UMADHV-15-2 Report: Independent Directors and Internal Audit Analysis

This report, prepared for Corporate Governance Consultants 'Andrew Clase & Co Ltd', addresses the importance of independent non-executive directors (INEDs) and internal audits (IA) in corporate governance. It defines INEDs, outlining their responsibilities in monitoring executive directors, improving transparency, and ensuring compliance with regulations. The report details the functions of internal audits, including fraud detection, compliance with laws, and risk management. It also discusses the relationship between INEDs, IAs, and corporate collapses, emphasizing that while they reduce risk, they do not guarantee against failure. The report highlights potential difficulties companies might face when implementing these governance measures, such as the need for INEDs to gain company-specific knowledge and the handling of confidential information. The report stresses the significant benefits of adopting these practices in terms of improved governance and risk mitigation, concluding that the costs are justified by the reduced risk of corporate scandals and collapses. The report is based on reputable and reliable sources, drawing on the UK Corporate Governance Code.

Running Head: BUSINESS AND CORPORATION LAW 0
Accounting and Finance
UMADHV-15-2
4/19/2020
Student’s Name

Accounting and Finance 1
Contents
Annexure 1.................................................................................................................................. 2
Independent directors.................................................................................................................. 2
Who is an independent non-executive director (INED)? 3
How an independent director is important 3
Internal Audit............................................................................................................................... 5
Importance of internal audit 5
INEDs, IA and Corporate collapse...............................................................................................7
Potential difficulties......................................................................................................................7
Reference.................................................................................................................................... 9

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Letter
Andrew Clase ACMA
Andrew Clase and Co Ltd
10, Presceli Avenue
Swansea
SA75 6XX
Gareth Roberts
Chief Executive
HK Design Ltd
Buccaneer Buildings
Caer Street
Swansea
SA51 2JJ
11th January 2020
Dear Gareth,
I have received your letter dated 8th January 2020 and knew that you want to gain an
understanding of the topic of “independent non-executive directors” and internal audits. I have
arranged a report consisting answers of to your questions and the same is attached herewith as
Annexure A. In this report, you may find answers to questions that you have directly asked as
well as other related aspects.
I hope that you would find this cover letter and the attached report in order. I further hope that
the report will fulfill its purpose by removing all of your possible doubts about the addition of
“independent non-executive directors (INEDs)” and an Internal Audit (IA) to your company.
Thanks and Regards
Andy Clase

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Annexure 1
Independent directors
Corporate Governance refers to a combination of process, customs, rules and law through that
business are operated regulated and controlled (Khan, 2011). A business needs to have good
governance for many reasons such as avoidance of conflict of interest consideration of the
interest of all stakeholders, development and maintenance of transparency and so on. Here the
question arises that how a company can ensure good governance at the place. I would like to
inform you in the UK, the corporate governance code is there which applies to each listed
company and outlines the standard way in which these companies should operate. This code is
not law but a set of guiding principles and therefore the compliance of the same is not
mandatory but is advisory to be different in the industry, reducing the risk of corporate collapse
and creating positive value and image in the eyes of shareholders and other stakeholders. The
code suggests standard practices about board composition and development, shareholder
relation, audit, accountability, and remuneration (icaew.com, 2020). The concept of an
“independent non-executive director” is mentioned under this code. As per this code, half of the
board of the listed company should consist of “non-executive directors” that board treats as an
independent. The one important thing to inform here is that an independent director is always a
non-executive one, but a non-executive director does not need to be independent always.
Who is an “independent non-executive director (INED)”s?
An “independent non-executive director” is the one who:-
 has the capacity to influence the decision of the board of directors but is not a
representative of the shareholders
 is not or have not been an employee in the company or any other group company during
the last five years (Angwin, Cummings and Smith, 2011)
 does not have or had any material business relationship with the company directly or in
the capacity of a director, partner or senior employee of an entity who had such
relationship (Zhao , 2011)
 do not receive or received any additional payments apart from the director fee in any
form such as bonus share, dividend, participation in the company's share scheme and
so on (frc.org.uk, 2018)
 Is not involved in any with any other group company
 do not have any close relationship with any director, senior employee or advisor of the
company
 do not serve for more than 9 years since his/her first appointment (issgovernance.com,
2014)
How an “independent director” is important
If a person fails to possess any one or more of the abovementioned requirements, the same
cannot be treated or appointed as an “independent non-executive director”. Such directors are
not engaged in day-to-day management of the business, however, they take part in policy and
decision-making. This is a common question to ask how such a director can be independent
while working for the company. To answer this query, this is to state that these directors only
take director fee and in return to this, monitor the performance of the executive directors.
Executive directors are often relatives to each other and in such a situation, there are high
chances of consideration of personal interest or ignorance of the interest of other stakeholders.
It is not always about fraudulent behavior of executive directors but many times, they commit

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some mistakes while performing their functions or influence their decision through personal
interest due to their relationship with the company and other directors. In such a way,
independent directors ensure that executive directors are working in the best interest of the
company and the stakeholders and regulate their behavior.
These directors improve corporate governance in many modes. One of the ways is already
discussed where they evaluate the performance of the executive directors (icsa.org.uk, 2010).
Secondly, they improve transparency in the working of the company. Due to the existence of
these directors, a company no longer remains a closely held company and “independent non-
executive directors” motivate the company to operate more transparently (Clarke and Branso,
2012). Further, it is common for companies to enter into related party transactions regularly, for
instance, transactions related to sale, purchase of goods and so on. Due to involvement in
regular commercial dealings, it does not become possible for executive directors to check the
legality of such transactions as per Companies Act 2006 and in such a way, independent
directors play their crucial role as they additional attention to such transactions. Here they
reduce the risk of legal actions against the company. In conjunction with this, such directors
usually have expertise in one or more area and in this way company get the benefit of their
impendent expertise
The presence of independent directors also provides indirect benefits to the company where
stakeholder values those firms and companies who have such directors on the board. The
presence of such directors shows that the company is credible to the outside stakeholders.
Lastly, these directors also enhance access of the company to the external connections and
resources.
Internal Audit
Internal audit is one of the important aspects of the UK corporate governance code. The internal
audit refers to a consulting and objective assurance activity, which is designed to improve
operations of the organization, by a disciplined and systemic approach to evaluate and improve
the effectiveness of governance process and risk management and control (deloitte.com, 2020).
Similar to “independent non-executive directors”, internal audit also proves beneficial for the
company as the same also enhances the level of good governance. The internal auditor is a
professional who possesses an internal audit in a company. The main objective of this audit is
to provide independent assurance that the company is operating effectively without breaching
any provision of applicable laws (Daniela, 2020).
Importance of internal audit
One of the major functions of the internal audit is to identify fraud in the company. Internal
auditors time check all the major and significant transactions of the company and identify
whether all those transactions have been done in the best interest of the company or directors
officers of senior employees of the company have committed any fraud (Petraşcu and Tieanu,
2014). In case of finding any such issue, internal audit goes into the matter and check what was
the reason behind the same. This audit also works on the ways in which the happening of
similar issues can be prevented in the future. The second favor that this audit does to the
company in ensuring compliance with the law (Caratas and Spatariu, 2014). This is one of the
major functions of such an audit. During the process of internal audit, the auditor checks the
annual and other periodic compliance. Since the internal audit is a continuous process hence
any noncompliance can be identified on time and it cost the charges of an additional fee as well
as penalty notices. Further, at many times, some specific events are there that requires to be

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notified to the stock exchange or other authorities and internal audit also check compliance with
some additional requirements.
As you have asked that how a company can get benefited by adopting internal audits, hence in
the due course of answering it, this is to state that it also plays an important in the risk
management of the company (iia.org.uk, 2020). An internal audit of the company identifies and
assesses the risky areas of business. In the sector of risk management, internal audit identifies
the complexity of the operations and also prescribes measures of internal control (Ismajli, Guda
Ferati, and Ferati, 2017). Every company has certain internal control measures and system,
which refers to the rules, policies, and procedures of the company. These internal controls
regulate the manner of working of the company (Kabuye, Kato, Akugizibwe and Bugambiro,
2019). Internal audit also checks the effectiveness of such internal controls. Many of the times,
companies make policies that do work as per expectations and in an effective manner but the
same is not the situation all the time. Usually, some changes occur in the business environment
due to t the rules and policies of the company become outdated that managers of the business
cannot identify, however, internal audit check such gaps. In this way, it ensures good
governance in the company where all the policies are updated as per the current and
companies comply with all the compliances. Internal audit (IA) also checks whether the directors
are fulfilling their duties or not. It identifies a breach of director’s duties whether the same is
intentional or not and in this way ensures good governance and the fact that directors of the
company are performing their functions in a required manner.
INEDs, IA and Corporate collapse
I am glad to know that you have heard about corporate collapses occurred in the past and
would like to discuss the matter further. This is to inform you that the lead reason behind the
corporate collapse is mismanagement and negligence behavior of the directors. However many
times fraudulent intention of directors and managers of the businesses are also involved but this
is not the case every time. Independent directors and internal audits ensure those directors are
following their duties, a good level of transparency and fairness is there in the functions of the
company. However, the involvement of INEDs, as well as internal audit, carries a certain cost to
the companies, nevertheless, the benefits of the same cannot be ignored due to this additional
cost factor.
This is important to inform here that neither INED nor IA makes sure that no corporate collapse
would be there. It means both of these studied measures do not guarantee of an ideal situation.
However, the same reduces the risk of such collapse and corporate governance scandal by a
significant rate. If you are concerned about the additional cost of these governance measures I
need to tell that it would cost very less than the potential cost your company may suffer under a
corporate collapse. Hence it is advisable to appoint INED and adopt IA in functions as there will
be very little chance of scandals after such changes.
Potential difficulties
I have already notified you of the additional points that you need to know while discussing two of
these aspects. As you have asked I would like to bring your attention to the difficulties that you
may face if would go with these changes. The very first difficulty that you may face is that the
independent director does not have much knowledge about the company and therefore you
would have to spend your time procuring some basic documents related to the company to such
directors. This is generally a one-time activity. The second difficulty you may face is related to
confidential information of the company. It may difficult to share the company's information as

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well as resolutions and plans with an outsider. The conflict of opinion is another obstacle that
the directors may face. There are usually different opinions of executive directors and
independent directors; however, the same does not remain there after a certain period.
Some challenges may also be there to the internal, audit, where different stakeholders have
different and extended expectations out of the same. The second challenge that is likely to be
there is that it sometimes requires changes in the policies that affect the current working of the
company and delays the matter.
I am hereby concluding this report answering all the questions asked by you in a direct and easy
to understand language.

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Reference
Angwin, D., Cummings, S., and Smith, C., (2011) The Strategy Pathfinder: Core Concepts and
Live Cases. UK: John Wiley & Sons.
Caratas, M.A. and Spatariu, E.C., 2014. Contemporary approaches in internal audit. Procedia
Economics and Finance, 15, pp.530-537.
Clarke, T., and Branso, D. (2012) The SAGE Handbook of Corporate Governance. London:
SAGE.
Companies Act 2006
Daniela, P. (2020) Internal audit: defining, objectives, functions and stages. [online] Available
from: https://core.ac.uk/download/pdf/6313583.pdf [Accessed on 19/04/2020]
deloitte.com. (2020) Internal Audit. [online] Available from:
https://www2.deloitte.com/uk/en/pages/audit/topics/internal-audit.html [Accessed on 19/04/2020]
frc.org.uk. (2018) The Uk corporate governance code. [online] Available from:
https://www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-
Corporate-Governance-Code-FINAL.pdf [Accessed on 19/04/2020]
icaew.com. (2020) UK Corporate Governance Code. [online] Available from:
https://www.icaew.com/technical/corporate-governance/codes-and-reports/uk-corporate-
governance-code
icsa.org.uk. (2010) ICSA Review of the Higgs Guidance on behalf of the FRC. [online] Available
from: https://www.icsa.org.uk/assets/files/pdfs/guidance/IBE%20Second%20Consultation/
Improving%20Board%20Effectiveness.pdf [Accessed on 19/04/2020]
iia.org.uk. (2020) What is internal audit? [online] Available from: https://www.iia.org.uk/about-
us/what-is-internal-audit/ [Accessed on 19/04/2020]
Ismajli, H., Guda Ferati, M. and Ferati, A., 2017. The role of internal audit in risk management–
Evidence from private sector of Kosovo. Acta Universitatis Danubius. Œconomica, 13(5).
issgovernance.com. (2014) Corporate Governance Policy and Voting Guidelines for Investment
Companies. [online] Available from:
https://www.issgovernance.com/file/2014_Policies/0279_Corporate_governance_policy_and_vo
ting_guidelines_for_investment_companies_an_NAPF_document.pdf [Accessed on 19/04/2020]
Kabuye, F., Kato, J., Akugizibwe, I. and Bugambiro, N., 2019. Internal control systems, working
capital management and financial performance of supermarkets. Cogent Business &
Management, 6(1), p.1573524.
Khan, H., 2011. A literature review of corporate governance. In International Conference on E-
business, Management and Economics (Vol. 25, pp. 1-5).
Petraşcu, D. and Tieanu, A., 2014. The role of internal audit in fraud prevention and
detection. Procedia Economics and Finance, 16(8), pp.489-497.

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Zhao, Y. (2011) Corporate Governance and Directors' Independence. The Netherlands Kluwer
Law International B.V.