Auditing and Stewardship

Shareholders are the owners of a company but directors conduct the equity management. The company's act requires directors to prepare and submit a corporate report to shareholders to show them how they have managed the company. The act requires that six documents (statutory accounts) to be approved by the board of directors and published annually. These are:

  • Income statement.
  • Statement of changes in equity.
  • Statement of financial position.
  • Statement of cash flows (IAS 7).
  • Director’s report.
  • Auditor’s report.

In addition to these statutory accounts and reports, the corporate report must contain notes to the accounts (disclosures) and a statement of accounting policies that have been applied (IAS 8). The IAS 1 framework identifies 4 qualitative characteristics of financial statements that are meant to ensure the usefulness to users.

  • Understanding.
  • Relevance.
  • Reliability.
  • Comparability

Information disclosed as notes to the accounts

  • Auditor’s remuneration.
  • Director’s remuneration.
  • Salary of highest paid director.
  • Chairman's salary.
  • Accounting policies.
  • Depreciation charged and method used.
  • Treatment of intangible non-current assets.
  • Basic of inventory valuation.
  • Disposal of non-current asset.
  • Acquisition of non-current assets.

Director's report

  • Names of directors.
  • Director’s shareholdings.
  • Amount of dividend proposed and transferred to reserves.
  • Principal activities of the company.
  • Review of future development.
  • Events after the balance sheet date (IAS 10).
  • Changes in non-current assets.
  • Employee's involvement in the company.
  • Donation for political or charitable use.
  • Employment of disabled persons.
  • Research and development carried out.
  • Policy regarding payment to suppliers.

Auditing

Auditing is a systematic and a scientific examination of the books of accounts and financial statements of a company. It is a critical review of the system of accounting and internal control. Auditing is performed with the help of source documents, vouchers and explanations received from third parties. Auditing is undertaken by an independent person or body of persons (external auditors).

An auditor must be a qualified accountant who has a thorough knowledge of general principles of law, taxation and computer information systems. An auditor is recommended by directors but appointed by shareholders. The main duties of an auditor are:

  • Verify that transactions have actually taken place.
  • Verify that transactions have been recorded in the books accurately.
  • Verify that assets exist and are owned by the company.
  • Verify that assets are stated at amounts in accordance with accepted accounting policies.
  • Verify that all liabilities are included according to policies.
  • Confirm that reasons shown in financial statements are truly and fairly stated.
  • Confirm that fundamental accounting concepts have been applied.
  • Confirm that accounting conventions followed in the preparation of financial statement is stated.
  • Confirm that financial statements are consistent with previous periods.
  • Provide users with an assurance that financial statements prepared are reliable.
  • Prepare a report (auditor’s report) to give an opinion whether the financial statements published are truthful and unbiased.

The auditor’s report has three main sections:

  • Responsibilities of directors and auditors. 
  • Basis of opinion. (The framework of auditing standard within which the audit was performed.)
  • Opinion of the auditor.

If in the auditor's opinion, adequate reports have not been kept then the auditor must issue a qualified report. A qualified report will raise points that the auditor considers have not been dealt with correctly by directors. If the points raised by the auditor are not of serious nature, the report may state:

“With the exception of the following items the financial statements do show a true and fair view.”

However if the auditor believes that there has been a serious breach and that the points raised are of serious nature then the report should state:

“The financial statements do not show a true and fair view.”

Advantages of auditing

  • Helps in detection of errors and frauds.
  • Contribute to the improvement of financial reporting and internal control system.
  • Enhances the company’s reputation.
  • Ensures that financial statements are reliable.
  • Ensures that financial statements are prepared in accordance with the company’s act and the accounting standards.

Disadvantages / Limitations of auditing

  • It is virtually impossible for an auditor to examine all transactions.
  • The opinion of the auditor may be bias since it is based on selective testing using sampling techniques.
  • Auditing provide assurance that financial statements are free of errors but does not provide a guarantee of absolute accuracy.
  • Irregularities or fraud conceal through forgery.
  • Auditing depends on explanations and information provided by the company. The audit report will obviously be affected if these information are proven false.
  • Auditing cannot give assurance about future profitability and prospects.

True and fair view in auditing means that the financial statements are free from material misstated and faithfully represent the financial performance and position of the entity. True suggests that financial statements are correct and have been prepared according to applicable reporting framework and they do not contain misstatement that may mislead users.  Fair implies that the financial statements present the information faithfully without any element of bias and they reflect the economic substance of transactions rather than just their legal form.

Role of directors

The two main purposes of producing and reporting financial statement is the management function and stewardship function. The management function enables the directors to analyse how well the company has performed and to provide information that might highlight areas of improvements (financial statements for internal use.) The stewardship function is to show shareholders that their funds are safe and are being used wisely by the directors (financial statements for external use – published accounts.)

It is the responsibility of shareholders to appoint directors to run and manage the company on their behalf. “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 the company it is the directors who control the day to day activities of the business. Since directors are appointed by shareholders, they must report financial statements to them. Directors are paid emoluments as their rewards for running the business. The main responsibilities of a director:

  • Keep proper accounting records that allow financial statements to be prepared in accordance with the company’s act and IAS.
  • Safeguard business assets.
  • Select accounting policies to be applied to the business accounts.
  • State which IAS has been applied in preparation of financial statements.
  • Report on the state of affairs of the company.
  • Prepare published financial.
  • Ensure that at least two directors have signed the published accounts.