How critical is corporate governance in a depressed economy?

BUSINESSES have been forced to evolve by the operational, financial and workforce disruptions caused by the Covid-19 pandemic, and adapting to the new normal includes updating norms to be followed.

The responsibilities of auditors are piling up, fueled by the need to focus on areas such as risk oversight, management of internal and external audits, and ethics and compliance as the integrity of companies has become more vulnerable.

For professional services firm P&A Grant Thornton, the main role of auditors is to ensure that corporate governance is not compromised. In the new normal, auditors should help redefine existing internal audit plans in a bid to re-prioritize audits, based on evolving organizational risks, ongoing regulatory requirements and practicalities in executing each audit.

This reshaping of auditing frameworks can help management and boards address crucial risks while also reinforcing the relevance and purpose of internal audit teams. Internal auditors must enforce stricter measures to promote accountability in the workplace and make these tailor fit to address any potential risks.

“One example is implementing a penalty system for employees who manipulate financial statements by making up accounting numbers. Penalties can include removing the office in the question from [his or her] position and reducing compensation such as bonuses and/or pensions,” said Marivic Españo, chief executive officer and Chairman of P&A Grant Thornton.

Internal auditors can also investigate how an organization does risk assessment. They can review the anti-fraud or anti-corruption measures an organization has in place. After these, auditors should analyze an organization’s risk tolerance and mitigation method.

“As businesses shift to more flexible work arrangements, internal auditors can contribute to achieve effective crisis-management plans through their periodic review of business processes that can be used in case of fraud or corruption allegations,” Españo said.

Whenever there is a financial crisis, there should, likewise, be a plan ready to be employed to maintain confidence among investors, who count on a company’s integrity as it does business with them.

On the part of external auditors, Españo said they can help companies release credible financial reports. Government regulators, in particular, rely heavily on these audited financial statements in the performance of their duty to protect investors from fraud and other irregularities.

“In light of the impact of the Covid-19 pandemic on the economy, new risks may emerge or the assessments of previously identified risk may need to be revisited by external auditors because the expected likelihood of misstatements in the financial statements has changed,” she noted.

Españo added that changes in incentives or more pressure put on management could lead to new risks of misstatement due to fraud or changes to the external auditor’s prior assessment of misstatement risks.

Similarly, changes in management processes, systems and controls may contribute to increased audit risks.

There are several areas auditors need to pay attention to in a depressed economy, Españo noted. These include asset impairment, going concern issues, accounting estimates, fraud risks, and accounting for contractual modifications and government grants, among others.

Since impairment involves using data to predict cash flows, auditors need to be skeptical when they examine client models. Going concern is another factor to focus on since auditors need to understand their clients’ operating models and determine the quality of underlying data and forecasted cash flows.

With regard to accounting estimates arising from market uncertainty and volatility, estimation uncertainty associated with accounting estimates may require significant attention. Estimates need to be revisited as the sources of these outlooks may have changed due to the pandemic.

Dealing with fraud is one area auditors are known to focus on. They must be fully aware of fraud to avoid struggles with revenues cashflows debt and payroll. Alterations in contracts should also be scrutinized since the pandemic has caused additional pressures that may affect accounting for loans, revenues, compensation and leases. Auditors, likewise, need to closely monitor government programs and financial reporting reliefs as there is risk of noncompliance among businesses.

Españo pointed out that the companies and external auditors should also be made aware that their decisions could be subject to future litigation and investigations if they are not careful or thorough.

“It is important that companies and auditors assess which aspects of their financial reporting, disclosure and audit processes are most likely to be subject to scrutiny during and after the present crisis and to take steps now to help ensure that decision on those points are reasonable and defensible,” she said.

However, spotting irregularities and discrepancies is not the only role of auditors. They can also help with a company’s fiscal recovery by examining data and analyzing how it can recover.

“With risks such as fraud, corruption and manipulation of data currently at large, the challenge of strictly adhering to corporate governance policies comes up,” Españo noted.

External auditors must also ensure that companies do not misdeclare its income taxes. This area needs special attention as taxes are used to support various government programs, geared towards addressing the impact of the Covid-19 pandemic.

In conclusion, Españo said auditors were needed now more than ever given the disruptions brought by the pandemic. They must continue to fulfill their usual roles and, at the same time, take on new responsibilities.

Their role now includes developing alternative procedures, gathering sufficient evidence to support their opinions and understanding enhanced considerations. These are especially needed by stakeholders, who rely on auditors’ guidance and insights to help them make the correct decisions for their organizations when it comes to operations and risk management.

Auditors can be considered the partners of top management and the board as they ensure that companies maintain their integrity and responsible corporate governance in the face of adversity.

As published in The Manila Times Top 500 Corporations.