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Institutional Control and its Role in Promoting Modern International Trends
in Auditing
Dr. Abdul Razzaq Mohammed Othman
Associate Professor of Accounting Department
Zarqa Private University
Abstract
This research focuses on the role of positive institutional control due to the
circumstances of the global financial crisis in enhancing modern international
trends in the auditing process. The research findings clarified that the institutional
control shall enhance the modern international trends in internal and external
auditing processes as well as establishing the auditing committees along with
identifying the duties of the executive management for contributing to the
effectiveness of the auditing accounting. Therefore, the researcher recommended
adapting concept of institutional control practically in the projects due to increasing
of accounting auditing value which supports its role in auditing process , but this
step needs to the requirements that must be met for developing the applicable
local standards
in order to keep pace with international standards for the
transparency of financial statements which needs modern communications
techniques in addition to reviewing existing legislations, besides requesting
guidance of the control institutional principals.
Keywords: Institutional control, internal auditing, external auditing, auditing
committees, the executive management
Introduction
Several studies confirmed that companies and organizations across the world began
to realize the institutional control value along with adopting their
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the best global practices which included in the Center for International Private
Enterprise (CIPE) report on the latest developments regarding the efforts of
international organizations in many countries that Japan has begun the task of
reforms in its organizations since 1977, through finding the mechanisms of
administrative applications based on the overall institutional control organizations
philosophy, as well as the form of the American Institute of Certified Public
Accountants Committee for protecting administrative regulations as well as to
study the financial reports of counterfeit in the facilities of US business
organizations along with identifying the reasons PEGA for AFS facts represented
in the financial reports and making recommendations about reducing fraud, in the
UK United Cadbury which formed a committee to audit the financial affairs of the
companies identified mission
for specifying implementation of the internal
controls in order to prevent the occurrence of large companies such losses.
Developing countries encounter
the challenge on organizing economic and
financial systems aiming to ensure the provision of an appropriate environment for
the application of Principles of Institutional Control issued by the Organization for
Economic Cooperation and Development on the companies , in addition to
establishing some Arab countries applying this guideline principles in Jordan,
Egypt, Lebanon , the United Arab Emirates, Saudi Arabia and Morocco in spite of
the challenges occurred in these countries in the application process, including the
economic, social, political and technological dimensions, which impose the
development and use of a framework of institutional control.
Internal auditing, External Auditing, Auditing Committees, the Executive
Management
The cooperation among these parties is considered the basic factor for success of
the Institutional Control
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The Research Problem: The research problem examines the role of institutional control in enhancing of
modern international trends in the auditing process by asking the following
questions: 1- Does the institutional control enhance the modern international trends in internal
auditing?
2- Does the institutional control enhance the modern international trends in the
composition of auditing committees?
3- Does the institutional control enhance the modern international trends in the
external auditing?
4-Does the institutional control enhance the modern international trends
in
determining the duties of the executive management?
The Research Objectives: This research discusses the institutional control role in enhancing the modern
international trends in internal and external auditing as well as establishing the
auditing committees along with renewing executive management duties.
The Importance of Research: The research importance is emerged for finding solutions to previous global
financial crisis which was a result of accounting auditing problems trough focusing
on the institutional control role to solve such issues which demands the
application's success in providing added value to the state, employees, shareholders
and lenders.
The idea of this research concentrates on the following topics:
- Modern trends in internal auditing.
- Modern trends in identifying the duties of the executive management.
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- Modern trends in establishing the auditing committees.
- Modern trends in enhancing the external auditor role.
Concept of institutional control and its elements: The subject of institutional control increasing attention in the twentieth century and
the beginning of this century as a result of the financial and economic crises
experienced by many international companies from Watergate scandal in the
United States, which followed the collapse of many companies due to the most
important causes of these crises with the loss of trust between the parties that
represent the key players in the organizations (Board of Directors, Executives,
Shareholders)
www.Tahkeem.com/spotlo.htm.2004 & (Johnson.2000)
These economic collapses revealed numerous cases of bribes offered by financial
businesses and working in the field of foreign trade and officials attributed the
cause of these frauds that have occurred in the companies as follows: • Weak independence of the companies’ Board Members of Directors, besides
entire internal and external auditor.
• Weakness of the effectiveness of internal control systems.
• Lack of efficiency of the internal auditing.
The Organization for Economic Co-operation and Development (OECD) is
considered the first early organizations that have interest in the institutional control
subject, it is defined by (OECD) as follows: The relationship between the company
management and the board of directors, shareholders and stakeholders for the
purpose of formulating goals and control along with development of appropriate
motivations which it takes into account the interests of the companies as well as
their shareholders.
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The Organization for Economic Co-operation and Development (OECD) and
(levitte.1999) believe that the institutional control has a wide concept where it is
used by legislators, investors, accountants and members of the Board of Directors
which can be interpreted a set of instructions that were indispensable to achieve
market efficiency.
(Khoury, 2003) indicated in his study that the institutional control of the system is
self-directed, management and control facilities in order to achieve its goals and
objectives on their own without any effectiveness or influence which provides a
fair deal with all interested parties with the company.
(Jaziri, 1997) confirmed in his study that the use of institutional control resulted
from the purposes of the provisions on the control managers and organizations to
ensure that the failure of these departments and the exploitation of the invested
money in non-rational projects through previous definitions of this concept that can
be argued by the term institutional control which is associated closely linked to
internal control where approaching the concept with a direct sense of internal
control, but the general framework concept of institutional control with more
extensive contact for the business and social environment of the surrounding
environment.
Institutional Control Elements: The respondents to the literature that dealt with this subject see the use of many
terms, and the guideline principles, supports, and the executives chiefs, bases which
forms a kind of overlapping in some researchers basic elements of institutional
control, transparency, accountability, responsibility, justice and autonomy laws and
legislations and others basic elements of institutional control or task set of rules.
The different interpretations of foreign terms have identified four elements of
institutional control as follows:
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1- Internal Auditing
2- Executive Directors
3- Auditing Committee
4- External Auditing
These four elements are considered the independence of the institutional control
will be effective in this research by focusing on the executives’ directors and their
roles in promotion of institutional control for adoption of modern trends in the
effective system regarding institutional organized and operational work through
practicing these elements as indicated below.
First: - Recent Trends in Internal Auditing: (Rittenbergn & Schwieger) indicated in their studies that internal auditors were
50 years ago from the accounts examiners where their work now is considered
professional and advanced functionality which practiced by many complex
activities, including computerized auditing systems, operational auditing , analysis
of operations ,
risks analysis and implementing special tasks related to the
administration and constant evolution in the field of internal auditing that has made
the essentials of these activities to evaluate the efficiency and effectiveness of
policies, plans, procedures, laws and regulations that have a significant impact on
the operations inside the project as well as the basics of the work and risks analysis
for assisting the management.
These factors led to contribute effectively in the process of institutional control as
indicated in a study conducted by (Aldhnabiyat, 2006).
Moreover, the studies conducted by the Institute of Internal Auditors development
taking place in the internal auditing activities confirmed this activity for focusing
on financial and operational auditing in order to help solving problems in field of
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finance, besides discovering the financial difficulties that may be faced by the
facility before they occur.
Therefore Jumah in his study confirmed that modern internal auditing standards
focused on the goals of the internal auditing (Jumah 2003) are as follows: - Increasing value of the company by improving its operations.
- Evaluating and improving the effectiveness of risk management in the company.
- Evaluating and improving the effectiveness of control in the company.
- Evaluating and improving the effectiveness of institutional control.
These objectives are commensurate with internal auditing, which referred to the
Internal Auditors Institute’s definition as a separate activities objectively by
confirming a consultative nature which aims to add value to the company tasks in
addition to improving its operations, and assisting the internal auditing process at
the company to achieve its goals through evaluating and improving risk control
efficiency and managing of institutional control (Internal Auditors Institute, 1999)
(This definition is the nature of the auditing that become a guidance rather than an
executive process and it's independent oversight instruments extends for the
purpose of evaluating all other control systems adopted by the administration for
the work of the internal auditors in the area of risks evaluation including risk
management when there is a gap existence in the management for helping the
administration to implement a form of risk management as confirmed in a study by
(Hermamson & Rittenberg. 2003).
In 1977, the Internal Auditors Institute formed a working committee to study the
gap between the evolution in the practice of internal auditing and standards of
internal auditing to determine the financial operations of the internal auditing and
the improvements that could be made on those operations included the
recommendations of the committee to establish the framework of a recent auditing
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process in line with changes in the environment, including new standards for
auditing status changes internal where dealt with modern standards two sets of
standards are standards features of tags results or characteristics of the parties that
lead performance activities that describe the nature of internal audit activities and
the development of standards by which evaluate the performance of these activities
and includes the general framework for the standards of internal audit
independence and objectivity, efficient and professional care needed , quality
assurance and improvement programs as criteria for attributes.
The performance standards include managing the internal audit activities, the
nature of work, work planning, work performance, communicating the results of
monitoring programs, satisfaction for the level of risk management criteria for
performance.
( Ratliff & Reding , 2002) pointed out in their study that the development that took
place in the internal auditing standards contributing to support the effectiveness of
institutional control because the auditors in the atheist and the twentieth century
should be prepared to audit current systems and accounting controls and managerial
and strategic and operational performance of public and private information
systems, accounting and administrative information processes along comply with
the laws and regulations which require that the available internal auditor critical
and analytical thinking and know-how and full understanding of the risks,
opportunities and threats concerning the activities of the project and a commitment
to professional ethics and take advantage of the technology in the performance of
his skills.
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Modern Trends in Determining the Duties of Executive Directors:
Institutional control operations require that significant changes in the
administration's policy to fit the goals of institutional control and these changes are
in vision of the administration to put the company and the quality of facilities and
programs that are applied and culture enjoyed by (Al Shara & Al-Najjar, 2003)
studies that the agency theory is the main institutional control where it is daily
work tasks on behalf of the owners, which can combine the features through the
decision-making of the operational nature and strategy related to the acts of the
company which concentrates on the role of the administration of their
responsibilities in designing of the internal control procedures which can achieve
these goals.
Sarbanes_Osley Act requires Department of Law every public shareholding
company in the United States to issue a report including the following aspects. (,
2006)
1. A statement that the administration is responsible for providing internal control
system as well as implementing the operation of the system for providing justice
for presentation of the financial statements.
2. Administration evaluates the effectiveness of the internal control system in terms
of structure and procedures relating to the financial statements as at the end of the
financial period of the company.
3. Administration report must indicate framework that governs the internal control
which evaluating the effectiveness of the system.
For example, this framework in the United States is set by the Commission
(COSO) has identified ISA No. 315 modification that internal controls are designed
and influenced by the administration for all those concerned to manage the
company through which they can obtain reasonable assurance regarding the
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achievement of the objectives of ensuring the credibility of the data accounting
besides achieving the efficiency and effectiveness of operations for compliance
with policies or Laws , regulations and internal control components in accordance
with this standard in five steps, the same entities identified by the American
Institute of Certified Public Accountants including the following:
1. Regulatory environment, which is considered including the rest of the parts
underneath the internal control.
2. Supervisory procedures.
3. Risks Assessment.
4. Information and Communication Systems.
5. Supervision and Guidance.
These entities for application needs to incompetent managers are able to make the
hard decisions to achieve the goals of the company for meeting its obligations to
several parties, including www.csr.htm.2005
1. Role of the administration towards the customers by fulfilling their
responsibilities to the development and processing of goods and services with high
quality that maintains the company's share of the market as well as maximizing the
use of modern technology for adapting the benefit of customers.
2. Role of Legislators to shareholders by maximizing the value of shareholders
based on the high quality of financial management in dealing with the risks and
controls about the preparation of financial plans and standards.
3. Role of the administration and is working toward through fulfilling their
responsibilities in preparation of programs to protect workers against the dangers
and improving the working environment along with developing plans that will
improve their performance and increasing the atmosphere of competition, including
through giving them the abilities to develop performance.
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4. Role of the administration towards society and the environment surrounding the
company through the necessary policies to meet their obligations towards society
and the environment and the implementation of laws and cooperation with social
organizations, voluntary practices carried out by the service of society and the
environment.
Third: Formation of the Modern Trends of the Auditing Committee:
Different legislation in different countries in the number of members of this
committee who are identified as members of the Board of Directors of the nonexecutives, but in general, can this committee consisting of two to seven members
of the Board of external administration and who have not entered their policy's
Executive and independent
process as the minimum responsibility of this
committee to examine the results of the external auditor and giving observations
taking the proposals relating to internal control and reporting to the Board of
Directors and is functioning according to a study conducted by Tamimi (2006):
1. The proposal to the General Authority for shareholders on behalf of the external
auditor.
2. Discussing the auditing with the external auditor programs.
3. Assigning Internal Auditing Director and determining his salary.
4. Studying and discussing the financial statements with the external auditor.
5. Studying and discussing of the internal auditor reports.
Several pieces of legislation have been committed in many countries of the world
councils subsidiaries manage the formation of committees check the mission to
verify the efficiency of the internal control system and financial reporting and to
report directly to the Board of Directors, it is the connecting link between the Board
of Directors and all of the internal and external auditors, and given the importance
of these committees stipulated that the New York Stock Exchange Securities, for
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example, in 1978, the companies that want to Affiliate to the stock exchange to
have audit committees that have all of its members from outside the company are
not bound together by any relationship independence (Al Ani , 2005).
Securities Commission has issued an exchange (SEC) bulletin identified a new
mechanism in which the work of auditing committees in terms of membership,
meetings , tasks and report their work as well as the areas of financial reporting,
represented by: First: - Documenting the credibility of the methods used by the company for
disclosure of financial information and examining any changes in the adopted
accounting policies.
Second: - Examining the main control risks to the company's activity and reducing
these risks by checking periodically to plan the work and reports of the internal
auditor.
Third: - Relationship auditors outlaw through their proposal and examine the audit
plan approved by them for ensuring their independence and the receipt of all
inquiries as well as providing clarifications requested by the external auditor
(www.oecd.htm.2005).
Therefore, independent of the auditing committees of the cornerstones of
institutional control has been entrusted Principles of Institutional Control audit
committees following main functions (Auditing & corporate Governance, 2002): 1. Supervision and control of financial disclosure processes within the company
and assess the risks associated with their operations.
2. Selection of the external auditor and the follow-up and evaluation of its
performance and the recommendation to change much in the case of breach of
duties.
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3. Follow-up the commitment of corporate policies, laws and ethics of the
profession.
4. Discussion of the administration and the external auditor on the annual financial
reports before approval and prior to submission to the Board of Directors.
5. Evaluation and follow-up procedures and internal control system and audit him
appoint a director of internal auditing and finding a direct connection between the
internal and the external auditor and the Board of Directors section channels.
6. Overseeing the appointment of staff in the internal auditing system.
It is clear that through the role of independent audit committees in strengthening
the institutional control operations through the help of the Board of Legislators to
complete supervisory responsibilities for the purpose of achieving the following
objectives: • Integration of financial reports.
• Compliance with corporate legal and regulatory requirements.
• Ensuring the independence of the internal and external auditors when doing their
job duties.
Fourth: - Recent trends in strengthening the role of the external auditor: American Accounting Association Auditing known as an organized and systematic
process of collecting evidences objectively related to the results of the economic
activities and objectives in order to determine the compatibility and congruence
between these results and the planned and reporting results of the concerned parties
for the auditing process. Through this definition, it is clear that the external auditor
shall examine the various economic activities for serving multiple parties.
Therefore, the scope of responsibility and multiplicity of groups that depend on the
results of its work based on these findings in making various economic decisions.
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American Institute of Certified Public Accountants in 1974 has formed committee
responsibilities of the auditor in order to study its responsibilities and after four
years, the Commission has reached a (Thunaibat, A reference mentioned previously
in this research).
1. There is no gap in expectations between the performance of auditors and users
between the auditor's report about the performance of their responsibilities and the
expectations of auditors.
2. The basic task in eliminating such
gap is the responsibility of the auditors
themselves through community education by enhancing its performance standards
have been confirmed ISA No. 220 which is related to the control of quality needed
for the external auditing firms control the quality of the policies and procedures
followed by both at the level of the auditing office as a whole, or at the level of
each auditing process in order to ensure the external auditor as well as the relevant
parties to serve appropriately in accordance with auditing standards including
elements of control over the quality of the external auditor work.
 Professional requirements indicated for commitment to independence and the
necessary care by abiding with the rules of professional conduct.
 Efficiency and competence of the auditing office's policy of hiring people who
have the professional capability and technological knowledge to enable them to
accomplish their responsibilities
 Authorization of business that must have auditing firms and instructions clear
regarding delegation of business staff commensurate with the degree of efficiency
and vocational training
 Supervision where there is supposed to be a guide and supervision in an ongoing
review of the business at all levels.
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 Consulting, as this is supposed to provide those who have subject matter
expertise consulting advice.
 Accepting new customers and continuing with the old ones
 Inspection on continuity of adequacy and effectiveness of policies and
procedures
The commitment of the auditing control over the quality of work in their offices
standards offices will enhance the performance of their responsibilities by reducing
the cases of the emergence of institutional failure, which was one of the factors
influencing the interest in the concept of institutional control, as it is responsible for
evaluating the sustainability of companies inspector
in accordance with
international standard No. 570 where noted in the seventeenth paragraphs on the
auditor's evaluation of management estimations of the company's ability for
continuation.
(IAASB, ISA, NO570, Para 17, 2003) is also issued by the International Auditing
Standards No. 260 Council Decree (It showed the relevant responsibilities of
institutional control audit Affairs) as mentioned in the following main topics:
1. Changes in accounting policies and the responsibility of the auditor about them
2 Judicial proceedings and law cases
3. Cases that raise controversy about the company's ability for continuation.
4. Cases of physical weakness in internal control process
The last topic of the internal control of the most important topics that are relevant
to the institutional control and the role of the external auditor, in (Cofo bulletin) in
1999 reported that the causes of landslides that occurred proceedings of the
American companies is due to the weakness of the internal control systems along
with lack of effectiveness of the internal auditor as well as the lack of independence
of the external auditor that autonomy which would enhance efforts in making the
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examination of the internal control procedures , risks assessment, and information
of the communication systems and determining the accounting auditing procedures
besides strengthening the role of the external auditor which shall contribute in
achieving accountability for the administration, which is one of the basic elements
as confirmed by a study conducted by Nassar concluded that the institutional
control effectively linked to a range of internal and external controls which is
considered an estimator for the external controls which strengthen the internal
controls that are related to the role of the Board of Directors and the nature of the
organizational structure along with the quality of accounting and the current control
systems (Nassar, 2003).
The Research Results and Recommendations
Results
Institutional control has positive effectiveness in enhancing modern
international trends in the auditing process as mentioned below: 1. Increasing the need for establishing a system of institutional control as collapse
consequences that occurred in international companies, requiring an obligation to
find a organized system for improving the performance of the companies and
organizations through the availability of sub-control systems as well as progressing
for eliminating the management risks.
2-Institutional control success requires an adoption of several standards governing
the work of both the internal and external auditing, besides contributing to the
strengthening of their roles.
3. The effectiveness of the management institutional control has a range of negative
factors where the most important one is violating the independence of each of the
acts of the executive management, the external auditor and the Audit Committee
missions.
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4. Strengthening the institutional control requirements through constructive
cooperation between the basic control and staff in order to improve the
performance of companies by adding value to them.
5. Success in the internal and external auditing responsibilities requires a deep
understanding of the goals of the company and its strategies, objectives and
developing appropriate plans to determine the priorities of work and reducing
inconsistencies between them.
6. Enhancing the internal auditing to cause effectiveness in contributing to the
institutional control over the evolution of the activities and internal auditing
functions.
7. Identifying and reinforcing the duties of the executive management by causing
important changes in the administration's policy to conform with the requirements
of institutional control and administration to fulfill its obligations to customers,
shareholders, employees, as well as the community and the surrounding
environment.
8. Supporting the auditing process in formation of auditing committees cause in
specifying the responsibility of these committees to examine the external auditing
results by observations and taking the proposals relating to internal control as well
as reporting to the Board of Directors, besides their role in the disclosure process,
the selection of the external auditor and a discussion of management's annual
financial reports and supervision working in the internal auditing system .
9. Enhancing external auditing cause through the commitment of auditing firms and
auditing standards on the quality of work within their offices which shall enhance
the principles of responsibility and reduces the appearance of cases of institutional
failure.
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Recommendations
It is included previously in the above research findings the positive impact of
institutional control, which enabled this researcher to recommend his
implementation practically based on the following requirements: 1. It is necessary to develop the internal auditing standards in the Arab Countries
which cope with the international development considering the auditing which is a
major element of institutional control, as well as the adoption of standards related
to external auditing process.
2. Commitment to the formation of auditing committees in each organization to be
a connection between the internal auditor, the board of directors and external
auditors for determining their missions based on clear instructions.
3. Institutional control application requires acceptance of modern information and
communication technologies in order to enhance the company staff.
4. Re-examining the current and applicable legislations in the Arab Countries in
order to evaluate and introduce provisions that support the application of
institutional control.
5. Reconsidering the current practices of the internal auditing and the external input
which are essential for development of the internal control systems in the
accounting and administrative dimensions and it guided by the institutional control.
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