Restmount Kenya Ltd. was formed on 1 October 1997 in order to export tea and coffee to European markets. The Directors are unsure as to their responsibilities and the nature of their relationship with the external auditors. The audit partner has asked you to visit the client and explain to the directors, the fundamental aspects of the accountability of the directors and their relationship with the auditor.
Explain to the directors of Restmount Kenya Ltd: –
a) The need for an audit. (6 marks)
b) Procedures for the appointment of an auditor of a public company under the
Companies Act. (5 marks)
c) Directors‘ responsibilities in relation to the accounting function of the Company.
d) Auditors‘ statutory responsibilities in relation to the audit of the company‘s financial statements. (5 marks)
a) Need for an audit
Today most businesses are operated limited companies, which are owned the shareholders and managed directors appointed such shareholders. The appointed management is faced with a conflict of interest i.e. whether to act in the best interest of the company and extension the shareholders‘ interest or to act in their best interest. This is what is referred to as the agency problem.
The separation that exists between the owners and management forces the absentee owners to institute control measures to ensure honesty of their company‘s stewards (i.e. management). The companies Act attempts to remedy this problem requiring the management to maintain proper accounting records of all the transactions of the company and to prepare financial statements that show a true and fair view to be presented to the shareholders at the annual general meeting.
However, even with this requirement there still exists the risk that the accounting records maintained and the financial statements prepared management might not be
accurate, free from bias and reflect the true financial position and performance of the company. The companies Act therefore goes further to require that management must have the financial statements subjected to an independent examination and a report issued to the shareholders as to whether the financial statements show a true and fair view. This therefore creates the need for an audit. The auditor carries out this independent examination. To ensure independence of the auditor the companies Act gives the power of appointment and removal of the auditor from office to the shareholders.
The primary objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework and show a true and fair view. (Financial reporting framework refers to the international accounting standards, provisions of the companies Act and other relevant statutes and legislation). The auditor expresses an opinion as to whether the financial statements give a true and fair view of the financial position and performance of the company.
Note that: an auditor does not certify the financial statements as true and fair but only reports his opinion basing on the evidence obtained.
b) Procedures for appointment of auditor
The appointment of a statutory auditor is governed the Company‘s Act Cap 486.
S.259 (2) provides that ―every company shall at each annual general meeting appointan auditor or auditors to hold office from the conclusion of that, until the conclusion of the next, annual general meeting.‖
The auditor‘s appointment thus runs for approximately a year from the moment the meeting ends. This section makes it clear that it is the company (i.e. the members/shareholders) which appoints the auditor(s) and not the directors.
However, in practice it is important to note that there will be occasions where the company is wholly, or mainly made up of director shareholders. Also in most cases the directors; acting as agents of the company will choose or recommend to the shareholders which auditing firm to appoint.
REAPPOINTMENT OF AUDITORS
S.259 (2)‖ a retiring auditor shall be deemed to be re-appointed without any resolution being passed unless: –
a) He is not qualified for appointment; or
b) A resolution has been passed at that meeting (i.e. annual general meeting) appointing somebody instead of him or providing expressly that he shall not be re-appointed; or
c) He has given the company notice in writing of his unwillingness to be re- appointed.
According to this provision of the company‘s Act an appointed auditor is deemed to be automatically re-appointed come the next annual general meeting for another term in office unless any of the three mentioned situations exist.
APPOINTMENT BY REGISTRAR
S.259 (3) ―Where at an annual general meeting no auditors are appointed or deemed to be appointed, the registrar may appoint a person to fill the vacancy‖
The directors have the duty of informing the registrar of the failure the company to appoint an auditor within seven (7) days.
APPOINTMENT BY DIRECTORS
S. 259 (5)-the first auditors of a company may be appointed the directors at any time before the annual general meeting, and the auditors so appointed shall hold office until the conclusion of that meeting.
In default of appointment, the first auditors the directors the company may do so. Where the directors have appointed the first auditors, the company may at a general meeting remove such auditors and appoint in their place any other persons who have been nominated for appointment any member of the company. Notice of nomination to be given to the members at least 24 days before the date of the meeting.
S. 159 (6) ―The directors may fill any casual vacancy in the office of the auditor, but while any such vacancy continues the surviving or continuing auditor(s), if any may act.‖
A casual vacancy may arise out of any of the following reasons;
a) Death of the auditor
i.e. a casual vacancy arises when any of the above circumstances arise leaving the office of the auditor vacant before the expiry of the term in office under the contract.
The directors of the company may fill a casual vacancy in the office of the auditor.
c) The responsibilities of the directors in relation to the accounting function of the company are as follows:-
1. To safeguard the company‘s assets and to prevent fraud and errors in the company.
2. To ensure that the company keeps proper accounting records.
3. To prepare annual financial statements to show the results of the company for the year and the state of affairs of the company at the balance sheet date. (Must show a true and fair view).
4. To deliver to the registrar of companies a copy of the company‘s audited
financial statements within seven months of the end of the accounting year.
5. To set up an ICS in the company to ensure that all the above are carried out.
d) Duties/responsibilities of the auditor
To report to the shareholders on whether the financial statements of the company (or group of companies) show a true ad fair view or present fairly and have been properly prepared in accordance with the requirements of the companies Act i.e. the profit and loss account and the balance sheet show a true and fair view.
To consider whether the information on the directors report is consistent with the financial statements and if not, to state the fact in his report.
To report whether proper accounting records have been kept the company
To report whether proper returns adequate for their audit have been received branches not visited them
To report whether the company‘s balance sheet and its profit and loss account are in agreement with the acting records
To report whether he has received such information and explanations s he thinks necessary for the performance of his duties.