Download 8 III. Audit expectations gap What has happened

Financial sector governance
Financial Statements, Audit and
Regulation
December 6, 2002
José Monsalve
Managing Partner – E&Y Chile
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Financial Statements, Audit and Regulation
Contents:
I.
Corporate governance accountability
II. Financial statement perception gap
III. Audit expectations gap
IV. Regulation
V.
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Final comments
I. Corporate governance accountability
Issuers:
• Establish effective external control systems
• Apply adequate GAAP and disclose relevant events
• Deliver reliable information to the market
Regulators:
• Dictate standards and
regulations
• Monitor compliance
• Sanction deviations
Corporate
Governance
Market:
• Be adequately informed
• Act responsibly
• Praise/punish conduct
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External Auditors:
• Professional independence
• Compliance with GAAS
• Evaluate GAAP used
II. Financial statement perception gap
What do the financial statements represent?
• Main source of infomation on the company for the market
• Fundamental tool for decision making
• Used by investors, analists, management, regulators and the market in
general.
But, .........
What has been lost from sight?
How do you explain the gap between the book values and market values of
the companies?
Is the problem with the accounting principles used or with errors in the
prices established by the market?
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II. Financial statement perception gap
Bookmarker
Average price/book ratio of the S&P 500 companies
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Average price/book ratio
Source: The Economist – May 2002
5
00
20
99
19
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
19
82
19
19
80
0
II. Financial statement perception gap
What has been lost from sight ?
Limitations inherent to the financial statements:
• Opportunity
• Use of judgement and estimates that in time can differ
• Accounting criteria alternatives for the same transaction
• Chilean GAAP v/s US GAAP v/s IAS
And what happens with GAAP ?
• Complexity in basic accounting issues:
- Recording and valuation of assets
- Recognition of income
- Adequate disclosures
• It has not advanced at the required speed
• Substance over form
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III. Audit expectations gap
What is an audit ?
• It is a critical and sistematic review
• Independent
• Performed in accordance with audit standards
• Performed on selective basis
• It is performed under materiality concept
• What is the objective of having an opinion on the reasonability of the
financial statements
But, .........
Does the market understand these concepts ?
What has been done to close this expectiations gap?
What is the responsibility in cases of fraud?
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III. Audit expectations gap
What has happened ?
The Largest Bankrupcies in History
(Amount of Assets in MU$)
WordlCom ('02)
107.000
Enron ('01)
63.400
Texaco ('87)
35.900
Fin. Corp. Of America ('98)
33.900
Global Crossing Ltd-. ('02)
25.500
Adelphia Communications ('02)
24.400
Pacific Gas & Electric Co. ('01)
21.500
Mcorp ('89)
20.200
Kmart Corp ('02)
17.000
NTL Inc. ('02)
16.800
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20.000
40.000
60.000
80.000
100.000
120.000
III. Audit expectations gap
What has failed?
• Has the concept “in our opinion” been lost ?
• Negligence problems ?
• Independence problems ?
• Lack of adequate expertise for current businesses?
• Professional skepticism in fraud detection?
What can be done so this does not happen again ?
• Go from a “pass or fail” concept to a “risk rated opinion” in the use of GAAP
• Improve “enforcement”
• Regulate “real” conflicts of interest
• Establish regulations to detect fraud
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IV. Regulation
Certain concepts:
• Perception versus reality
• All services should be approved by the Audit Committee, not only “nonaudit services” – Achieve management independence
• Ethics and integrity problems are not avoided with more regulations
• A fair balance between regulation and self regulation – The market
rewards, but it also punishes
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V. Final comments
•
Standardize accounting regulations worldwide
•
Modernize accounting regulations
•
Regulation of real conflicts of interest
•
Ethics and codes of conduct
“No client is more important than our integrity”
“Our main asset is our reputation”
Jim Turley – Chairman Ernst & Young
October 2002
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