Auditing and governing are two
separate functions. But, these are not mutually exclusive. Neither are
they independent; nor interdependent. Rather, one reinforces the other.
Hence, the question arises how far one can go to fortify the other? Let
us open our discussion with 'governance'.
By Prof S. SABIR A.
June 03 - 09, 2002
The term governance refers to the functions of a government evidenced by
'ruling', 'directing', 'controlling', 'exercising of authority', and the
like. These include a wide range of functions performed by the
executive, judiciary, and legislative realms of a country, which work as
a continuum. Hence, precisely speaking, good governance describes the
successful performance of a government in carrying out its governing
However, the expression 'successful performance' has
no fixed meanings. It is some thing relative to the situation that may
vary from country to country, and even in the same country, from time to
time. Moreover, any performance may have more than one rating. What one
government claims to be 'good' may be condemned and even undone by the
other that follows. Freezing of foreign currency accounts by Nawaz
Sharif Government is an example near at hand.
Again, what is 'good' according to the government is
normally 'otherwise' from the opposition's point of view. In the 55
years' history of Pakistan, there were not more than two occasions when
our law makers had consensus of opinion in the Assembly: one, when their
perks were being revised upwards; and, two, when the levy of tax on
agriculture income was being debated.
Nevertheless, certain characteristics have been
assigned to good governance by social scientists, which, inter alia,
>Safety and security.
>Participation with accountability.
>Transparency and openness.
>Justice and the rule of law.
>Simple and easily understandable rules of business
GOVERNANCE IN CORPORATE SECTOR — A JOURNEY IN
RETROSPECT: The concept
of governance, particularly in a business organization, had died out by
the end of the 18th century with the emergence of management as a
systematic body of knowledge, an after effect of Industrial Revolution.
Then onwards, terms like 'directing', 'controlling', 'administering'
were substituted by 'leading', 'coordinating', and 'managing'.
Gradually, the culture of giving orders and chasing men gave way to
creating and maintaining of a work situation that was conducive to work.
This obviously did not simply mean providing of
physical setting for the work, or developing good working methods. It
was rather primarily concerned with providing the motivational climate.
Thus, manager's task was destined to be the serving of the cause of the
work through the people prompted by him to get that work done, instead
of lashing at a reluctant work force to drag the workload to a
distasteful destination. In this context, the abbreviations like IBA or
MBA seem to be a misnomer. How on earth the institutions which claim to
be management-oriented, and the degree that is said to be an emblem of
proficiency in management, can justify the patch of 'administration' in
Nonetheless, the foregone concept of 'administration'
.is prepanng to stage a comeback under the garb of 'governance'. It is
tantamount to moving the wheel in reverse. The purpose underlying this
somersault seems to be to gradually regain the autocratic style of
exercising the authority once lost under the philosophies of
participative management, or, scientific management, or, management by
At this stage, it was considered desirable to
precisely define what good governance is in the context of corporate
sector. In Pakistan, this gap was filled by the SECP (Securities and
Exchange Commission of Pakistan). The Commission envisaged a code of
conduct for the corporate sector, especially the listed companies, for
the purpose of "establishing a framework of good corporate
The nucleus of this code was reproduced by Mr. Khalid
A Mirza, Chairman, SECP, in his presidential address at the workshop
organized in Lahore on 2nd May 2002. He reiterated that there are four
essential components of good corporate governance, namely: (i)
sound value structure and high moral standards; (ii)
basic framework of laws and regulations; (iii)
judicial system / enforcement mechanism; and (iv)
separation of ownership from management. "With the exception of
legal framework", he added, "none of the above fundamentals
was noticeable in Pakistan's corporate sector."
While keeping the text of the code aside for a while,
one would like to ask the SECP's Chief about the affairs of public
sector corporations apropos the essentials of good governance envisaged
by him. Taking the last item first, he is requested to kindly enlighten
the nation as to why the chairman (chairperson in case of the First
Women Bank) and the president in each nationalized commercial bank is
one and the same person? Where goes the dogma of separation of ownership
and management in these cases? The chairman as head of the board of
directors gives policy which is implemented by the management headed by
the president. The president then reports compliance to the chairman who
evaluates the performance of the team led by the president. Can there be
any thing more ridiculous than a situation in which a person frames the
policy, passes it on to himself for implementation, himself implements
it, then reports the compliance to himself, and finally, himself
evaluates his own performance?
Let us now examine what audit functions are, and how
can they be reconciled with the needs of good corporate governance
described in the foregoing paragraphs?
AUDITING — ROLE OF AUDITORS IN GOOD GOVERNANCE:
Auditing is defined as obtaining and evaluating evidences regarding
assertions about economic actions and events to ascertain the extent to
which they correspond with the established criteria, and to
communicating the result to the interested users. Thus, it encompasses
investigation process, attestation process, and the reporting process,
pertaining to economic actions and events.
International Audit Standards maintain that an
auditor's mandate may require him to take cognizance and report matters
that come to his knowledge in performing his audit duties which relate
>Compliance with legislative or regulatory
>Adequacy of accounting and control systems;
>Viability of econonuc activities, programmes, and projects.
Two variant situations emerge when the functions of
auditors and the requirements of good governance are placed face to
face. The former is confined to 'econonuc actions and events, while the
later is the outcome of a wide range of managerial functions. The
question then arises whether the auditors should cross their operational
limits in order to bring about the desired level of improvement in the
quality of governance, or, alternatively, while restricting themselves
to their term of reference, they should operate more effectively so as
to help improve the quality of governance.
Lately, a view has emerged that auditors should play
a more vital and direct role in establishing good governance. Should
this mean to expect them to cross the established borders of genuine
audit functions, it would be stretching the string too far, without
gaining any thing positive and substantial. The only alternative then is
to make the auditors feel more conscientious, more dutiful, and
therefore to be more effective, while restricting themselves to their
term of reference.
International Auditing Standards (IAS) also recognize
that the matters that may be relevant to the governance of any business
entity may be broader than those that form the subject matter of IAS,
which are directly related to the audit of financial statements. IAS 260
categorically requires the auditors to communicate with the officials
charged with the governance of an entity the matters arising from the
audit of financial statements. They will not be required, the IAS
continues, "to design procedure for the specific purpose of
identifying matters of governance interest".
Even the Code of Good Corporate Governance envisaged
by the SECP subscribes to this phenomenon. Rather, it prohibits in
explicit terms any such excesses on the part of the auditors. Paragraph
xl under the heading 'External Auditors' reads:
"No listed company shall appoint its auditors to
provide services in addition to audit except in accordance with the
regulations and shall require the auditors to observe applicable IFAC
(International Federation of Accountants) guidelines in this regard and
shall ensure that the auditors do not perform management functions or
make management decisions, responsibility for which remains with the
Board of directors and management of the listed company. "
Thus, it is established that auditors are not
required to traverse their area of operation. Whatever they are expected
to contribute towards good governance shall, therefore, be from within
their range or sphere of activity. In other words, it is the quality of
their performance that will make all the difference, which, therefore,
needs to be ameliorated to match the requisites of good governance.
Once it is settled that it is the quality of audit
that is aimed at, the question arises what is the desirable quality, and
how can it be measured? The question has gained great momentum in recent
years when considerable attention has been focused on the auditor's
responsibility for negligence. This is largely the result of wide
publicity being given world over to considerable sums sought by
plaintiffs in compensation for losses they have suffered, losses which,
they believe, could have been prevented had the auditors been more
vigilant. To quote a lively example, m/s Pricewater House, auditors of
BCCI, remained in the news for quite some time during the last decade of
the preceding century for their reportedly inapt behaviour leading to
the collapse of the Bank.
An answer to this very pertinent question can be
traced back in what Denning LJ observed in Candler v. Crane Christmas
& Co. (1951), whose opinion was later upheld in famous Hedley Byrne
case [Hedley Byrne & Co. v. Heller and Partners Ltd. (1963)], and
which reads. " Their [the auditors'] duty is not merely a duty to
use care in their reports. They have also duty to use care in their work
which results in their reports".
The 'care' again is a relative term. The degree of
care required may also vary from situation to situation. However, the
overriding requirement is to have a "true and fair view".
Interestingly enough, what is 'true and fair' is not
necessarily the 'truth'. The famous Elephant Story will help explain
this riddle. Three blind men were led to an elephant and asked to state
by touching it what it was. The first who touched the animal from the
side and felt hard and broad span of the skin said it was a wall. The
other who groped around the tail announced that it was a rope. The third
gentleman who came in contact with the trunk claimed that it was a
hose-pipe. All the three, to the best of their knowledge, were 'true and
fair' but none of them was right. This leads to the conclusion that the
perception and belief a person may have, and the opinion that he forms,
about a set of circumstances depend upon: (i)
his view point, and (ii) the
information made available to him.
This becomes all the more important in view of the
fact that the law has not defined the expression 'true and fair'.
Moreover, the whole process of auditing requires much
imagination and careful thought from beginning to end. It is highly
demanding and is often described as a very onerous responsibility. No
doubt the vast majority of the profession do behave with integrity but
auditors can and do some times fail to exercise their duty to as high a
standard as is expected of them.
This whole discussion leads to the conclusions that:
>The auditors should restrict themselves to their
>Professionally, they should strictly abide by the Accounting
Principles / International Accounting Standards.
>Morally, they should comply with the International Federation of
Accountants' (IFAC's) Guidelines on Code of Ethics, as adopted by the
Institute of Chartered Accountants of Pakistan.
With this discipline followed meticulously, the
auditors' role would have overriding impact on the overall performance
of an organization, thereby contributing substantially and meaningfully
towards "establishing a framework of good corporate
governance", the objective underlying the Code of Corporate
Governance envisaged by the Securities and Exchange Commission of