The New Internal Audit Code Of Practice: A Step To Prevent Corporate Crash

  • Jan 10, 2020 GMT
  • Team Kalkine
The New Internal Audit Code Of Practice: A Step To Prevent Corporate Crash

A new industry code of the United Kingdom has stated that the Internal auditors should have direct access to top company bosses to help avoid corporate crashes. The new code developed by the CIIA (Chartered Institute of Internal Auditors) reinstates the credibility in internal auditors by energising and empowering the management to scrutinise misconduct and poor governance. The new code has been written by officials of top listed companies along with the Financial Reporting Council.

The new code is based on principles and is considered as an industry benchmark, to deploy best practices in internal audit and take the industry standards to a new high. To keep a check on the company’s compliance level with regulations, internal auditors are hired by the company. The external auditors differ in the way as they audit the company’s financial statements independently.

The code devised by the CIIA members empowers the internal auditors with unrestricted access to any part of a company. It also provides them with authority to attend and observe executive committee meetings. It states that the internal auditors will have access to external auditors and top executives of the company. The new code also talks about sharing information with external auditors. Even if internal auditing is outsourced, the company should deploy its own internal auditor.

The internal auditors for quite some time had been considered redundant. In case of financial services companies, this code has increased the participation of chief auditors drastically, according to the CIIA whose members come from the biggest listed companies in the United Kingdom.

The companies have taken this audit process seriously and the culture has improved drastically in case of financial services-based companies. The CIIA looks forward to extending this code beyond the financial services sector to other sectors.

Purpose Behind The Formulation Of A New Code

The major objective of devising this code is to make internal audit functions more effective in the corporate sectors. For the code to work properly, it is imperative to gather support from all the stakeholders including board members and chief auditors to endorse the principles and the recommendations of the code. The recommendations which the code provides are believed to make the internal audit more effective for the companies operating in the United Kingdom and Ireland.

However, the code of practice should be used in combination with the International Professional Practices Framework (IPPF) published by the Global Institute of Internal Auditors. The IPPF framework is exemplary and based on the International Standards.

The Code seeks to increase the effectiveness and impact of internal audit within organisations by clarifying expectations and requirements as it was devised on the International Standards for the Professional Practice of Internal Auditing.  In the case of procedural requirements, the Code should be applied accordingly. The smaller companies should use this Code considering their scope and size of their operations and their procedural requirements.

The internal audit is supposed to empower the top management and the board to protect the assets, reputation and to make sure that the company is a going concern. This shall help the management to identify, address and mitigate all the potential risks; and focus on improving governance, implementing checks and internal controls. The policies related to internal audit should be disclosed in a charter which should be made available to the public.

Carillion Catastrophe: An Eye Opener  

We need to delve deep to understand what exactly transpired the authorities to go for a new code, so it is about one of the UK’s largest construction companies, Carillion based in Wolverhampton, with a representative base of around 43,000 globally, including 20,000 in Britain. The company was also into outsourcing businesses for the public sector and undertook contracts like maintenance and operating estates and buildings, housekeeping and security maintenance, cleaning & catering at NHS hospitals and providing dinners at school. The company was known for its several projects such as the Channel Tunnel, Tate Modern and the Royal Opera House. The iconic doughnut building project of GCHQ (Government Communications Headquarters) in the United Kingdom.

Carillion had a debt-ridden balance sheet amounting to £900 million and reported losses of £1.15 billion for the half-year in 2018. In addition, the company had reported a pension deficit of £587 million. A year earlier, in 2017, Carillion issued profit warnings after its construction contracts were devalued from earlier valuations resulting in £845 million write-off. The situation was further aggravated, and Richard Howson (Chief Executive) resigned.

As its debts soared and contracts underperformed, the company needed liquidity of £300 million, but the financial institutions refused to lend it money and the government also refused to bail it out. Carillion was unable to continue business operations as it did not have enough cash and needed funding from the government to run public services, forcing it to go into liquidation.

Carillion tried to defer financial covenant test, in order to raise funding from the banks and the Government to survive but failed. The UK government had already bailed out major lenders including Royal Bank of Scotland (RBS) and Lloyds and funding Carillion would have looked like the Government was bailing out yet another private firm. The government said that the taxpayer’s money cannot be used to bail out a private company. KPMG, a leading audit and consulting group, auditor of Carillion signed off accounts in 2016. The Carillion had consulted KPMG in around 58 contracts regarding delayed payments which were followed by profit warnings and eventual departure of the chief executive from the company.

Carillion Catastrophe: Another Dimension

The collapse of the construction giant turned worse due to government outsourcing flaws. The outsourcing entities like Carillion are forced to take unacceptable levels of financial risk from the market to minimize the cost of providing public services. There are fundamental flaws in the way the government awards contracts as they look to try to spend as little money as possible when awarding contracts and transfer risk without looking at the bigger picture.

The government does not evaluate the risks it is transferring to private entities and fails to appreciate differences in quality offered by other competitive bidders because procurement decisions are fundamentally driven by price. However, the former directors of the company believed that Brexit uncertainty, an unpaid bill owed by Qatar, and issues related to the Royal Liverpool Hospital project were responsible for the collapse of Carillion. Now as per the new code, internal auditors should share information with external auditors, making it harder for company management to evade internal auditors' concerns.

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