Legal duties of the external auditor

1
Auditing I Week 4

• Legal duties of the external auditor
• Duties under common law
• Professional duties
• Expectation gap

2
Rights, Responsibilities and Duties

• Defined by 4 separate institutions
• Parliament (in statute law)
• Courts (in common/case law)
• Profession (APB for UK and Ireland)
• Other Regulators whose role is derived from
  Statute e.g. FSA, UKLA..

3
Statutory Audit Requirement

• Most audit work relates to companies (public and
  private) incorporated under the Companies Act
  1985 (NI Order 1986).
• CA1985 requires that
• The Directors of all companies must prepare and
  provide to all share and debenture holders and to
  the Registrar of Companies a balance sheet and
  profit and loss account for each financial year.
• These F/S must comply with the form and content
  set out in Schgedule 4 of CA1985 (s.226) and
  present a True and Fair view of
• State of affairs
• Profit or Loss AND
• Cashflow (where applicable).

4
Statutory Audit Requirement

• NOTE
• The meaning of True and Fair is not defined in
  legislation or by the courts but it is generally
  accepted that to be True and Fair they must
  comply with FRSs and SSAPs issued by the
  Accounting Standards Board (ASB).

5
Statutory Audit Requirement

• CA1985 also sets out
• Who may be an auditor.
• Who is responsible for appointing and
  remunerating auditors.
• How auditors may resign or be removed.
• Basic rights and duties of auditors.

6
Statutory Audit Requirement

• Section 384 of the Act requires every company
  incorporated to appoint an auditor.
• Now relaxed to exclude companies which qualify as
  small and with less than 5.6m turnover and 2.8m
  balance sheet total.
• Casual vacancy can be appointed by the directors.
• Appointed at general meeting or for first
  auditors by directors until general meeting.
• If none appointed the Secretary of State shall
  appoint.
• Section 236 the auditor shall make a report to
  the members.

7
Statutory Audit Requirement

• S 236 states
• The auditors report shall state whether in the
  auditors opinion the annual accounts have been
  properly prepared in accordance with this Act,
  and in particular whether a true and fair view is
  given.
• S 237 states
• Proper accounting records are kept.
• Financial statements are in agreement with
  underlying accounting records.
• Right of access at all times to the companys
  books, accounts.and entitled to require from the
  companys officers such information and
  explanations he thinks necessary.
• Need to report if they fail to obtain
  information.
• Need to report if Directors emoluments, employee
  information and loans to Directors are not
  disclosed in accordance with Sch. 5 Parts V and
  VI and Sch. 6 Parts I to III.
• Information in directors report consistent with
  financial statements.

8
Statutory Audit Requirement

• Who may be an auditor S. 389 (CA 1985)
• Member of a body of accountants established in UK
  and recognised by Secretary of State
• ICAEW
• ICAS
• ICAI
• ACCA
• Authorised by Secretary of State with similar
  qualifications.
• Cannot be
• An officer or servant of the company
• A person who is a partner or employee of above
• A body corporate.

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Statutory Audit Requirement

• Who may be an auditor S. 25-27 (CA 1989)
• As 1985 Act.
• Introduced a regime for regulating auditors in
  line with EU 8th Directive. To ensure that
• only people who are properly supervised and
  appropriately qualified are appointed as company
  auditors, and that audits are carried out
  properly, with integrity and with the proper
  degree of independence
• Need to qualify with one of the RQBs
• Need to register with one of the RSBs.

10
Statutory Audit Requirement

• Audit remuneration S 385
• Power to appoint hence also to fix the
  remuneration in general meeting.
• however this power is normally delegated by the
  members to the directors in general meeting.
• Note To allow transparency audit and non audit
  fees are disclosed in the notes to the financial
  statements.

11
Statutory Audit Requirement

• Removal of an auditor s.391
• Ordinary resolution required.
• Special notice given 28 days before meeting.
• Existing auditor has right to make
  representations.
• Concerning the facts which they consider should
  be brought to the members attention.
• Representations may be read out at the meeting.

12
Statutory Audit Requirement

• Resignation of the auditor.
• Resign at any time.
• By depositing a written notice of resignation.
• Notice must contain
• Either a statement that there are no
  circumstances connected with the resignation
  which the auditor considers should be brought to
  the members attention.
• A statement of any such circumstances.

13
Statutory Audit Requirement

• Auditors right to an EGM s392A 1985.
• The auditor may require the directors to
• Convene an EGM for the purpose of receiving and
  considering their statement of circumstances.

14
Auditors Statutory Rights

• Right of access at all times to accounting and
  other records.
• Right to require directors and employees to
  provide information and explanations necessary
  for performance of duties.
• Right to attend any AGM.

15
Auditors duty under common law

• Re Kinston Cotton Mill 1896
• London Oil Storage 1904
• Pacific Acceptance Corporation Ltd v Forsyth
  (Aus) 1970 J Moffit
• Underlies the Auditing Standards of today.

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Auditors duty under common law

• Pacific Acceptance Corporation Ltd v Forsyth
  (Aus) 1970.
• Need to conduct such examination as is necessary
  to form their opinion and to take due skill
  care in doing so.
• Duties not confined to an examination of books
  and records.
• Pay due regard to the possibility of fraud.
• Make prompt and frank disclosure to appropriate
  level of management of material matters
  discovered during the course of the audit.
• Report at general meeting.
• Paramount duty to check for him/herself material
  matters, reliance on others is an aid but not a
  substitute.
• Negligence is not established by use of
  inexperienced staff etc., but may be seen as
  evidence of negligence.

17
Auditors duties under professional standards

• APB Re-established 2002 replacing the one
  established in 1991.
• Part of FRC.
• Committed to leading the development of auditing
  practice in UK and Ireland by
• Establishing high standards.
• Meeting developing needs of users of financial
  information.
• Ensuring public confidence.

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Publications of the APB

• Standards produced serve 2 purposes
• Inform auditors about standard of work required.
• Help to protect the reputation of the profession
  as a whole.
• Three categories of publications
• Statements of Auditing Standards SASs (Now
  aligned with ISAs)
• Practice Notes (PNs)
• Bulletins
• Also Ethical Standards.

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Who is responsible for the accounts preparation ?

• Clearly the Companies Act 1985 states it is the
  responsibility of the Directors of the company.
• Research by Lee Tweedie (1975) Porter and
  Gowthorpe (2001).
• 25 of financial community and
• 25 of Non Audit beneficiaries

20
Who is responsible for the accounts preparation ?

• Think the auditors are responsible for the
  preparation of financial statements of a company.
• Hence we have the

21
Expectation Gap

• Mismatch
• between what duties society expects of auditors
  and what it perceives it receives from them.
• Because of this mismatch auditors fail to meet
  societys expectations and therefore
• Considerable litigation against the audit
  profession and
• Loss of public confidence in audits.

22
Identification of the Gap

• Reasonableness gap
• The duties that society unreasonably expects
  auditors to perform.
• Performance gap
• The gap between societys reasonable expectations
  and what society perceives auditors actually
  accomplish. Comprising
• Deficient standards gap
• Deficient performance gap

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The Gaps

• Reasonableness gap
• Should be cost beneficial for auditors to
  perform.
• E.g. 100 testing, newly emerging issues.

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The Gaps

• Standards gap
• Reasonably expected of auditors but not required
• Reporting material theft to appropriate
  authority.
• Corporate governance issues e.g. controls and
  risk management reporting.
• Performance gap
• Where the audit is performed below existing
  standards required by the profession.
• Detecting material theft
• Reporting to appropriate authorities
• Going concern reporting
• Liability gap
• Where the public does not know to whom an auditor
  is legally responsible.

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Closing the gap

• Biggest issue is narrowing the reasonableness gap
  with better understanding of financial statements
  and the audit report EDUCATION!
• Better quality control should reduce performance
  gap ISA 220.
• Standards which embrace cost effective duties
  e.g. corporate governance issues.
• Monitoring by RSBs.

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Understanding financial statements and the audit
report

• Public perception
• Education
• More informational audit report
• Meaningful statements

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Closing the gap

• NOTE Since 1989 two reasonable but not required
  duties have become existing duties
• Reporting theft and other illegal acts by company
  officials to appropriate authorities when in the
  public interest.
• Stronger going concern guidance.
• Also Anti-money laundering regulation.