Business Page – August 26th, 2001


Just Fire the Damn Auditors !

 

Introduction

                     'Accountants only slow things down when figures get in the way. Never been an      account in the name of Evita Peron' 

                                                (Tim Rice and Andrew Lloyd Webber - Evita)

 

The words auditor and accountant are sometimes used interchangeably even in the profession. It seems that Che Guevera, who played the fictional role of social commentator in the musical Evita was referring to accountants in their capacity as auditors, the type of people who face a serious occupational hazard. Directors and management, and that includes politicians, do not like auditors who take their job too seriously. To them auditors are a necessary evil imposed on them by law, an overhead that creates disruption for the finance staff, wastes important management time and adds no value to the business.

It is surprising the number of companies which appoint and retain auditors without only a modest idea of their statutory duties, their reporting obligations and their potential liability for poor quality work which may cause shareholders, investors and other third parties considerable losses. Management, particularly in privately owned companies, consider auditors as they do employees - there to carry out their instructions and wishes particularly in matters relating to tax savings, disclosure of information (which in practice means non-disclosure) and transactions involving directors and management.

Under the Companies' Act and by implication the Corporation Tax Act each incorporated entity is required to have its financial statements audited by a member of the Institute of Chartered Accountants of Guyana. (ICAG). The auditor has considerable legal rights to information and explanations and access to records, documents, books etc. which in his opinion are necessary to enable him to carry out his statutory duties. I highlight in his opinion because of the number of times auditors are asked why they need a particular record or access to a person. Nothing arouses more suspicion in an auditor than an apparent reluctance to make a record or access available!

Independence

The Act imposes a standard of independence which in small societies is not always easy to maintain. In the absence of an effective audit committee, the mutual interest of auditor as well as the management is served by a close relationship between management and auditor. While the auditor is technically and legally appointed by and responsible to the shareholders, his fees are fixed by the same directors whose stewardship he is required to report on. Often the audit fee is a small proportion of the total amount he can collect from the client in any particular year. For example, he can expect payments for disbursements, tax and accounting work and lucrative consulting assignments. It is the directors who decide whether such work will go his way. Given that fees are the principal if not only source of income, he cannot afford to antagonize those directors.

Duty of the Auditors

There is some anecdotal evidence that auditors of certain companies also do professional work for individual directors and other related parties who have other business interests. While there is no official pronouncement on this practice, such close relationship is best avoided to ensure that there is not only real, but also perceived independence.

The principal duty of the auditors is to make a report to the members on the accounts examined by them. He is expected to exercise reasonable care and skill in making enquiries and investigations. In re Kingston Cotton Mills Co., Lopes, LJ remarked: " An auditor is not bound to be a detective, or… to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is a watch dog, but not a blood hound…" Expounding on this, the late Lord Denning, in a case dealing with the duties of an auditor, said thus: 'An auditor…. is not a professional adder-upper and subtractor"

For all of the provisions of the Companies Act which set outs the duties of the auditor, case law interpreting the statutes and pronouncements by the accounting profession on what are and are not good accounting practice and standards of auditing, the scope for disagreement between client and auditor is wide. Indeed it would be worrying if there are not differences of opinion on matters of substance since the perspectives from which they view matters are so different. For example, auditors like to have what they refer to as audit evidence. On the other hand, when in what is still a cash society, the client asserts that he does not have records to support payments which he affirms on all the holy books were legitimate business expenses, do you tell him you will not accept his statement, effectively telling him you do not believe him? And if you continue to doubt him, is he not going to say that the relationship is not sustainable and he considers its termination unavoidable?

Disclosure

Then there is the question of disclosure of information. The Act and accounting standards which have been accorded legal status, have attempted to specify the nature and details of information which need to be disclosed and/or be available to the shareholders. For example, Section 104 of the Companies Act provides for remuneration paid to a director to be specified in the constituent documents of the company or in a service agreement approved by the shareholders. Auditors routinely report that records and the statements comply with the Companies' Act and applicable accounting standards. But would this be supported by a critical review of those statements or the records required to be maintained? And how does one auditor insist on a particular treatment when the client tells you no one else is doing it your way?

One of the products of the audit is a management letter addressed to the directors setting out some of the errors, control weaknesses and the recommendations of the auditor designed to reduce such weaknesses and errors in the future. Management sometimes uses all kinds of reasons why particular items should not be included or, if included, so watered down as to become meaningless. How does the auditor protect his independence and convey his concerns while avoiding conflict with the client and accusations about non-cooperation?

Taxation

One of the most serious areas of potential conflict is in relation to taxation. It is incredible the number of clients who wrongly believe that the duty of the auditor is to assist in tax minimisation. Even if the auditor is acting as the agent of the client in his tax affairs, he has to consider his own exposure if it is proved that he has aided and abetted the client in tax evasion. In any case, his role as preparer of tax returns is separate from that as auditor, a distinction that the client understandably finds hard to appreciate.

Firing the Auditor

Modern company law and practice have sought to protect the auditor from arbitrary dismissal usually at the instigation of the directors who of course are elected by the shareholders. The law requires a shareholders resolution at a special meeting to remove an auditor. The problem is that the director is no more than a surrogate of some powerful shareholder and it would be like appealing to Satan in hell. However to ensure that the change takes place in the most transparent manner, the law provides for any auditor who resigns or who receives a notice or learns of a meeting of shareholders called for the purpose of removing him from office or to appoint another person to fill the office of auditor, to submit to the company a written statement giving the reasons for his resignation or the reasons why he opposes any proposed action or resolution. When the company receives the statement it must send a copy to every shareholder entitled to receive notice thereof and to the Registrar.

To protect its integrity, the profession has established rules which are embodied in the law which require a successor auditor to seek professional clearance from the outgoing auditor. This includes a written statement of the circumstances and the reasons why, in that auditor's opinion, he is to be replaced. He may, however, accept the appointment if within fourteen (14) days of the request he has received no response.

In practice and in the case of private and controlled public companies it is not too difficult to change auditors for any of a number of reasons. While the outgoing auditor may make a convincing case why he thinks he is being unfairly treated, he is unlikely to want to be seen struggling to hold on to the engagement and often quietly withdraws. After all, even if the auditor's case is made, if confidence and mutual respect no longer exist, there is no basis for a continuing relationship.

On the other hand and depending on the circumstances, the auditor should recognise that he has a wider public interest obligation and he has to resist improper pressure. Professionals are one of the pillars of governance in the society and at all times they have to take a professional stand even at the expense of challenging directors and management. One has to wonder how differently things might have been if Guyanese professionals had taken a different stand on the accounting, economic, legal, political and social challenges which have faced us over the decades.