UK Corporate Governance Code Impact

Corporate governance rules have been developed to lead companies to have greater transparency and accountability in their management. This essay will discuss the role of the auditors in the context of greater transparency and accountability and how the UK Corporate Governance Code applies in this regard. This essay demonstrates that although auditors play and important role in corporate governance, it is the directors that are given more responsibilities as the appointment of auditors as well as the formulation of the terms of the engagement between the company and the external auditors is done through the directors. However, the Code of Corporate Governance ensures that despite much responsibilities given to the directors, it is the non executive directors that are involved in these processes so as to ensure the independence of the corporate governance.

The UK Corporate Governance Code of 2012 and subsequent years contain provisions regarding auditing and external auditors. The recent code is from 2018. Also relevant are the Financial Reporting Council’s Guidance on Audit Committees and Guidance on Risk Management, Internal Control and Related Financial and Business Reporting. Under the Code, three principles are crucial to the auditing in the company as part of the corporate governance system. These principles are addressed to the board: the first principle relates to the duty of the board to establish formal and transparent policies and procedures for independent and effective internal and external audit functions. This includes the duty of the board to ensure that the financial and narrative statements are credible and have integrity. The second principle relates to the duty of the board to present a fair, balanced and understandable assessment of the company’s position and prospects. The third principle relates to the duty of the board to establish procedures to manage risk, oversee the internal control framework. These provisions are relevant to how auditing function is to be undertaken as a part of the system of corporate governance. There are two bodies that are relevant to auditing function, which are, the audit committee of the company and the auditor themselves. Audit committee is a part of the company, but the Code ensures the independence of the audit committee through specific provisions. The audit committee is responsible for specific functions with respect of the external auditors; these functions include recommendations relating to the appointment and removal of the external auditor, and the formulation of the terms of engagement with the external auditor. These provisions are important to maintaining a transparent relationship between the company and the auditor and ensuring the effectiveness of the Code provisions on auditing function. Under the 2018 UK Corporate Governance Code, there are provisions relating to the internal and external auditors. The code provides that the internal auditor will need to consider their stakeholders’ expectations; stakeholders include regulators, board, audit committee, senior management, head of internal audit. The chair of the board of directors is also supposed to consult with the auditors on the performance of the board and other individual directors.

There is a difference between management of the company and governance of the company, which is the difference that is manifested in the way corporate governance rules are applied to ensure that the company is governed by rules that increase transparency of its functions and accountability. The Cadbury Report of 1992 defined corporate governance as a system by which the companies are directed and controlled.” As noted by Tricker governance of the company is about seeing that it is run properly. Thus, corporate governance guides the relationship between the board of directors, shareholders and other stakeholders by guiding the actions of the decision makers as per the rules of corporate governance and by holding them to account for their decisions and actions. There is a separation between the ownership and management of the company which creates a need for transparency and accountability so that those who are managing the company are accountable to those who own it and other stakeholders. Corporate governance plays an important role in balancing the interests of shareholders, directors, and other stakeholders.

Although a greater part of the corporate governance system is aimed at key decision makers in the company like directors and shareholders, it also has relevance to auditors. This is because the published audited financial statements and related information are key to understanding how the company’s financial decisions have been taken and the implications of these decisions. This information is relevant to set shareholders and other stakeholders and it is of the first importance that these statements are credible and supported by the opinion of independent auditor. This is to be seen in the context of the duty of the board of directors to present a correct assessment of the company’s position and prospects under the Companies Act 2006, as part of the duty of disclosure of the directors which would include the duty to disclose a business review in the form of financial statements. This is related to increasing transparency and accountability of the company. The board of directors are also responsible for this as this is a part of risk management and internal control systems. The board is to work along with the auditors for this purpose as they have to establish formal and transparent arrangements for maintaining an appropriate relationship with the company’s auditor. In order to ensure that the auditing is independent of the influence of anyone in the company, the corporate governance code makes certain provisions. For instance, under the 2014 Code, it is provided that there should be an audit committee in the company which is supposed to make recommendations for the appointment of external auditor to the shareholders and also to approve of their remuneration and engagement terms. The audit committee is also supposed to regularly review the independence and objectivity of the external auditor. The audit committee is therefore under a duty to ensure the independence of the external auditor. The audit committee is also meant to be independent of the influence of the executive directors of the company so as to ensure that the audit committee’s role of transparency and accountability are not compromised. For this purpose, the code requires that the audit committee be made up of at least three independent non-executive directors. Appointment of non executive directors to the audit committee is done to ensure that the audit committee plays an independent role in appointment of external auditor. The audit committee and auditor are supposed to work towards increasing the transparency and accountability of the board of directors. The audit committee is supposed to monitor the integrity of the company’s financial statements and also review the financial reporting judgements of the company.

In the UK, the corporate governance code uses the code of best practice, which is also termed as ‘comply or explain’. The directors are supposed to comply with the regulatory rules or explain as to why they did not comply with these rules. The question is whether this system leads to effective corporate governance. As the system is based on a comply or explain methodology, it may be questioned whether this methodology is appropriate for achieving the objectives of accountability and transparency. It is submitted that this is an effective system because the board is required to comply with the provisions of corporate governance or explain to the stakeholders as to how not complying is financially beneficial for the stakeholders. To this end, one of the provisions in the 2018 Code is that the board of directors should explain their responsibility for preparing the annual report and accounts, and explain whether they consider the annual report and accounts is fair, balanced and understandable, and provides the information necessary for shareholders to assess the company’s position, performance, business model and strategy. This is for the purpose of ensuring accountability of the directors as part of the corporate governance system because directors are ultimately responsible for the proper auditing of the company and for laying down the internal controls and procedures for ensuring that the auditors have the independence to deal with the financial statements of the company.

To conclude, although there is an important role played by the auditors in the corporate governance of the company, much of how the auditors play this role depends on the directors of the company because it is the directors who are responsible for the appointment of the auditors as well as laying down the terms of the engagement of the company and the auditors. However, it is important to note that the independence of the auditors is maintained through the use of the non executive directors to make recommendations on the appointment of the auditors as well as formulating the terms of engagement between the company and the auditors. The internal as well as external auditors work closely with the audit committee and it is the latter that plays an important role in auditing function of the corporate governance system.