Under the provisions of the Companies Act, companies are obliged to keep certain books of accounts known as the Annual Financial Statements in the English language.
Every company must keep proper books of accounts with respect to:
• All sums of money received and expected by the company and the matters in respect of which the receipt and expenditure takes place.
• All sales and purchases of goods by the company.
• The assets and liabilities of the company
Section 620 defines “annual financial statement”, in relation to a company to mean the company’s individual financial statement for a financial year, and includes any group financial statement prepared by the company for that year. Specifically the annual financial statements and reports for a financial year consist of the following:
|Unquoted Companies||Quoted Companies|
|a) The Annual Financial Statements||a) The Annual Financial Statements|
|b) The Director’s report||b) The Director’s remuneration report|
|c) The Auditor’s report on both (a) and (b) above||c) The Director’s report|
|d) The Auditor’s report on (a), (b) and (c) above|
The Small Company Regime
Under the 2015 Act, regulations on companies and small companies as concerns Company Accounts vary. Under Section 623, a company is deemed a “small company” if any two of the following conditions apply:
a) it has a turnover of not more than KES 50Million;
b) the value of its net assets as shown in its balance sheet as at the end of the year is not more than KES 20M; and
c) it does not have more than 50 employees on average per year.
However, S.626 excludes the following companies from the small companies regime identified above:
a) a public company
b) a member of an ineligible group
c) a person who carries on insurance market or banking activity
Companies Required to Keep Proper Accounting Records – S.628
S.628 is clear that every company shall keep proper accounting records i.e. records which:
a) show and explain the transactions of the company;
b) disclose with reasonable accuracy, the financial position of the company at that time; and
c) enable the directors lo ensure that every financial statement required to be prepared complies with the requirements of the 2015 Companies Act.
These records should contain:
• Entries from day to day of all amounts of money received and, spent by the ,company and the matters in, respect of which the receipt and expenditure takes place; and
• A record of the assets and liabilities of the company;
• statements of stock held by the company at the end of each financial year of the company
• all statements of stock-taking
• statements of all goods purchased and sold identifying the buyers and sellers in detail
Default fine: Company = KES 2M fine; Natural person = KES 1M fine and/or 2yrs imprisonment
Location of Accounting Records
S.630 dictates that these are to be maintained in the company’s registered office. The records must be open to inspection by the officers of the company.
These accounting records are to be preserved for a period of 7years.
Default fine: Company = KES 2M; Natural person = KES 1M fine and/or 2yrs imprisonment
Annual Financial Statements: Composition and Preparation
Under S.635 these are to be prepared by the company directors failing which a default penalty of KES 1M applies.
S.636 dictates that the AFS so prepared must give a true and fair view of the assets, liabilities, profit or loss of the company, failing which a default fine of KES 500,000 applies.
S.638 provides that the financial statements prepared comprise:
• a balance sheet as at the last day of the financial year;
• a profit and loss account;
• a statement of cash flow; and
• a statement of change in equity
Purposes of the profit and loss account:
1. It shows the profit and loss of the company that is the difference between the revenue for the period covered by the account and the expenditure chargeable in the period.
2. To explain the company’s transactions, for example, all money received and spent and what matters, all sales and purchases of goods
3. To present the true and fair view of the profit and loss of the company for the financial year
4. To safeguard the interest of creditors, investors and shareholders
5. The profit and loss statement shows:
• The amount charged to revenue by way of provisions for depreciation renewals or diminution in value of fixed assets
• The amount of interest on the company’s debentures and fixed loans
• The amount charged against income tax and other taxation on profits
Parent companies not exempted by the small companies’ regime are also required, under S.639, to prepare group financial statements for the year. Subsidiary companies are however not required to prepare group accounts.
The group accounts laid before the meeting must comprise consolidated accounts consisting:
• A consolidated balance sheet dealing with the state of the affairs of the company and all the subsidiaries dealt with in the group accounts.
• A consolidated profit and loss account dealing with the profit or loss of the company and those subsidiaries.
Under S.645, the directors of a parent company shall ensure that the individual financial statements of the parent company and the subsidiaries are all prepared using the same financial reporting framework.
Further, a holding company’s directors shall ensure that except where in their opinion there are good reasons against it, the financial year of each of its subsidiaries shall coincide with the company’s own financial year.
The group accounts of a company need not deal with the subsidiary if the directors are of the opinion that:
1. It is impracticable.
2. It will be of no real value to members of the company in view of the insignificant amounts involved.
3. It would involve expense or delay out of proportion to the value the member of the company.
4. The result will be misleading.
5. The result would be harmful to the business of the company or any of the subsidiaries.
6. The business of the holding company and that the subsidiaries are so different that they cannot reasonably be treated as a single understanding.
Disclosure of Director’s Benefits
Under S.650directors shall include, as notes to the company’s individual financial statements, details of benefits received during the relevant financial year of the company including:
• gains made by directors on the exercise of share options;
• benefits received or receivable by directors under long-term incentive schemes;
• payments for loss of office;
• benefits receivable, and contributions for the purpose of providing benefits, in respect of past services of a person as director or in any other capacity while director;
• consideration paid to, or receivable by, third parties for making available the services of a person as director or in any other capacity while a director.
Approval and Signing the Financial Statements
This is to be done by the Directors as soon as practicable after the AFS have been prepared, bearing in mind the timelines to file Annual and Tax returns.
At least 2 directors must sign the books of accounts of a company.
Under Section 683, the signed financial statements must be filed with the Registrar:
a) For private companies – within 9 months after end of financial year
b) For public companies – within 6 months after end of financial year
The Director’s Report
This report must be prepared by the directors and accompany the AFS whenever published. The contents of this report include but are not limited to:
1. The names of director’s during the year
2. Principal activities of the company
3. The amount, if any, which the Director’s recommended to be paid out as dividend
4. A business review, relevant to the company, identifying:
a. Principal risks and uncertainties facing the company
b. The company’s development and performance
c. The company’s position vis-à-vis its size and complexity
d. Factors and trends likely to affect future development and performance of the company
e. The company’s environmental impact
f. Information on the company’s employees
g. Social and community issues
h. Information on key stakeholders
i. Analyses using identifiable KPI’s
j. References to and additional information on amounts declared in the AFS
Default fine on directors: KES 1M fine and/or 5yrs imprisonment.
The Director’s Remuneration Report
S.659 – this must be prepared by the directors of quoted companies in each financial year outlining the remuneration earned by the directors of the quoted company.
A default fine of KES 500,000 applies.
As soon as it is prepared, the Directors will approve the report and arrange for its sign-off by one of them ofr the company secretary.
Under S.681, the director’s remuneration report must be approved, by ordinary resolution, at a general meeting of members of the company.
Circulation of Annual Financial Statements
S.662 – every company shall send a copy of its annual financial statement and reports for each financial year to:
a) every member of the company;
b) every holder of the company’s debentures
c) every person who is -entitled to receive notice of general meetings;
Under S.665, the Directors have an option to circulate a summarized version of the financial statements.
Public companies must comply with S.662 at least 21 days before the date of the general meeting at which the financial statements are to be laid.
A default fine of KES 1M applies.
Under S.673, a member or debenture holder of an unquoted company is entitled to be provided, on demand and without charge, a copy of:
a) the last annual financial statement of the company;
b) the last directors’ report; and
c) the auditor’s report on that statement and that report
Under S.674, a member or debenture holder of a quoted company is entitled to be provided, on demand and without charge, a copy of:
a) the company’s most recent annual financial statement;
b) the most recent director’s remuneration report
c) the most recent director’s report
d) the auditor’s report on the financial statements
Director’s Liability on Financial Statement
S.703 provides that a company director is liable to compensate the company for any loss suffered as a result of
a) any untrue or misleading statement in the director’s report, director’s remuneration report or a summary financial statement; or
b) the omission of anything required to be in the abovementioned documents.
The Company’s Annual Return
Under S.705, these must be filed with the Registrar on the company’s return date i.e.:
a) The anniversary of the company’s incorporation; or
b) If the company’s last return lodged was made up to a different date, the anniversary of that date.
The Annual Return must contain the following details:
1. The address of the company’s registered office
2. The physical address of that office;
3. the type of company and its principal business activities;
4. The financial statements or exemption statement, where applicable.
5. A statement of capital comprising:
a. The total number of shares of the company
b. The aggregate nominal value of those shares
c. For each class of shares
i. The particulars of rights attached therein
ii. The total number of shares of that class
iii. The aggregate nominal value of shares that class
d. The amount paid up on each share and the amount (if any) unpaid
6. Particulars or every member, past or present
7. The number of shares held by each member
8. The number of shares of each class transferred and the dates of transfer
A default fine of KES 200,000 applies for not filing an annual return.
INTRODUCTION TO AUDIT
Section 709 of the Companies Act states that the directors of a company shall ensure that the company’s annual financial statements are audited, unless it is a small company which is exempted.
An audit is the independent examination of and expression of an opinion on the financial statements of an economic entity (in this case a company) by an appointed auditor in pursuance of that appointment and in compliance with any relevant statutory obligation.
The objective of an audit is to enable the auditor express an opinion whether financial statements show a true and fair view of the company state of affairs in accordance with an identified financial reporting framework.
The purpose of an audit is not to provide additional information but rather it is intended to provide the users of the accounts with assurance that the information provided to then by directors is reliable. However, the users should not assume the auditor’s opinion is on the efficiency with which management has conducted the affairs of the entity.
Auditing is a check carried out by an independent auditor to make sure that what a company is saying about its financial statement is true. Auditing therefore adds credibility to the financial statements by ensuring the availability of accurate and reliable financial information.
ISA200 (objectives and General principles Governing an audit of Financial accounting) states that the objective of an audit of financial statement is to enable auditors give an opinion on financial statements taken as a whole thereby provide reasonable assurance that the statements give a true and fair view and have been prepared in accordance with relevant accounting and other requirements.
The auditor’s opinion is not a guarantee that the financial statements actually show true and a fair view but that in his or her opinion, they show a true and fair view as to the state of affairs of the company.
The True and Fair View
The true and fair view is a concept of S.636 of the Companies Act. However, the Companies act does not define or even describe what is true and fair view.
The Companies Act requires all limited liability companies to appoint an auditor whose task is to express an independent opinion as to whether financial statement show true and fair view of the financial performance and position of the company. True and fair view implies that the financial statements are not prejudicial to any user of the financial statements. Financial statements will present a true and fair view if:
• They contain in all material respects with the disclosure requirement of the Companies Act and other relevant regulations.
• They contain material matter and not full of needless details.
• They are complete in every respect within the constraints of materiality and the inevitable estimation of some items.
• The values attributed to the items in the financial statements are reasonable amounts within a range in which if a major decision was taken on their basis the user would not make a material error.
• The information contained therein is presented and disclosed without bias and all relevant information for evaluation and decision making is available.
THE COMPANY AUDITOR
Every company must have an external auditor whose responsibility is to examine the company’s books, accounts, vouchers and other information and make a report for submission to members at the general meeting. The report must contain the auditor’s opinion on the accounts.
The auditor’s task is deemed complete when his report is handled over to the Company Secretary.
Appointment Of Auditors
Under sections717 and 721 of the Act, auditors for private or public companies respectively may be appointed either by the directors, the AGM or the Cabinet Secretary.
• Appointment by Directors
The first auditors of the company may be appointed by directors before the first AGM. Such auditors hold office until the conclusion of the meeting. However their appointment may be confirmed if the notice of a resolution to do so has been given to members within 14 days before the meeting.
Under the above sections, directors may fill a casual vacancy in the office of auditor.
• Appointment by the AGM
Every company must at each AGM appoint an auditor to hold office from the conclusion of that meeting to the conclusion of the next AGM. The appointment is by ordinary resolution.
However, at every AGM a retiring auditor is to be reappointed without resolution being passed unless:
i. He is not qualified for reappointment.
ii. He has given the company a written notice of his unwillingness to be reappointed.
iii. The meeting has by resolution resolved to appoint some other person auditor.
iv. The meeting has expressly resolved not to reappoint him.
However if an AGM appoints some other person auditor who subsequently dies or is incapacitated or disqualified, the retiring auditor is not deemed to be automatically reappointed.
If at an AGM no auditor is appointed or deemed to be reappointed, a vacancy arises in the office of auditor and the Cabinet Secretary must be notified within 7 days failing which the company and every officer in default are liable to a default fine.
• Appointment by the Cabinet Secretary
If the AGM fails to appoint an auditor and no auditor is deemed to be reappointed, the Cabinet Secretary may upon notification appoint a person to fill the vacancy within 7 days.
Qualifications of the Auditor
To qualify for appointment a person must be registered accountant practicing accountancy individually or as a partner in a firm. For one to be appointed as an auditor he must meet the following requirements under S.772 of the Companies Act:
1. Must be a holder of a practicing certificate issued under S.21 of the Accountants Act
2. Must have a valid annual license issued under S.22 of the Accountants Act
Under section 774of the Act the following persons are not qualified for appointment as auditors:
1. A body corporate.
2. An officer or servant of the company.
3. A partner or employee of an officer or servant of the company
4. A person disqualified for appointment as auditor for the holding company is likewise disqualified for appointment as auditor for the subsidiary.
5. Undischarged bankrupts and persons of unsound mind are disqualified for appointment by the company law.
If a disqualified person is appointed auditor the person, the company and every officer of the company in default are liable to a fine not exceeding KES 1M
Remuneration of Auditors
Under section 724the term “remuneration” refers to any sums paid by the company in respect of his expenses. The auditor’s remuneration may be fixed by:
• Directors, if appointed by them.
• The Cabinet Secretary, if appointed by him.
• By the company (members) in a General meeting.
• In the manner determined by the company in General meeting.
Under Section 725, a company is required to disclose the terms on which the company’s auditor is appointed, remunerated or is required to exercise their function.
Rights of Auditors
1. Under section 731 every auditor has the right to access to the company’s accounting records and financial statements, in whatever form they are held.
2. The right to demand information and explanations from officers of the company if necessary.
3. The right to a notice of intended resolution to appoint some other person auditor.
4. The rights to all notices and other communication sent to members.
5. Right to seek professional advice whenever necessary.
6. Right to attend all General Meetings of the company.
7. The right to rely on information provided by trusted officers of the company.
8. The right to remuneration for services rendered.
9. The right to make representations as a defense to a notice for his removal.
10. The right to be heard at a General Meeting on any matter concerning him as auditor.
11. The right to be compensated/indemnified for any loss or liability arising in the course of discharging his obligations.
12. A right of lien over the company’s assets in his possession to enforce the right of remuneration
S.733 is clear that any person who makes a false, misleading or reckless statement to the auditor commits an offence and is liable to a fine not exceeding KES 1M and/or 3 years imprisonment.
Statutory Functions of Auditors
Under S.727, an auditor shall make a report to the members of the company on all annual financial statements of the company.
He shall include in the auditor’s report:
a) an introduction identifying the annual financial statement that is the subject of the audit and the financial reporting framework that has been applied in its preparation; and
b) a description of the scope of the audit identifying the auditing standards in accordance with which the audit was conducted.
The auditor shall also clearly state in the report whether, in the auditor’s opinion, the annual financial statements:
a) Give a true and fair view of the company’s financial position and profit or loss at the end of the financial year.
b) Has been properly prepared in accordance with the relevant financial reporting framework
c) Has been prepared in accordance with the requirements of the 2015 Companies Act.
Further, under S.728, The auditor shall state in the auditor’s report on the company’s annual financial statement whether in the auditor’s opinion the information given in the directors’ report for the financial year for which the financial statement is prepared is consistent with that statement.
Under S.729, in reporting on the annual financial statement of a quoted company, the auditor shall:
a) report to the company’s members on the auditable part of the directors’ remuneration report; and
b) state whether in the auditor’s opinion that part of the directors’ remuneration report has been properly prepared in accordance with the 2015 Companies Act.
Responsibilities of the Auditor
Under S.730, the company’s auditor shall carry out such investigations as will enable the auditor to form an opinion:
a) whether adequate accounting records have been kept by the company and returns adequate for their audit have been received from the company’s branches not visited by the auditor;
b) whether the company’s individual financial statement is in agreement with the company’s accounting records and returns-, and
c) in the case of a quoted company—whether the auditable part of the company’s directors’ remuneration report is in agreement with those accounting records and returns
If the auditor fails to obtain all the information and explanations that, to the best of the auditor’s knowledge and belief, are necessary for the purposes of the audit, the auditor shall qualify his report by stating that fact in the report.
Common Law Duties/Obligations of Auditors
It is the duty of the auditor to examine the accounts of the company, its balance sheet, profit and loss account, any group accounts, vouchers and other material information and make a report for submission to members at general meeting during his tenure of office.
The auditor’s report must be read out before the company in general meeting and must be accessible to members.
He is bound to acquaint himself with his duties under Companies Act and the Articles of the company. In the words of Asbury J in Re: Republic of Bolivia Exploration Syndicate:
“Auditors of a limited company are bound to know or make themselves acquainted with their duties under the Articles of the company whose accounts they are appointed to audit under the Companies Act for the time being in force.”
It is the duty of the auditor to execute his task with an inquiring mind and not with a pre-gone conclusion of dishonesty. In the words of Lopes L.J Re Kingston Cotton Mills (No. 2 1896):
“An auditor is not bound to be a detective… to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is watchdog but not a bloodhound.”
An auditor is obliged to satisfy himself that the company’s securities exist and are in safe custody. However whether he must inspect the documents or accept the assurance of the officer of the company in possession depends on the circumstances of the case in the words of Romer J in Re: City Equitable Fire Insurance Co. (1925):
“It is the duty of a company’s auditor in general to satisfy himself that the securities of the company in fact exist and are in safe custody and whenever an auditor discovers that the securities of a company are not in proper custody it is his duty to require that the matter be put right at once.”
An auditor is bound to exercise reasonable care, skill and caution. The standard of care and skill expected of an auditor is that of a reasonably competent careful and cautious auditor. In the words of Lopes L.J in Re: Kingston Cotton Mills (No 2 1896):
“… it is the duty of an auditor to bring to bear on the work he has to perform, that skill, care and caution which a reasonably competent, careful and cautions auditor would use. What is reasonable care, skill and caution must depend on the particular circumstances of each case.”
An auditor is bound to act honestly. He must not certify as true what he does not believe to be true and must take reasonable care and skill before certifying something as true. In the words of Lindsey J in Re: London and General bank (1895):
“An auditor however is not bound to do more than exercise reasonable care and skill in making inquiries and investigations… he must be honest, he must not certify what he does not believe to be true and he must take reasonable care and skill before he believes that what he certifies is true.”
It is the duty of the auditor to provide professional advice whenever called upon to do so. It was so held in Tomenta v. Selsdon (Foundation) Pen Co Ltd.
It is not the duty of the auditor to take stock. In Re Kingston Cotton Mills Lopes L.J observed,
“… It is not the duty the duty of the auditor to take stock. He is not a stock expert. There are many matters in respect of which he must on the honesty and accuracy of others. He does not guarantee the discovery of all fraud.”
Is an auditor an investigator? No
Questions have arisen as to whether the auditor is an investigator. As appointed at general meeting or by directors or the registrar he is not an investigator.
His primary duty is to examine the company’s books, accounts, vouchers other documents and considers any other necessary information for the purpose of making a report for submission to members at a General Meeting.
The auditor must approach his task with an enquiring mind.
It has been observed that he is a watchdog but not a bloodhound.
His standards of care and skill are that of a reasonably competent careful and cautious auditor. He is not bound to do more.
He does not guarantee the discovery of all fraud, nor does he guarantee that the company’s business has been prudently or imprudently carried on.
However he must satisfy himself the company’s securities exist and are in safe custody.
However an auditor may be deemed to be an investigator in certain circumstances.
• If appointed to investigate the affairs of a company.
• If there is anything calculated to excite his suspicion he must probe it to the bottom.
The duties of an auditor are owned to the company as a legal person. There is a contractual relationship between the auditor and the company. However in certain circumstances the auditor owes a legal duty of care to existing and potential shareholders whom he knows or reasonably ought to foresee will rely on his audit and report.
Removal of the Auditor from Office
The provisions of the 2015 Companies Act confer upon a company the power to remove an auditor from office by ordinary resolution with special notice at general meeting. Under section 740:
• A special notice of the intended resolution to remove an auditor from office must be given to the company.
• Upon receipt of the notice the company must send a copy thereof to the auditor concerned.
• The auditor is entitled to make written representations not exceeding reasonable length as his defense
• The auditor may then request the company to notify its members the fact that he has made representations.
• The company must convene an extraordinary general meeting to determine the issue. A special notice of the intended resolution must be sent to every member and members must be notified that the auditor has made representations if any.
• Copies of the representations must be enclosed with the notice of the meeting and sent to the members. If this is not possible by reason of lateness or default by the company, the auditor is entitled to have them read out at the meeting. However, copies of the auditor’s representations need not be sent to members or be read out at the meeting if upon application by the company or any other aggrieved party, the Court is satisfied that the auditor is abusing the right to be heard to secure needless publicity for defamatory purposes. The Court may order the company’s cost of the application be paid wholly or in part by the auditor.
• An ordinary resolution is then passed at the General Meeting and the auditor is considered removed from office.
Directors are however empowered to fill any casual vacancies arising in the office of an auditor.
Under S.741, the resolution passed to remove an auditor from office must be filed with the Registrar within 14 days of its passing.
Resignation of the auditor under S.747 takes a similar approach.
If an auditor ceases to hold office before the end of his term, the auditor (under S.751) and the company (under S.752) shall notify the appropriate audit authority (ICPAK) of that fact.
Liability of Auditors
Liability to the company
i. Damages for professional negligence
The company has an action in damages against an auditor who has failed to exhibit the care and skill of a reasonably competent, careful and cautious auditor.
The company must prove that some other auditor would have acted otherwise.
ii. Damages for misfeasance
A misfeasance is a transgression, especially the wrongful/improper exercise of lawful authority.
Although an auditor is not an officer of the company properly so called, case law demonstrates that he may be held liable in damages for misfeasances committed or omitted in the course of discharging his obligations.
This was the case in Re: London General Bank where an auditor had failed to detect that certain items had been over valued resulting in dividends being paid out of capital and it was held that the auditor was liable in damages for the misfeasance.
Liability to third parties
As a general rule, auditors are not liable to third parties. However a third party who suffers loss or damage by reason of relying on the audit, and its report may hold the auditor liable if it is proved that:
1. There was a special relationship between the auditor and the party and therefore the auditor owed the party a legal duty of care.
2. The auditor knows or reasonably ought to have known that his audit and report was to be relied upon by the third parties
3. The auditor broke his duty of care.
4. The third party suffered loss of a financial nature.
Liability Limitation Agreements
Under S.764, these are agreements which purport to limit the extent of a liability owed to a company by its auditor in respect of any negligence, default, breach of duty or breach of trust, occurring in the course of auditing financial statements, of which the auditor may be guilty in relation to the company.
Section 767 however is clear that a liability limitation agreement is not effective to reduce the auditor’s liability to less than what is fair and reasonable having regard to:
a) the auditor’s responsibilities under the Companies Act;
b) the nature and purpose of the auditor’s contractual obligations to the company; and
c) the professional standards expected of the auditor
Section 769 provides that the directors of a quoted company shall ensure that the company has an audit committee appointed by the shareholders of a size and capability appropriate for the business conducted by the company.
Under S.770, the audit committee shall:
a) set out the corporate governance principles that are appropriate for the nature and scope of the company’s business;
b) establish policies and strategies for achieving them; and
c) annually assess the extent to which the company has observed those policies and strategies.
The audit committee is also responsible for:
a) Organizing the company to promote the effective and prudent management of the company and the directors oversight of that management; and
b) Establishing standards of business conduct and ethical behaviour for directors, managers and other personnel, including policies on private transactions, self-dealing, and other transactions or practices of a non-arm’s length nature.
c) overseeing the operations of the company and providing direction to it on a day-to-day basis, subject to the objectives and policies set out by the audit committee and any other written law;
d) Providing the directors with recommendations, for their review and approval, on the objectives, strategy, business plans and major policies that are to govern the operation of the company; and
e) Providing the directors with comprehensive, relevant and timely information that will enable the directors to review the company’s business objectives, business strategy and policies, and to hold senior management accountable for the company’s performance.