The comparison of the auditors’ report format prescribed in the Companies Ordinance, 1984 prescribed auditor report’s format with other jurisdictions shows it to be more a legal document to avoid liability than to inform users. It also suffers from craftsmanship flaws, such as the following:
(I) auditors state that they had conducted audit on sample basis, which implies that audit was not an assurance of financial statements being 100 per cent free from errors. The situation is however not disclosed. The primary constituency of the financial report, as brought out by the Institute of Chartered Accountants (Australia) in their ‘statement of accounting concepts No 1’ are those users who cannot “command the preparation of information to satisfy their individual information needs.” For such non-specialist users, the information is ‘material’ and needs to be disclosed.
It should be mentioned in passing that the argument that 100 per cent checking would increase audit fee manifold looks to be unreasonable—fee would still be very negligible percentage of total corporate expenses. The ‘Economist’ has pointed out that, “higher prices are by no means most serious danger reform poses for auditors clients. For some companies, the real threat is that their accounts may be properly audited.”
(II) In paragraph (c) of their opinion, the auditors certify that “the balance sheet, profit and loss account, cash flow statement and statement of changes in equity respectively give a fair view of the state of the company’s affairs as at date and of the profit/loss, its cash flows and changes in equity for the year then ended. However, neither “profit, cash flows and changes in equity,” nor where the information about such additional profit etc, was placed in financial statements are identified.
The House of Lords in Caparo’s case sought to identify the statutory purpose for an audit and concluded that the main function of an audit was the exercise of an opinion upon the “truth and fairness” of the financial statements and the accounts from which such statements are derived for the benefit of shareholders as a body. (Caparo Industries PLC V Dickman & Others (1990). Christopher Nobe’s survey in 1991, however, showed that the profession did not have generally acceptable meaning of the words ‘true’ and ‘fair’ and different audit firms interpreted the words differently - the UK’s then ‘Big Eight’ and next ‘Twelve Audit Firms’ interpreted the words as under:
True: (i) based in fact; (ii) undistorted facts; (iii) correct; (iv) complies with rules; (v) objective; (vi) correct within materiality; (vii) adherence to events; and (viii) factual accuracy.
Fair: (i) not misleading (3 times); (ii) substance over form (2 times); (iii) proper reflection; (iv) putting in right place; (v) consistent with ‘underlying reality’ (vi) not in conflict with facts; (vii) ability to understand what has gone on; (viii) in accordance with rules in context; (ix) reasonable; (x) gives right impression; and (xi) whether reader right message.
The profession (probably) still does not have generally acceptable interpretation of the two words “auditors’ opinion” about financial statements giving true and fair view is stated to be based on statements’ conformance with approved accounting standards and information being in the manner required by the Companies Ordinance, 1984.
However, neither conformance with accounting standards nor complying with the Companies Ordinance (Act) peremptorily gives a true and fair view. The legal attorney to the Institute of Chartered Accountants in England and Wales, in an advice concerning the true and fair view said adherence to accounting standards alone does not guarantee true and fair view; only the court can decide it.
Compliance with the Companies’ Act also does not necessarily ensure a true and fair view. e.g, the acts of UK and New Zealand provide a ‘rider’ clause that obliges management to go beyond the Act if following it would not make the statement true and fair. (Section 226(5) and 11(2) of the UK and New Zealand’s Act respectively). It could be a debatable point that whereas in Pakistan, conformance with the accounting standards and the Companies Ordinance, 1984 always gives true and fair view, other jurisdictions hold it may not be so? Obviously, either other jurisdictions are wrong, or the provision in the Companies Ordinance, 1984 is deficient.
Also, wide gap exists between what the public perceives auditors do and what they really do. A general perception is that financial statements present the true and fair view and that financial statements are prepared by auditors who, as well, make estimates and adopt accounting policies etc. Bridging of this huge ‘expectation gap’ is in profession’s best interest.
Clearly, the financial statement’s view is one of the many possible views. The Chairman, UK Auditing Practices Board, has pointed out “there is rarely a single ‘right’ amount for either profit or net assets”. Harvey Pitt, Chairman, US SEC, wants to end the notion that there was one (and only one) correct version of accounts. He wants profession, instead, to shed light “on the processes of calculation that lead to the numbers in the financial statements.” He “has already ordered auditors to identify the five assumptions that make the biggest difference, and to show how the numbers would look were different assumptions made,” reports the ‘Economist’.
Bikini-like effect of existing report revealing what may be interesting and concealing what is vital can be significantly remedied at no extra labour if it is replaced by a reader friendly report in every day English and a format with proper headings. The ‘expectation gap’ also can be significantly reduced by minor modification of the report and slight readjustment of the place of the SECP’s recently mandated directors’ declarations.
The existing statement that financial statements were the responsibility of management should be deleted and the declarations be made an independent document of the annual report. Or, if it is to be retained in the report, then declarations should be reproduced immediately after it. I would suggest that applicability of the amended report should be extended from listed companies to all companies other than small and medium enterprises. Auditors’ report modelled on New Zealand’s report could not be included here due to space restrictions.
In the UK in order to add due weight to auditors’ position vis-a-vis management, the CA 1985 makes elaborate, robust provisions with respect to their appointment and removal, (Section 393, UK CA 1985). In New Zealand, if auditor’s report indicated that the requirements of the Act have not been complied with, the auditors are to send a copy of the report to the Registrar who must, in turn, forthwith send it to regulatory Board, (Section 16(2) NZ CA). Regulations on these lines should send much needed signal of regulatory authority’s continued vigilance.
The comparison of the auditors’ report format prescribed in the Companies Ordinance, 1984 prescribed auditor report’s format with other jurisdictions shows it to be more a legal document to avoid liability than to inform users. It also suffers from craftsmanship flaws, such as the following:
