External Auditing and Corporate Governance: Key Roles

Introduction: Corporate Governance and External Auditing

Corporate governance refers to the processes and policies through which a firm manages its culture, finances, and institutions. It is important because it promotes workplace honesty and impartiality in firms and organizations, achieved through thorough output monitoring and the enforcement of accountability across all sectors. One of the most important specialists who strengthen the resolve of corporate leaders in following good governance practices is the external auditor.

An external auditor's primary function is to ensure that a firm's shareholders do not suffer unnecessary losses. Because an external auditor has no affiliation with the company, this objective can be more easily met. Determining the financial health of a firm and verifying the accuracy of previous financial statements are also key functions. An audit gives shareholders peace of mind regarding the firm's true condition, and sometimes they request the auditor's opinion about the financial processes applied within the firm (Keith, 2017).

In order to foster accountability, external auditors may suggest new processes and steps that the firm should adopt. One example is recommending appropriate disciplinary measures for employees found guilty of falsifying financial figures or artificially inflating costs. Such employees may be demoted, dismissed, or stripped of benefits such as pensions and bonuses.

Another way external auditors enhance corporate governance is by conducting periodic risk assessments. Auditors examine the firm's safeguards against business fraud and unethical conduct, the level of risk the company can manage, and the effectiveness of the company's efforts to reduce that risk.

Finally, external auditors have the function of developing effective crisis management frameworks for the firm, to be applied whenever the firm is accused of dishonesty or unethical conduct. In most cases, the assignment of responsibilities to a number of senior executives is one of the first steps taken in such situations. Whatever the circumstances, a firm's leadership must have a ready-made framework to apply in order to retain the confidence of investors and customers (Keith, 2017).

Accounting Failures and the Sarbanes-Oxley Act of 2002

In 2002, President George W. Bush signed the Sarbanes-Oxley Act into law. The need for this legislation arose in the aftermath of the damaging accounting-related scandals at companies such as Enron, Tyco International, and WorldCom, among others (Ference, 2014). The Act was developed as a basic standard for financial firms and the general public, intended to prevent a further erosion of trust in American companies.

In the period just before the Act became law, several accountants were found guilty of unethical and substandard conduct. These violations included embezzlement, falsification of financial records, fraud, and corruption — acts that caused many ordinary Americans to lose their savings. Workers in other corporate sectors that collaborated with the accounting profession noticed these dishonest acts but failed to report them, contributing to a negative perception of Certified Public Accountants (CPAs). CPA guidelines clearly state that fellow accountants and auditors should not hesitate to report cases or credible rumors of unethical conduct (Ference, 2014).

External Auditors as Public Watchdogs

External auditors are referred to as public watchdogs because it is widely understood that their role includes identifying signs of unethical conduct or other harmful activities that could affect the savings of the general public. Such activities may include shady financial dealings or poor monitoring of employee activity. External audits are expected to help clients understand the risks associated with doing business with a particular firm. If a client is in danger of losing funds through theft or corruption, it is the external auditor's responsibility to make this known (ICAEW, 2011). Several parts of an organization — including employees, executives, or internal groups — can be the drivers of unethical activity.

Although an external auditor is not expected to fear blowing the whistle on illegal activities, it is advisable that they exercise caution to avoid becoming targets of retaliation. They should develop a thorough understanding of the methods by which fraud occurs. Examples include the diversion of funds through unchecked financial records, granting excessive financial control to a single individual, or permitting company funds to be used for personal purposes. External auditors are responsible for reducing the vulnerabilities inherent in financial management — vulnerabilities that fraudulent individuals may exploit, such as weak leadership, unequal distribution of duties, or a lack of mandatory leave for key financial officers (Morrissey, 2000).

Over time, a mutual familiarity can develop between auditors and clients, and this may diminish objectivity. Auditors must strive to remain professional and ethical despite such relationships and must maintain honesty as a core principle. Auditors should be prepared to report all forms of illegal and dangerous activity. When they identify weaknesses in a firm's financial framework, they must bring these to the attention of executives without hesitation. Addressing organizational problems can be challenging, but persistence is essential until meaningful progress is achieved.

References

Williamson, K., & Hobbs, A. (2013). Assessing the effectiveness of the external audit process. Ernst & Young.

ICAEW. (2011). Code of ethics A: General application of this code. Retrieved from http://www.icaew.com/en/membership/regulations-standards-and-guidance/ethics/code-of-ethics-a

Morrissey, J. (2000). Corporate responsibility and the audit committee. U.S. Securities and Exchange Commission. Retrieved from https://www.sec.gov/news/speech/spch357.htm

Ference, S. B. (2014). Failure to detect theft and fraud: It's not just an audit issue. Journal of Accountancy. Retrieved from http://www.journalofaccountancy.com/issues/2014/feb/20139031.html

Keith, H. (2017). Role of an external auditor in corporate governance. Chron.com.