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Company Law

Accounts and the

Role of the
Auditor
LECTURER: ALDITH HYLTON
  The main purpose of the legal
requirements relating to the accounts
of a company is essentially for the
interest and protection of the
shareholders, creditors and those who
manage the company.
Accounts  However, the accounts of a company
have acquired value for those
contemplating investing in the
company and for employees of the
company for the purpose of bargaining
for improved terms and conditions of
employment.

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  Section 144 (1) of the Companies Act,
2004 provides that it is the duty of
every company to keep proper books
of account with respect to-
a) Money received and expended
and the matters in respect of
which the receipt and expenditure
Accounts takes place.
b) All sales and purchases of goods
by the company.
c) The assets and liabilities of the
company.

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  The proper books of account are such
books as are necessary “ to give a true
“True and Fair and fair view of the state of the
company’s affairs and to explain its
View of The transactions”- S. 144 ( 2 ).
Company’s  It is thought that in order to comply
State of Affairs with S.144 ( 2 ) the company should
follow the standard practices of
“ reputable accountants generally.

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  The company’s books of account
should be kept at the company’s
registered office or such other place as
the company’s directors think fit and
proper - S. 144 (3)
 The company’s books are open to
Company’s inspection by the directors – S. 144
(3)
Books Kept at
 S. 144 (4) provides that if the
Registered company’s books are kept outside
Office Jamaica, the company must keep such
accounts and returns in Jamaica with
respect to the business. These accounts
are to be up to date and should be up
to date at intervals of 6 months. These
accounts are open to the inspection of
the directors.

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  Should a company not want to keep
accounts in Jamaica as aforesaid, the
company would have to get approval
for exemption from the Minister.
 S. 144 (5) provides that every director
Company’s of the company has the responsibility
Accounts To for ensuring that the company’s
accounts are kept in accordance with
Be Kept In the requirements of the Act.
Accordance  The directors will be criminally liable
if they negligently or willfully fail to
With The Act do so. The penalty includes
imprisonment with or without hard
labour not exceeding 6 months or a
fine not exceeding $50,000.00

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  S. 145 (1) makes it mandatory for
directors to lay before the company in
the general meeting, the profit and loss
account (or income and expenditure
account) made up from a certain date
and to a certain date as set out in the
Accounts Laid Act.
Before Annual  This obligation of the directors must
General be fulfilled at a date not later than 18
months after incorporation and
Meeting subsequently at least once in every
(AGM) calendar year.
 In addition, the directors are obliged to
have prepared and laid in the general
meeting, a balance sheet as at the date
to which the profit and loss account is
made - S.145(2)).

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  Attached to the balance sheet should
be the report of the directors with
respect to the state of the company's
Report of The affairs and the amounts , if any, which
Directors they recommend should be paid as
dividend or transferred to reserves.

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  The Seventh Schedule of the
Companies Act states that the
accounts should conform to the
Conform To principles promulgated from time to
time by the ‘Institute of Chartered
Institute of Accountants of Jamaica’ or such other
Chartered body as the Minister may prescribe
(exceptions have been made for small
Accountants of companies).
Jamaica  The Minister can also permit a format
other than that which is prescribed.

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  S. 146 governs the form and content of
the accounts.
 The accounts should give a true and
Form and fair view of the state of affairs of the
company at the end of the financial
Content of year.
Accounts  Further, the accounts should comply
with the Seventh Schedule of the
Companies Act.

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  The Seventh Schedule - S. 2 (b)
provides that the accounts shall
contain:
1) A balance sheet;
2) A statement of changes in equity;
A profit and loss account;
The Seventh 3)

A statement of changes in
Schedule 4)
financial position;
5) Notes to the accounts;
6) Such other variation or addition to
the above list as may be
promulgated by the Institute of
Chartered Accountants of Jamaica.

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  Where a company is a holding
company for a group of companies,
then the group accounts must be laid
before the company in general meeting
when its own balance sheet and profit
and loss are laid - S. 147.
Group  Group accounts must be prepared in
Accounts the format stated in S. 148. They
should be presented as consolidated
accounts unless in the opinion of the
directors they would be better
understood in another format.

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  Group accounts must also give “a true
and fair view” of the state of affairs
and profit and loss of the company and
the relevant subsidiaries as a whole.
 If group accounts are prepared as
Group consolidated accounts, they must
Accounts comply with the requirements of the
Seventh Schedule to the extent
applicable but always subject to the
overriding requirement that they give
“a true and fair view” of the
company’s financial position.

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  Finally, please note that S. 190 of the
Companies Act specifically requires
Directors’ that particulars of the directors’
emoluments be set out in the accounts
Emoluments of companies.

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  The independent examination of the
company’s accounts by a person of
established competence is regarded as
an indispensable feature of company
practice.
 S. 154 (1) provides that every
company shall at each annual general
meeting appoint an auditor or
Auditors auditors to hold office from the
conclusion of that meeting, until the
conclusion of the next annual general
meeting.
 However, note that the directors are
given the power to appoint the first
auditors at any time before the first
annual general meeting (AGM).
 The first auditors holds office until
the conclusion of the first AGM.
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  Before a company appoints an auditor,
it must be ensured that the person is
qualified for appointment.
 A person cannot be qualified for
appointment as an auditor of a public
Auditors company or of a private company
which is obliged to file accounts,
unless he is a registered public
accountant as defined by S. 2 of the
‘Public Accountancy Act’ - S.155.

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  At any AGM, a retiring auditor
however appointed, shall be
automatically reappointed without the
passing of a resolution unless -
1) he is not qualified for
reappointment;
a resolution has been passed
Auditors 2)
appointing someone else; or
3) a resolution has been passed
providing expressly that he should
not be reappointed; or
4) he has given the company notice
in writing of his unwillingness to
be reappointed.

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  If at an AGM no auditor is appointed
or reappointed, the Minister may
appoint an auditor for the company.
 Where it is proposed that a new
auditor should be appointed and that
the current auditor should not be
Auditors reappointed, the current auditor should
be advised by way of a copy of the
notice and he/she should have an
opportunity to make representation in
respect of the matter.
 The remuneration of the auditors is
fixed by the company at the AGM.

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  S. 155 provides that the auditors of
public companies and non – exempt
private companies must be ‘registered
public accountants’ as defined by the
“Public Accountancy Act”.
 S. 156 sets out the persons who shall
not be auditors:
Auditors
a) An officer or servant of the
company;
b) A person who is a partner of, or in
the employment of an officer or
servant of the company;
c) A body corporate.

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  S. 157 sets out the duties of auditors to
report to the members on the accounts
Matters To Be of the company examined by them.
Expressly The content of the report is mandated
by Schedule 8 of the Companies Act.
Stated In
 The report shall contain statements as
Auditors to the matters hereunder-
Report - 1) Whether they have obtained all the
(Eighth information and explanations which to
the best of their knowledge and belief
Schedule ) were necessary for the purposes of
their audit.

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 2) Whether, in their opinion, proper books
of account have been kept by the
company, so far as appears from their
examination of those books, and proper
Matters to Be returns adequate for the purposes of their
audit have been received from branches
Expressly not visited by them.
Stated 3.(1) Whether the company's balance
(continued) sheet and (unless it is framed as a
consolidated profit and loss account) profit
and loss account dealt with by the report
are in agreement with the books of
account and returns.

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 3.(2) Whether in their opinion and to the
best of their information and according to
the explanations given them, the said
Matters accounts give the information required by
Expressly the Act in the manner so required and give
a true and fair view –
Stated
a) In the case of the balance sheet,
(continued) of the state of the company’s
affairs as at the end of its
financial year,

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 b) in the case of the profit and loss
account, of the profit or loss for its
financial year;
c) a statement of change in equity for its
financial year; and
a statement of change in finances for
Matters d)
its financial year;
Expressly or, as the case may be, give a true and
Stated fair view thereof subject to the non –
disclosure of any matters ( to be
(continued) indicated in the report ) which by
virtue of Part 11 of the Seventh
Schedule are not required to be
disclosed.

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 4. In the case of a holding company
submitting group accounts, whether in
their opinion, the group accounts have
Matters been properly prepared in accordance
with the provisions of the Act so as to
Expressly give a true and fair view of the state of
affairs and profit or loss of the
Stated company and its subsidiaries dealt
(continued) with thereby, so far as concerns
members of the company, or as the
case may be, so as to give a true and
fair view thereof.

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  Section 157 (3) provides that every
auditor has the right of access to all
books and accounts and vouchers of
the company and shall be entitled to
require from the officers of the
company such information and
explanations as he/she considers
necessary for the performance of
Section 157 his/her duties.
 The auditor has the right to attend and
to be heard at general meetings of the
company – S.157 (4).
 The auditor’s reports must be read to
the general meeting and be open for
inspection.

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  Section 159 of the Companies Act,
exempts certain categories of
companies from the requirement to
have an auditor’s report prepared in
respect of any financial year, provided
Exemptions the company has passed a unanimous
resolution at a general meeting of the
company that no auditor’s report shall
be prepared in respect of the
company’s accounts for the relevant
financial year.

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  For a company to be eligible for
exemption, it must meet the
requirements set out in paragraph 7 of
Part 11 of the Seventh Schedule in the
relevant financial year, i.e. (meet 2 or
more of the criteria)-
Exemptions a) Its turnover is less than $40M;
b) Its balance sheet total is less than
$30M;
c) The number of employees is less
than 25.

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  However, a company is disqualified
from this benefit if at anytime within
the financial year to which the
accounts relate, the company is –
a) A public company;
b) A private company whose articles
Disqualification provide otherwise;
From c) A bank as defined under the
Exemptions – Banking Services Act;
S. 159 (1) d) A merchant bank as defined under
the Banking Services Act;
e) An insurance company registered
under the Insurance Act;
f) A company licensed under the
Securities Act;

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 g) A building Society as defined under
the Banking Services Act;
h) A society registered under the Co-
Disqualification operative Societies Act; and which
From carries on credit union business.
Exemptions – i) A subsidiary of a company,
S. 159 (1) falling within any of the
categories in paragraphs (a) to (h)
above.

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  Note therefore, that all public
No Exemption companies must have annual audits of
their accounts and only some private
For Public companies are exempt.
Companies

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  A company may indemnify a director,
an officer of the company or the
auditor against all costs, charges and
expenses.
Indemnifying  These persons will be indemnified if
they acted honestly and in good faith
Directors and and in the best interest of the company
Auditors - and had reasonable grounds to believe
that their conduct was lawful.
S. 201
 An auditor will be indemnified if the
act or omission for which he is
indemnified did not arise due to a
breach of duty on his part.

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  The auditor is expected to operate with
care and skill in making inquiries and
investigations.
 S. 157 states that the auditor is
required to provide a report on the
accounts to the members.
Duty of the  An auditor is not a guarantor of the
Auditor accuracy of the company’s accounts
nor is he expected to ensure that the
company through its managers and
directors are acting within the law.
 However, an auditor who fails to
exercise the degree of care and skill
required may be liable in negligence.

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  In Kingston Cotton Mill Co. (No.
2) (1896), Lopes L.J. stated:
“It is the duty of that auditor to bring to
bear on the work he has to perform
that skill, care and caution which a
reasonably competent, careful and
Care - Skill - cautious auditor would use. What is
reasonable skill, care and caution must
Caution depend on the particular
circumstances of each case. An auditor
is not bound to be a detective, or, as
was said, to approach his work with
suspicion or with a forgone conclusion
that there is something wrong. He is a
watch dog but not a bloodhound.

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  “He is a watch dog but not a
bloodhound. He is justified in
believing tried servants of the
company in whom confidence is placed
by the company. He is entitled to
Auditor – A assume that they are honest, to rely on
Watchdog, Not their representations, provided he
takes reasonable care. If there is
A Bloodhound! 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.”

34
  In Re. London & General Bank (No.
2) 1895, Lindley L.J. stated:
“ Such I take to be the duty of the
auditor, he must be honest – i.e., he
must not certify what he does not
believe to be true, and he must take
Auditor Must reasonable care and skill before he
Be Honest believes that what he certifies is true.
What is reasonable care in any
particular case must depend upon the
circumstances of that case. Where
there is nothing to excite suspicion
very little inquiry will be reasonably
sufficient.

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  “Where suspicion is aroused more
Auditor Must care is obviously necessary, but still an
auditor is not bound to exercise more
Be Honest than reasonable care and skill, even in
case of suspicion, and he is perfectly
Lindley L. J. justified in acting on the opinion of an
(continued) expert where special knowledge is
required.”

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  In the case of Fomento (Sterling
Area ) Ltd. v Selsdon, (1958 ), Lord
Denning stated:
“His (the auditor’s) vital task is to
Initiation of take care to see that errors are not
made, be they errors of computation,
Enquiry Even in or errors of omission or commission,
Absence of or downright untruths. To perform this
Suspicious task properly, he must come to it with
an enquiring mind – not suspicious of
Circumstances dishonesty I agree – but suspecting
that someone may have made a
mistake somewhere and a check must
be done to ensure that there has been
none.”

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  The Fomento case was not a case
about the statutory duties of auditors,
so Lord Denning’s comments were
Initiation of
‘obiter’, that is. not authoritative on
Enquiry even in the point.
Absence of  However, his Lordship’s comments
Suspicious suggest that auditors should initiate
Circumstances inquiries even in the absence of
suspicious circumstances.

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  It should be noted that with the
passage of time the standard of care
and skill has become more exacting.
 In Re. Thomas Gerrard & Son Ltd.
(1968), the auditors were held liable,
Standard of as compared to the decision in Re.
Care More Kingston Cotton Mill ( No. 2 )
(1896 ).
Exacting

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  Re Kingston Cotton Mill (No. 2)
(1896), the liquidator of a company
claimed against the auditors as
accounts audited by them grossly
overstated the value of stock in trade.
This overstatement led to an apparent
profit which had been wrongfully
Re. Kingston distributed as dividends.

Cotton Mill  For the value of stock, the auditors

had relied on the certificate of a
(No. 2) (1896) Director and the Managing Director. If
the auditors had deducted stock sold
during the year from stock held during
the year, it would have been apparent
that the value of the stock at year end
was overvalued.

40
  It was held that the auditors were not
in breach of their duty of care and skill
and were entitled to rely on the
directors. One of them was described
as a man of competence and high
Re. Kingston reputation.
Cotton Mill  Lopes L.J. commented that it is not the
(No. 2) (1896) duty of the auditor to take stock and
there are many matters on which an
auditor must rely on the honesty and
accuracy of others.

41
  Re. Thomas Gerrard & Son Ltd.
(1968 ), the company had a successful
cotton spinning business. Mr. Croston
was the Managing Director. Inventory
was taken half yearly and from the
years March 31, 1957 – March 31,
Re. Thomas 1962, and the company’s accounts
Gerrard & stated that the company was in good
financial health making a net profit
Son Ltd. (1968 each year.
)  Each year the auditors gave a clean
report on the accounts to the members
of the company. For each year the
directors recommended a payment of
dividends which the general meeting
approved.

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  At the end of September,1962, it was
discovered that the company accounts
presented each year was completely
Re. Thomas inaccurate and in fact the company was
Gerrard & insolvent. The company went into
liquidation.
Son Ltd. (1968  Investigations revealed that the
) Managing Director had been falsifying the
accounts thus concealing the fact that the
company had been suffering heavy losses.

43
  The liquidator brought an action
against the auditors and succeeded.
 In holding the auditors liable, the
Re. Thomas judge said there had been altered
invoices which based on the evidence
Gerrard & ought to have aroused the suspicions
Son Ltd. (1968 of the auditors . They had failed to
take an investigative approach which
) the circumstances dictated that they
take.

44
  It was asserted on behalf of the
auditors that they were never given
enough time to do what was necessary.
To this the judge said -
 “The auditors of the company owe a
statutory duty to make to the members
a report containing certain statements.
Re. Thomas If the directors do not allow auditors
Gerrard & time to conduct such investigations as
are necessary in order to make these
Son Ltd. (1968 statements, the auditors must, it seems
to me, either refuse to make the report
) at all or make an appropriately
qualified report. They cannot be
justified in making a report containing
a statement the truth of which they
have not had an opportunity of
ascertaining.”

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  It should be borne in mind that in
1896, at the time of the Kingston case,
the requirements in relation to a
Auditor still a company’s accounts were far less
onerous than it is today.
Watchdog and
 The judge in the Thomas Gerrard
not a case argued that the standard of care
Bloodhound!! and skill had been raised significantly
between 1896 and 1962. However, the
case still maintained that the auditor is
a watchdog and not a bloodhound.

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  Auditors can defend themselves
against an allegation of negligence by
showing that they have acted in
accordance with the practice accepted
as proper in the general opinion of
reputable skilled professionals.
 Accordingly, statements of standard
Auditors practice which support the actions
taken by auditors will be most
Defence persuasive in determining if an auditor
is guilty or not guilty of negligence.
 However, where an auditor acts
outside the standard practice, he/she is
at risk. Further, as the practices change
so too will the benchmark of what is
reasonable care and skill.

47
  One of the most contentious issues in
recent years has been the extent of any
duty of care owed by the company’s
auditors to the company, the
Duty of Care shareholders and others who read and
rely on the audited accounts.
…To Whom ?  The general trend is a reluctance to
find that a professional adviser owes a
common law duty of care to a non
client.

48
  There are two possible classes of
claims-
1) Claims by clients against auditors
– claims in contract (auditor owes
the company appointing them a
duty to exercise reasonable care
and skill in performing their
contractual obligation).
Duty of Care
Claims in tort by third parties who
…To Whom ? 2)
have no direct relationship with
the auditors but who claim
damages for losses arising from
the reliance on negligently audited
accounts. The extent of any duty
of care in tort to such users of the
company's accounts has been
problematic.

49
  The leading case on the subject is
Caparo Industries plc v Dickman
(1990), where the defendants were the
auditors of a company, Fidelity plc.
The plaintiff acquired shares in
Caparo Fidelity on the basis of the accounts of
Fidelity as audited by the defendants.
Industries plc
 Shortly after the plaintiff acquired the
v Dickman shares, the reality of the financial
(1990) position of the company was
announced to the stock exchange
which was significantly worse than the
audited accounts.

50
  On a preliminary issue of whether a
duty of care existed in the
circumstances as alleged by the
plaintiffs, the plaintiffs were
Caparo unsuccessful at first instance but were
successful in the Court of Appeal in
Industries plc establishing that a duty of care might
exist in the circumstances.
v. Dickman
 The House of Lords, however, on
(1990 ) appeal, unanimously held there was no
duty of care on the facts as alleged by
the plaintiff.

51
  The House of Lords concluded that in
order for a duty of care to arise, there
Caparo must be:
Industries plc 1) a reasonable forseeability of damage,
v. Dickman 2) a relationship of sufficient “proximity"
(1990) - between the party owing the duty and
the party to whom it is owed, and
(The Caparo 3) the imposition of the duty of care
Test ) contended for should be just and
reasonable in all the circumstances.

52
  Foreseeability alone is not a sufficient
test of proximity. It is necessary to
consider the particular circumstances
Caparo and relationship which exist. The
Industries plc accountant and auditor preparing the
accounts should be aware of the
v. Dickman particular person and the purpose for
which the accounts would be used.
(1990 )
 They could not have a duty of care to
an indeterminate amount of persons,
for an indeterminate amount of time
and an indeterminate exposure.

53
  The key is whether the auditor knows
whether actually or inferentially that
his report will be communicated to a
person (whether individually or as a
Caparo class), specifically for a particular
Industries plc purpose and that there will be a
reliance on it.
v. Dickman  In the Caparo case, the House of
(1990) Lords concluded that the purpose of
the audit was to enable the
shareholders as a body to exercise
informed control over the company.

54
  The auditors do not owe a duty of care
to members of the public at large who
rely on the audited accounts to buy
shares in the company or to an
Caparo individual shareholder in the company
Industries plc who wishes to buy more shares in the
company.
v. Dickman  Likewise, auditors owe no duty of care
(1990 ) to existing or future creditors who
extend credit on the strength of the
audited accounts.

55
  There is therefore no duty of care
between the auditors and all persons
who are entitled to receive a copy of
the auditor’s report.
 However, the shareholders collectively
have a right to ensure the proper
management of the company’s affairs
and so they ought to have a remedy
Duty of Care where the auditors negligently fail to
report accurately on the company’s
finances.
 However, this duty is not extended to
members who bought further shares in
the company in reliance on the
auditor’s report and suffered losses as
a result.

56
  However, auditors can become liable to
members generally and to other third
parties for negligence: Hedley Byrne &
Co. Ltd. v Heller & Partners Ltd.
(1964 ).
 An auditor can be liable where there is a
special relationship with a third party
who suffers a loss as a result of relying
on the auditors’ report.
Special  Such special relationships will be
Relationship established if they know that the audited
accounts are going to be used in making
a decision regarding a particular
transaction, e.g., in order to induce
someone to invest in the company
(unless there is a disclaimer of
responsibility).
 That knowledge is sufficient to create the
proximity between the parties, i.e., the
auditor and the third party.

57
  In Hedley Byrne & Co. Ltd. v Heller
& Partners Ltd. (1964 ), Hedley (the
appellants), were advertising agents
who had provided a substantial amount
Hedley Byrne of advertising on credit for Easipower.
If Easipower did not pay for the
& Co. Ltd. v advertising, then Hedley would be
responsible for such amounts.
Heller &
 Hedley became concerned that
Partners Ltd. Easipower would not be in a financial
(1964 ) position to pay the debt and sought
assurances from Easipower’s bank that
Easipower was in a position to pay for
the additional advertising which
Hedley may give them on credit.

58
  The respondents, who were
Easipower’s bankers, gave a
favourable report of Easipowers
financial position, but stipulated that
the report was given "without
responsibility.“
Hedley Byrne
 On the strength of the report given by
& Co. Ltd. v the respondents, Hedley placed
Heller & additional orders on behalf of
Easipower which eventually resulted
Partners Ltd. in a loss of £17,000. Hedley then
(1964 ) brought an action against the
respondents for damages under the tort
of negligence.

59
  The Court (House of Lords) held that a
negligent, although honest,
misrepresentation, may give rise to an
action for damages for financial loss
even if there was no contract between
Hedley Byrne the advisor and the advisee and no
fiduciary relationship.
& Co. Ltd. v
 The law will imply a duty of care when
Heller & the advisee seeks information from an
Partners Ltd. advisor who has special skill and
where the advisee trusts the advisor to
(1964 ) exercise due care, and that the advisor
knew or ought to have known that
reliance was being placed upon his
skill and judgment.

60
  However, in this case there was an
Hedley Byrne express disclaimer of responsibility
& Co. Ltd. v and there was therefore no liability.
This case established the doctrine of
Heller & “negligent misrepresentation”, but in
this case, the disclaimer effectively
Partners Ltd. barred the claim.
(1964 )

61
  Another interesting case to note is
Sasea Finance Ltd. v KPMG (2000),
where the Court of Appeal concluded
that where a company’s auditors
discover that a senior employee has
Sasea Finance been defrauding the company on a
massive scale, and that employee is in
Ltd. v KPMG a position to continue doing so, the
auditors have a duty to report the
(2000) discovery to the management
immediately, and not merely when
rendering the report.
 Sasea was therefore successful in its
suit against KPMG.

62
  When reviewing all the principles and
cases regarding the duty of care for
auditors, one notes that the test as laid
down by the Caparo case makes good
“Buyer sense as to hold otherwise, would
make the auditors open to liability for
Beware!! “ all and sundry and this would not be
desirable and certainly would not be
practical.
 The bottom line is “buyer beware”!!

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THE END