Audit - Solutions for Chapter 2

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  • Topic: Auditing, Audit, Financial audit
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* Solutions for Chapter 2
*
Corporate Governance

Review Questions:

2-1. Corporate governance is defined as:

“a process by which the owners and creditors of an organization exert control and require accountability for the resources entrusted to the organization. The owners (stockholders) elect a board of directors to provide oversight of the organization’s activities and accountability back to its stakeholders.”

The key players in corporate governance are the stockholders (owners), board of directors, audit committees, management, regulatory bodies, and both internal and external auditors.

2-2.In the past decade, all parties failed to a certain extent. For detailed analysis, see exhibit 2.2 in the chapter and repeated here:

Corporate Governance Responsibilities and Failures

Party | Overview of Responsibilities| Overview of Corporate Governance Failures| Stockholders| Broad Role: Provide effective oversight through election of Board process, approve major initiatives, buy or sell stock. | Focused on short-term prices; failed to perform long-term growth analysis; abdicated all responsibilities to management as long as stock price increased.| Board of Directors| Broad Role: the major representative of stockholders to ensure that the organization is run according to the organization charter and there is proper accountability. Specific activities include: * Selecting management. * Reviewing management performance and determining compensation. * Declaring dividends * Approving major changes, e.g. mergers * Approving corporate strategy * Overseeing accountability activities.| * Inadequate oversight of management. * Approval of management compensation plans, particularly stock options that provided perverse incentives, including incentives to manage earnings. * Non-independent, often dominated by management. * Did not spend sufficient time or have sufficient expertise to perform duties. * Continually re-priced stock options when market price declined.| Management| Broad Role: Operations and Accountability. Managing the organization effectively and provide accurate and timely accountability to shareholders and other stakeholders. Specific activities include: * Formulating strategy and risk appetite. * Implementing effective internal controls. * Developing financial reports. * Developing other reports to meet public, stakeholder, and regulatory requirements.| * Earnings management to meet analyst expectations. * Fraudulent financial reporting. * Pushing accounting concepts to achieve reporting objective. * Viewed accounting as a tool, not a framework for accurate reporting.| Audit Committees of the Board of Directors| Broad Role: Provide oversight of the internal and external audit function and the process of preparing the annual accuracy financial statements and public reports on internal control. Specific activities include: * Selecting the external audit firm. * Approving any non-audit work performed by audit firm. * Selecting and/or approving the appointment of the Chief Audit Executive (Internal Auditor), * Reviewing and approving the scope and budget of the internal audit function. * Discussing audit findings with internal auditor and external auditor and advising the Board (and management) on specific actions that should be taken.| * Similar to Board members – did not have expertise or time to provide effective oversight of audit functions. * Were not viewed by auditors as the ‘audit client’. Rather the power to hire and fire the auditors often rested with management. | Self-Regulatory Organizations: AICPA, FASB| Broad Role: Setting accounting and auditing standards dictating underlying financial reporting and auditing concepts. Set the expectations of audit quality and accounting quality. Specific roles include: * Establishing accounting principles * Establishing auditing...
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