The industrial revolution and the subsequent growth of business activity is largely credited for the adoption of audit and audit methods.
While auditing procedures have been relied upon for a long time, the formal practice has been in existence for a relatively shorter period. This practice was fuelled by the financial crises of the early 20th century which questioned the role of audit in ensuring prudent risk management.
Following the stock market crash of 1929, auditing became an obligatory process in the United States and in many other jurisdictions around the world.
In the years that followed, auditing was streamlined, with the promulgation of the Accounting and Audit Oversight Standards by the Securities and Exchange Commission, following the enactment of the Securities and Exchange Act of 1934.
Firms were required to provide certain assurances about the information they submitted to ensure compliance with accounting standards. The process of verification of this information relied heavily on explanations provided by management, with little or no independent confirmation.
This has since evolved and today, there is great emphasis on independent verification of information provided by Management.
From a corporate governance perspective, there have been tremendous efforts towards building an appreciation of audit in the minds of the custodians of governance, especially for public companies.
Many jurisdictions around the world have made it a requirement for public companies to establish board audit committees with specific member constitution, requirements and responsibilities in respect of the external auditors.
Following a revision to the UK Corporate Governance Code in 2012, there is now a requirement for FTSE 350 companies to put the external audit assignment out to tender every 10 years.
This has been domesticated in Kenya through the Corporate Governance Code for Issuers of Securities to the Public which requires auditor rotation every six to nine years. These are just some among the many codes around the world which place specific requirements on audit and audit committee matters.
Audit committees play a vital role in ensuring the integrity of financial controls and integrated reporting and in the identification and management of financial risk.
The prominence of audit committees is demonstrated through the inclusion of the requirement for quoted firms to create audit committees by the Kenyan Companies’ Act.
The only exception is where the quoted company is a subsidiary of another quoted company, in which case the parent company assumes the obligation to form the audit committee.
Failure by the directors of a quoted company to form an audit committee makes them liable to a fine of up to one million shillings.
The Act sets out the obligations of the audit committee of quoted companies to include the establishment of appropriate policies and strategies for corporate governance principles and to annually assess the extent to which the company has observed these policies and strategies.
In addition, the Capital Markets Authority in its Code of Corporate Governance for Issuers recommends that audit committees should have at least three independent and non-executive directors.
The code further recommends that at least one of the committee members be a holder of relevant professional qualification and be in good standing with their respective professional bodies.
The Companies Act also defines the obligations of both the board and company officers in regard to financial reporting and audit. Management of every company, particularly the chief executive officer and the chief finance officer, are required to keep proper accounting records.
Failure to fulfil this obligation could earn these officers a prison term of up to two years, and a fine of one million shillings which the company may be required to pay.
A similar obligation has been placed on the board of directors. Where directors fail to ensure proper preparation and audit of financial statements, they become liable to penalties of up to one million shillings.
In the spirit of the Code of Corporate Governance, companies should ensure compliance with all applicable laws, regulations, standards and internal policies.
Boards should establish internal procedures and monitoring systems to promote this by ensuring proper accounting records are kept and audited, and that the audit committee is properly constituted and executes its mandate as expected.
To respond to some of the shortcomings noted in corporate governance and financial reporting in the recent past, and to comply with the requirements of the IOSCO-Enhanced Multilateral Memorandum of Understanding (IOSCO-EMMoU), the authority is in discussions with the National Treasury to introduce a regime of approval of audit firms participating in the Capital Markets.
If adopted, approved auditors will have increased legal obligations to the authority and will be required to confirm the company’s level of compliance with the Capital Markets Act, laws and regulations and the Code for Corporate Governance.
Victor Oluoch, Acting Head of Financial Analysis, Capital Markets Authority.