The
roles of External Auditors under Companies Act 1965
Abstract
Recently,
the corporate governance in Malaysia has been called in question especially
when it involves a government linked strategic development company who amassed
billion of ringgit debt. This company had changed numerous external auditors
for the past few years. All the controversies leads people to question whether
the Auditors had neglected their duties in addressing myriad of controversies
surrounding this company; whether the auditors’ report truly reflects the
accurate financial report of this company. There is also a question whether the
correct standard of accounting practice has been implemented. If the answer is
affirmative, we also would like to know which standard of accounting practice
that being used; is it the high standard or lower standard. Is the external
auditors really are independent body? Hence, this article is to examine the
roles of the external auditors under the Companies Act 1965 (“CA 1965”).
Background
Section 143 of the Companies Act says that Directors may appoint a
person(s) to be the auditor(s) of the company. If the director fails to appoint
an auditor, the shareholders during the Annual General Meeting can appoint an
auditor. The appointment shall be valid from one Annual General Meeting to the
next meeting (section 172 (2) of the CA 1965).
For the purpose of this article, the term “auditor” is referring to the
external auditor of the company.
According to section 172 of the CA 1965, it is a compulsory requirement
under the law for appointment of auditor who is an independent body.
Reasons:
•
CA 1965
require every co to have its profit & loss account and balance sheet
audited before presentation at annual general meeting
•
Company is
carrying on business with capital contributed by Share Holder.
•
Potential
conflict of interest that exist between the members & managers. Auditing
provides protection to members / Share Holders, creditors so that they are accurately
informed of the company’s financial position. Protection to Share Holder
against misappropriation of money or mismanagement. To check company’s
affairs and report to Share Holders
•
Safeguard to
Share Holders on veracity / truth of financial & written material prepared
by directors. Share Holders are passive. Company’s affairs under control of
management of directors and officers
Obligations of Auditors
Section 174 of the CA 1965
(1) Every auditor of a company shall report to the members on the accounts
required to be laid before the company in general meeting and on the company’s
accounting and other records relating those accounts and if its is a holding
company for which consolidated accounts are prepared shall also report to the
members on the consolidated accounts.
(2) An auditor shall, in a report under this section, state-
(a) whether the accounts and, if the company is a holding company for which
consolidated accounts are prepared, the consolidated accounts are in his
opinion properly drawn up –
(i)
so as to give a true and fair
view of the matters required by section 169 to be dealt with in the accounts
and, if there are consolidated accounts;…
(ii)
in accordance with the
provisions of this Act so as to give a true and fair view of the company’s
affairs; [and]
(iii)
in accordance with the
applicable approved accounting standard;
The duty of the auditors is to check the account of the company, making
sure that the account is accurate. The main duty is to investigate and form a
fair and accurate opinion on the adequacy of the company’s accounting and
financial affairs.
In the case of Caparo Industries plc v Dickman & Ors
[1990] 1 All ER 568, 583, HL, Lord Oliver held that:
It is the auditors’ function to ensure, so far as
possible, that the financial information as to the company’s affairs are
prepared by the directors accurately reflects the company’s position in order,
first to protect the company itself from the consequences of undetected
errors or, possibly, wrongdoing (by instance, declaring dividends out of
capital) and, second, to provide shareholders with reliable intelligence
for the purpose of enabling them to scrutinize the conduct of the company’s
affairs and to exercise their collective powers to rewards or control or remove
those to whom that conduct has been confided.
The role of the auditors basically to give the shareholders with
“reliable intelligence” of the company’s financial affairs. We may argue that
for information to be “reliable intelligence”, the report must be fair,
accurate, and not tainted with biasness. Hence, the external auditors must be
independent in preparing his report without any interference of any invisible hand
of the company. However, according to section 172 (4) of the CA, the auditor
may be removed form from office. The possibility of the auditors being removed
from their appointment make us wonder whether an auditor is truly independent
in preparing the audited report.
Liabilities of the auditor
The law says that the auditors owe the duty to the client; which is the
company. We also had established that the purpose of the audited report is to
enable the shareholders to make an informed control over the company.
The duty of an auditor is to exercise reasonable care and skill in
preparing his report. The standard of care is the acceptable industrial
practice of a reasonable auditor. In the case of Re Kingston Cotton Mill Co
(no 2) [1896] 2 Ch 279 the court held that:
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 cautious auditor would use, What is reasonable skill,
care and caution must depend on the particular circumstances of each case. An
auditor is not bound to be detective, or as was said to approach his work with
suspicion or with foregone conclusion that there is something wrong. He is a
watchdog, not a bloodhound. He is justified in believing tried servants of the
company in whom confidence is place by the company. He is entitled to assume
that they are honest and to rely upon their representation, provided he takes
reasonable care. If there is anything calculated to excite, suspicion he should
probe it to the bottom; but in the absence of anything of that kind he is only
bound to be reasonably cautious and careful.
Basically, the auditor must perform his duty based on the standard
practice expected from an auditor. The auditor is a watchdog not a bloodhound. In
one hand, the auditor should not come to the company with prejudicial mindset. On
the hand the auditor should investigate further only if there is glaringly
reason to be suspicious. If the auditor ignores these suspicious transactions,
the auditor may be liable for negligence.
The auditors are under the duty to exercise reasonable care and skills
in preparing their audited report. However, what complies as reasonable care
and skills? What tantamount to suspicion that renders the auditors to
investigate further? We make be guided by the judgment in the case of Re
London and General Bank [1895] 2 Ch 673, 683, CA, when Lindley LJ
stated that:
What is reasonable care in particular case must
depend upon the circumstances of that case. Where there is nothing to excite
suspicion, very little inquiry will be reasonably sufficient, and in practice I
believe businessmen select few cases at haphazard, see that they are right, and
assume that others like them are correct also. When suspicion is aroused, more
care is obviously necessary, but, still, an auditor is not bound to exercise
more than reasonable care and skill, even in the case of suspicion, and he is
perfectly justified in acting on the opinion of an expert where special
knowledge is required.
In the recent case that involves the country’s strategic development
company, various suspicious transactions are being questions again and again.
It is arguable that the auditors should put their mind to investigate further
those transactions and come up with a fair and accurate report on those
transactions.
To enable the auditors in performing his duties with reasonable care and
skills, and without fear and favour, all statements verbal or in writing made
by the shareholders in discharging is duties are protected from defamation
suit. Section 174A(1) and 174A(2) of the CA 1965 stated that the auditors are
protected if he made the statement without malice (bad intention).
Auditor also has a wide power under the Companies Act to scrutinize the
account of a company. He has an access
at all reasonable time to the accounting and other records of the company. He
is also entitled to request from the any officer of the company for any
information to assist in his duties as an auditor (Section 174 (4) of the CA
1965). An auditor for holding company may request for the record of the
subsidiary companies.
Hence, with such ample powers given to the auditors, it would be
atrocious and negligence of the said auditors if they fail to discharge their
duties under the CA 1965 in giving a fair and accurate report to the
shareholders of the company.
The duty of the auditor is make a report to the registrar of companies
and the shareholders. If the auditors spotted any fraud or non-compliance with
the accounting standard, the matter should be reported to the Companies
Commission of Malaysia (“CCM”). These obligations were spelled out in section
174(8) and (8A) of the CA 1965.
Conclusions
A company is a body without a soul. It is the directors and the management
of the company that form the blood and flesh of the company; forming the muscle
to move the company. However, the action by the management of the company if
left unchecked may be detrimental to both the company and the shareholders of
the company. It is left to the auditors to make sure that the financial affairs
of the company being run according to the acceptable accounting practice. The
auditors have a heavy burden of obligation to carry but not without necessary
powers to discharge their duties. The auditors must remain independent in
discharging their duties. Cases like Enron shows how difficult for auditors to
remain independent while keeping their corporate client under their account.
Hopefully, good conscience will, at the end of the day, triumph over any other
considerations.
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