Following numerous large bankruptcies recently — the most recent being those of the Allied Irish Bank and the Enron — questions have been raised all over the world over the reliability and effectiveness of audited financial statements and the auditors’ independence under the International Federation of Accountants (IFAC’s) code of ethics. Self-regulation by the accountancy industry has proved of little value and it is increasingly being considered everywhere whether the profession should be monitored by a tough, statutorily independent body, that has no direct interest in the accountancy industry?
It is admitted that the accountancy profession has made some progress towards the quality control reviews (QCRs) in Pakistan but the accountancy profession still has a long way to go. The accountancy industry is generally taking a minimalist approach in complying with International Accounting Standards (IAS); disclosure levels are weak and the attempt has been made to avoid liability rather than to inform through adequate and timely disclosure of material information.
It is strongly felt that accountancy firms should not be allowed to provide consultancy services to clients whose books they audit. The members of the profession in Pakistan should have followed the lead of four of the world’s big five (Pricewaterhouse; Coopers; Ernst & Young; KPMG and Arthur Andersen) that had rejected the industry practice of taking up both the audit and consulting jobs of the same clients, but since the professional body here had taken no visible steps, the SECP was constrained to step in.
The SECP is now in the process of identifying services other than audit, which the auditors may carry out, and those that raise the spectre of ‘conflict of interest’ and hence must be shed.
The question of rotation of auditors was also under consideration by the commission. It was recommended that audit clients desist from hiring staff of the external auditors as internal auditors, finance and management officers, etc. It shall be in the public interest if the auditors are compulsorily retired/changed in one company on a five-year rotation basis. Undoubtedly, the ICAP was faced with constraints of resources. The commission may consider allowing certain classes or parts of audits to be performed by other professional bodies. The opening up of the audit profession to others, as in Thailand, should not be ruled out. “The over-riding concern of the commission, is to ensure the highest and most reliable standards of audits, which is the first requisite to attract large-scale investments in our capital market.”
The most disappointing conclusion of the UK debate ten years ago, was that investors and creditors could not rely on their auditors’ opinions. Investors used to scan the audit report to see if it consisted of two lines claiming that the accounts showed a true and fair view. If there was more, it was a red signal that made investors read carefully, even if what followed was complex.
Now the audit report is a page of querulous, self-preservative verbiage, but no more communicative. Accountants admit that audits are liable to miss major boardroom fraud. Forensic auditing would cost much more, they claim. But no auditor that values its name could take on a dodgy character like Robert Maxwell unless they adopt a forensic approach.
Role of auditors: There is a general consensus that auditors should never sink into a client/servant relationship with client companies. Independence is lost when an auditor depends too much on the fees, as when a small firm has a couple of big clients. The size of the audit firm should relate to the size of the company, because big names send juniors to handle small audits.
Since the Enron’s auditing failure, the world’s leading accounting firms are splitting their auditing and consulting businesses. Among these are the world’s largest firms, like Deloitte and Touche, Tohamastu, Pricewaterhouse, Coopers and Andersen. Greater emphasis will again he placed on transparency. The division of services may be more expensive, but such companies are easier to monitor.
Separation would rarely make business sense: there are more links than barriers between audit, due diligence, financial systems design and tax consultancy. It may still be a price that is worth shareholders paying.
Rather than rush into bureaucratic rules, however, let the market test reform. Investors big and small should lobby some boards to experiment with dedicated auditors, reporting only to non-executive audit committees. And more auditors should resign when they do not like how a company is being run or accounted for.
Enron and the global accountancy profession’s commitment to the public interest: The International Federation of Accountants (IFAC), readily accepts that the profession must contribute to reducing the occurrence of major failures such as Enron and will play its part in the drive for greater quality and consistency of accounting and auditing services. It will also take steps to encourage improved corporate governance. To that end, it is planning to form an international task force of investors, directors and auditors to make recommendations on the role and composition of audit committees and how they should report to shareholders.
The collapse of the Enron Corporation in the US has made it incumbent upon all accountancy organizations to assess what they can do to ensure the soundness of financial reporting worldwide and to encourage and support accountants in their efforts to protect the public interest.
The US is already scrutinising the regulation of the accounting profession and the auditing standard-setting process. In addition, those investigating the Enron case must take a close look at corporate disclosure rules, the effectiveness of various securities laws, and the responsibilities and accountability of board of directors and audit committees. A sound global financial architecture depends upon an independent accounting profession supported by the highest professional standards, an effective regulatory framework, and strong corporate governance.
Initiatives: The Enron case clearly demonstrates the value of the traditional work of the IFAC and its more recent public interest initiatives, which have been under development and/or review during the past two years. These include:
* promulgation of international standards of auditing and the IFAC Code of Ethics, including its new rules on independence, and active support of the standards produced by the International Accounting Standards Board;
* decision to strengthen the process and transparency of the work of the International Auditing Practices Committee (IAPC). Effective in mid-2002, the IAPC will be renamed the International Auditing and Assurance Standards Board (IAASB). Membership will be expanded to include members independent of the profession, and meetings will be open to the public;
* Initiatives of the IFAC and the major firms in establishing the Forum of Firms (FoF), which is designed to improve the standard and consistency of the audit of trans-national entities around the world;
* establishment of an independent review board to oversee the activities of the IFAC and the FoF that affect the public interest;
* implementation of the IFAC compliance regime, designed to ensure that national accountancy bodies that are members of IFAC meet the obligations of membership and, in particular, that they require compliance by their members with such standards;
* establishment of the International Forum on Accountancy Development (IFAD), in 1999 by the World Bank and the IFAC in order to improve corporate reporting and the alignment of national standards with global standards for accounting; auditing, corporate governance, and market regulation.
Corporate governance: During recent years, good corporate governance has emerged as a key component in the successful functioning of financial markets and the corporate sector. Corporate governance is concerned with promoting corporate practices that ensure transparency and accountability. It entails holding the balance between economic and social goals and between individual and communal aims. Good corporate governance seeks to create an institutional framework that encourages all participants of the governance system to contribute towards better corporate performance through an alignment of their objectives.
The SECP has taken several important steps to improve corporate governance in the country. While the governance of stock exchange has significantly improved with the inclusion of independent directors and appointment of independent, managing directors, the SECP has developed and asked the stock exchanges to enforce the first Code of Corporate Governance for Pakistan.
Role of SECP: Several economic analysts in Pakistan attribute weak corporate governance, arising from the lack of proper disclosure, transparency and accountability in the corporate sector, to be among the main reasons for declining investor confidence. It is empirically evident that international capital flows towards economies adhering to better standards of governance. In order to revive investor confidence in the economy, the need for good corporate governance in Pakistan is undeniable.
As a result of recent geo-political developments in the region and the government’s economic policies for improving marco-economic indicators, Pakistan’s economy seems to be well poised for a revival. Several foreign investors are exploring investment opportunities in the country. In order to provide the impetus for sustainable economic growth,the SECP has taken several steps to eliminate structural weaknesses in the corporate governance systems . One such step has been the support to the Institute of Chartered Accountants of Pakistan (ICAP) in development of a code of corporate governance . The Code not only incorporates principles of sound corporate practices from around the world, but also tailors them to the particular needs of the country.
Code of Ethics: The SECP has issued directives for auditors of listed companies to provide all information including the audit working papers to the quality control review (QCR) of the ICAP. It has also directed all stock exchanges to insert several clauses in the regulations related to auditors of the listed companies.
All listed companies shall facilitate the QCR with the audit working papers of practising chartered accountants, carried out by the Institute of Chartered Accountants of Pakistan (ICAP) and, therefore, shall authorise their auditors to make available all the relevant information including the audit working papers to the QCR Committee of ICAP.
No listed company shall appoint or continue to retain any person as an auditor who has been found guilty of professional misconduct, by the Commission or by a court of law, for a period of three years, unless a lesser period is determined by the Commission.
In case of a firm which has been appointed as an auditor, and any of its partners has been held guilty of professional misconduct, the firm shall only be eligible for appointment as an auditor providing a written confirmation is given by the firm to all the stock exchanges of the country and the Commission with a copy to the ICAP, to the effect that such a partner shall not be engaged in the audit of any listed company for the specified period.