Auditing and economic growth

Auditing and economic growth

Tuesday, May 24, 2016 11:23 pm


Dada Adefolami

Dada Adefolami

By Dada Adefolami

Auditing refers to a systematic and independent examination of books, accounts, documents and vouchers of an organization to ascertain how far the financial statements present a true and fair view of the concern. It also attempts to ensure that the books of accounts are properly maintained by the concern as required by law.

Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.

An external auditor performs an audit, in accordance with specific laws or rules, of the financial statements of a company, government entity, other legal entity, or organization, and is independent of the entity being audited

The Chief Audit Executive (CAE), Director of Audit, Director of Internal Audit, Auditor General, or Controller General is a high level independent corporate executive with overall responsibility for the internal audit. He must have an understanding of how laws and regulations affect an audit, not only in terms of the work the auditor is required to do, but also to appreciate the responsibilities of both management and the auditor where laws and regulations are concerned.  

The auditing standard that is relevant to this is ISA 250, Consideration of Laws and Regulations in an Audit of Financial Statements and the objectives of the auditor according to paragraph 10 in ISA 250 are:

1. To obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations that have a direct effect on the determination of material amounts and disclosures in the financial statements
2. To perform specified audit procedures to help identify non-compliance with other laws and regulations that may have a material effect on the financial statements
3. To respond appropriately to non-compliance or suspected non-compliance identified during the audit.

The standard defines an act of ‘non-compliance’ as follows:
‘Acts of omission or commission by the entity, either intentional or unintentional, which are contrary to the prevailing laws or regulations, Such acts include transactions entered into by, or in the name of, the entity, or on its behalf, by those charged with governance, management or employees. Non-compliance does not include personal misconduct (unrelated to the business activities of the entity) by those charged with governance, management or employees of the entity.’

The auditor’s report is a formal opinion, or disclaimer thereof, issued by either an internal auditor or an independent external auditor as a result of an internal or external audit or evaluation performed on a legal entity or subdivision thereof (called an “auditee”).

Responsibilities of management and auditors:
Need to go into the exam with an understanding as to who is responsible for compliance with laws and regulations and who is responsible for the detection of non-compliance with laws and regulations.

It is the responsibility of management to ensure that an entity complies with relevant laws and regulations. It is not the responsibility of the auditor to either prevent or detect non-compliance.   

1. Understand that it is role of the management is to ensure the operations of the entity are conducted in accordance with laws and regulations (this applies to tax legislation also)
2. Appreciate that an auditor is not responsible for prevention of non-compliance with laws and regulations and is not expected to detect instances of non-compliance
3. The auditor’s responsibility to obtain reasonable assurance that the financial statements are free from material misstatement. To that end the auditor will take into account the legal and regulatory framework within which the entity operates
4. Reference to the auditor’s responsibility to consider those laws and regulations that have both a direct and an indirect effect on the determination of material amounts disclosures in the financial statements.

Direct and indirect laws and regulations
There are many laws and regulations that a reporting entity may have to comply with in order to continue in business. For example, many entities will have to comply with strict health and safety legislation; a food manufacturer may have strict food hygiene legislation to comply with, and an accountancy firm will have a code of ethics to follow from its professional body. Such laws and regulations will have both a direct effect on the financial statements and an indirect effect.   

For those laws and regulations that have a direct effect on the financial statements, the auditor will be concerned about gathering sufficient and appropriate audit evidence that the entity has complied with such laws and regulations. For example, when auditing the payroll the auditor will be concerned with gathering sufficient and appropriate audit evidence to ensure that tax legislation has been correctly applied by the entity because if it has not there is risk that the entity could be fined for non-compliance and the fines could be material, either in isolation or when aggregated with other misstatements. In addition, amounts within the financial statements may also be misstated as a result of the non-compliance with laws and regulations.

For those laws and regulations that have an indirect effect on the financial statements, the auditor will undertake procedures with the objective of identifying non-compliance with such laws and regulations. ISA 250 gives examples in paragraph 6(b) of:
1. Compliance with the terms of an operating license 
2. Compliance with regulatory solvency requirements, or
3. Compliance with environmental regulations.

When designing procedures to help to identify non-compliance with laws and regulations, ISA 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment requires an auditor to obtain a general understanding of:
1. The applicable legal and regulatory framework, and
2. How the entity complies with that framework.

Identifying non-compliance with laws and regulations can be tricky for auditors, particularly where fraud and/or money laundering is concerned. For this reason, the auditor must maintain a degree of professional scepticism and remain alert to the possibility that other audit procedures applied may bring instances of non-compliance or suspected non-compliance with laws and regulations to the auditor’s attention, and such procedures could include:
1. Reading minutes of board meetings
2. Enquiring of management and/or legal advisers concerning litigation or claims brought against the entity, and
3. Undertaking substantive tests on classes of transactions, account balances or disclosures.

Reporting suspected non-compliance with laws and regulations
Where the auditor discovers non-compliance with laws and regulations, the auditor must notify those charged with governance. However, care must be taken by the auditor because if the auditor suspects that those charged with governance are involved, the auditor must then communicate with the next highest level of authority, which may include the audit committee. If a higher level of authority does not exist, the auditor will then consider the need to obtain legal advice.

The auditor must also consider whether the non-compliance has a material effect on the financial statements and, in turn, the impact the non-compliance will have on their report. 

Where the auditor discovers non-compliance with laws and regulations, the auditor must notify those charged with governance. However, care must be taken by the auditor because if the auditor suspects that those charged with governance are involved, the auditor must then communicate with the next highest level of authority, which may include the audit committee. If a higher level of authority does not exist, the auditor will then consider the need to obtain legal advice.

 

There may be occasions when the auditor’s duty of confidentiality may be overridden by law or statute. This can be the case when the auditor discovers non-compliance with legislation such asmoney launderingand drug trafficking.

Money laundering and interpretation
The Accountant professional body e.g. ACCA’s Code of Ethics and Conduct defines,
Money laundering’as:
“The process by which criminals attempt to conceal the true origin and ownership of the proceeds of their criminal activity, allowing them to maintain control over the proceeds and, ultimately, providing a legitimate cover for their sources of income.” Also, money laundering is the process of transforming the proceeds of crime into ostensibly legitimate money or other assets.

Auditors need to be particularly careful where money laundering issues are concerned – especially for a business that is predominantly cash-based because the scope for money laundering in such businesses is wide. There are usually three stages in money laundering:

1. Placement –: This is the introduction or ‘placement’ of illegal funds into a financial system.
2. Layering –:  This is where the money is passed through a large number of transactions. This is done so that it makes it difficult to trace the money to its original source.
3. Integration –: This is where the ‘dirty’ money becomes ‘clean’ as it passes back into a legitimate economy.

Money laundering offences can include:
1. Concealing criminal property
2. Acquiring, using or possessing criminal property
3. Becoming involved in arrangement which is known, or suspected, of facilitating the acquisition of criminal property. 

There are many countries in which money laundering is a criminal offence and, where finance officer or an auditor discovers a situation which may give rise to money laundering, the finance officer or auditor must report such suspicions to a ‘money laundering reporting officer’ (MLRO) whose responsibility it is to report such suspicions to an enforcement agency, EFCC.

It is an offence to fail to report suspicions of money laundering to EFCC as soon as practicable, where the entity is actively involved in money laundering, the signs are likely to be similar to those where there is a risk of fraud, and can include:
1. Complex corporate structure where complexity does not seem to be warranted 
2. Transactions not in the ordinary course of business 
3. Many large cash transactions when not expected 
4. Transactions where there is a lack of information or explanations, or where explanations are unsatisfactory, or
5. Transactions with little commercial logic taking place in the normal course of business.

Money laundering is therefore very similar if not identical in many ways to frauds and, therefore, auditors should set aside any beliefs concerning the integrity and honesty of the audit client and keep a sceptical mind set where such issues are concerned.

FINALLY
The term ‘tipping off’ means that the MLRO discloses something that will prejudice an investigation. It is an offence to make the perpetrators of money laundering aware that the auditor has suspicions or knowledge regarding their money laundering activities or that these suspicions or knowledge have been reported. It is unnecessary for the auditor to gain all the facts, or to ascertain without a doubt, that an offence has occurred. The auditor only needs to satisfy themselves that their suspicions are reasonable, and obtain sufficient evidence to show the allegations are made in good faith.

Audit is undertaken to confirm whether a firm is following the terms of an agreement (such as a bond indenture), or the rules and regulations applicable to an activity or practice prescribed by an external agency.

Materiality is a concept or convention within auditing, accounting, and securities regulation relating to the importance/significance of an amount, transaction, or discrepancy

Dada Suraju Adefolami, Professor of Finance, School of Business Administration, UNEM University, Costa Rica, is a Finance / Management Consultant and Certified Forensic Accountant. You can reach him via: surajudada@yahoo.com; 08052043855


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