The relationship between corporate governance and internal audit Essay


This assignment is an attempt to depict the relationship between corporate administration and internal audit. But the first thing that has to be done is to understand what truly corporate administration and internal audit are, and how they can be defined.

Corporate Administration can non be defined exactly ; nevertheless, there are some theories and definitions. Corporate Administration can be considered as “ a field in economic sciences that investigates how to procure / motivate efficient direction of corporations by the usage of inducement mechanisms, such as contracts, organisational designs and statute law ” . But, it is frequently limited in how fiscal public presentation can be improved. For illustration, how the company ‘s proprietors can procure that the directors will present a positive rate of return ( Mathiesen 2002, cited in ) . Another theory defines the corporate administration as the manner of how steadfast and organisations can be managed and controlled ( OCED 1999 ) .

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Furthermore, companies select the directors in order to be accountable and trusty to the stockholders. However, sometimes the involvements of the two sides are controversial and can diverge. For case, directors want to increase the market portion and on the contrary, stockholders wish to work the Firm ‘s value. Obviously, there is a confliction between the two sides. The purpose of Corporate Governance is to decide this confliction in order effectivity and profitableness can be achieved. ( Tirole 2001 ; Berle & A ; Means 1932 ; Shleifer & A ; Vishny 1997 )

Corporate administration is consisted of three chief pillars: Management, Board of Directors and the External hearer. However, internal audit is supposed to be the 4th. Internal audit can be defined as an independent confidence and confer withing method that has been created in order to increase value and better company ‘s operations. Furthermore, aids the company to accomplish its ends by utilizing a systematic and disciplined methodological analysis to gauge and increase the efficiency of administration, control and hazard direction processs ( KPMG, 2007 ; Rezaee, 2002 ) .

Internal audit

Internal audit and internal control should non be confused each other because they are two wholly different significance.

Furthermore, internal control is a process, caused by a company ‘s board of managers and direction, which is established to present realistic confidence sing the achievement of company ‘s ends in the succeeding classs:

Effectiveness and efficiency of operations.

Dependability of fiscal coverage.

Conformity with applicable Torahs and ordinances.

Furthermore, internal control ‘s intent at organisational degree is to: guarantee the dependability of the provided fiscal studies, to give a suited feedback on the achievement of company ‘s strategic or operational aims, and to guarantee that company complies with ordinances and statute law. At transactional degree, internal control refers to the activities that company has been made in order to carry through peculiar aims such as payments to 3rd parties. Additionally, internal control has important function in debaring and comprehending fraud and besides in protecting company ‘s assets, both touchable and intangible. ( Cattrysse, 2005 ; KPMG, 2008 ) .

On the other manus, as it was referred before, internal audit AIDSs the company to achieve its ends by utilizing specific methodological analysiss to gauge and upsurge the efficiency of administration, control and hazard direction and has been created in order to increase value and better company ‘s operations. As it could be easy understood internal audit ‘s function is really important non merely for the Board of Directors but for the External Auditors and the Audit Committee excessively. ( Deloitte, 2009 ; KPMG, 2007 )

However, except from its commanding and back uping operations, it can besides be referred as consultative, because can supply information of prospective defects of the company both in concern and fiscal degree. Furthermore, the Board of Directors through internal audit can be informed about the company ‘s internal control map ( KPMG, 2007 ) .

To go on with, the chief aims of the internal audit are:

Specify the important hazards that the company ‘s activities cope within the range of the audit

Constitution and execution of a risk-based testing method to analyze if the most of import controls are working decently

Identifying and describing jobs to the direction and propose actions to turn to them

Investigate and measure every operational and fiscal information

Examine and measure internal control system and model

Analyze in deepness every fiscal statement, in order to analyze: a ) whether the company operates efficaciously b ) and if its aims have been achieved ( Morariu, A. , 2009 )

The above aims can change and some of them may non take topographic point, because of many factors such as: company ‘s nature, complexness of the activity being audited and the available resources. Furthermore, hearers could back up the company to accomplish its aims by measuring and urging possible betterments in critical countries. But, all these benefits of the internal audit can non be trusty when the hearer is from company ‘s internal environment and non independent. Auditor could lose his unity if he deals with day-to-day procedures that are being audited. ( Morariu, A. , 2009 ; KPMG, 2007 )

The function of Internal Audit Unit, Audit Committee and External Auditor

Internal Audit Unit is a critical portion of the company. It is established by top direction executives who are qualified and trained to propose disciplinary actions when a job occurs. It has an independent intent and it is straight committed to the disposal of the company. The grounds that exists are legion but the big leagues are the succeeding:

To depict the company ‘s control type

To find impartial hazard appraisal,

To bespeak the several process signifiers of the company

To show the conformity model,

To show and analyze both the fiscal and the operational public presentation

To do recommendations for maximising the use of the available resources

To measure if the desired aims have been achieved

To be responsible for provender endorsing about company ‘s moralss and values ( Hermanson & A ; Rittenberg, 2003 ; KPMG, 2008 ) .

Additionally, the function of the internal audit in the company is chiefly based on the company ‘s size. The higher the company is the higher the function the internal audit is and the higher its duties are. Furthermore, the formation of the internal audit commission depends on one chief factor, whether the company is listed in Stock Exchange or non. Whether the company is listed in the stock exchange, internal audit could be more efficient as the lone individual in charge is the CEO. Contrariwise, whether the company is listed, the internal audit has to be supervised by the Audit Committee ( Hermalin B. & A ; Michael W. , 2001 ) .

Audit Committee is in charge of monitoring and supervising revelation and fiscal coverage. Its members are selected from the Board of Directors of the company, and the president is selected amongst the members of the Audit Committee. Furthermore, Audit Committees are authorized to obtain the consulting resources and the cognition which are considered to be required in order to put to death their duties expeditiously. Their duties are:

Monitoring the fiscal coverage and the revelation process

Oversing accounting rules and policies

Controling the internal control patterned advance

Oversing the public presentation of external and internal hearers

Oversing the hazard direction policies and suggests betterments to company ‘s direction

( Hermanson & A ; Rittenberg, 2003 ; McMullen D.A. & A ; Raghunandan K. 1996 ; AICPA Committee On Auditing Procedures )

External auditing is really important procedure for the appropriate corporate administration which is being made from independent qualified professionals. Furthermore, the external hearer executes an audit, harmonizing to peculiar Torahs and rules, on the fiscal statements of the company. As the hearer is wholly independent of the companies or entities being audited, his fiscal information studies are indifferent and besides dependable for the investors and authorities bureaus. Furthermore, the audit studies are of important usage for the company because are focused chiefly on company ‘s fiscal consequences and public presentation and examines direction issues in order to avoid likely hazards ( Pop et al. , 2008 ; Ojo, M. , 2009 ) .

However, it is mandatory for the external hearers to be member of one recognized accounting organic structures and of class their makings, their format of describing are defined by the province and sometimes may differ from state to state. ( Omega Accountancy Company ) .

Internal Audit and Corporate Governance

The function of internal audit in execution of the Corporate Governance rules is really important. Furthermore, internal audit -always based on consistence, answerability and transparency- records and examines the internal procedures in pattern, presents the failings in the system and propose disciplinary actions and accommodations. The chief aim of internal control is to set up a strong connexion between directors and divisions of the company and to coerce company to accommodate its bing institutional model ( Allen S. , 2008 ) .

The internal audit can be characterized as a mechanism for supervising the operation of rules of corporate administration and for guaranting the stockholders ‘ involvements. Additionally, the internal audit direction examines whether the company ‘s activities operate decently, without been limited merely in fiscal and accounting activities, or non ( Baker C.R. & A ; Owsen D.M. , 2002 )

The importance of the internal audit and the audit commission was understood early and for that ground Corporate Governance ordinances and recommendations have been created and adopted by all states.

In 1992 Cadbury Report was established to do some accommodation to the bing model by presenting new rules such as unity, answerability and openness. Cadbury Report was chiefly focused on dividing the function of CEO and the president. Briefly the chief points were:

Audit Committee should be staffed by at least three non-executive managers

Every contract should run out after three old ages

Non-executive managers should be independent from direction and must be unrestricted from other duties or companies ( Cadbury A. , 1992 ; Cattrysse, 2005 )

However, despite the fact that Cadbury ‘s study ordinances were applied internationally, some major corporate dirts occurred such as Enron and WorldCom. For this ground, the US Government was enforced to set up in 2002 the Sarbanes-Oxley Act ( SOX ) in order to forestall another fraud. Furthermore, SOX included 11 subdivisions with ordinances which are focused chiefly on corporate duty, hearer ‘s independency and corporate fraud answerability. The subdivision 404 of the act makes recommendations for internal auditing ( Sarbanes-Oxley Act, 2002 ; Gillan, S. , 2007 )

Sarbanes-Oxley Act states that internal audit should: consult on the company ‘s bing internal control and suggest accommodations if needed examine and back up the function of the direction when it creates stress trials to measure the efficiency of the internal control and aid in the educational and developing portion of the internal control. Additionally, it refers that direction should merely oversee if the internal control ‘s procedures are applied on fiscal coverage ( Deloitte, 2009 ) .

In 2010 Combined Code has been established by the Financial Reporting Council to heighten the function of Corporate Governance. This Code is a combination between Cadbury ‘s, Greenbury ‘s and Hampel ‘s Report and it is focused on the corporation public presentation, answerability and prosperity. Furthermore, the Combined Code:

Includes risk debaring rules

Give to the non-executive managers new duties related on strategic issues

Enforces the stockholders of all the listed companies to re-elect yearly the managers

Established a rule that forces all the executives to be cognizant of their major stockholders ( Combined Code, 2010 ) .

Corporate Scandals

In past decennaries major corporate dirts have been recorded and eventually take to the fiscal crisis of 2007-2009.The most important are Enron, WorldCom and Lehman Brothers.

Enron was established in 1985 as a natural gas company. In 1999 the company transformed into a taking company in gas, electricity and oil with a stock value making $ 45 per portion. In 2000 it stock value reached in $ 91 per portion. In 2001, Sherron Watkins, who was the president of the company, decided to compose a missive anonymously to the CEO of the company Ken Lay. Watkins informed him that company was covering major jobs with its confederations sing the audit portion of them, the function of the CFO in them and the likely negative impact on the market if all these information were published.

Meanwhile, the company ‘s traded portions worth about about $ 41 million. Besides, other members of the company traded $ 71 million in portions. The value of the portion dramatically decreased to $ 28, after the terrorist onslaught of September 11. One month subsequently the company announced $ 618 million loss in the 3rd trimester, $ 1.2 billion sing the aforesaid studies ( Gudikunst A. , 2002 ) .

As it can be easy understood, the chief grounds that led Enron in bankruptcy were the unequal internal audit, the CFO ‘s extortionate wages and the inability of CEO to administer his ain company expeditiously.

Furthermore, another worth-mentioning instance of bankruptcy is WorldCom. The chief jobs were:

Bad hard currency direction – hard currency flows use

Operating disbursals were treated as Capital Investment

Weak internal Control

Questionable Ethical motives ( Gillan, S. 2006 )


As it was mentioned, Internal Audit Unit, Audit Committee and the External Auditor were some oversing governments which have been established in order to assist companies to work more expeditiously and to better their public presentation. Additionally, Cadbury Committee Report, Sarbanes-Oxley Act and the Combined Code 2010 were created for better Corporate Governance patterns and to restrict companies ‘ activities, prevent frauds and to protect the investors- Something that seems to travel well- .

However, despite the rough ordinance and the supervision of the governments some companies win in get the better ofing the existed statute law and committed major corporate dirts and frauds.

As it can be understood, irrespective of how many studies, statute laws will be created, companies will happen once more ways to get the better of them and perpetrate fiscal offenses. Because the chief jobs is non the model of internal audit or the efficient execution of the corporate administration ‘s rules but the deontology, corporate civilization and the moralss that the companies have. These are the first things that should be corrected and all the others are of minor importance.


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