How to Become the Managing Director

Managing Director means a person who, by virtue of an agreement with the company or of a resolution passed by the company in a general meeting or by its Board of directors or by virtue of its memorandum or articles of association, is entrusted with substantial powers of management which could not otherwise be exercisable by him and includes a director occupying the position of a managing director, by whatever name called. 

The power merely to do administrative acts of a routine nature, when so authorised by the Board such as the power to affix the common seal of the company on any document or to draw and endorse any cheque on the account of the company in any bank or to draw and endorse any negotiable instrument or to sign any share certificate or to direct registra­tion of share transfers will not be deemed to be included within substantial powers of management. 

The managing director must exercise his powers subject to the superintendence, control and direction of the Board.

When auditors can diclose confidential information to other parties

One of the five fundamental principles of Auditing is confidentiality. This principle states that information obtained in the course of professional work should not be disclosed to others, except where:

• consent has been obtained from the person or entity to which the information relates, or
• there is a legal or professional right or duty to disclose (as described below). In addition, information gained when acting in a professional capacity should not be disclosed in order to:
• gain a personal advantage, or
• gain an advantage for another party.

One of the reasons for this requirement for auditors is that auditors need to obtain full and open disclosure of information from a client in order to carry out their duties. If the client cannot be assured of the confidentiality of this information, he may be unwilling to provide the auditors with all the information that they need.

 

Obligatory disclosure

• disclose relevant information to an appropriate authority if he knows, or has reason to suspect, that a client has committed treason, terrorism, drug trafficking, or money laundering

• disclose information if forced to do so by the process of law (for example, a court)

Voluntary disclosure of confidential information is permitted in the following circumstances:

• to protect the member’s interests (for example, in making a defense against an official accusation of professional negligence)

• in the public interest (for example, making disclosures to the tax authorities of non-compliance by a client company with tax regulations)

• when authorized by local statute

• to non-governmental bodies which have the power to force such disclosure.

Procedures of Resignation of auditors

The auditor may decide to resign during his period of office. However, company law will generally give certain safeguards to make sure that the shareholders are made aware of any related circumstances concerning to the auditor’s resignation.

The procedures for the resignation of the present auditors will generally include the following:

• The resignation should be made to the corporation in writing. The corporation should submit this resignation letter to the proper regulatory authority.

• The auditor should prepare a statement of the circumstances. This sets out the circumstances leading to the resignation, if the auditor believes that these are related to the shareholders or creditors of the company. If no such circumstances be present, the auditor should create a statement to this effect. This statement should be sent by the auditor to the regulatory authority or by the company to all persons entitled to get a copy of the company’s financial statements.

•  The auditors may require the directors to call a meeting of the shareholders in order to discuss the circumstances of the auditor’s resignation.

•  In certain circumstances, auditors may be required to notify the authorities themselves of their removal.

 

 For example, in the UK, auditors of listed companies must do this whenever they cease to hold office and other auditors must do so when they cease to hold office before the end of their current term of office.

Advantages and disadvantages of statutory audits

There are several advantages in having a statutory audit, but there are also some limitations.

Advantages of statutory audits

An statutory audit offers the following benefits:

•  It enhances the trustworthiness of published financial statements.

• It ensures the management that they have performed their statutory duties appropriately.

•  It gives assurance to management that they have complied with non-statutory requirements, such as corporate governance requirements .

•  It gives view on the efficacy of internal controls. Where internal

controls are weak or inadequate, the auditor will provide recommendations for improvement. This will help management in reducing risk and improving the performance of the company. Even where a statutory audit is not required, for example due to small company statutory exemption limits, an audit will boost the trustworthiness of published financial statements. This may be important for potential investors to the company. Potential investors, such as banks, may insist on the company having an audit as a precondition for lending money.

Limitations of statutory audits

The main limitations of an audit are as follows:

•  The expenditure of an audit can be very high. However, if the audit firm is already hired to carry out non-audit work such as accounts preparation oradvisory work, the additional cost of an audit may be fairly small.

•  The disruption caused to a company’s staff during the audit. The company’s staff may be required to support the auditors by answering questions, providing documents and other information, and so on.

The role of the external auditor in corporate governance

The external auditor is part of the corporate governance system.

 He provides an independent check on the integrity of the financial information prepared by the directors for the use of shareholders and other stakeholders.  He may have a accountability for forming an opinion on the extent to which the directors have complied with specific corporate governance regulations.

In order to fulfill these roles, the external auditor will examine the company’s systems and controls. However, he is not responsible for those systems or controls. Responsibility remains with the directors and executive management.

The external auditor is moreover required by ISA 260 Communication of audit matters to those charged with governance to give management periodically with observations arising from the audit that are important and relevant to management’s responsibility to keep an eye on the financial reporting process.

These observations might comprise:

·         weaknesses in internal control found by the auditor, or

·         accounting policies adopted by the enterprise which the auditor considers improper.

In addition, all high-quality corporate governance systems have procedures and arrangements designed to preserve the independence of the external auditor. For example:

·         the external auditor may be required to report to an audit committee, as well as to work with the CEO and finance director

·         the nature and extent of non-audit services provided by the audit firm may be kept under review, to make sure that the auditor:

− has not become excessively dependent on the company and its executive management for fee income, and

− is not in risk of becoming too familiar with the company’s management and systems of operation

·         suitable procedures may be established for the discussion of arguable issues where the auditors and the finance director or the CEO have strong differences of opinion.

Auditors responsibility for reporting on corporate governance

The followings are auditors responsibility for reporting on corporate governance:

• Listed companies following the Combined Code in the UK, or other applicable guidance in respect of corporate governance, must include a corporate governance statement in the annual report.

• The auditors are not required to ‘audit’ this statement but must review it for inconsistencies with other information contained within the annual report.

• If inconsistencies are found, there may be an impact on the audit report in two ways:
– if the inconsistency highlights an error in the financial statements and the directors refuse to amend the error, the auditor will issue a qualified report
– if the inconsistency highlights an error or misleading information in the corporate governance statement, the auditor will add an emphasis of matter paragraph to their report. This is not a qualification. It is included to bring the reader’s attention to the matter.

• In the US, the requirements are more stringent. Sarbanes Oxley states that the auditors must attest as to whether the company has complied with corporate governance requirements. Therefore, they must give an
opinion as to the effectiveness of the company’s internal control system amongst other things.

6 auditor’s rights in business environment with 4 reponsibilities

During the audit/continued appointment
1. Access to the company’s books and records.
2. To receive information and explanations necessary for the audit.
3. To receive notice of and attend any general meeting of members of the company.

4. To be heard at such meetings on matters of concern to the auditor.
 

On resignation 

5. To request an Extraordinary General Meeting (EGM) of the company to explain the circumstances of the resignation.
6. To require the company to circulate the notice of circumstances relating to the resignation.

The auditor’s responsibilities on appointment and removal
 

On appointment
• Obtain clearance from the client to write to the existing auditor (if denied, appointment should be declined).
• Write to the existing auditor asking if there are any reasons why the appointment should not be accepted

On removal/resignation

  • Deposit at the company’s registered office a statement of the circumstances connected with the removal/resignation or • a statement that there are no such circumstances
• deal promptly with requests for clearance from new auditors.

Who are exempted from Audit?

In most countries it is possible for businesses to be operated through companies – a process known as incorporation. 

Audit exemption: In most countries, companies generally require an audit. However, small or owner managed companies are often exempt (e.g. in UK, companies with annual turnover < £5.6 million).

 
The main reasons for exempting small companies are:
• for owner managed companies, those receiving the audit report are those running the company (and hence preparing the accounts!)
• the advice/value which accountants can add to a small company is more likely to concern other services, such as accounting and tax, rather than audit and which may also give rise to a conflict of interest
under the ethics rules
• the impact of misstatements in the accounts of small companies is unlikely to be material to the wider economy
• given the above points, the audit fee and related disruption are seen as too great a cost for any benefits the audit might bring.

What is corporate governance?

Corporate governance is the means by which a company is operated and controlled.
It concerns such matters as:

Corporate governance is about ensuring that companies are run well in the interests of their shareholders and the wider community.
• the responsibilities of directors
• the appropriate composition of the board of directors
• the necessity for good internal control the necessity for an audit committee
• relationships with the external auditors.
• The need to improve corporate governance came to prominence in the UK in the 1980s, following the high profile collapses of a number of large companies.
• Poor standards of corporate governance had led to insufficient controls being in place to prevent wrongdoing in the US in the 1990s, as demonstrated by the collapses at Enron and WorldCom.

• The authorities internationally have now been working for a number of years to tighten up standards of corporate governance. 

• Good corporate governance is particularly important for publicly traded companies because large amounts of money are invested in them, either by ‘small’ shareholders, or from pension schemes and other financial institutions.

• The well publicised scandals mentioned above are examples of abuse of the trust placed in the management of publicly traded companies by investors. This abuse of trust usually takes one of two forms (although both can happen at the same time in the same company):

– the direct extraction from the company of excessive benefits by management, e.g. large salaries, pension entitlements, share options, use of company assets (jets, apartments etc)
– manipulation of the share price by misrepresenting the company’s profitability, usually so that shares in the company can be sold or options ‘cashed in’.

Does the external auditor report on whether the published financial statements are correct or not?

Simply No. The external auditor reports on whether the published financial statements give a true and fair view, or not (or give a fair presentation in all material respects, or not). This is different from certifying whether they are correct or not. 

For example, the financial statements may contain a figure (such as the valuation of a property) that is an estimate and where it is impossible to say precisely what the correct figure is. As long the auditor agrees that the estimate is reasonable, then the auditor can report that the financial statements give a true and fair view. He would be unable to give an opinion on whether the figures are ‘correct’ because absolute precision is impossible for many accounting values, e.g. the lives of non-current assets, the amounts necessary to write damaged inventories down to their net realisable value, possible losses from lawsuits in progress, etc.

How does an external audit contribute to the accountability of the directors of a company?

The directors are responsible for preparing draft financial statements that are submitted to the auditors for their audit. It is the directors who select the accounting policies and must make accounting estimates that are reasonable in the circumstances.

The auditors will inspect the various decisions and judgements that the directors have made. Only if the auditors agree will they report that the accounts do give a true and fair view. Thus the directors are held accountable for their decisions and judgements, since the reputation of the company and the directors may suffer if the auditors reported that the accounts did not give a true and fair view.

 

A general question may arise i our mind, how does an external audit contribute to checking whether the directors of a company have exercised good stewardship of the company’s assets?

 

Yes! The published financial statements will disclose the financial performance (i.e., profit or loss, and cash inflow or outflow) that the directors have achieved over the year, and the auditors will confirm whether or not these statements give a true and fair view. If the company has suffered a large loss during a period when its competitors have reported profits, then it appears that the directors have exercised poor stewardship of the assets under their control. The role of the auditors is to ensure that the directors are motivated to present accurate financial statements. If the directors try to hide the losses that have been incurred by unacceptable creative accounting, then the auditors will step in to persuade the directors to adopt proper accounting policies if they want the audit report to state that the accounts 

Six elements of a review engagement to give limited assurance in contrast with UK GAAP

A common example of a limited assurance engagement is when an accountant is engaged to review a set of accounts. The elements of a review engagement are:
 
• a three party relationship between:
– a professional accountant
– a responsible party (the board of directors of the company whose financial statements are being reviewed)
– intended users (the readers of the financial statements with the accompanying review report)

• a subject matter (the performance of the company)
• subject matter information (the financial statements being reviewed)
• suitable criteria (UK GAAP)
• sufficient appropriate evidence (the results of the procedures that the reviewer carries out)
• a written report (the review report that is issued. Note that, because this is only a limited assurance engagement, the report will be worded to offer negative assurance only: ‘Nothing has come to our attention that causes us to believe that the financial statements do not comply with UK GAAP . . ."

Three reports a purchaser may look for assurance before buying a house

Who wants to take risks unknowingly? Will a purchaser take risk without a report? The purchaser might pay for the following reports before buying a house:

• Surveyor’s report – a chartered surveyor will inspect the fabric of the property and give assurance that the walls and roof are soundly constructed. The surveyor will also give an estimated value for the property that a bank or building society will use as assurance that any loan they advance will be properly secured

• Electrician’s report – an electrician can can assure whether the wiring in the property is safe and complies with relevant building regulations

• Roofer’s report – if the roof looks unsound, or the surveyor raises queries on its quality, a roofer can report on how much it would cost to mend or replace the roof. This cost can be incorporated into the discussions on purchase price between the seller and the purchaser of the property

Relationship between the methods of audit evidence gathering

Relationship between the methods of evidence gathering

1. Analytical procedures are first used during the planning phase of the audit. Materiality levels and levels of tolerable error are often derived from analytical procedures. These are in turn used in audit sampling procedures.

2. Analytical procedures assist the auditor decide the audit approach.

3. The results of tests of controls determine the level of detailed testing of transactions and balances. Analytical procedures provide indirect evidence as to the effective operation of internal controls.

4. Detailed tests of transactions and balances are often performed towards the end of the audit in conjunction with analytical procedures – analytical procedures compensate to an extent for the weaknesses in sampling procedures both for tests of controls and detailed testing of transactions and balances and vice versa.

5. Sampling is used for both tests of controls and detailed testing of transactions and balances. Where CAATs are used, sampling may not be necessary because CAATs can often be used to test the whole population, either for tests of controls, or for detailed testing of transactions and balances.