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Reforming the Regulation of Accounting and Auditing New Responses to New Challenges

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Title: Reforming the Regulation of Accounting and Auditing New Responses to New Challenges


1
Reforming the Regulation of Accounting and
Auditing New Responses to New Challenges
  • John Hegarty
  • World Bank Group

2
Regulatory Reform Our Common Challenge
  • From the Asian Crisis (1997) to the Enron
    Collapse (2002)
  • Regulatory reform not only an emerging market
    concern
  • Widespread international pressure for change

3
Enron Symbol of Systemic Weaknesses
  • Problems relate to
  • More than one company
  • More than one audit firm
  • More than one country

4
Enron - What went wrong?Financial Reporting
  • Aggressive application of accounting rules
  • Inadequate disclosures of risk exposures and
    related party transactions
  • Incomplete consolidation of all group entities
  • Exaggerated reporting of revenues
  • Innovative use of fair value measurements
  • Non-accounting for stock options

5
Enron - What went wrong?Auditing
  • Combination of audit and advice
  • Tensions between objectivity and advocacy
  • Combination of internal and external audit
  • High reliance of one office / partner / audit
    team on one client
  • Incentives within the audit firm
  • Checks and balances within the audit firm
  • Competence seems not to be an issue

6
Enron - What went wrong?Corporate Governance
  • Weaknesses in management and organizational
    culture
  • Perverse / misaligned incentives
  • (stock options, related party transactions)
  • Ineffective Board oversight
  • Ineffective Audit Committee oversight
  • Absence of shareholder challenge
  • Absence of reputational agent challenge

7
Enron - What went wrong?Other Parties
  • Aggressive investment bankers
  • Non-objective financial analysts
  • Supportive legal advisors
  • Relaxed debt rating agencies
  • Optimistic investors and commentators
  • Non-interventionist regulators

8
What are the drivers of quality accounting and
auditing?
  • High quality standards
  • Education and training
  • Robust regulatory frameworks
  • Effective monitoring and enforcement
  • Adequate incentives and sanctions

9
Filling the gap
  • Reaching international consensus on a common
    framework of principles for the regulation of
    accounting and auditing
  • IAS and ISA are not enough
  • Contrast with the OECD, IOSCO, Basel and IAIS
    principles
  • No country has a perfect system

10
The Joint Forum Core Principles Cross-Sectoral
Comparison
  • Scope of regulatory principles
  • Attributes of supervisory systems
  • The supervised entity
  • Ongoing supervision
  • Prudential standards
  • Markets and customers

11
Getting the Standards Right
  • Acceptability of the standard-setting process
  • Balancing rules and principles
  • IAS/IFRS are not an appropriate framework for all
    enterprises
  • There is also a need for Little GAAP, but
    preferably international
  • ISA can be applied to all audits
  • The audit requirement should not be too extensive
  • Clarifying the role of national standards

12
Regulatory Framework
  • Recognizing the primacy of the State
  • Accepting the limits of self-regulation and the
    need for effective public oversight
  • Focus on the audit function
  • Acknowledging the role of the audit firm and of
    the international audit firm networks
  • Ensuring integration with corporate governance
    and market regulation
  • Incorporating the international dimension

13
Linkages with Corporate Governance and Market
Regulation
  • Effective monitoring and enforcement
  • Adequate incentives and sanctions

14
The EU Approach
  • Enhancing the quality of accounting, auditing and
    corporate governance
  • Creating a single market for accountancy services
  • Supporting the development and integration of a
    single Eurozone capital and financial market

15
The EU Approach
  • Delegated regulation, not self-regulation
  • Explicit State oversight of financial reporting
    and auditing
  • Independent monitoring, not peer review
  • Growing involvement of market regulators
  • Pure IAS for all EU listed companies (2005)
  • National Little GAAP for non-listed companies
  • ISA-plus for all audits (2005)
  • Principles-based approach to auditor independence

16
Outstanding Global Issues
  • Acceptance of IAS/IFRS and ISA
  • International Little GAAP
  • Development of a comprehensive framework of
    principles for the regulation of accounting and
    audit
  • International external oversight of the
    accountancy profession and audit firm networks
  • Supporting the post-Doha WTO negotiations

17
The International Dimension
  • Lowering of barriers to international trade and
    investment in audit services
  • Reducing regulatory divergence
  • Creating the confidence for mutual recognition
  • Governance of international firm networks
  • From private contract to public interest
  • Governance of IFAC
  • International standards as public goods
  • The death of pure self-regulation

18
Development of a Comprehensive Framework of
Regulatory Principles
  • Beyond accounting and auditing standards
  • Regulatory oversight enforcement discipline
    independence and ethics governance of audit
    firms and international networks etc.
  • Linkages with Basel, IOSCO and IAIS principles
  • Integration with the OECD Corporate Governance
    principles
  • Reliance on corporate governance to improve
    audit?
  • Implications of/for trade and competition policy

19
International Developments
  • International Accounting Standards Board (IASB)
  • International Federation of Accountants (IFAC)
    IAASB, Ethics Committee, Compliance Committee,
    Forum of Firms / Transnational Auditors Committee
  • Financial Stability Forum
  • Organization for Economic Cooperation and
    Development (OECD)
  • IOSCO, Basel Committee
  • International Forum on Accountancy Development
    (IFAD)

20
Unresolved Issues
  • Are we expecting too much from audit?
  • Protection from liability -v- relevance
  • How will the US post-Enron debate conclude?
  • Aligning auditor incentives with the public
    interest
  • Impact of non-audit activities on audit
    incentives
  • Governance of professional bodies
  • Governance of audit firms (Volcker proposals)
  • Scope of the profession, scope of practice
  • Competition policy considerations
  • Linkages with corporate governance and market
    regulation

21
The Role of the World Bank
  • ROSC accounting and auditing assessments
  • Support for international standards
  • Support for the development of an International
    Little GAAP and principles for the regulation of
    accounting and audit
  • Partnerships with other international
    organizations
  • Policy advice and development assistance to
    client countries

22
Lessons for Slovenia?
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