AUDITING

Difference between Shareholders and Directors?

Shareholders provide the capital of limited companies by the purchase of shares. In the case
of public limited companies there are often many thousands of shareholders. Clearly, all these
shareholders cannot run the business on a day-to-day basis, so it is the responsibility of
shareholders to appoint directors to run and manage the business on their behalf. These
directors can be within the shareholders or external.
The directors of a limited company are responsible for the preparation of annual financial
statements that are then used by shareholders to assess the performance of the company and
the directors whom they have appointed. The directors must ensure that the provisions of the
Companies Act 1985 are implemented. Directors are paid emoluments(salaries) as their
reward for running the business.

‘Divorce of ownership and control’ is the term often used to describe the relationship
between shareholders and directors because although shareholders are the owners of a
company, it is the directors who control the day-to-day affairs of the business.

Stewardship is the responsibility which directors have for the management of resources within a
business on behalf of the shareholders ( pls remember this definition)

Responsibilities of Directors

1. keep proper accounting records that allow financial statements to be prepared in

accordance with relevant companies legislation
2. safeguard business assets
3. Directors must avoid any situation which him/her in direct conflict with the interest
of the company.
4. select the accounting policies to be applied to the financial statements
5. report on the state of the company’s affairs
6. ensure that the financial statements are signed by two members of the board of
directors.

Directors are required to make a report at the end of each year

What is Directors Report and what are the contents? Directors report is a summary provided by
the directors to the shareholders and other stakeholders on the performance of a company for a
particular year. What you should realize is that the financial statements are just numbers and not
everyone can comrehend the numbers , A report from the director becomes absolutely important for
the shareholder if he wants to know his companys financail performance . It includes

1. An overall business review

2. Main (operations ) activities carried on by the company
3. Particulars of events occuring after the balance sheet date which effects the company
4. Recommendation of dividends
5. Name of directors and their financial interst (stake) in the business
6. Donations to political parties
7. Signifcant changes in Non-Current Assets during the year
8. An indication of future plans of the business
9. Information about research and devlopment expenditure carried out by the busienss.
If the directors are responsible for keeping financial records and the preparation of the annual
financial statements, how can shareholders be guaranteed that the records are prepared in an
objective way?

Shareholders appoint a team of professionally qualified accountants (external auditors) to

check and verify the financial statements and the transactions that led to their preparation.

So to summarize

-Shareholders : owners of the company they appoint directors(managers) to run the company
and external auditors to keep a check on directors.

What is Audit?

An official inspection of an organization’s account typically by an independent body.

In connection with a limited company there are two types of auditor:

1. Internal auditor The internal auditor is an employee of the company, appointed by

the directors. Their main role is to help ‘add value’ to the company and help the
organisation achieve its strategic objectives. They are thus part of the day-to-day
management team of the business. Their key roles are therefore:
1. Evaluate and assess the control systems inplace within the company
2. evaluate information security and risk within the company
3. consider and test the anti-fraud measures in place in the company
4. overall help to ensure that the company meets its strategic and ethical
objectives.

Remember Internal audit is not a legal requirement and its an option for directors to appoint
an internal auditor or not. The main audit which we have to consider in the External Audit
which is a legal requirement. If in exam they only mention “audit” then they are talking about
external audit.

2. External auditor The external auditor is not an employee of the company. They are
independent, usually large, firms of accountants. They are appointed by the
shareholders to ensure that the financial statements prepared by the directors are a
true and fair view of the state of financial affairs of the company. The auditors
examine the financial records and systems in an honest and forthright manner and
prepare an audit report. The auditor’s report is presented to the shareholders at the
annual general meeting. The shareholders are unable to inspect the company’s books
of account, indeed they may well lack the technical knowledge to do so. However,
they are, along with the debenture holders, entitled to receive copies of the annual
accounts. It is important that shareholders and debenture holders can be sure that the
directors can be trusted to conduct the company’s business well and that the financial
statements are reliable.
Duties of External Auditor :The shareholders appoint auditors to report at
each annual general meeting whether:

- proper books of account have been kept

- the annual financial statements are in agreement with the books of account

- in the auditor’s opinion,the statement of financial position gives a true and

fair view of the position of the company at the end of the financial year, and the
income statement gives a true and fair view of the profit or loss for the period
covered by the account

- the accounts have been prepared in accordance with the Companies Act and
all current, relevant International accounting standards.

- the information given in the directors report is consistent with the accounts

The auditor’s responsibility extends to reporting on the directors’ and any

strategic report and stating whether the statements in it are consistent with the
financial statements. They must also report whether, in their opinion, the report
contains misleading statements.

Auditors must be qualified accountants and independent of the company’s

directors and their associates. They report to the shareholders and not to the
directors; as a result, auditors enjoy protection from wrongful dismissal from
office by the directors.

What is True and Fair View?

The overall objectives of a set of financial statements is that they provide a true
and fair view of the profit or loss of the company for the year, and that the
statement of financial position likewise gives a true and fair view of the state of
affairs of the company at the end of the financial year.

True: here implies financial statements are factually correct and prepared in
accordance with the applicable financial standards and do not contain material
errors or omissions.

Fair: implies that the financial statements present the information faithfully
without any element of bias
The Audit Report

The auditor’s report has three main sections:

1 Responsibilities of directors and auditors

a Directors are responsible for preparing the financial statements.

b Auditors are responsible for forming an opinion on the financial statements

2 Basis of opinion – the framework of auditing standards within which the audit was
conducted, other assessments and the way in which the audit was planned and performed. If
the auditor fails to obtain information and explanations necessary to support his audit then
this must be reported. Any deviation from the necessary disclosure requirements must be
identified.

3 Opinion – the auditor’s view of the company’s financial statements.

The Audit opinion can be of 4 types

1.Unqualified Opinion: An unqualified opinion is given if the financial statements are

presumed to be free from any error or misstatements ( CLEAN REPORT)

2.Qualified Opinion: A qualified opinion is given when a company’s financial statements are
not in accordance with Accounting standards or show errors and misstatements. This is
usually given when auditor is not satisfied on certain items and does not want to issue a clean
report . The issues are highlighted in the audit report .

3.Disclaimer of Opinion: In the event the auditor is unable to complete the audit due to
absence of financial records or insufficient corporation from management, the auditor issues
a disclaimer of opinion.

4.Adverse Opinion

An adverse opinion specifies an extremely suspicious accounting statement that can

diminish the company’s market position, sometimes causing a lawsuit. Auditors who spot
extensive material misstatements and are fully dissatisfied with the accounting statements
have to present such a viewpoint.
Which documents must be Audited by the external auditor?

The main statements that have to be audited are:

● the income statement

● the statement of financial position

● statement of cash flows

● statement of changes in equity

● accounting policies and notes to the accounts

IMPORTANCE OF AUDIT OPINION

If audit opinion is qualified (or adverse) which means auditor is saying that the financial
statements have errors and misstatements. This will have an adverse effect on company and
its directors and shareholders will not trust the financial statements. The share price might
also get adversely effected.

If audit opinion is unqualified then it helps in building the trust and will effect the company
in a positive way. Confidence level of all stakeholders goes up when unqualified audit report
is issued by the External auditor.
ETHICS IN ACCOUNTING

Ethics deals with human conduct in relation to what is morally good and bad, right and
wrong. It is the application of values to decision making. These values include honesty,
fairness, responsibility, respect and compassion. It is usually believed that accountants should
be responsible enough to take care of the interests of those they serve. The professional ethics
guide accountants to follow a code of conduct so that their services provided can gain public
confidence.

In order to help accountants make ethical decisions, accounting bodies have developed a set of
fundamental principles to underlie ethical behaviour in accounting profession:

Integrity.
A professional accountant should be straightforward and honest in all professional and
business relationships

Objectivity.
A professional accountant should not allow bias, conflict of interest or undue influence of
others.

Professional Competence and Due Care.

A professional accountant has a continuing duty to maintain professional knowledge and skill
at the level required to ensure that a client or employer receives competent professional
services based on current developments in practice, legislation and techniques. A professional
accountant should act diligently and in accordance with applicable technical and professional
standards when providing professional services.

Confidentiality.
A professional accountant should respect the confidentiality of information acquired as a
result of professional and business relationships and should not disclose any such information
to third parties without proper and specific authority unless there is a legal or professional
right or duty to disclose. Confidential information acquired as a result of professional and
business relationships should not be used for the personal advantage of the professional
accountant or third parties.

Professional Behavior.
A professional accountant should comply with the relevant laws and regulations and should
avoid any action that discredits the profession.