External Auditors and their role in the Corporate Governance Framework Essay

External Hearers check company ‘s histories and study to the company based on the histories. Basically, the concern is how external hearers conduct these responsibilities efficaciously. Legislations, such as The Companies Act 1965, have made great attempts to guarantee external hearers conduct their responsibilities and duties efficaciously. The Code of Corporate Governance in 2001 and the amendment in 2007 have further enhanced the effectivity of audit in the involvements of shareholders and stockholders. In visible radiation of the recent dirts affecting external hearers in the universe, there is a turning concern for corporate administration globally as there is increased trust by the shareholders and stockholders on external hearers.

This survey examines the function of external hearers in the corporate administration model. The survey so reviews the fiscal dirts affecting hearers occurred in the universe and look into the function of external hearer in the prostration of the companies.


Corporate administration is a cardinal and dynamic facet of concern. It is really of import for corporate success and societal public assistance. In the aftermath of Enron, HIH Insurance and other similar instances, states around the universe have reacted rapidly by pre-examining similar events domestically. As a speedy response to these corporate failures, the USA issued the Sarbanes-Oxly Act in July 2002, and in UK, the Higgs Report and the Smith Report were published in January 2003 ( Solomon, 2007 ) .

Nowadays corporate administration is a globally debated subject with many features ( Nobel, 1998 ) . However, the concern is whether hearers play an of import function in the model of corporate administration.

Corporate Administration

Corporate administration is the relationship among assorted participants in finding the way and public presentation of corporations. The chief participants are the stockholders, the direction and the board of managers.

Corporate administration is the procedure whereby managers of a company are monitored and controlled. There are two countries considered to be cardinal to corporate administration, one is supervising and monitoring of direction public presentation and the other is guaranting answerability of direction to stockholders and other stakeholders ( Marianne, 2009 ) .

Till now, likely the two most of import basic elements of good corporate administration have been “ full revelation ” and the presence of independent managers and hearers, who each has their ain ways to corroborate that the informations provided by the corporation are true and reasonably stated. The contents of full revelation are listed out in regulative demands and professional dictums, and companies are expected to to the full follow. The independency of the outside manager and external hearer means the managers and hearers will hold to distance themselves well to guarantee stockholders that they have conducted their undertakings ( Bavly, 2004 ) .

Role of External Auditors in Corporate Administration

External hearers play a cardinal function in the corporate administration model. They conduct one of the most of import corporate administration cheques that help to supervise direction ‘s activities. The audit of fiscal statement makes revelations more dependable, therefore increasing assurance in the company ‘s transparence.

The function of external hearers is to do certain that Board of Directors and the direction are moving responsibly towards the stockholders ‘ investing involvements. By maintaining objectiveness, the external hearers can add value to stockholders by guaranting that the company ‘s internal controls are strong and effectual. And by working with the audit commission and interceding with internal hearers, external hearers can assist to ease a more effectual inadvertence of the fiscal coverage procedure by the Board of Directors ( Hassan, 2004 ) .

However, the “ audit outlooks gap ‘ demands to be acknowledged, as the audit map can merely make so much on the fraud. The external hearer can non be expected to happen every fraud and mistake during an audit. In conformity with the Cadbury Report, it is of import to cognize that the external hearer ‘s function is non to fix the fiscal statements, nor to supply confidence that the informations in the fiscal statements are right, nor to vouch that the company will go on as a traveling concern, but the external hearers have to province in the one-year study that the fiscal statements show a true and just position. The Cadbury Report highlighted that there was no uncertainty on whether there should be an audit but instead how the audit could be ensured to carry on efficaciously and objectively by the external hearers ( Solomon, 2007 ) .

Auditor Independence

External hearers are expected to be independent of the company and study on the company objectively. Actually, hearers can merely play their function efficaciously if they are independent ( Peel & A ; O’Donnell, 1995 ) . They have to carry on their undertakings in the most independent and dependable mode to supply puting public with the degree of confidence to do their determinations based on the fiscal statements.

Harmonizing to the Cadbury Report, hearer independency could be affected due to the stopping point relationship between hearers and company directors and due to the hearer ‘s purpose to develop a constructive relationship with their clients. There are a figure of menaces to auditor independency, one of which is to supply non-audit services since non-audit services are moneymaking. Hearers can obtain the contracts for non-audit services merely if they maintain a good relationship with the direction.

The Cadbury Report stressed that a balance is needed to be achieved in such manner that external hearers will work with, non against, company direction, but in making so they need to function stockholders. This is a hard way. The easiest manner to guarantee this balance being attained is suggested to set up audit commissions and develop effectual accounting criterions.

The Cadbury Report recommended all companies to set up audit commissions. Audit commissions serve as representative of stockholder involvements. They are non merely responsible for supervising fiscal describing procedure to back up good corporate administration, they are besides considered to be able to guarantee an appropriate relationship exists between the external hearer and the direction whose fiscal statements are being audited ( Hassan, 2004 ) . The Smith Report issued in 2003 highlighted that the audit commission needs to be proactive and raise the concern with managers instead than brush them under the rug. The Report besides stressed that all members of audit commission should be independent non-executive managers. Company ‘s one-year studies should unwrap elaborate information on the function and duties of their audit commission.

Lessons from Financial Scandals

4.1 Collapse of Enron

Enron, the energy trading company based on Texas is the first dirt agitating up the scrutinizing profession. It has led to a crisis to the assurance on hearers and the dependability of fiscal coverage ( Holm & A ; Laursen, 2007 ) . The audit quality and the independency of external hearers were questioned. In this instance, Enron ‘s audit and accounting map were deceitful. Arthur Andersen, the hearer of Enron, has been involved in Enron ‘s deceitful accounting and scrutinizing. Failure of the audit map is one of the cardinal factors lending to the company ‘s prostration.

Enron created ”The Raptors ” , four particular intent entities ( SPEs ) . SPEs are established in order that a company can organize a joint venture with other interested parties to carry on a specific dealing. This dealing will non subject the other parties to the hazards more by and large associated with the company ‘s operations. U.S Generally Accepted Accounting Principles ( GAPP ) allows companies to enter the additions and losingss of SPEs without describing their assets and liabilities in certain cases. In this manner, Enron avoided adding more than $ 1 billion debt to its balance sheet without consolidating certain SPEs ( Jenkins, 2003 ) . But the jobs are, when the losingss of these entities rapidly rose into one million millions of dollars, these entities were brought into the nucleus fiscal statements. It so became clear that Enron itself had great losingss. The corporation ‘s stock monetary value dropped aggressively, and the company went into bankruptcy in December 2001 ( Brown, 2005 ) .

Examples of Enron ‘s oblique accounting exist widely in the corporation. The company recorded net incomes, for illustration, from a joint venture with Blockbuster Video that was ne’er materialized ( The Economist, 7 February 2002 ) . In 2002, Enron restated its histories, which is really a procedure that reduced reported net incomes by $ 600 million ( The Economist, 6 December 2001 ) . In fact, the procedure resulted in a cumulative net income lessening of $ 591 million and a rise in debt of $ 628 million for the fiscal statements from 1997 to 2000. The difference between the net income figures was chiefly attributed to the earlier skip of three off-balance sheet entities. Such net income rising prices enabled the company to raise its net incomes per portion ( EPS ) .

The company non merely manipulated the accounting figures to blow up the net incomes, but it besides was found to take significant sums of debt from its histories by puting up a figure of off-balance sheet entities. Such particular purpose entities can be used to conceal a company ‘s liabilities from the balance sheet, in order to do the fiscal statements look much better than they truly are ( The Economist, 2 May 2002 ) . It means significant figure of liabilities did non hold to be disclosed on Enron ‘s fiscal statements, because they were chiefly attributed to another legal entity.

All these issues raise the inquiry, “ why did Enron ‘s hearer allow this type of activity? ” This is because the struggles of involvement exist between the external hearer and the direction.

Conflicts of Interest

Conflicts of involvement are a frequent job in the audit profession. Although independent assignment of external hearers by company ‘s stockholders is on a regular basis replaced by subjective assignment by the company direction, the hearer is all excessively frequently appreciated to the company ‘s senior direction.

Further, struggles of involvement arise from synergistic maps of audit and consultancy. Arthur Andersen has been blamed to use loose criterions in their audits because of struggle of involvement over the subatantial consulting fees collected from Enron. In 2000, Andersen collected $ 25 million for scrutinizing Enron ‘s books in add-on to $ 27 million for confer withing services. In 2001, Arthur Anderson earned US $ 55 million for proviso of non-audit services ( Brown, 2005 ) . Although Arthur Andersen reported on the company ‘s histories, they did non describe fraud to the stockholders. This is because the fraud was committed by the direction. Kenneth Lay, the Chief Executive Officer ( CEO ) from Feb 1986 until Feb 2001, took place US $ 152 million although the company was confronting a loss. If Andersen were to describe, they likely will non be appointed in the undermentioned old ages or be engaged in non-audit services ( Krishnan, L, 2009 ) .

Particularly, close relationships are established over clip between companies and their external hearers. It can once more impact independent judgement and impact on the scrutinizing map. In this instance, there are regular exchanges of employees within Enron from Arthur Anderson. Such struggles of involvement affect the corporate administration map.

Serious struggles of involvement have besides arisen among members of Enron ‘s internal audit commission, which causes the internal audit commission did non execute its maps of internal control and of look intoing the external auditing map. For illustration, Lord Wakeham, a member of the audit commission, was at the same clip holding a confer withing contract with Enron ( The Economist, 7February2002 ) . This shows that people in responsible places should hold detected deceitful activities if they were independent. Enron ‘s board of managers was composed of a figure of members who have been shown to be willing to carry on deceitful activity. It is besides because the non-executive managers were compromised by struggles of involvement.

4.2 Collapse of HIH Insurance

In Australia, the prostration of HIH Insurance Ltd was observed as the beginning of the contemplation into external hearers ‘ function. HIH is one of Australia ‘s biggest insurance companies, consisting several separate government-licensed insurance companies, including HIH Casualty & A ; General Insurance Ltd, FAI General Insurance Ltd, CIC Insurance Ltd and World Marine & A ; General Insurances Ltd. On 15 March 2001, HIH went into probationary settlement with losingss of A $ 800 million ( Peursem, Zhou, Flood & A ; Buttimore, 2007 ) .

HIH is one of the largest corporate prostrations in Australian history. Similar issues originate as in the Enron instance. HIH is claimed to misdirect investors by supplying wrong fiscal studies to the market and HIH ‘s hearer, Arthur Andersen, may hold played a portion in its prostration. Andersen conducted the external audits for HIH from 1971 until its prostration in 2001. Their part to the failure of HIH is considered in the undermentioned subdivisions:

Audited account Practices

As portion of audit procedure, hearers will carry on a hazard appraisal to find the construction and program of the audit. Andersen assessed the hazard of HIH and deemed it a maximal hazard client, nevertheless, the engagement squad of Andersen had non prepared the hazard direction program and therefore the senior direction squad at Anderson did non reexamine and O.K. the program ( Peursem, Zhou, Flood & A ; Buttimore, 2007 ) .

At the terminal, the hearer merely drew the incorrect decisions. Andersen signed off HIH ‘s one-year study for the 30th June 2000 and stated that it was a traveling concern with net assets of $ 939 million. Nine months subsequently, HIH collapsed with debts of $ 5.3 billion ( Peursem, Zhou, Flood & A ; Buttimore, 2007 ) . Andersen used HIH direction studies and prognosiss and did non obtain sufficient grounds to acquire the decisions they did. The murderer could non happen the certification on the grounds for sing HIH as a traveling concern. This implies that Anderson failed to bring forth sufficient working documents to turn out that the audit really is conducted.

Auditor Independence

Andersen had a close relationship with HIH. By the clip of settlement, three former Anderson spouses who had conducted HIH fiscal audit work held places on the HIH board of managers. This obvious deficiency of independency between the board of managers and the hearers indicated that the best involvements of HIH may hold non ever be a precedence. Anderson ‘s failure in bring forthing equal working documents or in obtaining equal grounds to back up their findings have serious concerns on the quality of the audit they did.

A important independency issue is besides reflected in the signifier of Anderson ‘s payment to HIH Chairman, Geoffrey Cohen for consultancy fees. These fees totaled $ 190,887 in nine old ages and included the usage of Anderson ‘s office and secretary. These fees were non disclosed to the staying board members in the one-year general meetings ( Peursem, Zhou, Flood & A ; Buttimore, 2007 ) . The stopping point and complicated fiscal relationship between the hearers and HIH president raise farther inquiries in this instance.

Finally, the menace to auditor independency is that Andersen provided both audit and non-audit services to HIH. It raises a inquiry on how can an hearer provide an independent sentiment on the fiscal statements when he may play a function in steering the readying of the statements?

The Royal Commission in Australia, which investigates the prostration of HIH, has found that the largest corporate prostration in Australia was non due to fraud but the consequence of trying to cover the clefts on the overpriced acquisition. Anderson ‘s function in it appeared to be significant.

Modern Approach to External Auditors ‘ Role in Corporate Administration

External hearers now have to take a much stricter attack to their clients ( Bourne, 1995 ) . There is an increasing position to back up that external hearers should take on a more proactive function ( Baxt, 1970 ) .

The Companies Act has set the judicial admission on assignment, eligibility, making, disqualification and remotion of external hearers ( Davies & A ; Prentice, 2003 ) . The purpose is to guarantee that hearers are able to transport out audit in an impersonal, nonsubjective and professional manner. It is besides to guarantee that hearers are independent of the company. The ground for such accent is to guarantee the external hearers are non in a place of struggle of involvements.

When there is struggle of involvement, revelation must be made to stockholders and stakeholders. Alternatively, there should be prohibition to the proviso of non-audit services to the company where they act as hearers. To guarantee hearers are genuinely independent and non in a struggle of involvement, hearers should be rotated every twelvemonth. Thereafter there should be a spread of five old ages before the same hearers are appointed by the company.


External hearers have an indispensable function in corporate administration through their engagement and their scrutiny of fiscal statements. The external hearer ‘s function in corporate administration is a cardinal complement to accomplish the coveted aim of corporate administration. Therefore, the responsibilities and duties of external hearers must be expanded for the rights and involvements of stockholders and stakeholders. There must be a modern attack to the hearers ‘ function in the corporate administration model.