Corporate Audit and Governance
Accountability of Corporate Assets
One of the touted advantages corporate governance provides is a system for traceability. This includes accountability of corporate assets. For this purpose, corporate assets are classified into two categories. These are corporate financial assets and corporate non-financial assets. The misappropriation or misuse of these corporate resources can severely erode the trust that shareholders have. The trust in management and result in significant economic losses to the company.
Corporate financial assets refer to those cash, receivables, investments, deposits with banks. Also includes other institutions (under different heads) which are available for disbursement by management. As well as available as security against loans from outside sources. These corporate financials generally fall under five categories. Cash on Hand; Creditors due within 1 year; Debtors + Trade credits; Investments (excluding corporate assets); Other Assets.
Corporate non-financial assets are those corporate resources that are not available for disbursement. They cannot be pledged to secure loans. These corporate resources include: Property, Plant and Equipment; Net intangible assets; Investment properties; Investment in associates etc. But exclude corporate financial assets. Corporate non-financials fall under three categories: Capital Work In Progress (Including advances made by the company to contractors/suppliers); Non Current Investments (including subsidiaries, jointly controlled entities, associates etc). Long Term Loans and Advances received from banks/ financial institutions/ creditors.
Sometimes corporate financials are classified into current or short-term corporate financials. Long term corporate financials based on the duration for which it is to be realized. For example, corporate financials available for less than 12 months are called current corporate financial assets. Corporate financials held more than 12 months are referred to as long-term corporate financial assets. Income from investment in subsidiaries, associates etc statement of corporate non-financial assets can fall under either corporate non-financial or corporate income statement. This depends on whether these investments result into realization of funds during that particular period.
Since the Enron Scandal in October 2001 brought corporate corruption and mismanagement to light. Corporate audits have become much more stringent with respect to proper accounting and recording of transactions. Ensuring proper accountability and traceability. In fact there has been a whole slew of changes made particularly by the Sarbanes-Oxley Act in the corporate governance of US companies. Also, corporate fraud and corporate theft are being penalized more severely. Several high profile corporate executives having been sent to jail on charges of accounting fraud or for misappropriation of corporate funds.
For example, Dennis Kozlowski who was the CEO and Chairman of Tyco has had to spend the last seven years in prison since his conviction for embezzlement, tax evasion and grand larceny. Similarly, Martha Stewart served a five-month sentence after having been found guilty of lying to federal agents about why she sold her ImClone stock during a certain time frame. In India too there have been many high profile cases where directors/chief executive officers have been sent to jail for corporate fraud and embezzlement. For example, Y.C. Deveshwar (the promoter of Satyam Computers) was sentenced to seven years in prison along with his son Raju after it was found out that the accounting fraud at Satyam. This went on much longer than expected and included many more executives than were originally thought .
The Sarbanes-Oxley Act has brought about several changes in corporate legislation which deal particularly with corporate governance. Among others these include certain requirements related to corporate audits such as:
- Section 404 requires management’s responsibility and the company’s internal controls over financial reporting; • Section 409 mandates corporate financial statement transparency through clear presentation of all material information; • Section 302 requires corporate financial statement auditors to present an opinion on management’s responsibility and the company’s internal controls over financial reporting;
Besides corporate audit, corporate transparency has also become more important since corporate frauds have come into light. Keeping corporate assets highly visible with full traceability from cradle to grave would help corporate compliance officers as well as corporate fraud investigators easily spot anything “fishy”. Also the same can be used by forensic accountants for tracing funds in case of embezzlement or corporate theft.
On the other hand establishing proper corporate governance helps a company avoid situations leading to mismanagement where these corporate resources do not have proper documentation or record keeping. Furthermore, full accountability at all levels will prevent any misuse of corporate funds and corporate assets.
For corporate audit purposes, corporate financial assets should be traced from the point of their origin all the way to the books of accounts where they are being recorded.
This process ensures that there is good corporate governance over corporate financials which eventually leads to long term corporate success .
1) For any corporate transaction involving a change in corporate ownership such as sale, merger or acquisition, appropriate documentation must accompany transfer documents. (for example shares/equity certificates). These include: • Ownership records; • Capitalization table; • Correspondence with previous owners etc; 2) Any changes in corporate finances need proper documentation to record who is responsible for what. This can be in the form of corporate resolutions such as corporate board meeting minutes, corporate committee reports etc; 3) All monetary transactions must go through a corporate bank account on which all payments/receipts are recorded and these records can be easily accessed by relevant corporate owners to ensure corporate financial transparency. No corporate funds should ever be transferred outside the company without proper documentation (otherwise there would be no way to trace such fund transfers). 4) Appropriate checks and balances must exist within corporate departments at an organizational level to ascertain that no one individual has full control over the flow of corporate assets.
4) Appropriate checks and balances must exist within corporate departments at an organizational level to ascertain that no one individual has full control over the flow of corporate assets.
5) All corporate assets must be recorded in corporate records. This includes corporate machinery, corporate inventory and any other corporate items which go into making up a company’s total corporate financial assets. These are basically assets that can be physical or intangible . 6) Proper documentation to account for all corporate financial expenses should exist. This includes salaries and wages of employees as well as any other corporate expenditure (including purchases). In some cases invoices may also accompany these payments/expenses so actual payment is reflected by this document 7) Regardless of whether it involves monetary transactions or not, all ownership changes must have appropriate corporate record keeping which keeps track of who owns what corporate assets. This is an important corporate audit function knowing who owns corporate shares or equity, corporate machinery etc. 8) Appropriate corporate record keeping must exist before any corporate transaction (whether monetary or otherwise) can be finalised.
7) Regardless of whether it involves monetary transactions or not, all ownership changes must have appropriate corporate record keeping which keeps track of who owns what corporate assets . This is an important corporate audit function – knowing who owns corporate shares or equity, corporate machinery etc; 8) Appropriate corporate record keeping must exist before any corporate transaction (whether monetary or otherwise) can be finalised. 9) Institutional mechanisms and checks and balances need to be built into the company so that no corporate financial transactions can be carried out without corporate audit feedback or corporate approval.
10) A corporate investment strategy must exist in order to ensure corporate profitability over a long term basis. This requires analysis of corporate expenses, corporate revenues and any other relevant information (such as market trends). Investments need to be made strategically based on the results of such analyses; 11) Any authorized corporate spending must go through an appropriate approval process before it is finalised. For example, if it involves significant amounts of monetary transactions.
Safeguard of Investors
‘Sarbanes-Oxley’, named after co-authors Senator Paul Sarbanes (D-MD) and Congressman Michael Oxley (R-OH), was signed into law by President George W. Bush on July 30, 2002. The act is designed to safeguard investors from wrongdoing within the accounting industry through corporate governance reforms and standards for financial reports and auditing procedures.
Much of the motivation for the legislation came as a result of Enron’s influence which began with energy trading in the mid 1990s. By 2000, Enron reported $111 billion in assets, annual revenue of nearly $100 billion and 17,000 employees worldwide but it officially entered bankruptcy proceedings on December 2nd 2001 following revelations that massive amounts of debt were being concealed. A further revelation was that Enron’s CEO Kenneth Lay had sold $60 million of his stock as knowledge of the company’s impending collapse became apparent amongst insiders.
Within days of its bankruptcy, Congress felt a need to introduce laws which would alleviate corporate misconduct and instil faith in American markets once more. President Bush stated that he would not have signed the legislation into law if it did not meet certain requirements:
1) Companies cannot disclose material non-public information such as internal financial projections or decisions; 2) Corporate officers, directors and employees must provide accurate financial representations; 3) Independent auditors are required to conduct annual audits with independence from their clients (companies). They are also obliged by law to report fraud in a timely manner; 4) Corporate boards are required to provide oversight and review of the financial operations of the corporation.
The ‘Sarbanes-Oxley Act’ greatly expands on corporate responsibilities previously limited under the 1934 Securities and Exchange Act, which stated that an audit was necessary but did not specify how independent auditors should conduct their reviews or how internal corporate operations should be supervised. One specific requirement is for a director to take appropriate steps when he becomes aware of potential illegal activity from within his firm.
The main purpose of the legislation is to restore public confidence in market place by creating and enforcing measures against corruption and fraud. When Enron entered bankruptcy proceedings it was discovered that many corporations had set up offshore entities in order to take advantage of international tax law; this practice was made illegal under the Act. In addition, corporations are now obliged to act legally and that they can no longer allow insider trading or misrepresentation of financial facts.
The Act is not without its critics who feel that it imposes excessive costs on corporations but at the same time there has been an overall increase in corporate compliance since its passing in 2002. Additional regulations have also been promulgated by the US Securities and Exchange Commission (SEC) which only serves to strengthen enforcement powers brought about by the ‘Sarbanes-Oxley Act’. Since 2010, four major cases involving fraud have resulted in prison terms for defendants with sentences ranging from 10 years to 25 years imprisonment. A further example of strengthened SEC enforcement is the introduction of whistle-blower awards for employees who experience retaliation as a result of reporting wrongdoing to corporate management.
The ‘Sarbanes-Oxley Act’ has been extended twice since its initial enactment in 2002 and was most recently due to expire on December 31st 2012. However, this deadline has been further extended until an official review can take place which will determine whether or not it should be allowed to lapse. The Office of Management and Budget (OMB) is conducting the review at present and it remains unclear as to when a final decision will be made. It is widely accepted that there are no plans to repeal the legislation but rather strengthen certain provisions relating to accounting practices within publicly traded corporations. In other words, Sarbanes-Oxley will continue to protect investors from mismanagement and fraudulent activities.
The corporate scandal shook the world as it was one of the largest corporate scandals in United States’ corporate history.
Enron Corporation, founded on November 1985 by Kenneth Lay and Jeff Skilling to provide natural gas upon deregulation of Houston’s energy market, grew from a small pipeline operator into an international conglomerate when they expanded their business scope into trading of commodities and derivative products before Enron eventually collapsed as result of scandalous corporate mismanagement which led to Arthur Andersen’s eventual demise (as auditors), corporate frauds leading to misrepresentation of actual financial conditions, and investors’ loss ultimately became what is known today as the Enron Scandal.
As a result of corporate greed, where several top executives sold off their stock holdings disclosing no positions in their individual portfolio, Enron’s corporate image was tarnished. When the United States’ corporate stock market took a downturn in 2001, it turned out to be the final straw that broke the corporate camel’s back for Enron Corporation which filed bankruptcy on December 2, 2001.
The corporate scandal shook the world as it was one of the largest corporate scandals in United States’ corporate history.