Learning objectives. In this chapter you wit learn: > about the role of the auditor > about the role of directors, ‘and their responsibities to shareholders > about the term ‘stewardship’ > about the importance of “true and fair view’ in the preparation of financial statements. 1.1.5: Auditing and stewardship of limited companies Introduction An important feature of larger limited companies is the face that the ‘owners (the shareholders) do not take pare in the day-to-day running of the business. Instead shareholders appoint directors to manage the company's affairs on their behalf. This separation of ownership and control leads to the idea of stewardship and the idea that directors have a duty to manage the business’ resources to the best of their ability on behalf of the shareholders. It also leads to some important legal requisements to ensure thar the interests of shareholders are safeguarded. The role of auditors ‘The law requires that limited companies have their accounts audited annually. (Ieshould be noted ehae usually smaller companies are exempt from this requirement, Ie is the shareholders who appoine the auditors, not the ditectors;it is to the shareholders that the auditors report every year: This legal requirement is designed to ensure thae shareholders ean hhave confidence that the stewards of the company (the directors) are giving them a true and fair view of the company's affairs, so thae they are in a good position to make valid decisions about their investment, ‘The law requires auditors to do the following: > Provide an independent check of the company’s accounting records. In order for this to happen, itis important that auditors are not influenced in any way by the directors of the company. > Carty out their duties objectively, so that their opinions and Jjudgments are based on evidence that they have been able to verify during the course of theie work. > Ensure that the accounts comply with current accounting standards and the requirements of the Companies Acts. > Ensure that the accounts provide shareholders with a true and fair view of che company’s financial position. > Ensure that the accounts are free from significant errors. In order to earry out their responsibilities, che law requires auditors to be suitably qualified and to be given reasonable access to the company's accounting records and to have questions answered within areasonable time. Internal and external audits ‘The independent audit described above is sometimes referred to as an external audit. It is also usual for large-scale organisations to carry out internal audits. Internal audits are conducted by the organisations own Scanned with CamScannerGetting it right It sacommon exror to think that auditors actually prepare the fmancial statements. This 's the responsibility of the directors, not the auditors, Key term Annual report: a document summarising a lntes company’ actos which ‘must be sent fo shareholders ‘each year. is often referred to as the ‘ennual report and: accounts! 1.1.5: Auditing and stewardship of limited companies staff whose main responsibility is to report on whether the company's own financial regulations have been followed. Internal auditors report to the management of the organisation for which they work. “The cost of an external audie, which can be considerable in the case of a large public company, is charged to the company's income statement along with other expenses. True and fair Ac the core of the responsibilities of auditors and directors is the duty co ensure chat shareholders are given a teue and fair view of the company's financial position. This is known as the true and fait concepe. The law requires auditors to confirm whether or not the financial statements represent a true and faie view of the company’s affairs. This is normally taken go mean thae the financial statements: D agree with the company’s records > are free from bias > include information about all of the company’s assets and all of che liabili > include assets thar are valued in accordance with international. accounting standards and that the values arise from the application of relevant accounting concepts > include an income statement which reports a profit or loss chat follows legal requirements and that is in accordance with intemational accounting standards > include a fair assessment of the company’s cash flows in accordance with international accounting standards >> are prepared so that there is consistency from one year to the next. ‘The assumption is chat if financial statements are comparable, reliable, relevant and understandable, they will presenta true and fair picture of the company’s financial affairs. Ie is sometimes thought thar auditors should be able to confirm that no feaud has taken place. Checking for fraud is not the duty of auditors. Howeves, should the audie process reveal anything suspicious (eg. alterations to source documents) the auditors must, of course, bring, this to theattention of the shareholders. The auditors’ report A company’s annual cepoet must contain a report from the auditors. Usually chis is quite a short srarement. The most important pare of the report is the auditors’ opinion that the finanei statements: } give a erue and fair view of the company's affairs > have been properly prepared in accordance with international accounting standards Scanned with CamScanner1 Financial accounting Key terms Unqualified auditors report where the auctor ae of the opion thatthe franca stotements give anus and sieve, Qualified auditors’ report: where the aucitors express some reservations which mean thal they have concluded that the financial statements do not (ye a tue ancl fir view. > comply with che requirements of the Companies Acts, A statement like this, where there are no reservations, is called an unqualified report. ‘The report will also include the following: > anote thar darifies the roles of the auditors and directors > a statement about the scope of the audit which explains how it was conducted and confirming thar the audie provides a sound basis for the auditors opinion. Where applicable the report will include any reservations the auditors may have, for example: > if theve are significant inconsistencies and/or errors in the financial starements > if the financial statements are misleading in any way > i€ the directors’ report contains statements which are inconsistent with the auditors’ view of che company’s affairs, Where a report contains reservations, itis referted to as a qualified report. The role of the directors Directors are appointed by the shareholders. Their main responsibilities to shareholders include the following: > The maintenance of proper accounting records which enable financial starements to be prepared in accordance with the requirements of the Companies Acts and international accounting standards. > Preparing annual financial statements, is income statement > statement of changes in equity > statement of financial position > starement of cash flows. Taking care of the company's resources. Deciding the company's accounting policies. Implementing suitable accounting controls. Confirming thar accounting standards have been followed, vvrvvy ‘Supporting the work of auditors by providing reasonable access to accounting records and responding to questions raised. > Preparing an annual report eo shareholders on the way in which they have managed the company, ic. how they have discharged their stewardship role (the directors’ report). Scanned with CamScanner1.1.5: Auditing and stewardship of limited companies The directors’ report ‘The Companies Act 2006 requires that the directors of the company prepare a reportat the end of the financial year for submission to the shareholders. The main contents of the directors’ report are as follows: > A statement of the affairs of the company, which may include non- monetary issues not highlighted by the financial statements. > The principal activities of the company and any significant changes made during the year. > Details of significant events that have occurred since the financial yearend. > Details of significane future events. > A statement of employees’ invelvement in: > information > consultation > common awareness. > Details of own shares puschased or charged. > Non-current assets: > significant changes > any difference between book value and market value of land. > Proposed dividends. D Transfers to reserves. > A statement of policy on: D the health and safery of employees > disabled persons. > Details of political and charitable donations. > Details of any directors serving during the year including: > name > interests in the shares of the company } share options granted or exercised during the yeas. > Details of the company’s policy on the payment of suppliers, > Information on research and development being carried out, Scanned with CamScanner1 Financial accounting The role and duties of shareholders Shareholders delegate the responsibility for running a company to the direccors. It follows that the main duty of a shareholder is to elect directors. Through their voting powers shareholders can re-elect dlrectors oF remove them when not satisfied. In some situations shareholders may be asked at the annual general meeting to give consent to directors’ actions (e.g. changing the name of the company). Ie is important wo note thar shareholders do not normally have the right eo interfere in the day-to-day management of the company or have access to the company's accounting records (other than the annual report). Shareholders are also requited by law co appoint auditors excepr where the law gives exemption to small companies. cis important to remember that directors may also be shareholders in a company. 1 True or false? Indicate whether each of the following statements is true or false by placing a tick (v7) in the appropriate column, 2 The importance of auditors Explain why itis a legal requirement that shareholders appoint auditors. 3. The role of auditors and directors. Ata recent annual general meeting of the Yushui Company Ltd, the shareholders reappointed the directors of the company and the firm of Kashchei & Co was appointed as aucitors for the next financial year: In regard ta the financial records of the company, explain the responsibilties to the shareholders ot a the directors b theauditors, ‘Scanned with CamScanner1.1.5: Auditing and stewardship of limited companies 4 Meaning of stewardship 7 Directors and auditors Explain what is meant by the term ‘stewardship’ In what ways are directors required to help in respact of a company’s financial afairs. auditors in their role? Meaning of true and fair 8 The auditors" report Describe three aspects of a company's financial a Explain the distinction between a qualified and ‘statements which would confirm that they Unqualifiad auditors’ report represent a true and fair view of the company's b Describe three important elements of an financial affairs, Unqualified auditors’ report, 6 Reservations in an auditors’ report Give two reasons why auditors might exeress, reservations in their report to shareholders. ‘Scanned with CamScanner