QUESTIONS AND ANSWERS Auditing Help

Enumerate right of auditors under the Companies Ordinance, 1984.

Right of access

Every auditor of a company has a right of access at all times to the books,papers, accounts and vouchers of the company.

Information and explanations The auditor has a right to. require from the company and the directors and the officers of the company such  information arid explanation as he thinks necessary for the performance of duties of the auditors.

Attend general meeting

The auditor is entitled to attend any general meeting of the company
and to receive all notices of, and any communications relating to, any general meeting which any member of the company is entitled to receive.

Right to speak at general meeting

The auditor is entitled to be heard at any general meeting which he attends on any part of the business which concerns him as auditor.

Notice for resolution for removal

In case of removal, the auditor has aright to receive a copy of the notice forwarded by a member to the company.

Right to make representation

The retiring auditor has a right to make a representation in writing to the company and request its communication to the members of the company.

The Companies Ordinance, 1984 disqualifies a body corporate for appointment as auditor of a company.

What could be possible reason for such disqualification?

The shareholders having invested substantial funds in the companies need a high level of assurance that the financial statements pepared by management faithfully represent the financial position and results of operations. If the liability of the auditors is restricted, the auditors will perform less tests and the quality of audit may suffer. The users of the financial statements will place less reliance on audited financial statements.

At present, if the audit firm is charged for negligence, all partners are jointly and severally liable. In order to save their liability, all partners are therefore cautious that no inappropriate audit opinion is issued by the firm. The position could be different in case the partners’ liability is limited. They can more easily dispose off their share in the audit practice.

Discuss auditor’s liability under following heads
a) Civil liability
b) Criminal liability
c) Liability in contract
d) Liability in tort.

a) Civil liability

Civil liability may arise (i) to creditors under the Insolvency Acts (ii) where auditor is aware of tax evasion committed by the client (iii) under stock exchange rules and (iv) under other laws and regulations ..

b) Criminal liability

– Working as auditor if he is disqualified to act as auditor
– Obtain financial advantage by deception
– Insider dealing
– Knowingly or recklessly make false statement in prospectus.

c) Liability in contract

– Failure to deliver audit report
– Inappropriate audit report (duty of care).

CASE LAWS -DUTY OF CARE

(i) Re London and General Bank (1895)

It is the duty of the auditor to bear on the work he has to perform that skill, care and caution which a reasonably careful and cautious auditor would use. What is reasonable skill, care and caution must depend on the particular circumstances of each case. He is not an insurer, he does not guarantee that the books do correctly how the true position of the company’s affairs. circumstances.

(ii) Re Kingston Cotton Mils (1896)

An auditor is not bound to be detective or to approach the work with suspicion or with foregone conclusion that there is something wrong. He is watch dog not a bloodhound.

(iii) Re Thomas Gerard and Son (1968)

Profits were being overstated for quite a few years by including fictitious inventory items and altering invoices which the auditors discovered but did not purse further. As result, dividends were paid out of capital.

It was held that the discovery of the altered invoices put the auditors on inquiry. Their suspicious should have been aroused and inquiries should have been made from suppliers to verify those assurances. They were therefore negligent.

(iv) Lloyd Cheyham v Little john de Paula (1985)

It was held that the auditors were not liable as the audit had been undertaken in accordance with auditing standards.

(d) Liability in tort

Liability in tort means a common law liability. This refers to a claim by a third party who has suffered damages but where there is no contractual obligation from the auditor.

A claim may from plaintiff may be successful if following can be demonstrated.

– The auditor was negligent in the performance of his duties
– The plaintiff has sustained a financial loss
– The loss was a direct consequence of auditor’s negligence.
– The auditors knew or ought to have known that their report will be relied upon by the plaintiff
– The law suit has not been filed by a shareholder in individual capacity.

Case law

Caparo Industries place v Discman and other 1990.

In this case Caparo purchased 100,000 Fidelity shares in 1984 from  the open market. On June 12, the date of which the financial statements were published they purchased a further 50,000 shares. Such shares were acquired on the basis of reliance placed on accounts audited by Touch Ross. In September and October, Caparo purchased further shares so as to acquire control of Fidelity. Caparo alleged the auditors that the reported profits of L 1.3 million were misstated and there was a loss of L 400,000. The plaintiff contented that Touch had duty of care to investors and potential investors.

It was held by the House of Lords in the hearings of the case in February 1990 that the auditors of a public company’s accounts owed no duty of care to members of the public at large who relied upon the accounts in deciding to buy shares in the company. And as a purchaser of further shares, while relying upon the auditor’s report, a shareholder stood in the same position as nay other investing member of the public to whom the auditors owed no duty.  the purpose of the audit was simply that of fulfilling the statutory requirements.

Are the auditors’ liabilities extended for institutions who hold clients’ money? Discuss

Financial and other institutions (like pension funds) holding clients’ money are regulated by more strict laws than normal commercial companies. Accordingly auditors’ responsibilities are also extended. It may be difficult for auditors to identify investment in those companies where directors are interested.

In certain instances, investments should only be allowed to listed companies.

Considerations may be given to following matters.

1. Auditor may be allowed to report to the regulating authorities without being liable for breach of the duty of confidentiality if there are breaches of laws and regulations.
2. Auditor may be required to make an annual report to the regulator of the entity’s investment business.
3. Additional controls are to be considered to detect misappropriations of clients’ funds.
4. The auditor should verify all material investment transactions.

Discuss circumstances under which the inspectors may be appointed for investigation of the affairs of a company as provided in the Companies Ordinance, 1984.

The Commission may appoint, on the application of members holding not less than one-tenth of the total voting powers, one or more competent persons as inspectors to investigate the affairs of any company and to report thereon in such manner as the Commission may direct.

The application shall be supported by such evidence as the Commission may require for the purpose of showing that the applicants have good reason for requiring investigation, and the Commission may, before appointing an inspector, require the applicants to give such security for payment of the costs of the investigation as the Commission may specify.

The Commission shall appoint inspectors to investigate the affairs of the company if the company by a resolution in general meeting or the Court by order declares that the affairs of the company ought to be investigated by an inspector appointed by the Commission.

The Commission may also appoint inspectors to investigate the affairs of the company, if in the opinion of then Commission there are circumstances suggesting:

(a) that the business of the company is being or has been conducted with intent to defraud its creditors, members or any other persons or for a fraudulent or unlawful purpose, or in a manner oppressive of any of its members or that company was formed for any fraudulent or unlawful purpose; or
(b) the persons concerned in the formation of the company or the management of its affairs have in connection there with been guilty of fraud, misfeasance, breach of trust, or other misconduct towards the company or towards any of its members or have been carrying on unauthorized business; or
(c) that the affairs of he company have been so conducted or managed as to deprive the members thereof of a reasonable return; or .
(d) the members of the company have not been given all the . information with respect to its affairs which they might reasonably expect; or
(e) that any shares of the company have been allotted for inadequate consideration; or
(f) that the affairs of the company have not been managed in accordance with sound business, principles or prudent commercial practices; or
(g) that the financial position of the company is such as to endanger its solvency. Before commencing such investigation, the Commission shall give the company an opportunity to show cause against the action proposed to be taken.

It shall be the duty of all officers and other employees and agents of the company and all persons who have dealings with the company to give the inspectors all such assistance in connections with the investigation which they are reasonably able to give.

The inspectors will have powers to carry investigation into the affairs  of, associated companies.

The Commission shall forward a copy of the report made by the inspectors to the company at its registered office.

State the contents of the report by the auditors of the company for inclusion in the prospectus?

Reports to be set out

28(1) A report by the auditors of the company with respect to:

(a) profit and losses and assets and liabilities in accordance with sub-clause (2) or (3) of this clause, as the case may require; and

(b) the rates of the dividends, if any, paid by the company in respect of each class of shares in the company for each of the five financial years immediately preceding the issue of the prospectus, giving particulars of each class of shares on which such dividends have been paid and particulars of the cases in which no dividends have been paid in respect of any class of shares for any those years;

and, if no accounts have been made up in respect of . part of the period of five years ending on a date three months before the issue of the prospectus, containing statement of that fact.

(2) If the company has no subsidiaries, the report shall:

(a) so far as regards profits and losses, deal with the profits or losses of the company (distinguishing items of a non- recurring nature) for each of the five financial years immediately preceding the issue of the prospectus;
(b) so far as regards assets and liabilities, deal with the assets and liabilities of the company at the last date to which the accounts of the company were made up.

(3) If the company has subsidiaries, the report shall:

(a) so far as regards profits and loss-es, deal separately with the company’s profit or losses as provided by sub- clauses (2) and in addition, deal either:

(i) as a whole with the combined profits or losses of its subsidiaries, so far as they concern members of the company; or
(ii) individually with the profits or losses of each subsidiary, so far as they concern member of the company;

or instead of dealing separately with the company’s profits or losses, deal as a whole with the profits or losses of the company, and so far as they concern members of the company, with the combined profits or losses of its subsidiaries; and.

(b) so far as regards assets and liabilities, deal separately with the company’s assets and liabilities as provided by sub-clauses (2) and in addition, deal either:

(i) as a whole with the combined assets and liabilities of its subsidiaries, with or without the company’s assets and liabilities; or
(ii) individually with the assets and liabilities of each subsidiary; and shall indicate as respects the assets and liabilities of the subsidiaries, the allowances to be made for persons other than members of the company.

29. If any shares have been or are to be issued or the proceeds, of the issue of the shares or debentures are or is to be applied directly or indirectly:

(i) in the purchase of any business; or
(ii) in the purchase of an interest in any business; and by reason of that purchase or anything to be done in consequence thereof, or in connection therewith, the company will become entitled to an interest, as respect either the capital or profits and losses or both, in such business exceeding fifty per cent. thereof; a report made by auditors (who shall be named in the prospectus) upon:

(a) the profits or losses of the business for each of the five financial years immediately preceding the issue of the prospectus; and
(b) the assets and liabilities of the business at the last date to which the accounts of the business were made up, being a date not more than one hundred and twenty days before the date of the issue of the prospectus.

30.(1) If:

(a) the proceeds; or any part of the proceeds, of the issue of the shares or debentures are or is to be applied directly or indirectly in any manner resulting in the acquisition by the company of shares in any other body corporate; and

(b) by reason of that acquisition or any thing to be done in consequence thereof or in connection there with, that body corporate will become a subsidiary of the company; a report made by auditors (who shall be named in the prospectus) upon:

(i) the profits or losses of the other body corporate for each of the five financial years immediately preceding the issue of the prospectus; and
(ii) the assets and liabilities of the other body corporate at the last date to which its accounts were its accounts were made up.

(2) The said report shall:

(a) indicate how the profits or losses of the other body corporate dealt with by the report would, in respect of the shares to be acquired, have concerned members of the company and what allowance would have fallen to be made, in relation to assets and liabilities so dealt with, for holders of other shares, if the company had at all material times held the shares to be acquired; and
(b) where the other body corporate has subsidiaries, deal with the profits or losses and the assets and the assets and liabilities of the body corporate and its subsidiaries in the manner provided by sub-clause

(3) of clause 28 in relation to the company and its subsidiaries.

The following three entities have approached Alpha & Company. Chartered Accountants (the firm) for appointment as their statutory auditors. In each case there are following issues which need to be considered before the firm are also using the bank’s credit card facility.

(i) Client: Safe Bank Limited
Issue: the firm has acquired office equipment from the bank under finance lease arrangements. In addition, some partners of the firm are also using the bank’s credit card facility.

(ii) Client: Pride Communication Limited (PCL):
Issue: One of the firm’s partners had remained the director of PCL for many years, as a nominee of Federal Government.

(iii) Client: Gama Limited
Issue: A partner of the firm holds shares in Beta Limited which is an associated company of Gama Limited.

Required
In each specify the minimum conditions specified by Companies Ordinance, 1984, which should be fulfilled in order to accept the audit engagement.

(i) The firm cannot be appointed as external auditor of the company unless the lease agreement is terminated and credit balance of the partners is reduced to Rs. 500,000.
(ii) A director can be appointed as auditor of the company three years after the date on which he ceases to be a director of the company. Therefore, it was only possible for the firm to accept the appointment if the concerned partner resigned from the firm.
(iii) The firm cannot accept the appointment as external auditors of the company if a partner of the firm holds shares in the associated undertaking of that company provided he disposed off the shares within 90 days of appointment.

Analyze the following independent situations with reference to
qualification of statutory auditor:

(i), Mr. Zakir Ali, a practicing chartered accountant, has been offered appointment in Heera Limited as external auditor. He was an employee of the company before he started his own practice.
(ii) Diamond Associated (Pvt) Limited, a consultancy company, the majority of whose directors are chartered accountants, have been offered appointment as external auditor in Lal (Pvt) Limited whose share capital is less than Rs. 1.5 million.
(iii) Miss. Fatima Khan, a practicing chartered accountant, has been offered appointment in Neelam Limited as external auditor. She was an employee of the company’s director two months before the offer.
(iv) Mr. Farid Hussain is a partner of Farid & Company, Chartered Accountants. The firm has been offered appointment in Feroza Limited as ‘external auditor. Son’ of Mr. Farid holds shares of Feroza Limited.

(i) Mr. Zakir cannot be appointed as auditor of Heera Limited because an employee of the company is disqualified to become auditor of that company if he was in service during the last three years.
(ii) A body corporate is disqualified to become auditor
(iii) The appointment is, valid because ex employees of director does not need a time lapse of three years for appointment as external auditor.
(iv) If shares are held by the minor son of a person he cannot accept an appointment as an external auditor. There is no such restriction if the son has attained the age of majority.\

Comment on each of the following situations with reference to the appointment of external auditors in accordance with the requirements of the Companies Ordinance, 1984:

(a) Farrukh & Co., Chartered Accountants, has received an offer to be appointed as the external auditor of Ebrahim Gas Company. The firm is indebted to the company as it has not paid the last two months’ bills amounting to Rs. 4,860.
(b) After seventy days of incorporations, the directors of Rahman Limited (RL) decided to appoint Mr. Shahid as the company’s statutory auditor. Mr. Shahid was employed by RL before he started his own practice.
(c) The directors of Fazal Limited (FL) have decided to appoint Syed & Company, Chartered Accountants, as external auditor of the company. One of the partner’s spouse holds 1,000 shares in the subsidiary of FL.
(d) The directors of Najam (Pvt.) Limited having paid-up capital of Rs. 4.5 million have appointed Me. Dawood to act as the external auditor of the company. Mr. Dawood has been awarded a diploma in International Financial Reporting Standards by the Institute of Chartered Accountants of Pakistan and has completed the mandatory period of training from a leading firm of chartered accountants.
(e) All directors of Hussain Associates (pvt.) Limited are chartered accountants. The company has recently received an offer for appointment as the external auditor of Masood (Pvt.) Limited which has a paid-up share capital ofRs. 1,000,000.

(a) The appointment of Farrukh & Co. will be in order because the firm would not be considered indebted to the company as the period for which the utility dues are unpaid does not exceed 90 days.
(b) Mr. Shahid cannot be appointed as statutory auditor of Rehman Limited because of the following:

(i) Mr. Shahid is not eligible for appointment as statutory auditor since only 70 days have passed since the company’s incorporation and therefore obviously less than three years have elapsed since he left the employment of the company.

(ii) Directors have lost their authority to appoint external auditors after the expiry of 60 days from date of incorporation.

(c) Syed & Co. shall not be appointed as auditor of the company because his spouse holds shares in its associated company. However, the firm can be appointed as auditor of Fazal Limited if the spouse of the partner disinvests the shares within 90 days of appointment. .

(d) Mr. Dawood’s appointment shall be void because only a chartered accountant can be appointed as auditor of a private limited company having share capital of Rs. 3 million or more.

(e) Hussain Associates (Pvt.) Ltd. being a body corporate cannot be appointed as external auditor of any company.

Set out significant contents of prospectus.

The information that must be included in a Prospectus is briefly listed below:

1. Permission from SECP, SE and Register

Example:

Approval of the SECP has been obtained for the Issue, circulation and publication of this Prospectus as required by Section 57(1) of Companies Ordinance, 1984.

2. Objects – Memorandum is to be attached

Example:

The objects for which company is established are:

(i) To provide modem and innovative services and products in the field of information technology, computers and communications. These services and products will include design, development and complete implementation of national and international telephone services, Pay phone service, Cellular phone service, radio service and all associated computer and  communication services subject to any permission as required under the law.

(ii) To set up a countrywide network for value added communication
services, procure equipment and arrange its management, operations and maintenance to serve the needs of the subscribers.

3. Capital Structure

Capture

4. Minimum Subscription for Allotment

Example:
The minimum subscription on which the Directors will proceed to allot shares is the full amount of the present issue which has also been underwritten in full, as that is the amount which in the opinion of the Directors, must be raised to meet the cost of implementation of the expansion plan of the project and to meet working capital requirements.

5. Time for Opening of Subscription List

Example:
The subscription list will open at the commencement of banking hours on Monday, March 27, 2000 and will close on the same day at the close of banking hours.

6. Amount payable with the Application – Basis of Allotment

Example:

a) Application for the shares below the total value of Rs. 7,500 (including premium of Rs. 2,500) shall not be entertained.
b) An applicant will be entitled to apply in one category only.

7. Shares issued for Consideration other than Cash

Example:

During the preceding two years an aggregate of 10,000,000 fully paid ordinary shares of the face value of Rs. 10/- each have been issued by the Company. Out of the 3,000,000 shares were issued for cash at par value of Rs. 10/- per share, 7,000,000 shares as fully paid bonus shares of Rs.IO/- at par value.

8. Premium or Discount on issue of Shares

Example:

Justification for the issue of Shares at Premium, as is given below, has been extracted from the due diligence reports of the underwriters:

a) The company has been operating for the past 3 years in the payphone industry and has displayed growth in revenue. As per the audited accounts for the year ending June 30, 1999, the Company does not have any long-term loans. The profit rate after tax has increased from Rs. 8.2 million in 1998 to Rs. 53 million in 1999. The Company’s growth and profitability are even more impressive when viewed in the background of the depressed economic scenario of the country during the past two years when most businesses were experiencing decreasing sales revenues and profits.

b) Pakistan has huge untapped demand for telecommunication services. Since the company operates in both the supervised and standalone segments of payphone industry, therefore, it will benefit maximum from the opportunity of available market. All the existing telecommunication sector companies are trading above par and having higher PIE ratios than the share of the
company being offered.

9. Underwriters and Commission on Underwriting

Example:

The present public issue of 950,000 of the face value of Rs. 10/- each, at an offer price of Rs. 15/- per share, including the premium of Rs. 5/- per share, of the total value of Rs. 142,500,000 has been fully underwritten.

If, and to the extent the shares hereby offered to General Public are no subscribed and paid for in cash in full, the underwriters shall, within 15 days of being duly called upon by the Company to do so, subscribe and pay or procure subscribers to subscribe and pay for in cash in full those shares not so subscribed in proportion to the underwriting commitments.

In the opinion of the directors, the resources of the underwriters are sufficient to discharge their respective underwriting commitments.

10. Preliminary Expenses / Expenses to the Issue

Example:

All expenses incurred in connection with the public issue of the Company and the distribution of such shares including charges payable to the underwriters, balloters, brokerage to members of the SE, commission to Bankers to the Issue, etc. shall be borne by the Company.

11. Particulars of Property Purchased

12. Particulars of Directors, Chief Executive etc. and extent to their Interest

13. Voting and other Rights

14. Particulars of the Contracts / Material Contracts

15. If the Share is at Premium, justification of Premium i.e., due Diligence Report

16. Auditors Report / Certificate U/S Section 53(1) and Clause 28(1)

a) Regarding assets & liabilities
b) Regarding Share Capital & Sponsor’s contribution
c) Auditor’s Certificate on Break-up Value of the Share

17. Share Application Form

18. Brief History of the Project

Example:

WorldCALL Payphones Limited (“WorldCALL”) was incorporated on December 14, 1995 and received Certificate of Commencement of Business on April 21, 1996. The main activity of the Company is the installation, operation and maintenance of a countrywide smart card payphone network.

Comment on each of the following independent situations in respect of appointment of auditors, with reference to the applicable rules and regulations:

(a) Guava and Company, Chartered Accountants, have received a request for appointment as auditor of Orange Bank Limited (OBL). Most of the partners of Guava and Company maintain their accounts with OBL and are enjoying credit card facilities from them. The maximum outstanding balance on the credit card facility, due from any partner is Rs. 399,000.
(b) Apricot and Company, Chartered Accountants, have received an offer for appointment as auditor of Banana Limited. Mr. Pumpkin who is a nominee director of the Government on the Board of Directors of Banana Limited holds 25% shares in Water Melon Limited. The spouse of a partner also holds shares in Water Melon Limited.
(c) Mr. Zaheer, a legal practitioner, has received an offer for appointment as external auditor of Lychee (Private) Limited (LPL). The paid up capital of LPL is Rs. 1,500,000 of which 40% is owned by Blue Black Limited, a listed company.
(d) Walnut and Company, Chartered Accountants, have received an offer for appointment as external auditors of Wasim (Private) Limited (WPL), in place of the previous auditors, who were removed before the completion of their term. You may assume that WPL has completed all the legal formalities before removing the previous auditors.
(e) Mr. Sadiq has recently joined your firm as a partner. He has served on the Board of Directors of Strawberry Limited (SL) until 30 June 2009, as a Government nominee. In the Annual General Meeting of SL held on 31 August 2011, a shareholder has proposed the name of your firm for appointment as the external auditors for the year ending 30 June 2012.

(a) (i) The appointment of Guava and Company, Chartered Accountants, will be in order.

(ii) The firm would not be deemed indebted to the company as the amount of debt is not exceeding Rs. 500,000.

(b) (i) The appointment of Apricot and Company, Chartered Accountants will be in order.

(ii) Banana Limited and Water Melon Limited are not associated companies as the common director is a Government nominee.

(c) (i) Mr. Zaheer can be appointed as the Auditor of Lychee  (Private) Limited.

(ii) There is no specific qualification requirement for auditors of companies having paid-up capital of less than Rs. 3 million.

(iii) The fact that 40% of the shareholding is owned by Blue Black Limited does not disqualify Mr. Zaheer as the auditor of LPL.

(d) Before accepting the offer Wallnut and Company, Chartered Accountants, apart from obtaining professional clearance from the existing auditor is also required to inform the ICAP (Institute) and obtain prior clearance from the institute.

(e) (i) Since the three year period has not been lapsed,

(ii) Our firm cannot be appointed as the auditor of Strawberry Limited,
(iii) The fact that Mr. Sadiq was serving on the board as a Government nominee does not make any difference, in this case.

Posted on November 3, 2015 in Legal Provisions Relating to Auditors

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