By Neville Robinson, Contributor
AUDIT COMMITTEES and Internal Audit functions are inescapable adjuncts in the modern organisation. Over the last twelve months, we have been informed that high profiled entities abroad have used fraudulent financial reporting to gain unfair advantages in the market place. Clearly, fraudulent reporting is a wrongdoing that is unacceptable to the accounting profession.
In order to remove any deliberate deception in financial reporting and, by extension, minimise inadvertent errors, the gatekeepers of the accounting profession are forced to strengthen the effectiveness of Audit Committees and Internal Audit functions. In North America, Audit Committees are popular and Stock Exchanges require the existence of Audit Committees. Notwithstanding, best practices dealing with matters of independence, qualifications, and outside auditor involvement, we have failures in the case of Enron, Worldcom and others.
However, deception in financial reporting has some antecedents. By carefully listening to a smooth talker, an experienced auditor may detect over-optimistic earnings projections. Auditors and Auditing Firms possess vast knowledge on industry trends and industry accounting practices. When an entity deviates too much from its industry norms, this should raise a red flag for further analysis. By nature, Auditors are sceptical and so unusually rapid growth figures, significant changes in accounting policies and/or the system of internal controls would likely draw their attention.
Here in Jamaica, trade data on specific industries is largely unpublished. STATIN (The Statistical Institute of Jamaica) publishes economic data on a sector basis. Such data may not be sufficiently detailed for a level of analysis which would be possible with more refined accounting information. In the case of an auditor, industry data can be pulled together, based on their clientele. This data can provide a springboard for effective analysis. There is indication that, given the wide knowledge and vast experience of Auditors and Audit Firms, an independent Audit Firm should be considered for the role of Internal Auditors. Ideally, such firms should be different from the External Auditors to preserve the latter's independence. This arrangement would allow a cross-check between auditors and provide the assurance required by Audit Committees.
In order to be effective, Audit Committees should be positioned between senior management and the External Auditors. This structure would enhance independence and allow the Audit Committee to question management's judgments and see to the approval and implementation of recommendations from the Internal Auditors. This structure would also avoid any limitation of scope which management may wish to place on the duties of both Internal and External Auditors. Provided the rules of selection are as stringent as those for External Auditors, independent audit firms serving as Internal Auditors would avoid the notion of ethical conflicts and ethical dilemma and, in a straightforward manner, prevent or detect management overrides. The matters of ethical conflict and ethical dilemma are adequately dealt with by Margaret Mendes and Margaretta Pearce in their book Essentials of Professional Ethics for Accountants. Effective Audit Committees must be vigilant and obtain satisfactory responses from probing questions to ensure the propriety of the reporting process and the quality of a company's financial reports. Competent Internal Auditors must be able to provide operational, financial and compliance audits.
An operational audit is a comprehensive examination and evaluation of the performance of an operating unit. The performance measurement is usually done against management objectives.
A financial audit determines the accuracy and propriety of the financial transactions of an organisation.
A compliance audit determines the degree to which an organisation conforms to the requirements of polices, procedures, law and government regulations.
According to Louis Braiotta Jr., MBA, CPA, and Associate Professor of Accounting at the State University of New York at Binghamton, "Audit Committee members should be highly attuned to the potential of fraudulent financial reporting. Failure on the part of the Audit Committee to question management's representations may be the basis for the Audit Committee's malfeasance, since the Committee and the Board may be held liable for failure to know what they were responsible for detecting".
If Mr. Braiotta is correct, then Company Directors and management should not hesitate to draw on expertise available to assist them in their oversight responsibilities. In fact it is evident, that the role of Audit Committees and Internal Auditors in the modern organisation are inextricable bound.
Neville Robinson is a partner in Robinson Davis and Company and a Member of the Institute of Chartered Accountants of Jamaica.
