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Corporate Governance and Audit
June, 02nd 2008

Our understanding of corporate governance has changed. Earlier we perceived corporate governance as a system that ensures that the manager (the CEO and her team) does not take decision for private gains and does not expropriate shareholders' wealth. We now understand corporate governance in a broader sense. It is now perceived as a system that ensures optimal utilisation of resources for the benefit of shareholders while meeting societal expectations.

For example, enterprise risk management, which includes identification, evaluation and management of enterprise risks, is an important element of the corporate governance system.

Similarly, strategy audit and corporate social responsibility (CSR) are elements of a corporate governance system. Some experts use the term enterprise governance to refer to this new concept of corporate governance. Enterprise governance subsumes corporate governance, as understood earlier.

Corporate financial reporting and financial audit support the corporate governance system as understood earlier. They are of immense importance to analysts and investors. Therefore, there is a need to further strengthen corporate financial reporting and financial audit.

In March 2008 International Federation of Accountants (IFAC) released its report entitled Financial reporting value chain current perspectives and direction'. The financial reporting supply chain refers to the people and processes involved in the preparation, approval, audit, analysis and use of financial reports. The report is based on a global survey conducted by IFAC.

The report observes "The results of this survey are clear. Participants feel that the three key areas of the financial reporting supply chain corporate governance, the process of preparing financial reports and the audit of financial reports have clearly improved in the last five years. Unfortunately, however, they do not feel that the products of this supply chain, the financial reports, have become more useful to them."

In fact, the revelation that the usefulness of financial reports has not improved over the years is not new. For some years now, all the participants in the value chain are arguing in favour of simplification of accounting standards and corporate financial report. But simplification is not easy. If business models and transactions get complex, it is but natural that accounting rules and corporate financial report get complex.

However, the moot question is have they lost relevance. The answer is no. Even today most analysts use corporate financial report as the primary source of information in the valuation of a company. This does not mean that there should be no endeavour to simplify accounting rules and corporate financial report. In future, simplification of international financial reporting standards (IFRS) will be the greatest challenge before the International Accounting Standards Board (IASB).

The IFAC report observes "Overall, respondents to the survey felt that the audit of financial reports has become better over the last five years; preparers and users were slightly less positive than other respondents" . The survey reported that auditors now are more focused on the overall risk profile of the audited company rather than on a micro review of transactions and that they enjoy greater independence than before.

However, many respondents are not happy with the auditor's communication with investors. They felt that excessive oversight and litigation has lead to the compliance audit' approach and the boiler plate' audit report. Respondents expect that the financial auditor should be innovative and that they should apply their professional judgement. They look for more detailed report from the auditor.

A question that needs to be examined is that whether shareholders can ask for the detailed report that the financial auditor submits to the management/audit committee. And if they ask for the report, can the board of directors deny the same. Perhaps, this is the high time that the government examines this issue, particularly in view of the fact that the financial auditor is appointed by shareholders and it is accountable to them.

Cost audit, which has not received due attention has the potential to support enterprise governance. In fact investors should insist for cost audit. In India cost audit exists for over four decades. But, it has not been used to its full potential. Till date, only 44 industries/products have been covered by Cost Accounting Record Rules, and cost audit orders have been issued in about 2,500 cases, covering about 2,000 companies.

In the era of price control and administered interventions, attested cost structure had a major role to play and hence the cost audit emphasised on this aspect. The cost audit had to play the key role of verifying and validating the cost figures in select industries before they were submitted to the government.

In the changed economic environment the emphasis should shift to efficiency review. The Ministry of Corporate Affairs has constituted an Expert Group to review the existing Cost Accounting Standards and Cost Audit Report Rules. Hopefully the cost audit in its new avatar will be effective in supporting the enterprise governance.

Some argue that cost audit has become irrelevant in a market economy. They are not correct. It is true that government control is unwarranted in a market economy. But, in a market economy, regulators are required to frame right regulations in the interest of the industry as a whole and also in the interest of the consumers.

Cost audit, supported by cost accounting standards, can provide relevant and credible cost and revenue data to regulators to support their decisions. Moreover, cost audit can provide relevant reports to the board of directors to strengthen its oversight function. Therefore, in a market economy, cost audit with changed emphasis on efficiency is as relevant as it was in a controlled economy.

In an environment where stakeholder theory' of corporate governance is still rhetoric and management focus is on capital market, cost audit will help to protect the interest of stakeholders including investors. It will also help optimal use of national resources.

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