Assessing the Integrity of Current
Accounting Practices
Nik Mohd Hasyudeen Yusoff
Corporate Governance Summit 2009
29 September 2009
Competitiveness Through Innovation and Strategy

Competitiveness Through Innovation and Strategy
Agenda
• The financial reporting supply chain
• Stress points in financial reporting
• The response from the accounting profession
• Reform in the regulatory landscape
• Would reporting failure occur again?
• Moving Forward Thoughts

Competitiveness Through Innovation and Strategy
The financial reporting supply chain
• The accounting and auditing
practices and the accounting
profession itself have been
under scrutiny since the
collapse of Enron in 2001
• Since then the landscape has
changed in line with the
development in corporate
governance globally

Competitiveness Through Innovation and Strategy
The financial reporting supply chain
• A business:
▫ Need to serve customers
▫ Need to compete
▫ Business environment keeps
on changing
▫ Affected by global
developments
▫ Stakeholders beyond
shareholders
▫ Profit is the result of risk
taking

Competitiveness Through Innovation and Strategy
The financial reporting supply chain
• The financial reporting supply
chain refers to the people and
processes involved in the
preparation, approval, audit,
analysis and use of financial
reports. All links in the chain
need to be of high quality and
closely connected to supply
high quality financial
1 Financial Reporting Supply Chain: reporting 1
Current Perspectives and Direction
International Federation of Accountants 2008

Competitiveness Through Innovation and Strategy
The financial reporting supply chain
Player Role in financial reporting supply chain
Management Prepares financial statements
Board Provides direction and approves
Auditors Provide independent opinion
Media Disseminates financial information
Investors/Stakeholders Make economic decisions
Professionals – Valuers, Lawyers Valuation, professional opinion
Bankers, Rating agencies Corporate proposals
Standards setters and Professional bodies Set standards – financial reporting,
auditing, ethics
Enforce standards
Regulators Ensure market integrity, enforcement
actions

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The financial reporting supply chain
Financial
And Business
Reporting Supply
Chain
Source:
XBRL
International

Competitiveness Through Innovation and Strategy
The financial reporting supply chain

Competitiveness Through Innovation and Strategy
Stress points in financial reporting
• Complexity of business
▫ Size
▫ Geographical coverage
▫ Industry
• Application of financial
reporting standards
▫ Complexity
▫ Mark-to-market issues
▫ Capacity to comply
▫ Lack of infrastructure

Competitiveness Through Innovation and Strategy
Stress points in financial reporting
• Tone from the boardroom
▫ Not given enough priority
▫ Heavy reliance on management’s
assurance without adequate
oversight
• Audit committee ineffectiveness
▫ Lack of expertise
▫ Blind reliance on external auditors
▫ Not enough support from internal
audit

Competitiveness Through Innovation and Strategy
Stress points in financial reporting
• Failure of risk management
▫ Financial reporting risks not
adequately address on timely manner
▫ Internal control break down
▫ Fraudulent behaviour not detected
• Meeting market expectation
▫ Attempting to meet analysts’
expectation
▫ Avoiding consequences of
enforcement actions or debt
covenant

Competitiveness Through Innovation and Strategy
Stress points in financial reporting
• Breakdown in auditors’ independence
▫ Financial interests from cross-selling of
other services
▫ Major clients
▫ Close relationship between auditors
and clients
• Quality control practices within
auditing firms
▫ Lack of leadership
▫ Inadequate understanding of business
and risks

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Stress points in financial reporting
•Greed!
▫ Unmitigated excessive risk taking
▫ Independent directors turn dependent
▫ Executive incentives linked to
performance
▫ Auditors putting business interests
above professional values

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Stress points in financial reporting
Business Oversight
failure failure
Governance
failure Audit failure

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The response from the accounting profession
• “You never want a
serious crisis to go to
waste. And what I mean
by that is an
opportunity to do
things you think you
could not do before”
Rahm Emanuel
White House Chief of
Staff

Competitiveness Through Innovation and Strategy
The response from the accounting profession
• Improvement in audit standards
setting process, International
Auditing and Assurance
Standards Board (IAASB)
reconstituted in 2002
• IAASB came under the preview
of the Public Interest Oversight
Board in 2005
• Completed the auditing
standards clarity project in 2008

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The response from the accounting profession
• Forum of Firms, which was established in
2002, is an association of international
networks of accounting firms that perform
audits of financial statements that are or may
be used across national borders
• The obligations of members include:
▫ Maintain appropriate quality control
▫ Policies and methodologies based on ISAs
▫ Policies and methodologies conform with
IFAC’s code of ethics for professional
accountants
▫ Submit annual report on meeting
obligations

Competitiveness Through Innovation and Strategy
The response from the accounting profession
• Improvements in ethical standards
including:
▫ Strengthening of the independence
requirements by using the threats-
safeguards approach
▫ Auditors rotation
▫ Network firm rules
▫ Clarifying guidance on non-assurance
services
▫ Relative fee size

Competitiveness Through Innovation and Strategy
The response from the accounting profession
Identify Evaluate Apply Decide on
Threats Threats Safeguards Engagements
Self-Review
Self-Interest Profession or
legislation
Significant?
Advocacy Assurance Assurance
team, firm, client Eliminate
network firm?
Firm’s
the threats
Familiarity or withdraw
Internal
procedures from
Intimidation engagement

Competitiveness Through Innovation and Strategy
The response from the accounting profession
• Competency requirements for audit
professional standard was issued in
2006
▫ Knowledge content
▫ Professional skills
▫ Professional values, ethics and attitude
▫ Continuing professional education
▫ Assessment
▫ Competent requirement for engagement
partner

Competitiveness Through Innovation and Strategy
The response from the accounting profession
• International Standards on Quality
Control
▫ Leadership Responsibilities for Quality
within the Firm
▫ Ethical requirements
▫ Acceptance of Continuance of Clients
Relationships and Specific Engagement
▫ Human Resources
▫ Engagement Performance
▫ Monitoring
▫ Documentation

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The response from the accounting profession
• The Malaysian Institute of
Accountants has also been active in
improving audit quality in Malaysia
through:
▫ Increased education activities on audit
quality and ethics
▫ Adopting international auditing standards
▫ Financial Reporting Standards
Implementation Committee
▫ Establishment of Ethics Standards Board
and Audit and Assurance Standards
Board

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Reform in the regulatory landscape

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Reform in the regulatory landscape
• The regulatory landscape has
changed and will continue to
change such as:
▫ Incorporation of whistle blowing
provisions in the securities law
and company law
▫ Independent audit oversight such
as the PCAOB, the Malaysian
Audit Oversight Board will be
established soon
▫ Making auditing standards law
e.g. Australia

Competitiveness Through Innovation and Strategy
Would reporting failure occur again?
• Unfortunately, the answer is
YES
• While the structure and
form of governance,
standards and regulation
are there, it is the PEOPLE
that would eventually
determine whether future
shocks could be avoided
• If the root cause is greed,
how do we overcome this?

Competitiveness Through Innovation and Strategy
Would reporting failure occur again?
• Is there another way of guiding
people to perform?
• MIA published a monograph on
human governance which focuses
on the inside-out approach instead
of parameter-driven rule-based
governance
• Spiritual aspect is recognised

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Moving Forward Thoughts
• Audit quality is the responsibility
of every player in the financial
reporting supply chain
• If a component fails, the stress
would be transferred to the next
component until the chain breaks
• While regulatory reform and
response from the accountancy
profession has improved audit
practices, the threat of future
failures remain real

Competitiveness Through Innovation and Strategy
Moving Forward Thoughts

Competitiveness Through Innovation and Strategy