| A sound and effective internal control system is a critical guarantee for the healthy development of enterprises. Investors and regulatory authorities blamed financial scandals such as Enron and WorldCom on the failure of internal control. In response, The Public Company Accounting Reform and Investor Protection Act of2002(Commonly referred to as The Sarbanes-Oxley Act) was enacted in the United States. The Act calls for listed companies to report on the internal control over financial reporting and requires external auditors to issue an opinion on financial related internal control. At this point, the institution of internal control audit was officially established in the United States and spread widely all over the world.In May2008, China’s Ministry of Finance, National Audit office, CSRC, CBRC and CIRC jointly issued the Basic Norms of Internal Control of Enterprises, which signified the legislative enactment of the internal control audit institution. In April2010, Guidelines for Internal Control Audit was issued, and it outlines that the policies on internal control audit shall apply to companies concurrently listed inside and outside China as of2011and to A-share companies listed on Main Board in China as of2012. The guidelines require auditors to perform an audit of the internal control over financial reporting. The institution of internal control audit was thereby officially implemented in China.However, during the course of legislating and implementing the institution on internal control audit, quite some controversies had been revealed, including practical level debates, such as technique auditing approach, appraisal standards on internal control weakness, and how to perform integrated audit with financial statement audit, furthermore, deepened in to theoretical level, such as the nature, objectives, scopes of internal control audit. Since2011, some scholars pointed out that the research in internal control over financial reporting has turned out to be an embarrassing situation because it is trying to find reasons of independent existence for a system that cannot exist independently. Furthermore, other scholars even doubted the rationality of the institution of auditing over financial related internal control. Thus, the author points out that there is a need to bring everything back to the starting point of audit theories thereby make theoretical explanations for the institution on internal control audit, and to answer the above fundamental theoretical questions, like the objectives, the realization mechanism of internal control audit. It will help clarify the doubts with internal control audit, systematically establish the theory framework of internal control audit institution, the methodology of internal control and give a guide to perfect the standards of internal control audit. This is the significant theoretical meanings of the dissertation and also where the practical meanings rest.Based on the above background and the selected research orientation, the dissertation is a fundamental theoretical research of institution on internal control audit, and the purpose is to reveal the nature of internal control audit, to issue the author’s new opinion on internal control audit institution, and to establish the framework of internal control audit, including objectives and mechanism. That is to say, the dissertation is on why and what of internal control audit, rather than on how, such as auditing practical technology.Audit is the product of principal-agent relationship; there is no exception for internal control audit. The author applies the following research route. In order to analyzing the cause of internal control audit, the dissertation started from the change of principal-agent relationship, then pointed out the malfunction of traditional principal-agent, and explained the nature of internal control audit as a renovation to the principal-agent relationship supervision mechanism. The author also re-recognizes the nature of internal control and its objective, and then establishes the mechanism of internal control audit. The dissertation draws the following main conclusions:Firstly, the dissertation renders a new idea of internal control audit institution, that is, internal control audit is a renovation to principal-agent relationship supervision mechanism, aiming to supervise the process of principal-agent relationship.Under the traditional Principal-Agent Relationship, the incentive mechanism is realized through operators’ sharing remaining profits, while the supervision mechanism is to monitor the results of principal-agent relationship, which is to carry out an audit of financial statements. While interests of different parties start to diverge, the supervision of principal-agent relationship cannot depend solely on results monitoring but also on the process of the principal-agent relationship, that is to say, internal control audit. This is the fundamental explanation of the institution of internal control audit.Secondly, the failure of the supervision mechanism of the traditional principal-agent relationship stems from the divergence of interests between different parties in principal-agent relationship, and the divergence is resulted from innovations of economic policies.From the principle’s perspective, innovations on modern financial policies such as joint stock company system and asset securitization diversified the principal-agent relationship where interests of different principles are not completely consistent and majority shareholders could make profits by taking advantage of minority shareholders; or innovations on modern company policies such as limited liability company system and bankruptcy protection, where the dominant principle could files for a bankruptcy to make profits, or majority shareholders make profits by exploiting creditors or by damaging the business interests. From the agencies’ perspectives, innovations on incentive systems for agencies such as stock options, where the agency does no longer rely on sharing remaining profits but stock capital to make profits. Therefore, the supervision mechanism of the traditional principal-agent relationship fails when the interests of different parties in principal-agent relationship start to diverge but at the same time the supervision system did not move forward.Thirdly, the objective of internal control audit is to assure the effectiveness of internal control and render an independent opinion. The definition of effectiveness of internal control relies on the understanding of nature of internal control and its objectives.Based on incomplete contract theory of property rights, the dissertation brings forward the contract view of internal control and pointed out that internal control is a supplement to the incomplete contract of enterprises. From the principal-agent relationship points of view, enterprise internal control includes controls on operators centered on owners, and controls on management and employees at all levels centered on operators. The objective of internal control is to reduce transaction costs, that is, to ensure the efficiency of second transactions, brought out by John Rogers Commons, and to make transaction costs in enterprises lower than the market price.Forthly, the realization mechanism of internal control audit includes three parts, setting up standards on internal control efficiency, establishing assessment mechanism on the effectiveness of internal control, and forming a complete set of measures.Based on the contract view of internal control, the dissertation brings forward three methods on how to appraisal effectiveness of internal control by reducing transaction costs, including the level, approach and mechanism dimensions; according to principal of Evaluating Science, the author points out the qualitative and quantitative appraisal routes of effectiveness of internal control, and sets up eight steps of internal control weakness appraisal, afterthat outline the principles of audit opinon; lastly, the author raise the suggestions on how to tackle the unique issues stem from internal control audit, such as audit independence, professional competence, costs and efficiency and the audit report’s legal liabilities. |
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