflicts, most organizations have a framework of rules to
help monitor and control the behavior of directors. Among such framework of rules is the
establishment of internal audit and the audit of financial statements.

2.1.2. Application of Agency Theory to Auditing

Agency theory holds that agents do not, necessarily, take decisions in the best interests of their
principals. It states that the objectives or goals of principals and agents mostly conflict and,
where they do, agents will, naturally, make the choice that benefits them the most, choices that
may not be the most beneficial decision for the principal.
No governance system, no matter how well designed, will fully prevent greedy, dishonest
people from putting their personal interests ahead of the interests of the companies they manage.
Despite this conflict of interest that may arise, many steps can be taken to improve corporate
governance and thereby reduce agency conflict and opportunities for accounting fraud. The
auditing profession has an important role to play. Corporate governance involves decision
making, accountability, and monitoring. Decisions require relevant and reliable information.
Accountability involves measuring, reporting, and transparency. Monitoring involves systems
and feedback. Auditor’s primary role is to check whether the financial information given to
investors is reliable, complied with law and standard and avoid of all material misstatements.

2.1.3 Principles of good corporate governance

3
There are a number of principles essential for good corporate governance practices. The
following have been identified as representative of critical foundations and virtues of good
corporate governance practices.
(1) There should be an effective board of directors. The directors should be independent-minded
and should collectively have a wide range of skills, knowledge and experience. The board of
directors should not be under the control or influence of an ‘all-powerful’ chairman and/or chief
executive officer, who is able to dictate the board’s decisions.
(2) The board of directors should have clearly-defined responsibilities that it must not delegate,
and it should carry out these responsibilities properly.
(3) The directors should govern the company in the best interests of its shareholders (and
possibly also other stakeholders); they should not run the company in their own self-interest.
(4) The financial statements of the company should be reliable. (In many cases of corporate
collapse, the financial statements were proved to have been misleading and unreliable.)
(5) Risks should be controlled, and the directors should provide assurance to the shareholders
about the systems of controls and risk management.
(6) The remuneration of directors should be fair. Directors should not fix their own remuneration,
and their remuneration package should provide them with incentives to achieve the objectives of
the company that are in the best interests of the shareholders. Directors should not be rewarded
for failure.
(7) There should be active, open and constructive dialogue between the company’s directors and
its shareholders, in particular its major shareholders.
As far as audit and assurance are concerned, the main relevant aspects of corporate governance
are items (4) and (5) above.

2.2. The role of the auditor in corporate governance

The external auditor is part of the corporate governance system. He provides an independent
check on the integrity of the financial information prepared by the directors for the use of
shareholders and other stakeholders for public companies in Ghana, he has a responsibility for
forming an opinion on the extent to which the directors have complied with the specific
corporate governance regulations imposed on them. In order to fulfil these roles, the external
auditor will examine the company’s systems and controls. However, he is not responsible for
those systems or controls. Responsibility remains with the directors and executive management.

The external auditor is also required by ISA 260 Communication with those charged with
governance to communicate with management periodically with observations arising from the
audit that are significant and relevant to management’s responsibility to oversee the financial
reporting process. These observations might include:
1. Weaknesses in internal control found by the auditor, or
2. Accounting policies adopted by the entity which the auditor considers inappropriate.

4
2.3. Corporate Governance and Internal Audit

Senior management is responsible for putting in place a system of internal controls that will
prevent or detect errors and fraud. An internal audit function may be used by management as a
means of monitoring these systems of internal control. An internal audit function can therefore
be used to obtain assurance that the system of internal controls is adequate and that it is
functioning properly.
Companies are not required by law to have an internal audit function. However, in Ghana, listed
companies are required to set up an audit committee which is required each year to:
 monitor and review the effectiveness of internal audit activities, or
 Where there is no internal audit function, to consider the need for an internal audit
function and make a recommendation to the board.

2.4. Corporate Governance and Audit committee independence

The audit committee is created as part of the corporate governance process, a process that is the
cornerstone of shareholder protection. The board of directors establishes the audit committee.
However, this committee should be independent of the board to be able to exercise its
responsibilities.
Some of the members of the board may be appointed members of the audit committee, usually
non- executive members. The audit committee has an oversight function that is a critical
corporate governance mechanism involving different managerial activities, corporate reporting
and auditing. This oversight includes ensuring that quality accounting policies, internal controls
and independent external auditors are in place to deter fraud, anticipate financial risks and
promote accurate, transparent and timely disclosure of corporate information to users.
Regulatory and financial market bodies have addressed the composition of the audit committee
and called for audit committee members to be independent of management. Indeed, an audit
committee’s independence is the cornerstone of its effectiveness, particularly when overseeing a
company’s financial integrity and ensuring appropriate internal control and audit systems within
the company.
The importance of an audit committee’s independence is closely related to its oversight role with
regard to management’s activities and external auditors. The audit committee obviously needs to
work closely and co-operatively with management, on which the committee depends for
information and resources. At the same time this relationship should not be jeopardized by
collusion or compromise.
The same approach towards audit committee independence should be also adopted with regard to
external auditors including the appointment and dismissal of auditors, evaluation of their
performance and the quality of financial statements and audit reports. One of the primary

5
functions of an audit committee is to safeguard the independence of external auditors and for this
reason the committee must maintain a very clear and transparent relationship with them to ensure
their objectivity.
2.4.1 Objectives of the audit committee
• Increasing public confidence and credibility and objectivity of published financial statements.
• Assisting directors in meeting their responsibilities in respect of financial reporting.
• Strengthening the independence position of a company’s external auditor by providing an
additional channel of communication.

2.4.2. Attributes of audit committee members

• Members of the audit committee should have the following attributes;
• Broad business knowledge relevant to the company’s business operations.
• Keen awareness on the interests of the investing public.
• Familiarity with basic accounting principles.
• Objectivity in carrying out their mandate with no conflict of interest.
2.4.3. Functions of an audit committee
 Act as an effective overseer of the financial reporting process and company
internal control system. E.g. it should be involved in review of company’s internal control
procedures.
 Reviews quarterly, semi-annually and yearly financial statements of the company
focusing particularly on any changes in accounting practices, significant adjustments
arising from the audit, the appropriateness of the going concern assumption adopted in
preparation of the financial statements and whether the financial statements comply with
IFRSs and other relevant regulations.
 Consider the appointment of the external auditor, the audit fees charged and any
questions regarding resignation or dismissal of the external auditor.
 Discuss with the external auditor before the audit commences the nature and
scope of the audit and ensure that the work is properly coordinated.
 Review management evaluation of the factors related to independence of the
external auditor. Both the audit committee and the management should assist the external
auditor in preserving his independence.
 Discuss problems and reservations arising from the audit and any matters that the
external auditor may want to discuss.
 Review any communication between the external auditor and management. Such
communication should include management letter issued after the conclusion of the audit.
 The committee considers any related party transactions that may arise within the
company and ensure that related party transactions are appropriately disclosed in the
financial statements in accordance with ISA 24 Related Party Disclosures.
6
  Consider major findings of any internal investigations undertaken and the
management’s response to the findings.
 The committee has exclusive authority to investigate any matter within its terms
of reference and management must provide access to the necessary information and any
resources required.
 Considers other issues as defined by the board of directors including regular
reviews of the capacity and effectiveness of internal audit function.
 Enable the non-executive directors to contribute an independent judgement and
play a positive role
 To facilitate a satisfactory working relationship between management and auditors
and between the internal audit and external audit functions.
In performing its duties, the audit committee should prepare a report for inclusion in the
company’s annual proxy statement, which will be submitted to the shareholders’ general
meeting, in accordance with applicable laws, regulations and listing standards. The
responsibility of the members’ committee in assessing the performance of the board of directors
is not simply whether the director’s fulfil their ‘legal’ requirements but, more importantly, their
respect of ethical principles, and how they put this into practice.

2.4.4. Advantages of audit committees

Advantages that are claimed to arise from the existence of an audit committee include:
(a) It will lead to increased confidence in the credibility and objectivity of financial reports.
(b) By specializing in the problems of financial reporting and thus, to some extent, fulfilling the
directors' responsibility in this area, it will allow the executive directors to devote their attention
to management.
c) It contributes to improvement of quality of financial statements and credibility of the
financial reporting process.
d) Assists the directors meeting the responsibilities in respect to financial reporting.
e) Strengthens independence position of the external auditor by providing additional channel of
communication.
f) Promotes effectiveness of internal audit function by ensuring that the function has authority
and resources to carry out its responsibilities and also ensures its recommendations to the
management are implemented.
g) Increases public confidence in credibility and objectivity of published financial information
including audited interim financial statements.
i) Improves communication between directors, the eternal auditor and the management.
7
2.4.5. Disadvantages of the audit committee
 It leads to fear that its purpose is to catch the management out and by so doing,
cause divisions in the board. All directors are equal and some should not be seen as
supervising others. However, the audit committee acts on behalf of the main group of
directors and reports to it.
 Audit committees are ineffective and powerless as they cannot enforce their
recommendations or report directly to shareholders.
 Appointment of non-executive directors is heavily influenced by the executive
hence ‘yes men’ may be appointed.
 Audit committee incurs time and costs unless it is justified that the benefits
outweigh costs.
 The committee may encourage prudence and risk aversion which can hamper
initiative and executive flair.
 Non-executive directors may lack the technical skills and the know-how and in
turn be rendered incompetent.

2.5. The Regulatory Framework of Auditing Practice in Ghana

The key reason why auditing practice should be regulated is to protect the shareholders interest,
government and the general public at large. Auditors provides an impartial, professional view on
issues that matter to users of financial and non-financial information. Users of financial
statement may wish to compare financial statements of two or more companies. Users want
assurance when making comparisons that the reliability of the financial statements does not vary
from company to company. This assurance will be obtained not just from knowing that each set
of financial statements has been audited, but knowing that this has been done to common
standards.
It is important that this assurance can be trusted by the various group of users. For this reason,
auditors need to operate with the laws of their country, ethical standard of their country,
professional body in which they belong to, the professional standards adopted by their country
and any other regulation or law required. The audit practice in Ghana is under institutional
regulation. Such institutions include: International Federation of Accountants (IFAC), The
Institute of Chartered Accountants – Ghana (ICAG), The Internal Audit Agency and The Ghana
Audit Service.

2.5.1. International Federation of Accountants (IFAC)

International Federation of Accountants (IFAC), based in New York, is a non-profit, non-
governmental, non-political international organization of accountancy bodies. The Institute of
Chartered Accountants – Ghana (ICAG) is a member of IFAC. IFAC came into being in the
1970s as a result of proposals put forward and eventually approved by the International Congress
8
of Accountants. IFAC's mission is: 'The development and enhancement of the profession to
enable it to provide services of consistently high quality in the public interest'. IFAC co-operates
with member bodies, regional organizations of accountancy bodies and other world
organizations. Through such co-operation, IFAC initiates, co-ordinates and guides efforts to
achieve international technical, ethical and educational pronouncements for the accountancy
profession.
Any accountancy body may join IFAC if it is recognized by law or general consensus within its
own country as a substantial national organization of good standing within the accountancy
profession. Members of IFAC automatically become members of the International Accounting
Standards Committee Foundation, which is an independent not-for-profit, private sector
organization which sets international financial reporting standards through its standard-setting
body, the International Accounting Standards Board. IFAC committed to the values of integrity,
transparency and expertise. It also seeks to reinforce auditor’s adherence to these values, which
are the reflected in the IFAC Code of Ethics for Auditors.

2.5.1.2. Objectives of IFAC

1. Serving the public interest by developing, promotion and maintaining global
professional standards and codes of ethics for Auditors.
2. Contribute to the efficiency of global economy through improving confidence in
the quality and reliability of financial reporting.
3. Actively encouraging convergence of professional standards, particularly
auditing, assurance, ethics and financial reporting.
4. Promoting compliance with membership obligations, and
5. Providing leadership and spokesman ship for the international accountancy
profession in a worldwide range of public issues, especially where the profession
expertise is more relevance as well as regulatory issues related to accounting and
auditing.

2.5.2. THE INTERNAL AUDIT AGENCY

Internal Audit Agency ACT, 2003, Act658
The Internal Audit Agency (IAA) was established by an Act of parliament in 2003, Act 658. The
object of the establishment of the Agency is to co-ordinate, facilitate and provide quality
assurance for internal audit activities within the Ministries, Departments and Agencies and the
Metropolitan, Municipal and District Assemblies.
Functions of the Agency

9
(1) The Agency shall set standards and procedures for the conduct of internal audit activities in
the MDAs and MMDAs.
(2) The Agency shall ensure that
(a) financial, managerial and operating information reported internally and externally is
accurate, reliable and timely;
(b) the financial activities of MDAs and MMDAs are in compliance with laws, policies, plans,
standards and procedures;
(c) national resources are adequately safeguarded;
(d) national resources are used economically, effectively and efficiently; (e) plans, goals
and objectives of MDAs and MMDAs are achieved; and (f) risks are adequately managed
in the MDAs and MMDAs.
(3) Without limiting subsections (1) and (2), the Agency shall (a) promote economy, efficiency
and effectiveness in the administration of government programs and operations; (b) prepare plans
to be approved by the Board for the development and maintenance of an efficient internal audit
for the MDAs and MMDAs; (c) facilitate the prevention and detection of fraud; and (d) provide a
means for keeping the MDAs and MMDAs fully and currently informed about problems and
deficiencies related to the administration of their programmes and operations and the necessity
for appropriate corrective action.
(4) The Agency shall monitor, undertake inspections and evaluate the internal auditing of the
MDAs and MMDAs.

2.5.2.1 Governing body of the Agency

The Agency shall have a governing Board known as the Internal Audit Board. Membership of the
Board
(1) The Board shall consist of the following members appointed by the President acting in
consultation with the Council of State:
(a) a chairperson;
(b) the Minister responsible for Finance or a representative of the Minister;
(c) the Minister for Local Government and Rural Development or a representative of the
Minister;
(d) The chairperson of the Public Services Commission or a representative of the chairperson;

(e) The Director-General of the Agency appointed under section 12 of this Act;
(f) Two other members appointed from the private sector; and
10
 (g) two professional accountants each with not less than ten years’ experience in the profession
nominated by the Council of the Institute of Chartered Accountants (Ghana).
(2) The President shall in appointing members of the Board have regard to the integrity,
knowledge, expertise and experience of the persons and in particular their knowledge in matters
relevant to the functions of the Agency.

2.5.2.2 Functions of the Board

The Board shall formulate policies for the Agency and shall
(a) establish appropriate structures for the effective and efficient execution of the object of the
Agency;
(b) secure the achievement of the object of the Agency;
(c) approve plans for the development and maintenance of an efficient internal audit for bodies
and institutions to whom this Act applies; and
(d) take reasonable and timely action on the reports submitted to it by the Director-General.

2.6. Ghana Audit Service

Audit Service was established in 1910 by the colonial government and was called the Audit

Department. It was headed by a Director. In the 1950s, the name was changed to Auditor-

General’s Department. On 22nd August 1969, the constitution of the 2nd Republic converted the

department into the Audit Service headed by an Auditor-General. This was to increase the degree

of independence of the Service. The 1992 Constitution (Article 187, 188, 189) and the Audit

Service Act 2000, (Act 584) reaffirms provisions made in the 1969 Constitution.

The mission of Audit Service is to promote good governance in the areas of transparency,

accountability and probity in the public financial management system of Ghana by auditing to

recognized international auditing standards, the management of public resources and reporting to

Parliament.

The governing body of the Service

11
(1) The governing body of the Service shall be the Audit Service Board referred to in this Act as

“the Board”.

(2) The Board shall consist of

(a) a chairman and four other members appointed by the President, acting in consultation with

the Council of State;

(b) the Auditor-General; and

(c) the Head of the Civil Service or his representative.

(3) A member of the Audit Service Board, other than the Auditor-General or the Head of the

Civil Service or his representative, may be removed from office by the President, acting in

accordance with the advice of the Council of State for inability to perform the functions of his

office arising from infirmity of mind or body or for any other sufficient cause.

2.6.1. Functions of the Board

(1) The Board shall

(a) determine the structure and technical expertise required for the efficient performance of the

functions of the Service;

(b) ensure that the auditing activities of the Audit Service as spelt out in this Act are carried out

in accordance with best international practices;

(c) appoint officers and other employees of the Service other than the Auditor-General; and

(d) determine the terms and conditions of service of officers and other employees of the Service

other than the Auditor-General.

(2) In pursuance of subsection (1) the Board shall hold consultation with the Public Services

Commission but final decision on any matter is subject to the approval of the Board.

12
(3) The Board may delegate to the Auditor-General or any officer of the Service or a committee

of the Board, the appointment of such category of staff of the Service as the Board may

determine.

2.6.2. Functions of Ghana Audit Service

By Article 187(2) of the constitution, the Audit Service carries out among other duties, the

auditing of:

a) The public accounts of Ghana, which include:

1.Central Government;

2.Ministries, Departments and Agencies (MDAs);

3.The Judiciary or Courts;

4.Parliament

b) Metropolitan, Municipal, and District Assemblies.

c) The Houses of Chiefs and Traditional Councils.

d) Public Educational Institutions

e) Governing boards: Bodies established with public funds including corporations,

companies and other enterprises.

f) Public offices established by the constitution and other public offices as defined

by Article 295 of the 1992 constitution.

g) An entity established with public funds or an act of Parliament e.g. GETfund,

Road fund, NHIS

h) Half yearly foreign exchange receipts & payments statement of the BoG for the

periods ending June 30 & Dec 31.

13
2.7. The Institute of Chartered Accountants – Ghana (ICAG)

The Institute of Chartered Accountants (Ghana) was established by an Act of parliament, Act
170, in 1963. It is the sole body charged with the regulation of the accountancy profession in
Ghana. Its members are the only persons recognized under the Companies Code (Act 179) 1963,
for the purpose of audit of company accounts. It is governed by a council of eleven chartered
accountants. The Council, headed by a President, holds office for a period of two years.

A candidate who successfully completes the professional program and obtain a working
experience in accountancy, approved by the Council of the |Institute., qualifies to use the
designatory letter ‘CA’ after his/her name. The mission of ICAG is to produce professional
accountants of the highest quality, ready to provide cutting edge services to their clients at all
times and upholding the ethical values of the accountancy profession.

2.7.1 Our Core Values:

 Competency: to display the highest professional competency in the technical

services rendered to the public, matching worldwide standards and measurable through
benchmarking with first class institutes.

 Integrity: to serve as trustworthy, dependable and respected in the conduct of our

duties, services and pronouncements relating to the profession.

 Excellence: to strive at all times to achieve excellence through continuous

improvement, benchmarking, research, technology, knowledge and expertise in various
fields and services provision to clients, members and students.

 Versatility: to proactively respond to changing times and challenges that are

faced by the profession, clients, members and students by maintaining a forward looking
posture that learns from the past and strives to anticipate and plan for future
developments

2.7.2. OBJECTIVES

Participants will:

 Increase their knowledge, skill and proficiency in the field of accountancy

14
  Subscribe to, join and associate with anybody or professional organization in any
member state or elsewhere whose objects are similar or not inconsistent with those of the
Institute, to further the interests of the profession.

 Be safeguarded and enhance the professional standing, interest and reputation of

its members.

2.8. Question for discussion

Mrs. Smith is both Chief Executive Officer (CEO) and Chairman of your client. The board of
directors consist of five executive and two non-executive directors. Board salaries are set by Mrs.
Smith based on her assessment of all the board members, including herself, and not their actual
performance.
Required;
Explain why your client does not meet international codes of corporate governance, why this
may cause a problem for the company and recommend changes?

15