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Sabtu, 14 Maret 2015

Audit Committee Effectiveness and Fraud Occurrence

THE INDONESIAN JOURNAL OF ACCOUNTING RESEARCH
Vol. 16, No. 1, January 2013
Page 18-38

CHRISTINE NOVITA DEWI
Universitas Duta Wacana

GUDONO
Universitas Gadjah Mada


Abstract: 
The purpose of this study is to examine the effect of audit committee effectiveness on the fraud occurrence within state-owned enterprises/BUMN. The study uses a Partial Least Square (PLS) based Structural Equation Model. The sample consists of thirty one state-owned companies (BUMN) – out of one hundred and fourty one BUMN which were actively operating in Indonesia during the period of 2007 – 2010 or about 22 percent of the existing BUMN. Samples were selected using the purposive sampling method. The results show that audit committee effectiveness is negatively associated with fraud indications within BUMN. The more effective the audit committee, which is proxied by its members’ expertise, size and activeness of the audit committee in carrying out the role and duties, the fewer the indications of fraud.

Keywords: audit committee effectiveness, fraud occurrence, stateowned enterprises



Introduction

Even though audit committees were already known in England, US and Canada in the 19 th century, 1939 and 1965, respectively (Burke et al, 2008), in Indonesia the audit committee had not yet been required until 1999 when the government set a policy on the establishment of audit committees in State-Owned Enterprises (BUMN) (Kep-133/MPBUMN/1999 dated on March 8th, 1999). In 2008, in line with the demands of stakeholders for good corporate governance, the Indonesia Capital Market and Financial Institution Supervisory Agency (Bappepam-LK) issued an appeal to support every public company to have an audit committee (SE Bapepam No. SE-03/PM/2000). However, the regulation has not been responded to well by public companies. Only in recent years the establishment of audit committees in Indonesia received positive feedback from various parties, including the Government, the Bapepam, the Indonesia Stock Exchange, investors, legal professions (lawyers), and professional accountants.

The issue of audit committees started to receive major attention after the Enron case which then triggered the enactment of Sarbanes-Oxley Act/SOX (2002). In Chapter 301 of the Act, it is stated that audit committees have the responsibility to appoint, to determine compensation, and to supervise external auditors related to their work in conducting an audit for the company. This also includes a mediating role if any dispute arises between management and external auditors. Furthermore, the same Chapter states that an audit committee has the authority to conduct direct communication with independent consultants.

State-owned enterprises are commonly intended to support sustainable national development as the main source of revenue for the state treasury (Act No 19 of 2003 BUMN). Nevertheless, in many cases, state-owned enterprises become burdens on the nation because of losses and misuses of funds. Indonesian Corruption Watch (ICW) reported an increasing number of potential misuse or corruption that occurred in both BUMN and Local Government-Owned Enterprises (BUMD) up to 2006 (Tempo Newspaper, July 20, 2006) . According to the ICW, from the potential corruption cases that occurred before 2006 , BUMN and local government-owned enterprises contributed around 13.4 percent, while from the total corruption cases that emerged in the first semester in 2006, the number reached 46.4 percent. At a glance, data presented by the ICW raise many questions regarding the weakness of internal control systems of many BUMNs. The public questions whether the supervision function is in place to prevent fraud from occuring in

BUMNs.

Within BUMN, directors, the commissioner/supervisory board and the audit committee, have an important role in conducting oversight functions at different levels of the performance of organizations as part of the establisment of good corporate governance. The BUMN Act No. 19 of 2003 section 6 number 1 states that the commissioner and board of supervisors are fully responsible for the supervision of BUMN for its purposes and objectives. In Chapter II Persero (limited liability company) the sixth part of article 31 and Chapter III Perum (public company) and the eighth part of article 60, stated that the commissioner/supervisory board oversees the board of directors in running their tasks and advising them, so that when irregularities occur, it would be used as an indicator of weak oversight by the commissioner/supervisory board. The BUMN Act No. 19 of 2003 chapter 70 number 1 stated that the commissioner and supervisory board are required to form an audit committee which works effectively and functions to support them in conducting their work. In principle, the roles and responsibilities of the audit committee include assisting the commissioner/supervisory board in performing the functions of internal control, financial reporting and management.

The audit committee’s membership is regulated by Decree of the Minister for BUMN No. KEP-103/MBU/2002 regarding the establishment of audit committees for State-Owned Enterprises which is set out as follows:
  1. An audit committee consists of at least : one member of commissioner/supervisory board; and two experts who are not employees of the BUMN itself
  2. One of the member of commissioner/supervisory board as mention in number (1) letter

“a” who is acting as chairman of the audit committee

Menon dan William (1994) found that to raise the effectiveness of an audit committee, what is needed is the active involvement of members of the audit committee in carrying their roles and functions. The results found by Menon and William were corroborated by the results of Abbot et al (2000) which showed that audit committee effectiveness is a function of: 1) the ability to effectively monitor the management and, 2) the desire to effectively fulfill the duties and responsibilities as an audit committee.

In this study, “ability” was proxied by the expertise of audit committee members while “desire” is proxied by the percentage of the audit committees that follow up the recommendations in the Examination Report (LHP) of the Indonesian Supreme Audit Board (BPK). The Indonesian Institute of Audit Committees (IKAI) said that an audit committee should have 5 I’s, namely 1) Integrity, 2) Proactive Initiative to conduct an audit of the internal audit reviews on auditors, 3) Innovation to develop risk reduction, 4) Independency and 5) high Intelligence. All of the five “I’s” which are mentioned by the IKAI have an important role in establishing an effective audit committee, however, Bappepam-LK ( capital market and financial institution supervisory agency) and the Indonesian Stock Exchange (BEI) has its own reasons to pay special attention to the fifth “I”, namely Intelligence. The audit committees whose members have high intelligence are expected to have an adequate ability to detect problems and execute the appropriate actions to solve these problems.

The audit committee that does not have the knowledge, experience and expertise that are appropriate and relevant to the needs of companies, will fail to perform effectively. The more effective the audit committee, the more optimal their oversight functions are carried out on state-owned enterprises. Since one of an audit committee’s roles is to eliminate risks of fraud, then the objective of this study is to test whether the oversight function would reduce the probability of fraud.
 
 

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