'Strive to drive corporate governance to prevent failures'

REPORTING failures can still occur even after all the structures, governance, standards and regulations are in place, says the former president of the Malaysian Institute of Accountants Nik Mohd Hasyudeen Yusoff.

"We are only human, and humans can fail. Structures can only do so much (to ensure corporate governance)," he said.

Nik Mohd was presenting a paper titled "Assessing the Integrity of Current Accounting Practices" at the Asian World Summit in Kuala Lumpur yesterday. The event was organised by the Asian World Summit Sdn Bhd.

"Nevertheless, we cannot take for granted the possibility of reporting failures, but should instead, strive to drive governance to prevent the failures," he added.

Nik Mohd, who is also the chief executive officer of business advisory firm Inovastra, said that as the economy recovers, people will tend to forget what caused the downturn.

He quoted the example of how companies would join the bandwagon, even if it may not be right thing to do, just so as not to lose out on the competition.

Meanwhile, he suggested that in order to strengthen corporate governance, an important question that could be posed to companies even prior to their listing was on their financial reporting.

"May be there is a need to consider the capability of companies to have good financial reporting as part of their listing requisite."

This, he said, may even be included as a section within a company listing prospectus.

"The capabilities are even more imperative due to the complexity in the accounting standards and businesses going forward, especially since the public listed companies hold public money," he said.

As reported in Business Times 30 September 2009

http://www.btimes.com.my/Current_News/BTIMES/articles/copgov/Article/

You can download the presentation slides here:

http://www.slideshare.net/hasyudeen/assessing-the-integrity-of-current-accounting-practices

More regulation in store for auditors?

The International Organisation of Securities Commission (IOSCO) Technical Committee has launched three related consultations on auditor transparency, communication and ownership structures.

Responding to concerns raised during the roundtable on the quality of public company audits in 2007, IOSCO launched three consultations reports on the transparency of audit firms and the effect this could have on the quality of audits and the availability and delivery of audit services; the adequacy of the standard audit report; and the impact of audit firm ownership structure on concentration in the market for auditing large issuers.

The first paper considers whether increased transparency about governance and indicators of audit quality by audit firms would provide the market with information necessary to create an environment where audit firms compete on audit quality.

This would also provide users of financial statements such as investors and audit committees information to make comparisons among audit firms and more informed decision-making, creating pressure for audit firms to raise audit quality.

Governance information such as how the firms’ network arrangements work, how quality control is implemented and monitored, human resource policies including how quality is linked to performance appraisal and ethics and independent practices would provide more insights into how audit firms are managed.

While the paper acknowledges the difficulty in defining audit quality, quality indicators such as experience and competency of professionals within firms, workload of the audit team and the percentage of senior engagement team spent time on an audit are input measures that contribute towards audit quality.

Disclosure of output measures such as firms’ involvements in disciplinary proceedings and restatement of audited financial statements are also being considered.

The second consultation paper explores the possibilities of enhancing the ways auditors report their opinions. The key concern on the existing way of reporting is that it has not changed to adequately reflect the growing complexity in business, financial reporting and auditing.

Apart from the binary nature of audit opinion and the use of boilerplate and technical language, the concern on the lack of robustness on the description of the auditors’ role in detecting fraud remains as a gap of the present reporting framework.

The options explored in improving audit reports are changing the organisational structure and the language of the standard audit report and incorporating additional communications to include matters such as other information in the annual report, association with interim information, internal accounting controls, corporate codes of conduct, and meetings with those charged with governance.

A more extreme option is to change the nature of assurance provided by auditors resulting in the consequential changes to the audit report.

The issue of audit concentration is addressed in the third consultation paper. The audit services for larger public companies are currently dominated by four large multinational networks of audit firms.

These four audit firms audited 98% of the 1,500 largest public companies in the US with annual revenues of more than US$1 billion (RM3.48 billion) in 2006 and 96% of the FTSE 250 companies in the UK as of February 2008.

As large public companies operate across many jurisdictions in many industries and engage in complex business arrangements, they seek audit firms that have the international breadth and specific industry expertise to satisfy the needs of their audits.

Ownership restriction has been identified as one of the critical factors that perpetuates the current state of concentration. Many jurisdictions require that audit firms be wholly or majority owned and controlled by practising licensed accounting professionals.

The paper notes that such practices restrict audit firms from accessing sources of ownership capital that could otherwise be used to create or develop firms capable of auditing the world’s largest companies and competing with the Big Four.

Allowing for non-practitioner ownership might enlarge the sophisticated pool of human capital with appropriate technical expertise, such as information technology, financial engineering, or legal services. This in turn could contribute to improvements in the quality of audit services and governance of audit firms.

There are both merits and risks in the present ownership rules applied across jurisdictions. It is argued that licensed public accountants carry higher public interest obligations and restricting ownership promotes the culture of professionalism.

The impact of an adverse judgment arising from a violation of professional standards could be greater for practitioners, increasing the deterrent effect of liability.

Audit firms are also observed to be managed by owner-practitioner boards and do not employ alternative governance structures, such as an independent board of directors.

It is noted that independent boards or management advisory boards, to the extent they have controlling voting rights, may help strengthen protections against conflicts of interest by maintaining the public interest perspective within the affairs of the firms.

The issues raised in the consultation documents would certainly inspire further debate in enhancing audit quality. At the same time implementation issues and cost factors should not be overlooked.

The last outcome that needs to be avoided is for any new rules resulting in further deterrent of the non-Big Four to scale up and compete effectively in the challenging auditing market.

http://www.theedgemalaysia.com/commentary/150141-more-regulation-in-store-for-auditors.html

Institutional reform needed to steer the accountancy sector forward

AMONG the 12 pillars of competitiveness applied by the World Economic Forum (WEF) in determining competitiveness of a country is its institutional environment.

This is determined by the legal and administrative framework within which individuals, firms and government interact to generate income and wealth in the economy.

The recent global economic crisis has certainly demonstrated the need for an effective framework in preventing systemic market failures which brought detrimental consequences to economies around the globe.

While market participants continue to be inclined towards efficient allocation of resources and wealth creation, total reliance on the wisdom of these players had proven to be significantly risky to the society.

Interestingly, the latest global competitiveness report issued by WEF mentions the relevance of accounting and reporting standards and transparency for preventing fraud and mismanagement, ensuring good governance, and maintaining investor and consumer confidence.

It also states that an economy will be well served by businesses that are run honestly, where managers abide by strong ethical practices in their dealings with the government, other firms and the public.

The report also emphasises that private-sector transparency is indispensable to business, and can be brought about through the use of standards as well as auditing and accounting practices that ensure access to information in a timely manner.

In the Global Competitiveness Report 2009-2010, the strength of auditing and reporting standards in Malaysia is ranked 43rd out of the 133 economies covered.

The ethical behaviour of firms and efficacy of corporate boards are ranked 44th and 25th respectively.

For Malaysia to be more competitive, these areas need to be improved as they relate directly with investor confidence.

The accountancy sector is well placed to be the key contributor in the enhancement of governance and ensuring quality information is made available to stakeholders both for the capital market as well as the small and medium enterprises sectors.

In addition to this, accountants play critical roles in supporting the value creation process of organisations by being involved at the strategic level, leading strategy implementation, ensuring good financial management as well as putting in place good managerial practices in organisations.

In moving forward the accountancy sector, strategic decisions need to be made and appropriate actions against those who fail to uphold professional standards would certainly be expected by the society.

As in any other case, timely decision-making and actions are important elements.

The Malaysian Institute of Accountants (MIA) was established under the Accountants Act in 1967. As it is, MIA plays both the role as regulator and provider of services to those who are registered with MIA.

Originally, all members of the Council were elected in the annual general meeting.

An amendment to the Accountants Act in 2000 enables the Minister of Finance to appoint two-thirds of the MIA Council members.

While this arrangement generally works, conflicts arise when MIA initiates policies and actions which are deemed unpopular to certain segment of its membership, particularly accountants who are in public practice. This had in the past delayed critical decisions as well as diluted the effectiveness of MIA’s actions.

Some of the challenges faced by this institution in performing its role in ensuring the interest of Malaysians is protected are the results of certain elements of the Accountants Act.

For example only members of MIA Council could be involved in running the disciplinary process. This has created bottlenecks, especially in investigation cases referred to MIA.

Changes to the rules which govern the relationship between MIA and its members need members' approval at a general meeting before they could be gazetted by the government.

Such a requirement is simply burdensome and could face resistance, especially involving changes that impose additional expectations on its membership.

Just imagine what would happen if the approval from lorry drivers is required before the Road Transport Department could enforce any rules regarding road safety?

The time has come for an overall institutional reform on how the accountancy sector is governed.

The dual roles of MIA as regulator and service provider may no longer be effective given hard and decisive actions are frequently needed in the present business environment. Perhaps a more independent Accountancy Development Board could be considered. This board would be given the responsibility of shaping policy, setting standards, developing the industry as well as enforcing disciplinary actions.

MIA could be transformed into a member-based organisation, dedicated to providing services to its membership.

Singapore has certainly taken this path very much earlier.

The Public Accountant Oversight Board which was established under the Singapore Accountants Act is an example that we could consider.

Perhaps in our case, instead of just focusing on public accountants, the Accountancy Development Board should also be involved in enhancing the value creation role of accountants as well as reinforcing the integrity of the financial reporting chain.

Moving up the economic value chain and enhancement of our competitiveness level require the necessary supporting infrastructures to be brought into action.

The Accountancy Development Board is certainly an idea which warrants serious consideration.

http://www.theedgemalaysia.com/commentary/149335-institutional-reform-needed-to-steer-the-accountancy-sector-forward.html

Could boards do a better job in risk oversight?

The demise of many large global companies as a result of the global financial crisis and their rescue by the state has brought the question on the role of the board of directors in risk oversight to the forefront.

Given that risk is inherent in business, and the global business environment getting more complex, the aftermath of the crisis has certainly resulted in more scrutiny on the effectiveness of risk management, especially in financial services institutions and public-listed corporations.

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) recently released a thought paper on risk oversight.

The paper observes that boards have a difficult task in overseeing the management of increasingly complex and interconnected risks that have the potential to devastate organisations overnight. It also maps recent development in risk oversight such as the practice of some rating agencies which are now assessing enterprise risk management processes as part of their corporate credit ratings analysis. Some regulators are considering the requirement for compensation committees of public financial institutions to review and disclose strategies for aligning compensation with sound risk management.

COSO acknowledges that the challenge facing the board is to balance between managing risks and adding value to the organisation at the same time. Enterprise-wide risk management which provides a top-down view of key risks facing an organisation has been adopted on a wider scale.

Four areas which require the focus of the board in ensuring the effectiveness of enterprise-wide risk management of the organisations under their care are understanding the organisation’s risk philosophy and concurring it with the entity’s appetite; knowing the extent to which effective risk management has been established by management; reviewing risk portfolio and balancing that with the entity’s appetite for risk; and be appraised of significant risks and the management’s response towards them.

Based on the discussion in this thought paper, directors could not take comfort from the appearance of the existence of a risk management framework put in place by management. The whole risk management framework needs to be challenged and validated on a continuing basis to ensure they are not an artificial facade which will crumble when surprises hit the organisation.

Since the dynamics which shape the business environment changes continuously, the risk model and risk mitigation concept require periodical review by the board and management to ensure they reflect the risk profile on the ground.

Sustainability of a business would only be enhanced with effective management of risks. As the board is charged with the responsibility for identifying risks, implementing the risk management system and reviewing the adequacy and integrity of internal control system, effective risk management should be on the agenda of the board although some of the responsibilities are normally entrusted to the audit committee.

The other important issue as indicated by the new COSO paper is how enterprise-wide risk management is linked to the compensation system.

The lapse in ensuring compensation packages has now triggered a strong response by some of the G20 countries. Boards should be assessing the position in their respective organisations and perhaps initiate reforms which would address this issue.

As organisations consist of people working and performing within the official organisational structure, the effectiveness of risk management boils down to how people behave in pursuing the organisational objectives. Beyond the brick and mortar and the legal framework that bind everybody together, the other component that is overlooked sometimes is the heart and mind of employees.

If risk management remains attached to the externalities and not internalised by their hearts, how could risk management be externalised in their day-to-day activities? Boards need to understand how this “soft but important issue” is addressed with respect to developing an organisational culture which is risk-sensitive.

For the independent non-executive directors in particular, the issue is always about how deep they should be involved with the details while remaining non-executive. While there is guidance provided in most jurisdictions, the ultimate test is for each of them to satisfy themselves that they have enough information and knowledge to discharge their fiduciary duty as expected by the stakeholders. Blind reliance on representation by management would not absolve them from being held responsible should the organisation suffer substantial losses due to its failure in managing risk.

There is so much that can be achieved through structure and process. Ultimately, as humans, acumen, integrity and well- informed judgements would be key in ensuring the effectiveness of risk management. Each board member would have to pursue this as doing nothing is definitely risky.


The article was also published in the Financialdaily which could be read here:

http://www.theedgemalaysia.com/commentary/148842-could-boards-do-a-better-job-in-risk-oversight.html

Where are people placed on corporate balance sheets?

If a plot of land is given to a group of monkeys, irrespective of where the land is, the chances are it would be left unattended and could eventually turn into little jungle. In fact, the jungle would be a natural place for monkeys to live.

The same plot of land in the hands of smart executives would certainly be transformed into sources of economic activities. It could be used for commercial plantations or be developed into housing estates and commercial centres. Millions could be made out of it.

From the above example, it is obvious that people drive value creation, be it the public or private sector. It is the quality of people in any organisation that determines its effectiveness and how successful it would be.

Generally, assets to corporations are those which will bring future economic benefits that would eventually contribute, directly or indirectly, to the cash flow of those corporations. Given that the drivers of value, hence economic benefits, in organisations are people, wouldn’t it be sensible for people to be recognised on balance sheets of corporations? The answer could be quite tricky.

In the United Kingdom, for example, soccer teams incur huge amounts of cost in transfer fees to obtain the service of good players.  The transfer fee is classified as an intangible asset, and accounted for according to the financial reporting framework applicable to the clubs. In such cases, we could see some sort of value attached to the people who generate excitement on the soccer field, eventually earning money for the clubs through tickets, merchandise and television rights.

However, in most other cases, people are hired on contract of employment, and the salary and other benefits paid are charged as expenses. If the person is senior enough in the organisation (such as directors), the benefits paid would be disclosed in the financial statements. Other than that, there would not be much disclosure about the people in the organisation.

Even the cost of training provided — which should enhance the future benefits of the corporation through better future performance — is charged out as expenses. This is understandable, as it would be difficult to quantify how much better the person would be and how much more benefits he or she could bring in.

The present issue about executive compensation, particularly through huge performance bonuses adds complexity to the challenge of how people in organisations should be appreciated. Although the thought behind such huge bonuses is rewarding performance, the outcome of such a practice to a number of big institutions, particularly in the developed world, which applied this idea blindly, was catastrophic.

Risky transactions were pursued to lock in profits which were the basis of the payouts. When some of the deals turned south, the institutions were caught with huge losses while the employees were insulated from the risks. Most corporations are now rethinking on the compensation models to ensure sustainable business.

The reverse is when rewards are made without distinction between the performers and non-performers. While this observation could be a simplistic view, the way bonuses are paid to the employees in the public sector in Malaysia seems to be as such. When a bonus payment is announced, normally during the budget speech, the allocation of bonuses would be based on the category of seniority or a minimum sum for those in the low-income bracket.

Any additional income would certainly be welcomed by employees, but whether such practice encourages people to perform would be something else. Perhaps with the introduction of Key Results Area and Key Performance Indicators in the public sector, bonuses for civil servants would reflect more on their performance and less as an entitlement.

Another important element which relates to people is integrity and honesty. Without doubt, huge amounts of resources could be saved if people are not involved in corrupt practices and perform their work diligently. At this moment, there is no indicator in practice that could measure the level of integrity and honesty in the workplace. We may never be able to do so but how could we improve if there is no sense of how people behave on the ground?

As countries and corporations compete for talents, the need to ensure people in organisations perform their roles and functions in the best interests of the organisations they work for is getting more critical. While the human resource practitioners continue to find innovative ways to make this happen, the ways to communicate the potentials of people in organisations need to be further explored.

We may not be able to translate this into ringgit and sen, but some sort of indicator of potentials would be good when corporations are assessed on their potential performance.

So, when you praise a person that he or she is a credit to the organisation, be careful. You may be indicating that he or she is a liability!

http://www.theedgemalaysia.com/commentary/148501-where-are-people-placed-on-corporate-balance-sheets.html

Three Accountants Fighting for the Asian Sky

Not only the Asian sky is seen as a lucrative growing market for airlines industry, the battle for the market, at least in South East Asia, are headed by three accountants. Tengku Dato' Azmil Raja Abdul Aziz, who was recently appointed as the Managing Director and CEO of Malaysian Airlines, joins Dato' Tony Fernandes of AirAsia and Emirshah Satar of Garuda as CEOs of three major players in the airlines business in the part of the world.

Although competing in the same market, the three airlines are operating in different context and pursuing different strategic goals.

Malaysia Airlines, being the national airline for Malaysia and controlled by the Malaysia government, has to live with such expectation while at the same time is transforming itself into a five star airline with lost cost structure. It has managed to re-structure its obligations in providing rural air services in Sabah and Sarawak and now serves the rural market as a service provider to the government.

AirAsia on the other hand is positioning itself to be the lowest cost airline in the market it serves. While based in Malaysia, AirAsia has been operating through its associated companies in Indonesia and Thailand, thus providing it with larger market base in the low cost market segment.

Garuda is in the turnaround pathway after suffering financial difficulties and faced with ban by the European Union. It has managed to get the ban lifted and with a large domestic market, it is moving fast to be a force to be reckon with in the near future.

It would be interesting to observe how the three trained accountants perform in the years to come. The airlines industry has been plagued with challenges for raising fuel prices, global economic crisis, epidemics. The open air policy adopted by Asean has also heightened competition, putting pressure of price and forcing airlines to be extra efficient.

Good luck to the three CEOs!