LESSON 9

CORPORATE AUDIT
Introduction
The Act does not define an auditor despite his essential role in the company. However,
he is an officer of the company for the purpose of a misfeasance under the Act. An
auditor is an officer in carrying out these duties as an auditor but is not liable as an
officer if he is only appointed ad hoc for a limitedpurpose.
On the other hand he is an agent of the members or the company in certain respect. An
auditor is specifically mentioned as an agent for the purpose of the Actis however not
an agent for the company and his signature in the statutory report and on the
balance sheet will not amount to an acknowledgement on behalf of the company.
Just as it is important for readers of financial statements to have a guarantee that they
have been properly prepared under an accepted set of conventions, it is also necessary
for them to be able to rely on the word of those persons who certify them as having
been so produced. This means that auditors should be recognized as fit and proper
persons to carry out the duties of their office,
If reliance is to be placed on accounts, it is essential that they should be true and fair
and that is more likely to be the case if someone independent of the company has
vetted them and certified that they are. lf however, that certification is to be relied on,
the scrutineer must be competent as well as independent. The Companies Act has
attempted to ensure that company auditor are both.
The provisions of the Companies Act are meant to ensure that only persons who are
properly supervised and appropriately qualified are appointed company auditors, and
that audits by persons so appointed are carried out properly and with integrity and
with proper degree of independence.
QUALIFICATION APPOINTMENT AND REMOVAL
Qualifications of Auditors
A person is eligible for appointment as an auditor of company only if he is a member
of the Institute of Certified Public Accountants of Kenya and is eligible to be
appointed under the rules of that body. It would appear that a firm of partners may be
appointed as auditors unless a contrary intention appears.
An appointment of the partnership as such is not appointment of individual partners
and when the composition of partnership changes, the appointment extends to the
successor partnership as long as its composition is substantially the same practice.
Where no one succeeds under the foregoing, the appointment may, with the consent of
the company, be extended to a partnership or other person eligible for the appointment
which succeeds to the business of the former partnership (or to such part of the
business as is agreed by the company to include the appointment).
Disqualifications for Appointment of Auditors
Under Section 161(2) the following persons are disqualified from being
appointed as auditors of a company,
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
d) If he is disqualified for appointment as auditor of any other body
corporate which is the company’s subsidiary, holding company or a
subsidiary of that company’s holding company, or would be so
disqualified if the body corporate were a company.
An officer of the company for this purpose includes director, manager or
secretary.
An auditor who discovers that he has become disqualified for appointment as
auditor shall cease to act as auditor, and shall give notice to the company that he
has vacated his office because of disqualification otherwise he shall together with
every officer of the company in default be liable to a fine not exceeding sh.4900
Appointment of Auditors
Every company shall at each annual general meeting, appoint an auditor or
auditors to hold office from the conclusion of that, until the conclusion of the
next, annual general meeting.
Automatic Appointment
There is a provision for automatic reappointment, without a resolution, of an
existing auditor who is willing to continue in the office. Under this provision,
the retiring auditor shall be deemed to be reappointed without any resolution
being passed unless;
a) he is not qualified for reappointment, or
b) a resolution has to be passed at that meeting appointing somebody instead
of him or providing expressly that he shall not be reappointed
c) he has given the company notice in writing of his unwillingness to be
reappointed, However, where notice is given of an intended resolution to
appoint some person or persons in place of retiring auditor, and by reason of
the death or incapacity disqualification of that person or of all those persons,
as the case may be, the resolution cannot be proceeded with, the retiring
auditor shall not be deemed to be automatically re appointed.
Where at an annual general meeting no auditors are appointed or are deemed to be
appointed, the registrar may appoint a person to fill the vacancy. In such a case
thecompany shall within 7 days give therefore and if the registrar notice thereof
and if the company fails to give notice as required the company and every
officer of the company who is in default shall be liable to a default fine.

Appointment of first auditors

The first auditors of a company are usually appointed by the board of directors
time before the first annual general meeting. The auditors so appointed hold
office until the conclusion of the first annual general meeting. The new auditor,
to be appointed in the place of the auditor who has been removed, must have
been nominated for appointment by any member of the company.
The notice of such a nomination must have been given to the members of the
company at least 14 days before the date of the meeting.
If the board fails to exercise its power to appoint first auditors, such power shall
cease upon the company in a general meeting, appointing the first auditors.
Subsequent appointment
At the expiry of the term of an auditor the company may, on the annual general
meeting, appoint another person in his place (ref. above).
Filling casual vacancies
The board may fill any casual vacancy in the office of an auditor, but while any
such vacancy continues, the surviving or continuing auditor or auditors, if any,
may act. However, where such vacancy is caused by the resignation of an
auditor, the vacancy can only be filled by the company in a general meeting, Any
auditor appointed in a vacancy holds office until the conclusion of the next annual
general meeting.
Removal and Resignation of Auditors
A company may by ordinary resolution at any time remove an auditor from
office notwithstanding anything in any agreement between the company and the
auditor. Unlike the removal of directors; auditors are specially protected to ensure
that auditors are not only protected but also companies are protected from being
deprived of an auditor whose fault in the eyes of directors may be that he is not
loyal to the whims of the directors.
For that reason, a special notice shall be required for a company’s annual general
meeting appointing as auditor a person other than a retiring auditor or providing
expressly that a retiring auditor shall not be reappointed.
On receipt of the notice, the company is required to send a copy thereof to the
retiring auditor. The auditor is entitled to make written representations to the
company within a reasonable time and may require the notification of the same to
the members unless the representations are received late for the company do to
so. Any notice of the resolution to remove an auditor is given to members of the
company shall state the fact of the representations having been made.
If a copy of the representations is not sent as aforesaid because it was received
too late or because of the company's default, the auditor may require that the
representations be read out at the meeting.
However, copies of the representations need not be set out and the
representations need not be read out at the meeting if, on the application either of
the company or of any other person who claims to be aggrieved, the court is
satisfied that the rights conferred are being abused to secure needless publicity for
defamatory matter.
In such a case, the court may order that the company's costs on this application be
paid in whole or in part by the auditor notwithstanding that he is not a party to the
application.
A company cannot remove an auditor against his will without facing a serious risk
of a row at the general meeting (and in the case of a listed company, adverse
publicity) and probably payment of compensation.

REMUNERATION OF AUDITORS
The term ‘remuneration’ includes sums paid by the company as auditors’
expenses. According to section 159 subsection 7
i) in the case of an auditor appointed by the directors or by the registrar his
remuneration is fixed by the directors or by the registrar respectively
ii) in case of an auditor appointed during an annual general meeting, his
remuneration shall be fixed by the company in general meeting or in such
manner as the company in general meeting may determine.
POWERS AND DUTIES OF AUDITORS
The rights and duties are interrelated. The several rights conferred upon an auditor
relate to the matters in respect of which he has to make a report to the members on
the annual accounts of the company.
Duties of an Auditor
The following are some of the duties of an auditor
1. Acquaintance with the Articles and the Companies Act.
 The auditor of a company is under a duty to make himself acquainted with
his duties under the articles of the company and under the Companies Act.
2. Report to members.
The main duty of an auditor is to make a report to the members of the company on
the accounts examined by him and on the balance sheet and the profit and loss
account of the company and on every document which is annexed to the
balance sheet or profit and loss account. If, in his opinion and to the best of his
information and according to the explanations given to him, the accounts do not
give a true and fair view, he must qualify his report.
In London & Genera1Bank,, Lindley L.J. observed in this regard as follows:
"A person whose duty it is to convey information to others does not discharge that
duty by simply giving them so much information as is calculated to induce them,
or some of them, to as for more…an auditors who gives shareholders means of
information, instead of information, in respect of a company's financial
position does so at his peril, and runs the very serious risk of being held
judicially to have failed to discharge his duty."
The duties of auditors have been exhaustively reviewed by the Court of Appeal
in City Equitable Fire Insurance Co., (1925) case the following propositions
were laid down in this case:
a) The measure of an auditor's responsibility depends upon the terms of his
engagement, either by a special contract, or as contained in the articles.
b) The duty imposed on the auditor by the Act is not defined as regards its
nature or extent, but it depends on the information and explanations
furnished to him.
c) The auditor should not be content with a certificate that securities of the
company are with a particular person or firm unless such person or firm
is trustworthy and is one which in the ordinary course of business keeps
securities for his customers. The auditor must also see that the securities
of the company exist by making a personal inspection of them. If they
are in safe custody of a banker in the ordinary course of business he may
rely upon the certificate of the banker.
In London & General Bank Case, Lindley, L.J. observed:
"An auditor is not bound to do more than exercise reasonable care and skill in
making inquiries and investigations ... He must be honest, he must not certify
what he does not believe to be true, and must take reasonable care before he
believes that what he certifies is true, Where there is nothing to excite suspicion,
very little inquiry will be reasonably sufficient Wheresuspicion is
aroused, more care is obviously necessary, but still an auditor is not bound to
exercise more than reasonable care and skill, even in a case of suspicion, and he is
perfectly justified in acting on the opinion of an expert where special knowledge
is required,"
In Kingston Cotton Mills Co. it was observed:
"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 watchdog
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 assume that they are honest and to rely upon their representations,
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.
Further duties
In addition to the duties of an auditor discussed above, he has also to
perform the following duties:
3. Statutory report
After the statutory report has been certified as correct by not less than 2
directors of a company, the auditor of the company must certify the report as
correct, so far as it relates to
(a) the shares allotted by the company,
(b) the cash received in respect of shares, and
(c) the receipts and payments of the company.
The provision does not apply to private companies as they are not required to
hold a statutory meeting.
4. Prospectus.
The law requires a report by the auditor of the company with respect to profits
and losses, assets and liabilities and the rates of dividends, if any, paid to the
company, to be included in a prospectus. The auditor has to certify these as
correct. This point was discussed in detail in the topic of 'prospectus'.
5. Assistance In investigation.
According to Sec.165 it is the duty of all the officers and other employees and
agents, the expression 'agent' includes 'auditors' of a company
a) to preserve and to produce to an inspector (appointed under Sec. 165 to
investigate the affairs of the company) or any person authorized by him in
 this behalf with the previous approval of the registrar all book and papers
of, or relating to, the company, which are in their custody and power; and
b) Otherwise to give to the inspector all assistance in connection with the
investigation which they are reasonably able to give.
6. In case of investigation of the company the auditor is required
i) to produce to an inspector all books and papers
ii) to give to the said inspector all assistance required for such
investigation.

7. Duty of care and skill

In relation to the duty of care and skills, the company should;
i) Ensure that only 'fit and proper' persons are appointed as company
auditors. In determining whether someone is fit and proper the
professional conduct of that person has to be taken into account.
ii) Ensure that audits are carried out with 'professional integrity'. One
component of this will be compliance with technical standards; the other
will cover independence, objectivity ant confidentiality.
The following guidelines that are laid down by judicial decisions are still
law will still play a key role part in determining the required standard care
and skill:
Auditors must ascertain that the books show the true financial position. To
do this, auditors must do more than merely verify the numerical accuracy, of
the accounts. If entries in or omissions from the books make the auditors
suspicious they must make a full investigation into the circumstances. For
example:
In Re Thomas Gerrard(1968) case, the managing director falsified the
accounts by including non existent stock and altering invoices. This caused
the company's profits to be overstated.
Dividends were declared that would not otherwise have been declared and
too much tax was paid. The auditors became suspicious when they noticed
that invoices had been altered, but they accepted the managing director's
explanation and made no further investigation.
The auditors were held liable to the company for the cost of recovering the
excess tax paid and for dividends and tax not recovered. Auditors must
check the cash in hand and the bank balance.
iii) Where payments have been made by the company, the auditors should
see that they are authorised.
 iv) Auditors should check that company borrowing has been authorised
and is in accordance with the articles.
Auditors should satisfy themselves that the securities of the company
exist and are in safe custody, either by making a personal inspection of
the securities or checking that the securities are in the possession of a
person who in the ordinary course of business keeps securities for
customers, for example a bank.
i. Auditors are not required to value stock or work in progress. They may
accept the valuation of a responsible official of the company, unless they
have reason to suppose it to be inaccurate. In practice auditors exceed
this legal duty with regard to stocktaking.
ii. Auditors do not have a duty to comment on whether the management is
running the business efficiently or profitably.
iii. If the directors do not allow auditors the time to conduct their
investigations, the auditors must either refuse to make a report or
make a qualified report. They must not make a report containing a
statement the truth of which they have not had an opportunity to verify.
Powers of Auditors
The following are some of the powers of an auditor
1. The auditors have a right of access to the books, accounts and vouchers of
the company.
2. The auditors may require from the officers of the company such
information and explanation they think necessary for the performance of
their duties. If they fail to obtain such informationthey must say so in
their report.
3. The auditors may attend any general meetings, they must be sent all
notices communications relating to general meetings, and they may speak
at a meeting on any matter which concerns them as auditors.
RIGHTS AND LIABILITIES OF AUDITORS
Rights of Auditors
Some of the rights of auditors include:
1. Right to access to books, accounts and vouchers
The auditor of a company has a right to access, at all times, to the book
and accounts and vouchers of the company, whether kept at the head office
of the company or elsewhere.
 2. Right to obtain information and explanation
He is entitled to require from the officers of the company such information
and explanations as he thinks necessary for the performance of his duties as
auditor.
3. Right to visit branch offices and right to books, etc.
Where the accounts of any branch office are audited by a person other
than the company's auditor, the company's auditor
a) is entitled to visit the branch office, if he deems it necessary to do so,
for the performance of his duties as auditor; and
b) has a right of access at all times to the book and accounts and
vouchers of the company maintained at branch office.
4. Right to receive notice of, and any other communications relating to,
any general meeting of Tile Company
He has also a right to attend any general meeting and to be heard on any
part of the business which concerns him as auditor
He has the right to receive remuneration for auditing the accounts of the
company.
5. Right to make representations
Where at a general meeting it is proposed to remove an auditor, he is entitled
to make written representation and demand that the same be circulated to
members, or be heard at the meeting thereof.
6. Action for damages
Where the termination of an auditor's service is unlawful or unprocedural, he
is entitled to sue for damages for compensation for loss of office.
Liabilities of Auditors
The auditor has a contractual relationship with the company and it is therefore
the company to the basic duty is owed. Even so auditors must, on occasions,
disclose facts which may harm the company.
Since the decision in Hedley Byrne V Heller(1964) it has been clear that a
person may be liable for financial loss resulting from a negligent statement
even if there is no contract between the maker of the statement and the recipient
(although a disclaimer of responsibility will exclude the defendant's liability).
As far as auditors are concerned, recipients of statements are likely to fall into
two categories, existing shareholders (members) and potential shareholders
(investors). The situation of both members and investors was recently considered
by the House of Lords in the leading case of Caparo Industries v Dickman
(1990) where the plaintiff company sued two directors of Fidelity Public
Limited Company and the accountant Touche Ross &Co , the auditors Fidelity.
The plaintiff had taken over Fidelity and allegedly that the profits were much
lower than shown in the audited accounts consequently they had suffered
financial loss. The House of Lord stated that whether a duty of care is owed to
persons who rely on accounts to deal with the company or buy and sell its shares.
The house stated that the criteria for imposition of duty were
a) Foreseeability of damage
b) Proximity of the relationship
c) The reasonableness or otherwise imposing duty
To establish proximity all of the following factors will typically need to be
present:
i. The advice was required for a purpose made know to the adviser
when the advice was given
ii. The adviser knew his advice would be communicated to the recipient
in order that it should be used for this purpose.
iii. It was known that the advice was likely to be acted upon without
independent inquiry
iv. It was acted on the recipient’s detriment

The house was prepared to acknowledge that liability for negligent audit can
exist, but the above factors were not present in Caparo case. The plaintiff case
therefore failed