Jenny Jordan, ‘has also anticipated that she will also engage your firm to act as tax advisors’.
By providing additional services as well as performing the function of auditor the issue of independence may be raised in a both positive and negative light. The provision of other services may increase independence because of the value of the auditor to the client , i.e. due to value of service, and therefore there will be increased dependence of the client on the auditor. This essentially reduces the pressure of the client and results in the perception of greater independence
On the other hand the greater the dependence of the auditor on the client because of the value of fee, thus reduces the auditors liability to withstand pressure and there independence is at risk.
Jenny Jordan ‘has enquired whether you or one of your partners could act as company secretary’
As auditor, Earnest Peat & Co. must members of an RSB as an overall prerequisite for eligibility to act as a corporate auditor. At the individual company level the CA 85 states that a person is ineligible for appointment as auditor if he or she is
- an officer or employee of the company
- a partner or employee of such a person
- a partnership in which such a person is a partner.
In light of this is a member of Earnest Peat & Co. is appointed as company secretary, he or she couldn’t be appointed as auditor as well.
Other issues that may be of some relevance
Size of firm: the audit firm; Earnest Peat & Co comprises of three partners and therefore considered to be a ‘small’ audit firm as opposed to large firms comprising of large numbers of partners and professional staff spread throughout the world with many offices.
Resources & Expertise
Earnest Peat & Co. must ensure that there are adequate resources for example staffing the audit with staff with the necessary expertise in order to maintain the integrity of the audit independence. Earnest Peat & Co. comprises of three partners who are registered auditors and accountants and therefore it must be questioned whether or not this is enough.
This is can be used as an indication of the dependence of the audit firm on the client, as Earnest Peat & Co are of a small nature the portion of fee generated by taking on Gadget Audit may exceed 10% of the practice’s annual income, hence over reliance to obtain the contract to act as auditors will have an adverse affect independence, as Gadget may go elsewhere.
Suitability of Gadget Ltd as an audit client.
2. Draft a letter to Jenny Jordan, in her capacity as a director of Gadget Limited, explaining and clarifying the following:
i. The regulation regarding audit exemption of small companies, as recently amended, and their relevance to Gadget Limited’s first set of accounts in respect of the year ended 30 June 2004;
ii. The benefits of the company and it’s users/stakeholder of under going an audit, whether or not required by statute (you should identify the principle users/stakeholders of Gadget limited and the particular benefits they may derive from audited accounts).
iii. The accounting records that must be maintained by Gadget limited in order to comply with the requirements of the Companies Act 1985.
Earnest Peat & Co.
Chartered Accountants & Auditors
10 Park Lane, Hamstead, London NE4 5.P.S Tel (020) 8553 0255 Fax (020) 8553 02556
Ms. Jenny Jordan (Director)
Gadget Limited
Unit 110-115
Park Royal Business Estates
London N4 3.L.Q
08 April 2004
RE: Explanation and clarification of Information requested
Dear Ms Jordan,
First of all may I express my gratitude for choosing Earnest Peat & Co to act as your first auditors. Further to out initial contact I have the pleasure in providing you with the information requested on the following information
- Regulations regarding audit exemption of small companies as recently amended.
- The benefits to the company and its users/stakeholder of undergoing an audit.
- The accounting records that must be maintained in order to comply with the requirements of the Companies Act 1985.
Please see enclosed attachment. I have included an explanation of the key points that are raised which I hope are of use to in clarifying any previous misleadings which you may have had .
It is of importance that arrangements are made at a convenient time for both of us to meet in order to discuss any points that you may wish to raise. In the mean time if you have any questions you can contact me on the above number.
I look forward to hear from you and would again like to extend my thanks to you for choosing Earnest Peat & Co.
Your Faithfully
Mr Nurul Ali
For and on the behalf of Earnest Peat & Co.
Registered Auditors with ICAEW
Chartered Accountants with ACCA
i) Audit Exemption Criteria
From 30 March 2004 companies whose gross turnover is less than 5.6 million, gross Assets is 2.8 million and employees are less than 50 employees will be exempt form an audit.
Prior to this new regulation private companies only with less than 1 million in gross turnover was exempt form carrying out a mandatory audit.
This means that the accounts before
ii)
As we have seen form the above, it become compulsory to carry out an audit once a company reaches the profit threshold of more than 5.6 million. However there are also potential benefits of carrying out an audit even the company may be exempt.
- Existing / Potential Investors
In accordance with the law existing shareholders must receive audited accounts. However many shareholders cannot identify flaws or use of creative accounting devices due to lack of expertise. Therefore there becomes a need to have an independent view provided by audited accounts which will be used to help investors decide whether to continue their investment of invest elsewhere.
Potential shareholders perceive audited accounts as a more reliable source of information than non-audited accounts. The evidence of the company’s performance is seen to be more factual and therefore can have an idea of the future benefits of their investment.
Directors are responsible for producing accounts; these accountants must be in accordance to the Companies Act 1985. For the stakeholders point of view-audited accounts ensures directors are fulfilling their duties by preparing accounts that represent a true and fair view.
One of the by products produced by carrying out an audit is that it recommends improvements that can be made to current practice. This can be sued to help managers improve overall efficiency.
Lenders such as banks have more confidence in accounts with a clean audit report therefore it would beneficial to carry out an audit in order to asses the company’s credibility.
In past cases lenders have issued a covenant (binding legal document) that they receive audited accounts. Further these convents may include features such as maximum lending, and hence limiting the use of other investors.
May look at audited accounts to asess financial credibility of the company.
Government agencies such as the Inland Revenue are reassured that adjustments made to profit are accurate, therefore less likely to carry out intense investigation.
It has been the growing trend that may auditors also offer the additional service tax advice. This can be particularly useful to the company as a means of saving tax.
Employees are less likely to be users of audited accounts unless it is related to their direct benefit for example performance related pay. Unions on behalf of employees may also be interested.
iii)
s221 Duty to keep accounting records
(1) Every Company shall keep accounting records which are sufficient to show and explain the company’s transactions and are such as to –
- disclose with reasonable accuracy, at any time, the financial position of the company at that time, and
- enable the directors to ensure that any balance sheet and profit and loss account prepared under this Part complies with the requirements of this Act
(2) The accounting records shall in particular contain-
- entries from day to day of all sums of money received and expended by the company, and the matters in respect o which the receipt and expenditure takes place, and
- a record of the assets and liabilities of the company.
(3) If the company business involves dealing in goods, the accounting records shall contain –
- statements of stock held by the company at the end of the financial year of the company
- all statements of stocktakings from which any such statement of stock mentioned in paragraph (a) has been or is to be prepared, and
- except in the case of goods sold by way of ordinary retail trade, statements of all goods sold and purchased, showing the goods and the buyers and sellers in sufficient detail to enable all these to be identified.
(4) A parent company which has a subsidiary undertaking in relation to which the above requirements do not apply shall take reasonable steps to secure that the undertaking keeps such accounting records as to enable the directors of the parent company to ensure that any balance sheet and profit and loss account prepared under this part complies with the requirements of this act.
In order to fully comprehend as to what is expected I have highlighted the key accounting requirements set out in the act.
Account must represent a true and fair view of the company, and therefore the accuracy of the figures such as liabilities is important.
‘Entries from day to day of all sums of money’
This includes a daily cash sheet of the takings coming in and as wll as the expenses going out.
‘a record of the assets and a liabilities of the company’
By assets means al
‘statements of the stock held’
A record of the stock, which are held on the premises as well as purchased stock on delivery, must be kept. If it has been bought it must be accounted for.
‘all statements of stocktaking’s’
Stock take’s must be carried out in order to support the value of the stock
‘all goods sold and purchased’
Once goods are purchased for example plant and machinery they must be included in the Assets of the company. Evidence supporting such purchases such as invoices are needed as some company’s may amplify the value of their current assets in order to perceive their business as being more healthier.
Goods sold must also be included. In some cases where goods are sold for more than the purchase price, the difference will be added to the company’s overall profit and hence be subject to Capital Gains Tax. Equally asset sold at a loss must be included to reduce the company’s overall profit.
NOTES
and therefore auditors must be objective by expressing opinions independently of the entity and it’s directors.
Therefore the principle objective underpinning an auditor is to remain independent in order to provide an objective
Yours Faithfully
Earnest Peat & Co.
Registered Auditors with ICAEW
For and on behalf of Earnets Peat & Co.
Nurul K Ali
