Second Middle East and North African Forum on Corporate Governance

Corporate Governance and International Auditing Standards in Lebanon Presented by Camille C. Sifri

3 June 2004

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Agenda Corporate governance and ISA The global context - trends and developments ISA and IFRS Implementation in Lebanon The role of external auditors in the governance framework Conclusion

Corporate governance and ISA

Corporate governance

• Corporate governance is about two things - accountability and communication - Accountability - how those entrusted with the day-to-day management of a company's affairs are held to account to shareholders and other providers of finance.

- Communication - how accountability is communicated to the wider world: to shareholders; to potential investors; to employees; to regulators; and to other groups with a legitimate interest in its affairs.

• In Lebanon, issues of corporate governance must take centre stage if the country is to attract and retain investment.

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Corporate governance and ISA

International standards on auditing (ISA)

• The International Auditing Practices Committee has been authorised to issue International Standards on Auditing (ISA).

• ISA are to be applied in the audit of financial statements as well as in the audit of other information and to related services.

• ISA contain the basic principles and essential procedures together with related guidance in the form of explanatory and other material. • Auditors and auditing standards play a critical role in the evolution towards better corporate governance globally and in Lebanon.

• ISA require the auditor to communicate audit matters of governance interest arising from the audit of financial statements with those charged with governance of an entity.

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Corporate governance and ISA

ISA and corporate governance (continued)

• When the entity's governance structure is not well defined, or those charged with governance are not clearly identified by the circumstances of the engagement, or by legislation, the auditor comes to an agreement with the entity about with whom audit matters of governance interest are to be communicated.

• Examples include some owner-managed entities, some not for profit organizations, and some government agencies.

• Small and medium-sized enterprises (SMEs) in Lebanon may face difficulty in enforcing some of the principles and standards of corporate governance PricewaterhouseCoopers Page 5 29 April 2020

The global context – trends and developments *connectedthinking

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The global context - trends and developments

Impact of the current economic and business environment on financial reporting

• The current economic downturn, the unprecedented events of September 11, and recent business failures and scandals have combined to create a financial reporting environment unlike any in recent memory.

• Some of the particularly challenging factors affecting financial reporting today include: - Difficult economic times - Pressures to perform - Complexity and sophistication of business structures and transactions - Complex and voluminous standards • Serious questions have been raised about the quality of financial reporting, the effectiveness of the independent audit process, and the efficacy of corporate governance. PricewaterhouseCoopers Page 7 29 April 2020

The global context - trends and developments

Global initiatives towards better corporate governance

Recent trends suggest a growing consensus for convergence around international “norms” relating to: • Corporate Governance - OECD Principles - reflected in national codes of practice • … and other international benchmarks - International Accounting Standards - International Standards on Auditing - Market regulation (securities, banking, insurance, etc.) PricewaterhouseCoopers Page 8 29 April 2020

The global context - trends and developments

The IAASB

• The International Auditing and Assurance Standards Board (IAASB) functions as an independent standard setting body under the auspices of the International Federation of Accountants (IFAC). • The mission of the IAASB is to establish high quality auditing, assurance, quality control and related services standards thereby strengthening public confidence in the global auditing profession and serving the public interest.

• In January, the International Auditing and Assurance Standards Board (IAASB) published an action plan setting out its work programme to 2005.

• It reflects a heightened level of activity to pave the way for Europe’s adoption of International Standards on Auditing (ISA).

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The global context - trends and developments

IAASB (continued)

• By then, the board aims to have new standards approved on the risk assessment process, fraud, the auditor’s report and quality control.

• Endorsement of the ISA is high on the European Commission’s (EC) agenda, and there are strong indications that the EC may include this proposal in its strategy for auditing that is expected to be published shortly.

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The global context – trends and developments

Status of current projects on IAASB's agenda

• Recently approved - Quality Control - Fraud - Assurance Engagements Framework and Standards - Audit Risk ISAs - Audit Risk conforming amendments - Revision to IAPS 1005 on Small Audits • Exposure Drafts approved and outstanding - Planning - Review of interim financial information - Auditor's report - Group Audits PricewaterhouseCoopers • Other Projects - Audit of estimates - Audit materiality - Documentation - Clarity - Convergence • New projects - Revision of guidance in ISA 700 on Modified reports - Revision of ISA 260, Communication with those charged with governance - Revision of ISA 550, Related parties - A revised proposal for the revision of ISA 620, Using the Work of an Expert - A new assurance standard on Sustainability reporting - A new assurance standard on Reporting on internal control Page 11 29 April 2020

The global context - trends and developments

Sarbanes-Oxley

The Sarbanes-Oxley Act of 2002 -which applies in general to publicly held companies and their audit firms- dramatically affects the accounting profession in the US. Significant areas covered include: • Public Company Accounting Oversight Board - Board Composition - Funding - Standard Setting - Investigative and Disciplinary Authority - International Authority • New Roles for Audit Committees and Auditors - Auditors Report to Audit Committee - Audit Committees Must Approve All Services - Auditor Must Report New Information to Audit Committee - Offering Specified Non-Audit Services Prohibited - Audit Partner Rotation - Employment Implications PricewaterhouseCoopers Page 12 29 April 2020

The global context - trends and developments

Sarbanes-Oxley (continued)

• Criminal Penalties and Protection for Whistleblowers - Failure to Maintain Workpapers - Document Destruction - Securities Fraud - Fraud Discovery - Other Provisions • Financial Reporting and Auditing Process Additions - Second Partner Review and Approval of Audit Reports - Management Assessment of Internal Controls - Audit Reports Must Contain Description of Internal Controls Testing PricewaterhouseCoopers Page 13 29 April 2020

The global context - trends and developments

The auditor's role in this challenging environment

• Understand how a company is affected by changes in the current business environment.

• Understand the stresses on the company’s internal control over financial reporting, and how they may impact its effectiveness.

• Identify key risk areas, particularly those involving significant estimates and judgments.

• Approach the audit with objectivity and skepticism • Pay special attention to complex transactions, especially those presenting difficult issues of form versus substance.

• Consider whether additional specialized knowledge is needed on the audit team.

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The global context - trends and developments

The auditor's role in this challenging environment (continued)

• Make management aware of identified audit differences on a timely basis.

• Question the unusual and challenge anything that doesn’t make sense.

• Foster open, ongoing communications with management and the audit committee, including discussions about the quality of financial reporting and any pressure to accept less than high-quality financial reporting.

• When faced with a "gray" area, perform appropriate procedures to test and corroborate management's explanations and representations, and consult with others as needed.

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ISA and IFRS implementation in Lebanon *connectedthinking

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ISA and IFRS implementation in Lebanon

Introduction

• Although there is wide recognition of both ISA and International Financial Reporting Standards (IFRS) in Lebanon, there are no formal mechanisms for monitoring compliance.

• No formal adaptation of ISA has been adopted in Lebanon.

• Audit opinions on financial statements issued by major multinational audit firms as well as local practitioners make reference to conformity with ISA.

• The rigour of implementation of ISA as well IFRS in Lebanon very much depends on the accounting or auditing practitioner involved.

• There are still significant gaps between accounting and auditing practices in Lebanon and ISA and IFRS.

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ISA and IFRS implementation in Lebanon

Statutory framework

• A number of laws, decrees and ministerial orders govern Lebanese private sector accounting and auditing: - Code of commerce - Ministerial order (1996) requires conformity with IAS for most companies - Higher Council of Accounting and Accounting (est. by Minister of Finance) - All listed companies are required to prepare a legal entity and consolidated FS under IAS - Banking Law requires all banks to follow accounting and auditing requirements set by the Banking Control Commission - The accounting and auditing regulatory framework for insurance companies is not as advanced as that of the banking sector - The Act of Regularisation of the Certified Public Accountant's Practice (1994) provides the regulatory framework for the accountancy profession PricewaterhouseCoopers Page 18 29 April 2020

ISA and IFRS implementation in Lebanon

The auditing profession in Lebanon

• The Lebanese Association of Certified Public Accountants (LACPA) is the only legally recognised professional body.

• All auditors are required to be members of LACPA.

• LACPA is a member of the International Federation of Accountants (IFAC) and is responsible for regulating the auditing profession in Lebanon.

• In practice, the LACPA does not have the proper resources to effectively monitor audit practitioners.

• There is no mechanism for the LACPA to monitor continuing professional education requirements of its members. PricewaterhouseCoopers Page 19 29 April 2020

ISA and IFRS implementation in Lebanon

The auditing profession in Lebanon (continued)

• The Lebanese Code of Commerce refers generally to auditor/client relationships but does not fully reflect the requirements of the IFAC Code of Ethics for Professional Accountants.

• Public accountants and auditors are neither subject to peer review nor review by regulatory bodies.

• Multinational audit firms rely on their own internal quality review for quality assurance and compliance with ISA and IFRS.

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ISA and IFRS implementation in Lebanon

International Standards on Auditing (ISA) in Lebanon

• ISA are applicable for the audits of listed companies and banks in accordance with the rules of the Beirut Stock Exchange and the Banking Control Commission • No provisions in the current legal framework for application of ISA to other companies • Most audit firms (both local and multinational) make reference to ISA when issuing an opinion on FS, but there are no mechanisms to ensure uniformity of their application • Degree of compliance with ISA varies widely • In the absence of detailed local professional guidance, Lebanese auditors must rely on ISA professional pronouncements PricewaterhouseCoopers Page 21 29 April 2020

ISA and IFRS implementation in Lebanon

IFRS (previously referred to as IAS) in Lebanon

• Ministerial Order (1996) requires compliance with IAS • No mandatory implementation or effective enforcement for companies other than publicly listed ones or banks • Significant compliance gaps, even within banks and publicly listed entities • Monitoring capacity shortfall of regulatory bodies • General lack of knowledge among finance managers and accountants in Lebanese firms • Sanctions and penalties on non-compliance are virtually non-existent PricewaterhouseCoopers Page 22 29 April 2020

ISA and IFRS implementation in Lebanon

IFRS (previously referred to as IAS) in Lebanon

• Shortfalls in implementation of IFRS include: - Retirement benefit obligations - Deferred taxes - Property,plant and equipment - Financial instruments - Consolidated financial statements - Related party transactions - Revenue recognition - Notes to the financial statements - Other areas PricewaterhouseCoopers Page 23 29 April 2020

ISA and IFRS implementation in Lebanon •

The Way Forward

Regulation needs common principles centred around: - * Audit committees - * Accountability for corporate governance and internal control - * Audit standards and regulation - * Market regulation itself • Diversity in national and corporate governance is healthy, but a world standard of corporate reporting is essential for the development of the global economy by: - Increasing the availability, and reducing the cost, of capital through globally competitive capital markets.

- Providing a single basis of measurement of economic performance Reducing companies’ cost of compliance with different accounting rules.

Raising all national standards of accounting to “world class”.

- Encouraging a global investment culture.

- Facilitating the provision of low cost capital to developing nations.

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ISA and IFRS implementation in Lebanon

Recommendations for Lebanon

• Review legislation in the areas of accounting, auditing, corporate reporting and accounting certification to ensure compliance with global trends and IFAC policy pronouncements • Enforce publication and filing of timely financial information by public interest entities • Create a taskforce to monitor the country's compliance with international standards in corporate reporting • Enforce stricter standards in terms of licensing and continuing education of public accountants and auditors • Educate regulators in the areas of ISA and IFRS PricewaterhouseCoopers Page 25 29 April 2020

The role of external auditors in the governance framework *connectedthinking

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The role of external auditors in the governance framework

Introduction

• Aside from the board and the company itself, there are three constituencies in particular which play a fundamental part in the governance framework: - institutional investors; - external auditors; and - regulators.

• The ultimate responsibility for preparing the financial statements rests with the board itself, and cannot be ‘delegated’ to the auditors.

• Whilst the auditors can, and should, advise management on matters of financial statement preparation and presentation, key decisions regarding the selection of accounting policies must remain with management.

• Nonetheless, the auditor plays a critical role in the governance process and .

often is the main source of independent information and advice to the board.

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The role of external auditors in the governance framework

Matters of governance interest to be considered by the auditor

• The auditor should consider audit matters of governance interest that arise from the audit and communicate them with those charged with governance. Ordinarily such matters include: - Approach and overall scope of the audit; - The selection of, or changes in, significant accounting policies; - The potential effect on the financial statements of any significant risks and exposures; - Material audit adjustments; - Material uncertainties related to events and conditions that may cast significant doubt on the entity's ability to continue as a going concern; - Disagreements with management; - Expected modifications to the auditor's report; and - Other matters warranting attention by those charged with governance, such as material weaknesses in internal control, questions regarding management integrity, and fraud involving management; PricewaterhouseCoopers Page 28 29 April 2020

The role of external auditors in the governance framework

Guiding principles

• There should be a strong independent element on boards to exercise impartial judgement.

•Company directors must be independent (this poses a serious challenge in respect of small and medium sized enterprises in Lebanon) the ability of a director to “walk away”; that is to say, the director is not dependent on the company for his or her financial security; the director is not “indebted” to management, for example through personal relationships or board appointment itself; or to other directors through cross-board membership; - the director is not influenced by material business relationships with the company.

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The role of external auditors in the governance framework

Guiding principles (continued)

• To assure objectivity of published information, there should be an audit committee comprised of at least a significant majority of independent directors, with an appropriate element of financial literacy.

• Not all countries recognise the term “audit committee”, but we see no reason why they should not do so within a continuing diversity of board structures. • In smaller companies, the board as a whole can operate as an audit committee • Globally agreed principles on the role and operation of the audit committee are required. • Our suggestions are set out in our separate global publication: “Audit Committees – Good Practices for Meeting Market Expectations”.

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The role of external auditors in the governance framework

The future of corporate reporting

• Our vision of the future of corporate reporting is set out in our book, “Building Public Trust”. In it, we suggest that every participant in the corporate reporting supply chain should live by three concepts: - A spirit of transparency - A culture of accountability - People of integrity • With these three concepts in mind, we then propose a three-tier model of corporate transparency: - Tier one: global, generally accepted accounting principles - Tier two: industry-specific standards, developed by the industries themselves - Tier three: company specific information unique to the company itself PricewaterhouseCoopers Page 31 29 April 2020

The role of external auditors in the governance framework

The corporate reporting supply chain

Conclusion *connectedthinking

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Conclusion

Auditors are not a substitute for good corporate governance

• Auditors must support corporate governance, but should not be seen as a substitute - the published audit report cannot possibly encapsulate all the many fine judgments required in portraying a company’s financial position and earnings.

- The auditors rely on the independent directors to support and act on audit recommendations.

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Conclusion

Global audit regulation

• For the same reasons as our support for global accounting standards, we would like to see convergence of global external auditing standards (i.e. convergence between the standards of the US Public Company Accounting Oversight Board and the International Accounting and Assurance Standards Board.

• We also recognise the role that the major accounting firms should play in applying and promoting consistent auditing standards around the world. • We welcome any role involved in lifting the barriers that are sometimes raised by domestic laws and regulations in Lebanon.

• Given the auditor’s crucial role in underpinning the world’s capital markets, we readily accept the need for globally accepted principles on how non accountants should participate in standard-setting and the regulation of the profession.

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Conclusion

Audit quality and independence

• Auditors and their regulators have a single common objective: high audit quality. Given that we share a common aim, we should also be working to the same agenda on such matters as auditor independence.

• For all the reasons already set out in this presentation, we strongly urge the adoption in Lebanon of a principles-based global regulatory approach to auditor independence • On their own, even the best standards in the world will not result in the highest standards of governance, accounting or auditing, unless the people putting those standards into effect are of the highest calibre and integrity PricewaterhouseCoopers Page 36 29 April 2020

Lebanon must support and implement a global approach to corporate governance, accountability, auditing and capital market regulation.

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