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 The Changing Role of
Internal Audit Function in Organization
 Edited by
Prof. Dr. Prem Lal Joshi (Editor)
ICSSR Senior Fellow, Western Regional Centre, Mumbai
(Former Professor of Accounting at
MMU Malaysia and University of Bahrain)
and
Dr. Suzan Dsouza (Co-editor)
Assistant Professor of Accounting
American University of the Middle East, Kuwait

Northern Book Centre

New Delhi
© 2021, Northern Book Centre, New Delhi

Price : ` 800.00

All rights reserved. No part of this book may be reproduced in any form, or
by any means, electronic or mechanical, including photocopying, recording
or by information strorage or retrieval system, without prior written
permission of the publishers.

Published by
Northern Book Centre
4221/1, Ansari Road, Daryaganj, New Delhi-110 002
Phones : 011-23264519, 23271626, 23280295
Fax : 011-23252651
E-mail : [email protected], [email protected]
Website : www.northernbook.com

Publisher’s Cataloging-in-Publication Data

Lal, Prem Joshi & Dsouza, Suzan
The Changing Role of Internal Audit Function in Organization
Dr. Prem Joshi Lal & Suzan Dsouza–1st ed.
p. cm.

ISBN 81-7211-397-8
978-81-7211-397-1

Printed at Swatantra Bharat Press, 423, Gali Jainyan,

Esplanade Road, Delhi-110 006
 Foreword

I have been involved with the theory and practice of auditing for the
last four decades. As a CPA in the US and a Chartered Accountant in
India, I have seen the changes in the auditing profession very closely.
As a researcher, I have evaluated the effects of such changes and I
found them very fulfilling, and at the same time, a frustrating venture.
I have also worked with Dr. Joshi for over a decade and did many
projects together. Dr. Joshi has a deep curiosity, wide-ranging
imagination, and the ability to complete the projects in time. I think
Dr. Joshi and his great team have done a tremendous job of capturing
changes and challenges facing the internal auditing profession.
The Institute of Internal Auditors (https://global.theiia.org/) defines
internal auditing as an independent, objective assurance and consulting
activity designed to add value and improve an organization’s
operations. The deceptively simple definition creates a colossal
knowledge field whose depth and breadth cannot be gauged easily.
The internal audit was traditionally focused on financial and
accounting matters and compliance with corporate policies. The role
then evolved to encompass corporate governance, enterprise risk
management, and operational efficiencies. Supporting the top
leadership strategies, developing a single view of risk, analyzing and
assessing multiple value measures became top priorities for the internal
auditors. As the objectives of the corporate world evolved, internal
auditors were involved in ethics audits, social and sustainability audits,
business continuity planning, and so on.
The rapidly changing nature of business and technology poses
challenges for all professions. However, as internal auditors sit at the
intersection of business and technology, they feel the impact of those
changes most directly and intimately. The new developments such as
vi Foreword

AI, machine learning, and data visualization change the very foundations
of the auditing profession. Add to that the explosion in business models,
professional standards, non-financial measures, and activist
shareholders; the scope of internal auditing continues to expand.
Specifically, how does that affect the auditing profession?
The first and foremost important question is what should be the
skillset of an internal auditor? The demands range from financial
expertise to programming fluency. Obviously, no one person can learn
all these techniques and many functions will be carried by internal audit
teams. However, we still need to answer the question of core
knowledge for an entry-level internal auditor. Every year, this question
becomes more difficult to answer. The internal auditor must perform
their duties in fundamental areas such as finance, accounting,
operations, governance, and risk assessment. At the same time, they
must be forward-looking and investigate the impact of new
technologies not only on their work but also on the organization. They
must understand the new capabilities of the software and also the
weaknesses of the new technologies. AI and machine learning can give
ridiculous answers, provide inane explanations, and can be destructive
if used without supervision. The internal auditors must assess what
works and under what conditions, where the machine ends and human
intuition begins. The answer changes constantly as machines become
better and encroach on human territory. Even technologies such as
blockchain though touted as impervious to fraud can be hacked and
new hacking tools emerge continuously. The challenge of cybersecurity
can keep internal auditors busy for a long time!
I believe this book provides partial answers to many of these
questions. It has the balanced treatment of traditional internal auditing
roles and I see many chapters that deal with organizational culture,
management support, the emerging roles such as advisor and assessor,
and corporate governance. At the same time, there is coverage of
fraud detection and blockchain. I believe a few more papers on new
technologies and the skill sets required for the new era may have
provided complete coverage. But I do understand the space and time
constraints faced by all researchers.
I congratulate Dr. Joshi and his team on an excellent book.

Dr. Ashutosh Deshmukh

Distinguished Professor and Department Chair of Accounting & MIS
Penn State, The Behrend College, USA
 vii

Preface

For last two decades, the accounting and auditing profession has
faced numerous problems such as collapse of major public
shareholding companies in various countries resulting in loss of
billions of dollars. Consequently, to bring transparency, improving,
controls, reporting quality, and corporate governance practices,
regulatory reforms have been enacted at the global level. The various
reforms have emphasized on the role of internal audit function (IAF) to
make it an effective arm of governance mechanism. The emerging
technologies are also impacting IAF and changing internal auditors’ role,
expectations, responsibilities, core competencies and training. Internal
auditors who better understand to adopt the latest technology within
their own teams, may be well equipped in assessing and mitigating
operations and cyber risks as well as system failures. The digitalized
business environment affects the IAF in three respects viz., scope,
consulting activities, and working practices (Betti & Sarens, 2020).
These changes have given the IAF a place in the front seat to
provide major support function for senior management, the Board
of Directors and the audit committee particularly as assurer, assessor
and advisor. Cox (2007) Institute of Internal Auditors argues that
today’s internal auditor works hard with senior management to find
solutions, adding that the internal auditor has become more focused
on adding value to the organization from finding errors. Furthermore,
the cooperation between the external and internal auditors is necessary
to ensure the most appropriate coverage of all major systems, and
more effective reporting of results.
On the one hand, the role of internal audit function is rapidly changing,
at the same time, there are barriers and challenges faced by it. Shikati
(2017) points out that finding right talent, matching the skills of internal
viii Preface

audit with organization needs, rendering additional value, use of technology

and gaining trust with auditee and stakeholders are major challenges. In
this regard, Financier Worldwide Magazine (2016) states that:
“As companies look to rebuild trust in their operations, one of
the most powerful and important weapons in their arsenal is the
internal audit”.
A deep knowledge of the organization, its culture, auditing, key
players and competitive environment, enhances creativity to adapt
innovations to the organization and adds value in the changing role
of an IAF. However, internal auditors have to maintain their
independence and operate objectively in making unbiased judgement
and decisions which are often questioned by the stakeholders. In fact,
today, this is one of the barriers faced by IAF.
FOCUS OF THE BOOK
The role of internal auditing has been transforming in organizations
and its acceptability has increased among stakeholders in protecting
their interests. The internal auditing profession has to know, understand
and embrace the new avenue taking place in their profession. An
attempt is made through this edited book to provide a comprehensive
study on the role and the changing role of internal auditing in
organizations. This book is brought out with an intention to discuss
and analyze the various issues and challenges that the internal auditing
profession are confronting today with opportunities to resolve them.
It discusses some examples, short cases, practitioners’ practices,
review of research studies and how the role of internal auditing is
shaping and transforming impacting the profession deeply.
TARGET AUDIENCE
This is a reference book which intends to serve a much broader
audience including practitioners, working professionals in the field of
internal auditing, researchers, academics and advanced students. The
book would be equally of interest and useful to auditing firms,
regulators and standard setters.
CONTRIBUTORS
Chapter One titled “Organizational Culture and Role of Internal
Audit” is penned by an audit practitioner T.N. Menon. He argues
that unhealthy organizational culture has been widely accepted to be
the root cause of corporate scandals which brought the corporate
Preface ix

governance to sharp focus in order to strengthen it. This chapter

examines the key components of corporate culture that differentiates
healthy and unhealthy cultures and goes on to identify the major
characteristics of both types. It examines various ways in which IA
can fulfill this role effectively and outlines the principles and
methodologies for auditing culture. He discusses two approaches to
auditing culture, namely integrated and targeted approaches are
discussed. How the auditors can add value to the organization and
identifies the attributes auditors need to possess to perform culture
audits are also discussed in this chapter.
Chapter Two titled “Internal Auditing, Organizational
Independence and Management support” is authored by Mansur
Lubabah Kwanbo and Hauwa Audu Galadima. They state that
addressing all kinds of risk by the internal audit has always been
dependent on the extent to which the entire organization and management
creates autonomy and grant authority to support the internal audit
activities and the roles the internal auditor plays in issues and crisis
situation. Furthermore, several factors are considered of utmost
importance for the organization and management to implement its risk
management process, this makes the audit risk based internal auditing.
Chapter Three titled “The Changing Role of Internal Auditor As
Assurer, Assessor and Advisor” is written Prem Lal Joshi and
Sadiksha Acharya. The objective of this chapter is to provide
insights into the changing role and functions of the IA in terms of
internal control, corporate governance, fraud detection and
prevention, risk assessment and management, cyber security risk,
integrated reporting, role in achieving organization goals and
objectives and accountability. Through a questionnaire survey, the
findings reveal that internal auditors extensively participate in risk
management and consulting services.
Chapter Four titled “The Advanced Role of Internal Audit as
Advisors” is authored by Suhaily Shahimi. She posits that internal
audit (IA) is considered as an enabler of business performance and
provider of knowhow that can ensure the support of business
objectives. Internal auditors’ detailed knowledge of the company can
position themselves as advisors when there is a necessity to utilize
the collective information gained during the audit to enhance the
organization. In this respect, internal auditors can play a proactive role
in supporting the board and the management team as an advisor. The
advisory activities implemented are mostly informal and/or on an ad-
x Preface

hoc basis. The issue of independence of internal auditor can be reduced

by reporting directly to the audit committee (functional level) and to
senior management (administrative matters).
Chapter Five titled “An Evaluation of Determinant Factors
in External Auditors’ Reliance on Internal Auditors: The Case of
Iran” is well attempted by Ashkan Mirzay Fasham. He investigates
the relationship between internal and external auditors and aims to
discover the factors that influence external auditors’ reliance on
internal auditors in Iran. Results show that three recognized
factors, namely internal auditors’ competence, objectivity, and
work performed, are less critical in external auditors’ reliance on
internal auditors in Iran. But risk factors havea major influence on
external auditors’ reliance.
While, Chapter Six namely “Internal Auditor and Fraud
Detection” is authored by Ajay Kumar Jain. He states that
significance of good internal control mechanism, governance and
audit has been evolving and Internal audit is the major part of all these
changes. Critical implication of frauds is happening within the
organization. His chapter evaluates and assesses the role of internal
auditor in detecting the possible fraud within the organization,
also highlights the history of frauds and recommendation by the
internal auditors in preventing the frauds.
Chapter Seven titled “Blockchain and Internal Auditing”
authored by Suzan Dsouza. She states that Blockchain systems
as emerging technology is expected to be the future of the digitalera
and it will also reshape the internal audit functions in the
organizations. This chapter discusses few general insights on
Blockchain technology and the extent to which it might influence and
transform the internal auditing system.
Chapter Eight titled “Impact of Blockchain on Internal Controls”
is written by Saravanan Muthaiyah. He argues that with recent
development of digital technologies, a new ecosystemis emerging
with the promise of a new value proposition that ensures better
provenance, controls and compliance. Blockchain technology allows
a shared consensus distributed ledger system that is immutable and
built upon principles of trust. Uninterrupted by human tampering the
distributed hyper ledgers in the Blockchain are immutable and
insurmountable thus preventing fraudulent entries that cannot be
committed without consent from process owners
Preface xi

at the same time. His chapter discusses how Blockchain

technology ensures true and fairness of reporting with internal
controls based on the concept of segregation of duties. A loan
approval use case is also presented in this chapter.
Chapter Nine titled “The Role of Auditing in Corporate
Governance “is authored in a detailed manner by Anbalagan
Krishnan and Selvi Narayanan. Their chapter is an exploration into
the world of auditing and corporate governance. It discusses the
concept of the auditing and corporate governance, types of auditing,
the importance of auditing and corporate governance, auditing
standard, corporate governance theoretical aspects, principles of
corporate governance and the role of internal auditing in corporate
governance. The chapter presents the material in a logical order with
convincing evidence related to the concept of auditing and corporate
governance.
Chapter Ten namely “The Evolving Role of Internal Auditing
and Corporate Governance” is authored by Jamel Azibi, Hanen
Amri, Ali Khelifi, and Riadh Gharfatta. They argue that audit
is an important mechanism of corporate governance. Internal auditing
is an important dimension of Section 404 of Sarbanes- Oxley Act and
PCAOB Standard No. 5.This chapter discusses the evolving role of
the internal auditing and corporate governance during the last
decades by supporting data. Results demonstrate the increasing
adoption of Sox requirements through the world. Furthermore, the
role of auditing in corporate governance through theories and the
relation between internal auditing and corporate governance
technology are also discussed.
Dr. Prem Lal Joshi
REFERENCES

Betti, N. & Saren, G., (2020). Understanding the internal audit function in a
digitalized business environment, Journal of Accounting & Organizational
Change. Retrieved on 16 February 2021 from: https://www.emerald.com/
insight/content/doi/10.1108/JAOC-11-2019-0114/full/html.
Financier Worldwide Magazine, (2016). The role of the internal audit. Retrieved
on 16 February 2021 from: https://www.financierworldwide.com/the-role-
of-the-internal-audit.
Cox, G., (2007). Going up, The Internal Auditor, 64(4) ABI/INFORM Global, pp
72-77.
Shikati, C., (2017). Challenges of internal audit. Retrieved on 16 February 2021
from: https://medium.com/@cshikati/challenges-of-internal-audit-
b0c2006147d7.
 Acknowledgement

In bringing out this edited book, we have received

help, support and encouragement from a number
of people. One person needs to be mentioned in
particular, is Prof. Dr. Ashutosh Deshmukh from
USA who has written a foreword for this book
and he has been instrumental in motivating us to
contribute in bringing out such a book on internal
auditing. We are highly indebted to him.
Additionally, we are indeed very grateful to all the
contributors who kindly agreed to our requests
to contribute chapters for the book and completed
their chapters before the deadline. They devoted
their valuable time from their professional
activities and family affairs, in completing the
chapters, which is highly appreciable. We are
very thankful to selected anonymous reviewers
for providing their comments. Our family
members also deserve appreciation for their
patience and providing useful tips. Last but the
not least, we highly appreciate to the publishers
Northern Book Centre, Delhi, for kindly agreeing
and putting their hard work in publishing this book.

Dr. Prem Lal Joshi

Dr. Suzan D’souza
 Contents

1. Organizational Culture and Role of Internal Audit 1

T.N. Menon
Abstract 1
1. Introduction 2
2. What is organizational culture? 3
2.1. The Main Components of Organizational Culture 3
2.2. Characteristics of a Healthy Organizational Culture 5
2.3. Characteristics of an Unhealthy Organizational
Culture 6
3. Role of Internal Audit 7
3.1. What can and should IA do? 8
4. Auditing culture 9
4.1. Approaches to auditing culture 10
5. Value-adding role of IA 16
6. Attributes required for auditors 17
7. Conclusion 17
References 18
2. Internal Auditing, Organizational Independence
and Management Support 19
Dr. Mansur Lubabah Kwanbo • Hauwa Audu Galadima
Abstract 19
Introduction 20
Internal Auditing 22
Risk-based internal auditing 22
Risk management process 23
Advantages of risk-based internal auditing 23
Organizational Independence 24
Management Support 25
Conclusion 29
References 29
3. The Changing Role of Internal Auditor as Assurer,
Assessor and Advisor 33
Prof. Dr. Prem Lal Joshi • Sadiksha Acharya
Abstract 34
1. Introduction 35
2. Theoretical Perspective 37
xiv Contents

2.1. Internal Auditing and Assurance 38

2.2. Internal Auditing and Assessment 52
2.3. Internal Auditing and Advising or Consulting 59
2.4. Role of Internal Auditing and Accountability 66
3. Survey Results 69
4. Conclusions and Implication 76
4.1. Current and Future Role of Internal Auditing 78
References 81
4. The Advanced Role of Internal Audit as Advisors 91
Dr Suhaily Shahimi
Abstract 91
1. Introduction 92
2. Definition and Underlying Theory 94
3. Advanced Role of Internal Audit as
Advisors – Nature and Extent 96
3.1. Reasons for Internal Auditors Performing
Advisory Role and the Level of Independence
and Objectivity when Performing such a Role 97
3.2. Factors Influencing Advisory Role of
Internal Auditors 99
4. Conclusion 101
References 102
5. An Evaluation of Determinant Factors in External
Auditors’ Reliance on Internal Auditors:
The Case of Iran 104
Dr. Ashkan Mirzay Fashami
Abstract 104
1. Introduction 105
2. Literature Review 106
2.1. Internal Auditors’ Competence 106
2.2. Internal Auditors’ Objectivity 107
2.3. Internal Auditors’ Work Performed 107
2.4. Risk Factors 107
2.5. Internal Auditors’ Related Factors 108
2.6. Internal Audit Departments’ Related Factors 109
2.7. Auditees’ Related Factors 110
3. Research Design 111
4. Preliminary Findings 112
4.1. Internal Auditors’ Competence 112
4.2. Internal Auditors’ Objectivity 112
4.3. Internal Auditors’ Work performed 112
4.4. Risk Factors 112
4.5. Internal Auditors’ Related Factors 113
4.6. Internal Audit Departments’ Related Factors 113
4.7. Auditees’ Related Factors 113
5. Main Findings 113
5.1. Internal Auditors’ Competence 114
5.2. Internal Auditors’ Objectivity 114
5.3. Internal Auditors’ Work Performed 114
Contents xv

5.4. Risk Factors 114

5.5. Internal Auditors’ Related Factors 115
5.6. Internal Audit Departments’ Related Factors 115
5.7. Auditees’ Related Factors 116
5.8. Discussions 116
6. Conclusions 116
6.1. Recommendations 117
References 118
6. Internal Auditor and Fraud Detection 123
Ajay Kumar Jain
Abstract 123
1. Introduction 124
2. Internal Auditor 125
2.1. Main Objectives of Internal Audit 126
2.2. Qualification and Competency of Internal Auditor 126
3. Fraud 127
3.1. Examples of fraud 127
3.2. History of Frauds 128
3.3. Detection of Fraud and Role of Internal Auditor 130
3.4. Prevention of Fraud 132
4. Literature Review 133
5. Conclusion 135
References 136
7. Blockchain and Internal Auditing 138
Dr. Suzan DSOUZA
Abstract 138
Introduction 139
Blockchain, Basic Technical Aspects and
Literature Review 140
Potential Influence of Blockchain Technology in
Accounting 141
Distributed Consensual Accounting
Records (DCAR) 141
Blockchain and Triple-entry Book Keeping 142
Influence of Blockchain Technology on
Internal Audit 142
Conclusion 147
References 147
8. Impact of Blockchain on Internal Controls 150
Prof Dr. Saravanan Muthaiyah
Abstract 150
1. Introduction 151
2. Key pillars in Accounting 152
2.1. Compliance 152
2.2. True and Fairness 153
2.3. Trust 153
3. State chart workflow for Internal Controls 155
4. Risk Graphs and Role Functions 157
xvi Contents

5. Conclusion and Future

Work
159
References

160
9. The Role of Auditing in Corporate
Governance

161
Dr Anbalagan Krishnan • Selvi Narayanan
Abstract

162
1. Introduction
162
2. Auditing
168
2.1. Audit
Evolution
169
2.2. Concept of
Auditing
169
2.3. Definition of
Auditing
170
3. Types of
Auditing
170
4. Internal
Control
173
4.1. Internal Control
Objectives
173
4.2. Components of Internal
Control
174
5. Internal
Check
176
6. Internal
Audit
178
6.1. Types of Internal
Audits
 179
6.2. Process of Internal
Audit
180
7. Auditing
Standards
180
8. Corporate Governance
Concept
181
8.1. Key Elements of Corporate
Governance
184
8.2. Corporate Governance Theoretical
Aspects
184
8.3. The Growth of Corporate Governance
Codes
185
8.4. Development of Corporate Governance Code
UK
185
8.5. OECD
Principles
185
8.6. World
Bank
185
8.7. Global Corporate Governance Forum
(GCGF)
186
8.8. Commonwealth Association for
Corporate Governance
(CACG)

186
8.9. US Corporate
Governance
186
8.10. The Finance Committee Report on
Corporate Governance,
Malaysia

187
9. The Role of Auditing & Auditor in Corporate
Governance
187
9.1. The Role of Internal Auditing in
Corporate
Governance

188
9.2. The Role of External Auditing in
Corporate
Governance

188
10. Conclusion
 190
References

191
10. The Evolving Role of Internal Auditing and
Corporate
Governance

194
Dr. Jamel Azibi • Hanen Amri • Ali Khelifi, CPA, Tunisia
Abstract

195
1. Introduction
195
2. The Scandal Series of 2001-2002:
Accelerator of Internal Auditing
Reforms
196
3. Internal Auditing and Corporate Governance
Technology
205
4. Conclusion
205
References

206
 The Role of Auditing in Corporate Governance 161

CHAPTER 9

The Role of Auditing inCorporate Governance

Dr Anbalagan Krishnan
Associate Professor
Wawasan Open University, Malaysia
Email: [email protected]; [email protected]
(*Corresponding author)
and
Selvi Narayanan
Senior Lecturer
MAHSA University, Malaysia
Email: [email protected]

Dr Anbalagan Krishnan is an Associate Professor of Accounting

at Wawasan Open University Malaysia. Previously, he has worked
with Curtin Unversity, Malaysia for several years. He was a Dean
at AMU (University), Malaysia. He is a member of CPA (Australia)
and MICPA (Malaysia) and has PhD in Accounting. He is a Certified
Trainer with Ministry of Human Resource Malaysia. He presented
number of research papers in accounting at reputed international
conferences organized at countries like Hong Kong, Singapore, India,
Australia and Malaysia. He has published extensively in accredited
international journals. He received several national, international and
industrial grants. He is on the Editorial Board of several international
journals.
Selvi Narayanan, is currently a Senior Lecturer at the Faculty of
Business, Finance & Information Technology, Mahsa University,
Malaysia. She obtained Mster degree in Public Management from
UUM, Malaysia. She also received her Postgraduate Certificate in
Teaching Methodology from Asia Metropolitan University, Malaysia.
 The Role of Auditing in Corporate Governance 162

She has teaching experiences of more than twelve years . She is also
actively involved in research activities and has published manyresearch
papers in conference proceedings and accredited journals.

ABSTRACT
Audits and auditors are the first and foremost to provide contentment
to shareholders and investors on the integrity and quality of a
company’s financial statements. Auditing plays an important role in
monitoring contracts and reducing the information risk and without
an external audit the accounting information used for decision-making
by several internal and external parties lacks of credibility. External
auditing has emerged from an ordinary checking of the books of
account to a vital part of the governance process of corporations. This
chapter is an exploration into the world of auditing and corporate
governance. Discussion is mainly focused on the concept of the
auditing and corporate governance, types of auditing, the importance
of auditing and corporate governance, auditing standard, corporate
governance theoretical aspects, principles of corporate governance
and the role of auditing in corporate governance. Information is
gathered from several resources, especially from literature
research in order to have clear history of auditing and corporate
governance. The information and facts in this chapter has been
presented in a logical order, with simple language, convincing with
evidences and easy to understand especially for those readers who are
at the beginner stage of understanding the concept of auditing and
governance.
Keywords: Corporate Governance, Auditing, Role of Auditor, Audit Evolution
and Internal Control

1. INTRODUCTION
Across the globe, the role of auditing and governance is of increasing
significance. Corporate governance deals with auditing and it isimportant
to consider how businesses are influenced by all of these factors. If good
governance is a replacement for auditing or a supplement is also an
argument-related concern. The partnership between governance and
auditing was concluded by a number of recent literature studies, including
audit boards, external audit and internal audit (Hay et al., (2017). They
inferred from research undertaken in Australia and New Zealand that,
considering its extensiveness, there is still significant confusion regarding
how
 The Role of Auditing in Corporate Governance 163

auditing is related to corporate governance processes and how auditing is

related to corporate governance.
On top of that, in conventional analysis, there are few corporate
governance viewpoints. Based on previous studies in accounting,
economics and strategy, Cohen et al., (2000) states that there are three
perspectives on corporate governance. Firstly, it applies tothe theory of
agencies from the point of view of accounting and finance and (Beatty &
Zajac, 1994; Bathala & Rao, 1995; Core et al., 1999). This view suggests
that, even though this is harmful to shareholders, management behave out
of self-interest.
The philosophy of corporate governance, meanwhile, focuses largely
on the nature of contractual structures for managing self- interested
management actions. The second view was drawn from management
literature focused on the view point of resource dependency (Pfeffer &
Salancik, 1978; Boyd, 1990). Management is regarded in this respect as
dependent on the board of directorsfor access to limited data and other
services (Pfeffer & Salancik, 1978; Boyd, 1990), as well as helping to
assess the company’s strategic path (Williamson, 1999). In this perspective,
the primary role of the board of directors often changes from being a
monitor, as in the view of the agency, to working collaboratively to set
policyand plans for management. The board of directors also works on
discovering new goods, opportunities and innovations and helping to
implement the business strategy for management (Boyd, 1990).
Therefore, in the resource dependency viewpoint, the most important
qualities of a board member are business experience,knowledge, and the
capacity to have access to external services (Cohen et al. 2000). Corporate
governance’s new perspective centerson managerial hegemony (Galbraith,
1967; Wolfson, 1984; Kosnick, 1987), where corporate governance is
viewed as an inevitable nuisance. And it is seen as inadequate for control and
merely symbolicin terms of management supervision. As a consequence,
executive management prefers associates and relatives to be members of
the board of directors rather than appointing neutral directors (Patton&
Baker, 1987). The board of directors are inactive actors in the governing
process and depend on the management of the business for information on
the company and its field (Wolfson, 1984).
However, there has been comparatively little study on the role of
auditing in corporate governance, and research has focused more on how
auditing is influenced by corporate governance, rather than
 The Role of Auditing in Corporate Governance 164

how auditing impacts corporate governance. Analysis by Cohen and

Hanno (2000) investigated, for example, how auditors take corporate
governance into account when planning an audit, finding that auditors were
considered to have lower audit risk by auditors in companies with
independent boards or directors and auditcommittees.
Although it is assumed that a good governance mechanism tends to
mitigate audit risk and that auditors are obviously able to access the
consistency of a company’s corporate governance and to changetheir audit
effort accordingly, it should be noted that previous research on the
relationship between auditing and corporate governance suggests that the
aim of both is generally, there is no recognition of larger social stakeholder
communities, even though they might be a tacit belief in this research line
that improving audit efficiency wouldfavour stakeholders and the wider
community.
The details of corporate governance have been the subject of several
controversies over the past few years (Forker & Green, 2000;O’Sullivan,
2000; Shleifer & Vishny, 1997; Solomon et al., 2000; Rosanstein & Wyatt,
1990). Nevertheless, the plan for better corporate governance that sets
limitations on top management rightshas always been an obstacle, such as
harming economic efficiency, encouraging state micro-management, and
even open capital markets(Jensen, 2001).
In at least four areas, however, attempts to change corporate
governance have arisen, including the organizational structure of theboard
of directors (O’Sullivan, 2000), the role of audit committees and restricting
the membership of audit committees to independent directors (Rosenstein
& Wyatt, 1990), the appointment of external auditors by the board of
directors’ audit committees (Cohen et al., 2000), and the selection of
external auditors by the board of directors’audit committees (Cohen et al.,
2000) (Colvin, 2001). Unfortunately, top executives have always
maintained the power to ignore thepurpose of these proposals because these
recommendations for better corporate governance were put forward as
proposals for “best practices” rather than legislative criteria (Cadbury
Committee, 1992; ICAE&W (The Turnball Report), 1999; OECD, 1999).
The historical interpretation of the arrangement between owners,
auditors and shareholders in limited liability corporations under British
corporate law in the past, according to Napier (1997), was that all these
parties were employees of the same company. According to
 The Role of Auditing in Corporate Governance 165

this corporate governance principle, the financial statements was given to

shareholders by supervisors, some of whom were chosen to audit the
managers’ operations
The Company

Shareholders Managing Directors

Auditors The Enterprise

Figure 9.1: Auditors and organization structure

Source: Watts & Zimmerman (1983); Napier (1997)

Following to the understanding, shareholders might be managers

at certain times and at other times they might be auditors and then
return to being only shareholders.
Furthermore, the basis for the present interpretation of the role of
auditing in corporate governance is provided by corporate and
corporation rules. Based on this, financial reports are required by
statute to be provided to shareholders on a quarterly basis. These
reports shall consist of mostly of financial statements compiled in
compliance with certain requirements, the financial statements shall
be audited (checked by individuals appointed or approved by law),
the owners shall not be deemed to be part of the corporation and shall
have no way of explicitly assessing the authenticity of the financial
report sent by the management to them.

The Company

Financial
Shareholders Management The Enterprise
Statements

Auditors

Figure 9.2: Auditors roles

Source: Napier (1997); EC Commission (1978)
The Role of Auditing in Corporate Governance 166

The constitutionally specified role of the auditor is to express

an opinion as to whether the financial statements present the financial
condition and performance of the company’s activities equally. In
most industrialized capitalist nations, this is the current agreed
interpretation of the role of auditing in corporate governance.
Two challenges or complications with the model are concerned.
First, audited financial statements are socially created goods that
represent a term called economic “reality” that is poorly understood.
The uncertainty of this description gives executives tremendous leeway
to theoretically deceive investors. The second challenge is that the
auditors are subject to tremendous control from the company’s audit
managers (Tinker, 1991; Byrne, 1998). They must gain access to the
accounting process and other related records prepared under the
guidance of management for them to receive and appreciate the
financial position of the company. Therefore, the problem of auditors
where they need to gain the company’s management support and its
control leads to their freedom being included.
In corporate governance, there is a need to consider the existing
and new position of auditing. Actually, corporate and legislation-agreeable
quarterly accounts are provided to shareholders by management during
a period spanning from several weeks to several months at the
completion of an accounting period. It is also clear that stock markets
do not make trading arrangements using audited financial statements.
Data reveals that investment decisions are taken on the basis of unaudited
interim income announcements, forecasts of financial experts, and data
collected privately (William, 1996). The recognition widely agreed of
the role of auditing in corporate governance does not reflect reality.
Financial Analyst and
other information providers

The Company
Shareholders

Management The Enterprise

Financial
Reports
Auditors

Figure 9.3: Auditors function in the organization

Source: William (1996); Frost & Pawnall (1996)
The Role of Auditing in Corporate Governance 167

Institutional investors are able to report directly from

management rather than by audited financial statements (Holland,
1995). Large investors will place pressure on top management to
pursue policies that strengthen these major investors’ economic role.
The role of corporate governance in auditing is to strengthen
management controls and practices in order to help CEOs optimize
their companies’ economic efficiency for the good of existing
management and other significant shareholders (Cadbury Report,
1992; EC Commission, 1997; Elliot, 1994). The auditor’s location
in close proximity to management suggests that the auditor does not
work in the manner mentioned in figure 9.3.
But in addressing the current position for auditing in corporate
governance, there are some arguments going on. The point that the
role of auditing incorporates governance should not need to be taken
into account beyond the narrow limits of decision-making by
investors, but should be viewed in relation to the larger interests of
different stakeholder groups and society in general. For a broader
spectrum of stakeholder reporting, these claims are associated with
Sutton and Arnord (1998) and related arguments by Roberts (1998)
and Gray (1998) for greater openness and disclosure in order to
improve public influence over businesses.
These claims are based on the paper prepared by the Institute
of Chartered Accountants in Scotland (ICAS) and Auditing into the
Twenty-first Century (Mclnnes, 1993). In addition, the ICAS paper
recommended that the audited financial statements should contain
guarantees as to: (1) that the financial statements present a fair
picture of the financial condition of the entity; (2) that the
company did not fail; (3) that there has been no fraud; (4) that the
company has been impaired by the law; (5) that the company has been
handled competently; and (6) that the company has not been affected
by the law; and (6) that the company has been managed competently.
The ICAS paper also raised the question of the integrity of the
auditor and argued that the auditors should: (1) be independent of
the audited business management; (2) be responsible for reporting
to a third party if they believe that managers are engaging in bribery
or other criminal activities; (3) be accountable to a wide variety of
stakeholders; and (4) be financially responsible if they fail to fulfil
their duties. It also argued that in these fields there is a lack of the
currently established paradigm of the role of auditing in corporate
 The Role of Auditing in Corporate Governance 168

governance and suggested the creation of a clear internal feature asbelow.

Supervisory
External
Auditors

Management

Accountability

Figure 9.4: External and internal auditor

Source: McInnes (1993); Schilder (1996)

One of the most significant qualities of the auditor’s career is

freedom. The investor depends on management data concerning the
company’s financial status. Managers are responsible for uploading
the consistency of the revenues and development of the business. The
customer is interested in ensuring that the company is in the right
place to determine whether or not to continue investing in the
company. Therefore, to shield taxpayers from the self-interest of
management, an agent (the auditor) participated. Corporate
governance guarantees that all of these processes conform with
openness and integrity procedures and regulations.
With this in mind, the aims of this chapter are to address the
importance of auditing and corporate governance from different
viewpoints and backgrounds in depth. In addition, this chapter would
provide a detailed overview of the forms of audits and the significance
of corporate auditing and governance. The goal is also to distinguish
between internal monitoring, internal audits, and internal audit
principles. In addition, this section has addressed the analytical
dimensions of auditing and corporate governance with evidence from
the previous review of literature. It also addressed in depth the role
of auditing and auditing in corporate governance.

2. AUDITING
Audits are meant to comfort shareholders or customers on theaccuracy and
consistency of the financial records of a corporation.
 The Role of Auditing in Corporate Governance 169

In theory, however, auditors still work hand in hand with regulators to

provide capital markets with prudential supervision. This balance of
priorities demands from the accountancy profession a much widerviewpoint
that it did 20 years ago. External auditing has grown froma regular review
of ledger to a critical feature of corporate governanceprocesses.
The changing role of the registered auditing profession has been
dramatically impacted by factors such as the scale of transactions,
information technologies, globalization and the relentless rise in the
complexity and number of rules, regulations and requirements
regulating organization and their auditors.

2.1. Audit Evolution

The term ‘auditing’ has derived from the word ‘Audire’ in Latin, meaning
‘to hear’. Dixie defined conventional auditing as a review of financial
documents conducted to ascertain if the execution ofthe operation was
accurately reflected for the relevant reason. In the meantime, the auditor
frequently shares his opinions on the financial essence of the statement of
accounts drawn up from the accounting documents in order to evaluate
whether they reflect an accurate and realistic interpretation of the financial
statements.

2.2. Concept of Auditing

Concept of Auditing dates back to ancient Egyptian, Roman and Greek
Civilization, where commercial transactions were systematically
checked and re-check by financial administrators. Pre-Vedic literature in
India refers to the presence of a well-developedaccountancy system. Present
auditing has come a long way from conventional auditing requiring the
vouching of all sales, the checking of ledger posting, comprehensive record
verification, subsidiary books and key entry books.
We need audit and auditors because we want some assurance and
confidence that the companies that we invest, bank that we keepour money,
pension funds at government firms and many othercapitals have been
use as the way it ought or should be used.
Audit is a type of assurance. All large companies and firms’ operations
need audit and auditors as their directors need assurance that all the
company assets and resources for which they are accountable are well
managed. They do not totally rely on theemployees report as they can make
mistakes unintentionally or
 The Role of Auditing in Corporate Governance 170

intentionally. Hence, an independent view is seeming to be more objective,

reliable, accurate and critical. Companies like education institutions, health
industries and other industries have internal audit functions for these
reasons. And some of these industries also have external audits which are
subject to independent regulatory oversight as not only directors need
assurance but also the people and public.

2.3. Definition of Auditing

In the modern world, business firms have expanded and diversified their
operations. Fast development of communication technology has made the
transactions through internet across the world. Use of paperwork also has
reduced greatly. Hence, it is impossible to apply the traditional methods of
auditing.
Auditing is the accumulation and review of information facts for
the calculation and reporting of the degree of correspondence between
the information and the requirements set. Auditing should be carried
out by an impartial, professional individual called an auditor.
“Auditing is concerned with the verification of accounting data,
with determining the accuracy and reliability of accounting
statements and reports”.
– R.R. Moutz
In a nutshell, auditing is a method to review and monitoring the financial
related matters in the organizations to testing the reliability, competency
and adequacy of evidence in support of monetary transactions.

3. TYPES OF AUDITING
Audit can usually be broken into two forms, internal audit and external
audit. Employees or heads of a single agency may carryout an internal
audit. Whereas an outside company or an independentauditor may carry out
an external audit. The goal is to audit and verify the records by an
independent body in order to ensure that all recordbooks are checked in a
correct way and there is no misinterpretationor deception being carried out.
Certified accountants perform three
(3) primary types of audits which are Operational Audit, Compliance
Audit and Financial Statement Audit.
Operational Audit
Operational Audit evaluates the efficiency and effectiveness of any part of
an organizations operating procedures and methods. It is a
 The Role of Auditing in Corporate Governance 171

detailed analysis of the goals, planning processes and results of the

operations of a business. It can be conducted internally or by an external
party. The purpose of the audit is to improve the organization operating
procedures and methods to be more effective.
Compliance Audit
The aim of this audit is to decide if the auditor is compliant with specific
policies, regulations and compliance with internal or regulatory
requirements provided by the higher authority. In managed businesses or
educational institutions, these modes of audit are mostcommonly used.
Financial Statement Audit
An analysis of the financial records is carried out to decide if the financial
statements on which the material is checked are published in compliancewith
the standards stated. In general, it is carried out by a CPA company, who is
independent of the organization under investigation and is therefore the most
frequent form of audit carried out.
Advantages of Auditing

To the Business To the Owners To the Outsiders

Exhibit a true and Sole proprietors Creditors
fair view Partners Banks and
Detection and Shareholders financial
prevention of Trustees and institutions
errors and frauds co-operative Insurance
Expert advice members companies
Check on Statutory
employees authorities
Resolving Prospective
disputes investors
Determination of
claims
Helps in obtaining
loan
Helps in decision-
making
Determining
future trends
Increases

Figure 26: Advantages of auditing

 The Role of Auditing in Corporate Governance 172

172
Table 9.1: Examples of the Three Types of Audits

Type of Audit Example Information Criteria Established Available Evidence

The Changing Role of Internal Audit Function in Organizations

Operational Audit Evaluates whether the Number of payroll records Company standards for Error report, payroll records,
computerized payroll processed in a month, costs efficiency and effectiveness and payroll processing costs
processing for a Malaysian of the department, and in payroll department
subsidiary is operating number of errors made
efficiently and effectively
Compliance Audit Determines whether finance Company records Loan agreement provisions Financial statements and
institute requirements for calculations by the auditor
loan continuation have
been met
Financial Statement Annual audit of Air Asia’s Financial Generally accepted Documents, records, and
Audit AirAsia’s financial statements accounting principles outside sources of evidence
statement
 The Role of Auditing in Corporate Governance 173

4. INTERNAL CONTROL
Internal management is an interlocking collection of operations that are
layered into an organization’s standard operating procedures in order to
secure properties, reduce errors and ensure that operations are carried out
in an approved manner.

4.1. Internal Control Objectives

An internal control structure consists of policies and procedures designed
to offer fair confidence to management that the organizationis meeting its
targets and objectives. Sometimes referred to as commands, they make up
the central security of the company collectively. In developing an efficient
internal management scheme,the firm ultimately has three (3) broad
objectives:
(a) Reliability of Financial Reporting. Management is responsible
for preparing documents for clients, creditors, and all
consumers and is responsible for ensuring that the material is
reasonably provided in compliance with the reporting provisions
of the accounting process, both legally and professionally.
Therefore, meeting these financial reporting obligations is the
purpose of successful internal regulation over financial
reporting.
(b) Efficiency and Effectiveness of Operations. Controls within an
enterprise promote productive and efficient usage of its
purposes to refine the company’s objectives. Internal
management guarantees detailed financial and non-financial
details regarding the decision-making practices of the
organization.
(c) Compliance with laws and regulations. Many laws and
legislation are expected to be implemented by governmental,
non-public, and not for profit organizations. Some apply
implicitly to accounting, such as civil rights law, and others are
closely connected to regulatory laws such as anti- fraud.
In order to meet these three aims, management constructs mechanisms
of internal control. In both the audit of financial statements and the audit
of internal controls, the auditor’s attention is on controls over the
transparency of financial reports and operations controls and compliance
with laws and regulations.
 The Role of Auditing in Corporate Governance 174

4.2. Components of Internal Control

Management developed and executes five (5) components of internalcontrol
to provide reasonable assurance in order to control objectiveswill be met.
There are several restrictions in each component, but auditors focus on
those intended to avoid or identify material misstatements in the financial
statements.

Control Environment

Risk Control Information and

Monitoring
Assessment Activities Communication

Figure 9.6: Component of internal control

The internal components are as follows:

(i) Control environment
(ii) Risk assessment
(iii) Control activities
(iv) Information and communication
(v) Monitoring
Control Environment
The control climate consists of actions, policies and practices that represent
the general attitudes of an organization’s top managers, directors, and
owners regarding internal control and its relevance to the entity. Auditors
should recognize the most relevant managementsub-components, which are
honesty and ethical principles, adherenceto excellence, and involvement of
the director’s board or audit committee, to understand and analyses the
control environment.
Risk Assessment
The risk evaluation for financial reports consists of defining and evaluating
the risks related to the production of financial statements by management
in compliance with appropriate accounting practices. Examples of causes
which contribute to increased risk include surplus inventory, inability to
achieve prior targets, employee quality, regionaldispersion of organization
activities, importance and sophistication
 The Role of Auditing in Corporate Governance 175

of key business processes, implementation of modern information systems,

economic downturns, and entry of new competitors. If a risk is defined by
management, it estimates the importance of the risk, assesses the possibility
of the risk happening, and develops concrete steps that need to be taken to
decrease the risk to anappropriate degree.
Control Activities
Policies and protocols, and those found in the other four control elements,
are monitoring activities that help ensure that the appropriatesteps are taken
to resolve the challenges to the accomplishment of the goals of the
agency. Generally, the monitoring tasks fell into the following types:
(a) Adequate separation of duties is to avoid of all fraud and
mistakes is particularly relevant for auditors.
(b) Proper authorization of transactions and activities to ensure
that, if controls are to be satisfactory, any activity is properly
approved. There are two types of consent, general permission,
and particular permission.
(c) Adequate documents and records, the map of accounts, which
classifies transactions into individual balance sheet and income
statement accounts, is a control directly linked to paperwork
and reports and this is useful in avoiding classification mistakes
if it explains correctly what form of transactions may be in each
account.
(d) Physical control over assets and records, Assets and documents
must be secured to ensure proper internal control. They can
be robbed if assets are left untouched, even if the records are
adequately secured, they can be stolen, destroyed, changed,
or lost, which can severely interrupt the accounting and
business management process.
(e) Independent checks and performance to check and assess
employee performance by independent personnel
Information and Communication
This framework is intended to initiate, register, process and report the
transactions of the company and to maintain responsibility for the relevant
properties. The auditor decides: (1) the entity’s main classes of transactions
to explain the architecture of the accounting information system; (2) how
such transactions are initiated and
 The Role of Auditing in Corporate Governance 176

recorded; (3) what accounting documents occur and their nature;

(4) how the system collects other activities that are relevant to the
financial statement; (5) the essence and specifics of the method of
financial statements followed.
Monitoring
The monitoring activities deal with the management’s continuing or
occasional quality review of internal controls in order to evaluate that the
controls are working as expected and that they are tailored tosuit changes
in circumstances. To be successful, personnel outside of both the
administrative and accounting divisions must conductthe internal audit
function and report directly to a high level of executive authority, either
senior management or the audit committeeof the board of directors.

5. INTERNAL CHECK
Internal check is an arrangement of the duties of the staff members of the
accounting functions in such a way that another automaticallychecks the
work performed by a person.
“A system of internal check is an arrangement of staff duties,
whereby no one person is allowed to carry through and to record
every aspect of a transaction so that without collusion between
two or more persons, fraud is activated and at the same time
the possibilities of errors are reduced to the minimum”.
– Spicer & Pegler
“Internal check is such an arrangement of book-keeping routine
that errors and fraud are likely to be prevented or discovered
by the very operation of the book-keeping itself”.
– L.R. Dicksee
Meantime, internal checks means practically a continuous internalaudit
carried on by the staff itself, using other members of the staff
independently check the work of each individual.
Internal control is defined by the Institute of Chartered Accountants
of England and Wales (ICAEW) as “checks on a day- to-day transaction
that continually runs a part of the routine framework where the work of
one person is proven independentlyor in addition to the work of another,
the purpose is to avoid or identify errors or fraud early”.
The Role of Auditing in Corporate Governance 177

Furthermore, an internal audit is an ongoing procedure that is

part of the everyday routine. It also applies to all the purchases that
exist every day. A complementary allocation of duties and impartial
checking of the function of one individual by another are used to
carry out an internal search.
In order to make internal check system more effective and
efficient, certain features are needed, which are as follows:
(i) Division of work. No one should be allowed to have the right to
perform the work from beginning to end. Different process of
transactions should be handled by different individual.
(ii) Provision of check. Firm should set up this provision so that
work can be checked by another staff. An officer can check
the work of one staff by transferring to the staff and verify
again.
(iii) Use of devices. Many devices are available such as time record
machines, wage determination machine, etc. and it can be used
to monitor of internal check easier.
(iv) Self-balancing system. An organization can use self-balancing
ledger accounts, which help to make the work of internalcheck
smooth and its effectiveness based on its management.
(v) Rotation for Work. No human employees should be permitted
to occupy a single area of activity for a long period of time.
Familiarity with exclusivity in a position offers greater flexibility
for an individual to try to exploit the system.
(vi) Specialization. Organization should provide training to every
staff to increase their skills, so that internal checks can be more
effective.
(vii) Controlling. When there is direct communication with
customers or the public, administrators need to control the unit
and there are more risks of theft.
(viii) Authority level. There must be a clear authority level based on
position to various transactions. Commensurate to the authority
vested, responsibility must be extracted. The existence of
authority level results in a review of the operations of
subordinates.

Principles of Internal Check

ã The process should be allocated among the staff of the business
based on duties, responsibilities and rights in such there is no
room for interference.
 The Role of Auditing in Corporate Governance 178

ã No one person should have independent power over the all-

important market elements.
ã The roles of the company’s workers should be changed from
time to time so that no employees should be interested in a
single job for a long time.
ã Each staff member should be encouraged to go on leave at
least once a year. This will aid with the investigation of hidden
fraud.
ã A successful mechanism of internal monitoring should ensure
that the function of an assistant is immediately reviewed by
others.
ã The method of self-balancing should be used invariably.
ã The financial and administrative powers of various officers
should be delegated very judiciously.
ã A person with physical possession of assets may not be allowed
to have access to account books.

6. INTERNAL AUDIT
Internal auditing is an autonomous evaluation function set up for thereview
of activities by management. It investigates, assesses and informs critically
on the adequacy of internal management as a commitment to the proper
use of resources. Internal auditing helps a company meet its target by
adopting a comprehensive, structured approach to evaluating and
enhancing the efficacy of risk management, monitoring and corporate
governance, according to theInstitute of Internal Auditors (IIA)
Internal audit functions are required in all public-listed companies.It is a
department or association of persons that is responsible for delivering
impartial, objective evaluations of programmes, corporate entities, and
procedures within a corporation. The aim of the internalaudit is to provide
a source of information to senior management and regulatory bodies of
an organization about the risks of theorganization, the atmosphere of
governance, organizational performance, and compliance with relevant
laws and regulations.
IIA defined internal auditing as “an independent, objective assurance
and consulting activity designed to add value and improveorganization’s
performance”. The primary purpose is to improve organizational efficiency
and effectiveness through constructive scrutiny of internal processes,
policies and procedures (Eden & Moriah, 1996). Also, internal auditing
supports corporate governance
 The Role of Auditing in Corporate Governance 179

in assisting in maintenance, reorganization of the internal control system

and management advisory in general.
As internal audit reports to senior management, it is only fitting that
operations be directed by the Audit Committee or by the CEOor Board of
Directors. In order to provide leadership with an impartial source of
knowledge, members must be independent of organizational policies and
neutral. The investigations carried out by Corporate Auditare also referred to
as internal audits. An internal audit may be used against a variety of
conventions, rules, metrics, or legislation to determine the efficiency of an
entity or the implementation of a process. These audits may involve
reviewing the internal regulation of a company around corporate
governance, accounting, reporting on finance, and general control of IT.
Internal audits can also include determining the quality or efficacy of
important business practices, such as supply chain management.
The aim of internal audits is to recognize vulnerabilities within the
structures of the organization and internally monitor the environmentso that
they can be addressed as soon as possible to avoid damage tothe company
or its stakeholders. In the meantime, the organization’s internal audit
strategy should be guided by or structured to analyse those areas with the
highest danger to the company, and should also include a portion of the
organization’s strategic strategy criteria.

6.1. Types of Internal Audits

(a) Compliance Audits – The aim of this audit is to determine
compliance with the rules, legislation, policies and procedures
relevant. Few of these laws may have a huge effect on the
financial well-being of the corporation and failure to comply
with such rules can result in high penalties or ban a firm from
conducting business in some jurisdictions.
(b) Environmental Audits – Evaluating the environmental effect of
a company’s practices and also evaluating the company’s
compliance with environmental laws and regulations
(c) Information Technology Audits – In order to ensure the quality
of the processing, protection and confidentiality of consumer
information or intellectual property, the assessment of
information systems and the associated technology is carried
out. It will require the measurement of logical entry, change
management, device operations, and backup and recovery
relevant to general IT controls.
 The Role of Auditing in Corporate Governance 180

(d) Operational Audits – Assess the management systems of the

company for their total performance and reliability.
(e) Performance Audits – Assess if the company meets the metrics
provided by management in order to fulfil the goals and goals
set by the Board of Directors.

6.2. Process of Internal Audit

Internal Control
Questionnaire  Fieldwork
Audit Scope  Evaluation
Objectives  Testing

Planning Assessment

Follow-Up Reporting

 Confirmation of  Communication
planned actions  Audit Findings
 Audit Response  Assessment
Verification Results

Figure 9.7: Process internal audit

(i) Planning – The internal audit team will outline the scope and
objectives, review guidance relevant to audit.
(ii) Assessment / Fieldwork – It is the actual act of auditing where
audit team will execute the audit plan
(iii) Reporting – Internal audit will draft the audit report during the
reporting phase. Report should be written clearly and succinctly
with recommendations.
(iv) Follow-up – Critical stage to ensure that the recommendations
have been implemented to address the findings identified.

7. AUDITING STANDARDS
The global of business and capital market has created a strong interest
towards developing uniform accounting and auditing standards throughout
world. There are several auditing standards that been usedas follow:
 The Role of Auditing in Corporate Governance 181

(i) International Standard on Auditing (ISAs) which issued by the

International Auditing Practices Committee (IAPC) of the
International Federation of Accountants (IFAC). IFAC is the
worldwide organization for the accountancy profession, with
more than 163 member organizations in more than 120
countries, representing more than 2.5 million accountants
throughout the world. IAPC plays its part in enhancing the
accuracy in the field of auditing procedures and related services
by making pronouncements on a range of audit and qualification
roles and by encouraging their worldwide recognition.
(ii) Generally Accepted Auditing Standards (GAAS) are the
standards used by private auditing services with three types,
general standard, fieldwork standard and reporting standard.
(iii) Malaysian Approved Standards on Auditing (MASA), the
standards pertaining to the actual auditing practice are issued by
the MIA (Malaysian Institute of Accountants)

8. CORPORATE GOVERNANCE CONCEPT

The term ‘corporate governance’ has been used aggressively in 1997during
the East Asian Financial Crisis and International Monetary Fundand the World
Bank included corporate governance reform as a condition to assistance
alongside traditional macroeconomics restraints such as deficit reduction.
Corporate governance replaced the term “Corporate Law”.
Corporate governance is the system of laws and controls that a board
of directors uses to supervise a company. An appropriate standard of
corporate governance requires being open in supplying outsiders with
knowledge, ensuring that the organization is permeatedby a sense of ethical
conduct and ensuring that a strong management mechanism is used to
identify variances.
A narrow definition by Shleifer and Vishny (1997), “corporate
governance deals with the ways in which suppliers of finance to
corporations assure themselves of getting a return on their
investment”. In addition to that, a broader definition is provided by the
Organization of Economic Co-operation and Development (OECD) (1999),
which describes corporate governance as “set of relationship between a
company’s board, its shareholders and other stakeholders”. It also provides
the structure through which the objectives of the company are set, and the
means of attaining those objectives and monitoring performance are
determined”.
The Role of Auditing in Corporate Governance 182

According to The Chartered Governance Institute (ICSA),

Corporate governance applies to the manner in which corporations
are run and for what reason. It determines who has authority and
responsibility, and who makes decisions, and it is, in essence, a toolkit
that helps management and the Board of Directors to deal efficiently
with the complexities of running a company. In addition, corporate
governance has been described as the mechanism and framework
used to guide and administer the company’s operations and affairs
to increase business prosperity and corporate responsibility with the
ultimate aim of ensuring long-term shareholder value while taking
into account the interests of other stakeholders’ (Finance Committee
Report on corporate governance, 1999).
Specifically, governance refers to the collection of laws, controls,
strategies, and resolutions placed in motion to determine
organizational behavior. The board of directors is pivotal in
government, and stock assessment may have significant implications.
All corporations aspire to have a high degree of corporate governance.
It is not enough for a corporation to simply be successful for many
shareholders; it also needs to show good corporate citizenship
through environmental consciousness, ethical conduct, and strong
corporate governance practices. Effective corporate governance
provides a consistent system of rules and control under which
incentives are aligned with owners, directors, and officers.
In Malaysia, a high level committee known as the Finance
Committee on Corporate Governance was established by the
government, headed by Secretary General of the Ministry of Finance
and comprising government and industry representatives on 25 March
1999. The report details 70 principal recommendations requiring law,
regulations and rule reform in critical areas, and set out the Malaysian
Code of Corporate Governance which comprises principles and best
practices for good governance by listed companies and identifies
necessary measures in training and education. Later, the code has
been revised on Oct 2007 to further strengthen and improve the
quality of board of public-listed companies, audit committees and the
internal audit function of public-listed companies in enhancing the
quality of the financial reporting.
Corporate governance is important for number of reasons as below:
(i) It helps to ensure that an adequate and appropriate system of
controls operates within a company and hence assets may be
safeguard.
 The Role of Auditing in Corporate Governance 183

(ii) It prevents any one entity from getting too great an impact.
(iii) It is about the relationship between the management of a
corporation, the board of directors, shareholders and other
stakeholders.
(iv) It aims to ensure that the company is managed in the best
interests of the shareholders and the other stakeholders.
(v) It tries to encourage both transparency and accountability,
which investors are increasingly looking for in both corporate
management and corporate performance.
Omolaye and Jacob (2017) have listed several benefits of corporate
governance in his studies as below:
(i)Prevent dominance by self-seeking CEOs.
(ii)Eliminate the risk of misleading or false financial reporting.
(iii)Enhance confidence in company’s management.
(iv) Higher probability of success. Good governance and good
leadership in management often go together.
(v) Strong reputation and therefore lesser like hood of exposure
to reputational risk.
(vi) Encourage investment in companies for longer term.
In addition to this, the survey that carried out by Mckinsey on investors
showed that an overwhelming majority on investors are prepared to pay a
premium for companies exhibiting high governance standards. Premium
range 12-14% in North America and Western Europe, 20-25% in Asia and
Latin America; and over 30% in EasternEurope and Africa. About more than
60% of the respondents informedthat they would avoid companies with poor
corporate governance controls, and about 33% said they would completely
avoid countriescorporate governance rules and regulations are not strictly
adheredto (Omolaye & Jacob, 2017).
As such, adherence to corporate governance helps improve confidence
of domestic investors, reduce cost of capital, underpin the proper
functioning of financial markets and ultimately induces more stable sources
of financing (OECD, 2004).
8.1. Key Elements of Corporate Governance
Below are the several key elements which incorporate in corporate
governance with all the following:
ã Business prosperity: Importance of corporate governance lies in
its contribution to both business prosperity and accountability.
The Role of Auditing in Corporate Governance 184

ã Accountability: Address the legitimacy of the entire corporate

system. Appropriate rules and regulations need to be in place
for ensuring accountability.
ã Enhancing shareholder value: The ultimate objective of directing
and managing the business and affairs of the company is to
enhance shareholders’ value.
ã Structure: Direction and management of the business and affairs
of every company are affected through a set of rules.
ã Process: Directed at persons who have the power to direct and
manage the business and refers to the system for decision-making
by the parties responsible for directing and managing the business
of a company and these decision-makers to be accountable.
8.2. Corporate Governance Theoretical Aspects
Corporate governance has only relatively come to prominence in the
business world and the term is a new phenomenon of last 20 years
or so. However, the theories related to the development of corporate
governance, and the areas it encompasses, date from much earlier and
are drawn from a variety of disciplines such as finance, economics,
accounting, law, management and organizational behavior.
Table 9.2: Summary of theories affecting corporate governance development
Theory Description
Agency Theory Identifies the agency relationship where one party (the
principal) delegates work to another party (the agent). In the
context of a corporation, the owners are the principal and the
directors are the agent.
Transaction Cost This theory views the firms itself as a governance structure.
Theory
Economic Theory The choice of an appropriate governance structure can help
align the interest of directors and shareholders.
Stakeholders It takes account of a wider group of constituents rather then
Theory focusing on shareholders. Where there is an emphasis on
stakeholders, the governance structure of the company may
provide for some direct representation of the stakeholder group.
Stewardship Directors are regarded as the stewards of the company’s assets
Theory and will be predisposed to act in the best interests of the
shareholders.
Resource Directors are able to connect the company to the resources
Dependence needed to achieve corporate objectives.
Theory
Institutional The institutional environment influences societal beliefs
Theory and practices that impact on various ‘actors’ within society
 The Role of Auditing in Corporate Governance 185

8.3. The Growth of Corporate Governance Codes

Corporate governance codes have been introduced and revised
continuously in number of countries in recent years. These countrieshave
encompassed a variety of legal backgrounds, cultural and political contexts,
business forms, and share ownership. However,in each of the countries,
the introduction of corporate governance codes basically been motivated by
a desire for more transparency and accountability, and a desire to increase
investor confidence (of both potential and existing investors) in the stock
market as a whole and the reasons of the development of codes has often
been driven by a financial scandal, corporate collapse, or similar crisis.

8.4. Development of Corporate Governance Code UK

Corporate governance codes were initially driven by corporate
collapse and financial scandal in UK. The UK’s code is combination
of UK’s Combined Code (1998) which embodied the findings of
trilogy; the Cadbury Report (1992), the Greenbury Report (1995) and
the Hampel Report (1998).
8.5. OECD Principles
The OECD Principles of Corporate Governance was issued in 1999 as
direct response to the Asian crisis and the principles were revisedin 2003.
These principles became international benchmark for corporate
governance, forming the basis for a number of corporate governance codes
and reform initiatives in both member countries and non-member countries
of the OECD. They have also been used by all major international financial
institutes such as World Bank / International Finance Corporation and the
Asian Development Bank, and also by many international institutional
investors. OECD principlescover six (6) key areas of corporate governance
as follows:
ã The structure of an effective corporate governance frame work.
ã The rights of shareholders and key ownership functions.
ã The equitable treatment of shareholders.
ã The role of stakeholders in corporate governance.
ã Disclosure and transparency.
ã The responsibilities of the board.
8.6. World Bank
The World Bank’s corporate governance activities focus on the rights of
shareholders, the equitable treatment of shareholders, the treatment
 The Role of Auditing in Corporate Governance 186

of stakeholders, disclosure and transparency, and the duties of board

members. World bank integrate OECD principles to prepare country
corporate governance assessment that detail and assess the corporate
governance institutional frameworks and practices in individual countries.
Theses assessment later be used to support policy dialogue,strategic work
and operations, and to aid in determining the level of technical assistance
needed in given countries in relation to their corporate governance
development.

8.7. Global Corporate Governance Forum (GCGF)

The GCGF is at the center of the OECD-World Bank corporate
governance partnership. This is an international effort to drawtogether leading
governance organizations, including banks, associations, national groups,
the private sector and specialist standard setting bodies.

8.8. Commonwealth Association for

Corporate Governance
(CACG)
Some useful recommendations and guidance standards have been
developed by CACG. The guidance included 15 standards outlining the
position and duties of the board, policy and values, business performance,
compliance, communication, shareholder responsibility, stakeholder
relationship, balance of power, organizational processes,appraisal of board
performance, appointments and advancement of management,
infrastructure, risk management, and potential solvencyannual review.

8.9. US Corporate Governance

USA is a well-developed market with a diverse shareholder base, including
institutional investors, financial institutions, and individuals.However, USA
not having definitive corporate governance code in the same way that
many others countries do. Instead, there havebeen various state and
federal development over a number of years, although the passage of
Sarbanes-Oxley (2002), the New York Stock Exchange Corporate
Governance Rules (2003) and subsequent developments have signaled
national developments in corporate governance. Some idiosyncratic
features of the USA include the Delaware General Corporation Law,
Employee Retirement Income Security Act 1974, and etc.
 The Role of Auditing in Corporate Governance 187

8.10. The Finance Committee Report

on Corporate Governance,
Malaysia
The committee focuses on the five important areas:
ã Strengthening laws governing shareholder rights, directors’
duties and duties of other corporate participants with particular
emphasis on related party transactions.
ã Enhancing disclosure and transparency.
ã Promoting effective enforcement.
ã Development of a Malaysian Code of Best Practices in
Corporate Governance, which seek to restructure board
composition and thereby create effective boards.
ã Identification of training and education needs of directors, other
key corporate participants and investors.

9. THE ROLE OF AUDITING &

AUDITOR IN CORPORATE GOVERNANCE
The relationship between corporate governance and auditing is a critical
feature of governance success and the interaction is not straight forward.
Good auditing can, to some degree, lead to changesthat will lead to better
governance; but good governance should alsolead to management setting
higher expectations, including demandinghigher quality auditing.
There has been very little study dealing with this connection, and the
analysis that has been undertaken appears to concentrate on howauditing is
influenced by corporate governance rather than how auditing influences
corporate governance. The association between audit fees(i.e. the proxy for
audit quality) in the United Kingdom and the proportion of non-executives
on the board of directors was investigatedby O’Sullivan (2000). The finding
that the greater the proportion on the board of directors, the higher the audit
fees. He believes that by the audit costs, having more non-executive board
of directors on theboard increases audit efficiency (i.e. increased effort).
Cohen and Hanno (2000) analyzed how auditors took corporate
governance into account when planning an audit, noting that auditorswere
considered to have lower audit risk by auditors in organizations with
independent boards of directors and audit committees. Meanwhile, Gul
and Tsui (2001) examined the effects on audit fees of free cash flow (i.e.
a metric of agency risk) and managementshare ownership (i.e. other
agency risk measures), finding that high
 The Role of Auditing in Corporate Governance 188

free cash flow is linked to higher audit fees (i.e. more audit effort) and high
management ownership is linked to lower audit fees (i.e. less audit effort).
Although it is advantageous that a strong corporate governance
mechanism tends to minimize audit risk and that auditors are obviously able
to determine the level of corporate governance in an organization and to
change their audit initiative accordingly, it shouldbe noted that the previous
study dealing with auditing-corporate governance relationships assumes
that all corporate governance targets are directed at.

9.1. The Role of Internal Auditing in

Corporate Governance
Internal audit is an autonomous, impartial assurance and consultation
practice intended to add value and optimize the practices of an entity
(Drogalas et. al., 2014). Internal audit consistently allows a company to
meet its targets by providing risk management systems, internal monitoring
and corporate governance with productivity (Coram, et. al., 2008). In
comparison, Karagiorgos et. al. (2010) acknowledge the importance of
internal audit to strengthening corporate governance effectiveness.
The positive relationship between the general characteristics of
corporate governance and internal audit was supported by their
findings. In addition, the International Professional Practice
Framework (IPPF) developed by the North American Institute of
Internal Auditors specifies that internal audit practices should review
and make relevant recommendations to enhance the governance
process (IPPF, 2017).
Furthermore, Saud and Marchand (2012) investigated the
importance of internal audit to good corporate governance, and the
findings revealed that internal audit leads to achieving operational
objectives and strengthening the corporate governance of the
enterprise.
Internal auditing plays some important roles in managing
corporate governance in an organization. Following are the role of
internal auditing in corporate governance:
Responsibility
In most organizations, the sole responsibility for corporate control rests
squarely with the board of directors. Internal auditors are responsible for
ensuring the functioning of organizational structures
 The Role of Auditing in Corporate Governance 189

and related controls as expected. They will also decide whether an

organizational procedure can be optimized and whether it can save money
for the company or becoming more successful. A significant task of
internal auditors is to ensure that the company’s servicesare used
efficiently.
Fraud
The prevention of wrongdoing is one of the internal auditor’s most
critical responsibilities. Fraud can incur millions of dollars in missed
sales for companies, and can also impact the public image of a
corporation. Many companies’ boards of directors rely exclusively on
the internal investigation team to report cases of misconduct and abuse.

9.2. The Role of External Auditing in

Corporate Governance
Generally, corporate governance means the way a firm controls and directs
its institutional systems, ethnic, social responsibility andaccounts and the
purpose is to promote transparency and fairness, by monitoring
performance and looking for accountability. Hence, external auditing
serves as one of the primary protectors of corporate governance in any
entity. Besides that, Sarbanes-Oxley 2002 Act requires external audits in
most of publicly listed companies.
The most important role of external auditing is corporate governance,
should be to protect the interests of shareholders. Externalaudits report on the
state of a company’s financial situation and certifythe validity of financial
reports that may have been released. Another role of external auditing is to
introduce policies to ensure accountabilityin the company and review the
security measures that a firm has in place against corporate fraud or
corruption. Next, external auditors also analyze the overall risk tolerance of
the firm, as well as, all the initiatives the company has made toward
mitigating risks. On top of that, external auditing helps promote corporate
governance by conducting period risk assessment and ensure good
corporate governance by developing efficient crisis management plans to be
usedin the event of allegations of corruption or fraud (Ferreira, 2018).

Promote Accountability
Forms and regulations intended to compel workplace transparency can be
implemented by external auditors. For example, for officers who distort
financial records by inflating statistics or frying
 The Role of Auditing in Corporate Governance 190

accounting numbers, auditors may suggest fines. Penalties for such

actions may include the dismissal of senior management or lowering
annual bonuses and even pensions.
Risk Assessment and Mitigation Planning
By performing time risk management, external auditors help foster
corporate governance. Auditors check the compliance mechanisms against
corporate theft or misconduct that an organization has in place. In addition
to evaluating future risks, auditors also evaluate the company’s overall risk
profile as well as the company’s attemptsto minimize risks. For example, if
a corporation or government agency has an under-performing system of
informants, attemptsshould be taken to reinforce this.

Crisis Management
Through designing effective crisis response procedures to be usedin the
case of claims of bribery or misconduct, external auditors mayhelp ensure
proper corporate governance. Usually, the plan includesallocating duties to
multiple executive authorities. In this way, officials have an aggressive
strategy that they will use to preserve trust amongcustomers if the company
gets embroiled in a financial crisis. Crisis response strategies can also
contain monitoring mechanisms to be used by leaders in the media and law
enforcement.
Maintain Strong Relationship with Regulators
An external auditor’s activities help encourage a successful partnership
with regulators. The majority of regulators favor firms and agencies that
tend to have open operations. The organization ofa company is reviewed
by external auditors for compliance with regulations. Regulators, once an
inspector attests to them, are much more likely to trust corporate
disclosures.

10. CONCLUSION
In corporate governance, auditing has a major role to play, and this has been
acknowledged by numerous reports. Corporate governancediscussions in
mainstream analyses have largely been limited to concerns about how best
to protect the rights of shareholders. However, as a stock market deal,
owners can become more obsessedabout how much of their investments
are shared with top management (Colvin, 2001). Any analysts or
corporate governance
 The Role of Auditing in Corporate Governance 191

suggest that it would be better to have fully autonomous boardmembers

appointed with input from public interest organizationsand employee
preferences from a professional community of individuals.
Similarly, there should be fully autonomous auditors that are unable to
be appointed by management and whose fee is determined by the
independent board (Cadbury Committee, 1992; The Turnball Report,
1999). Suggestions from the Cadbury Committee Report (1992), the
Turnball Report (1999) and the OECD Principles of Corporate Governance
(1999) should be taken into account as steps in the right direction to
improve corporate governance. However, both of these initiatives focus
solely on defending the interests of shareholders; they do not pay adequate
attention to the larger stakeholders and to society in general. In addition,
they do not concentrate on the role auditing could play in corporate
governance,as indicated in the ICAS document (Mclnnes, 1993).

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