ACCA Applied Skills · Audit and Assurance

Corporate governance: formula sheet

Full chapter guide

Key formulas

Agency relationship: Principals (shareholders) → appoint → Agents (directors); The agency problem arises from separation of ownership and control and from information asymmetry.
Agency costs: Agency costs = monitoring costs + bonding costs + residual loss; Use this list when asked what the costs of the agency problem are.
Core governance principles: Accountability, transparency, fairness, independence, integrity, responsibility, probity; Learn at least five and be able to apply each to a scenario. Do not just list them.
Rules-based vs principles-based: Rules-based = mandatory, compliance enforced; Principles-based = 'comply or explain', flexible; Give an advantage and a disadvantage of each when comparing.
Agency vs stewardship: Agency: directors self-interested → monitor; Stewardship: directors trustworthy → empower; Contrast the assumption about director motivation, then the governance consequence.
Comply or explain: Follow the provision, OR disclose non-compliance and give reasons; Applies to principles-based codes for listed companies. It is not a free choice to ignore the code without disclosure.
Split of roles: Chairman (leads the board) ≠ Chief executive (runs the business); Combining the roles concentrates power and weakens challenge.
Board balance: Executive directors + independent non-executive directors, with sufficient independent NEDs; Codes set a minimum proportion of independent NEDs for larger listed companies. Quote the proportion only if the question gives it.
Committees: Nomination, remuneration and audit committees = independent NEDs; No executive should decide their own pay or appointment.
Weakness answer pattern: Weakness → Risk → Recommendation; Use this for every governance weakness question.
Four NED roles: Strategy + Scrutiny + Risk + People; A quick memory frame for any question asking for the role of NEDs.
Audit committee functions: Reporting + Controls + Internal audit + External audit; Review financial statements and judgements; review internal control and risk management; oversee internal audit; recommend auditor appointment, fees and independence, and discuss audit findings.
Remuneration committee function: Set executive pay; no director decides own pay; Pay should attract and retain executives without overpaying, and be linked to performance and long-term success.
Nomination committee function: Evaluate board; identify skills gaps; recommend appointments; plan succession; Aims for a formal, transparent appointment process rather than the chair or CEO choosing alone.
Independence improvers: Fixed terms + fixed fees + independent selection + access to advice; Also avoid share options and past employment or close links with the company.
Board responsibility: Board = sets risk appetite + maintains and reviews risk management and internal control + reports on it; The board cannot hand over its accountability, even though it delegates the operation of controls to management.
Management responsibility: Management = designs, implements and operates the controls; Controls are management's job. The auditor does not take over this role.
Audit committee role: Audit committee = oversees reporting, controls, risk, internal audit and external auditor; Best practice is independent non-executive directors, including relevant financial experience.
Risk responses: Avoid | Reduce | Share | Accept; Internal controls mainly support the reduce response.
Internal audit need factors: Scale, complexity, number of employees, cost-benefit, risk, regulation and the previous record of fraud or error; Use these as a checklist when asked if an entity needs internal audit.
Limitation of control: Controls give reasonable, not absolute, assurance; Limits include collusion, management override, human error and cost.
Who TCWG are: TCWG = persons with responsibility for overseeing strategic direction and accountability (board, NEDs, audit committee); Where all TCWG are involved in managing the entity, matters already communicated to them in their management capacity need not be communicated to them again.
Matters to communicate (ISA 260): Auditor responsibilities + planned scope and timing + significant findings + independence; Use this as a four-part checklist in answers.
Significant findings: Accounting policies, estimates and disclosures + difficulties during audit + uncorrected misstatements + significant matters discussed with management + written representations; Written representations sit under significant findings, as in the ISA 260 requirements on significant findings. Also include anything else the auditor judges significant to oversight of the financial reporting process.
Control deficiencies (ISA 265): Significant deficiencies must be communicated in writing to TCWG on a timely basis; Other deficiencies are reported to management at an appropriate level.
Independence communication: For all audits, the auditor communicates that the engagement team and the firm comply with relevant ethical requirements, including independence, and discusses threats and safeguards with TCWG; for listed entities, the auditor also communicates relationships, services and related fees that may bear on independence; The confirmation of compliance with ethical requirements, including independence, applies to all audits, not only listed entities. Only the additional communication on relationships, services and related fees is specific to listed entities (PIEs).

Quick revision

Corporate governance is the system by which a company is directed and controlled.
The agency problem arises because managers run the company but shareholders own it, and their interests can differ.
Key principles: fairness, transparency, accountability and responsibility.
Comply-or-explain means a company follows the code or discloses and justifies where it does not.
The roles of chair and chief executive should normally be separate to avoid too much power in one person.
NEDs bring independent judgement, scrutiny of executives and a wider perspective.
Independence of a NED can be weakened by long service, share options, family ties or past employment with the company.
The audit committee oversees financial reporting, internal control, internal audit and the external auditor relationship.
The remuneration committee sets executive pay; the nomination committee leads board appointments.
The board is responsible for internal control and risk management; management implements it.
Internal audit has no formal ownership of control but evaluates and reports on it; it should have access to the audit committee.
The external auditor expresses an opinion on the financial statements and reports significant governance and control matters to those charged with governance.

Common mistakes

Describing agency theory as a conflict between directors and auditors. Fix: The principals are shareholders and the agents are directors. Auditors are one monitoring mechanism, not a party to the conflict.
Listing principles without applying them to the scenario. Fix: Tie each principle to a fact in the scenario, then say what has gone wrong and how to fix it.
Listing the code provision without applying it to the scenario. Fix: Quote a fact from the scenario in every point, then link it to the provision.
Stating the weakness but not the risk or recommendation. Fix: Always write three parts: weakness, risk, fix.
Saying NEDs manage the company day to day. Fix: Describe NEDs as overseeing and challenging. Executives manage and NEDs scrutinise.
Listing committee duties without linking them to the scenario. Fix: Use the scenario facts and say why the duty matters, for example the audit committee reduces reliance on the finance director's view.
Treating internal control and corporate governance as the same thing. Fix: Say that governance is the direction and oversight of the entity, and internal control is the set of procedures inside it that the governance system relies on.
Saying the external auditor is responsible for the internal control system. Fix: State that the board and management are responsible. The auditor only obtains an understanding and may test controls for the audit.
Saying the auditor is responsible for the company's corporate governance. Fix: State that directors are responsible for governance. The auditor gives an opinion on the financial statements and communicates with TCWG.
Listing ISA 260 matters without linking them to the scenario. Fix: Add a short reason for each point, for example why an uncorrected misstatement matters to the committee.

Exam tips

Always name the principals and agents when you mention agency theory. It is an easy mark.
In scenario questions, use the scenario's facts. Generic lists of principles score poorly.
Know a clear contrast between rules-based and principles-based approaches, with one strength and one weakness of each.
Link governance weaknesses to audit risk and the control environment. AA examiners reward the audit angle.
In objective questions, watch the wording: 'self-interest and monitoring' points to agency theory, 'trust and empowerment' points to stewardship theory.
In Section C, give each point as weakness, risk, recommendation. Examiners reward application to the scenario.
In objective questions, choose the answer that increases independence and separates power.
Comply or explain means disclose and justify non-compliance. Do not say it is optional.