Shareholders are the owners of a company but directors conduct the equity management. The company's act requires directors to prepare and submit a corporate report to shareholders to show them how they have managed the company. The act requires that six documents (statutory accounts) to be approved by the board of directors and published annually. These are:
In addition to these statutory accounts and reports, the corporate report must contain notes to the accounts (disclosures) and a statement of accounting policies that have been applied (IAS 8). The IAS 1 framework identifies 4 qualitative characteristics of financial statements that are meant to ensure the usefulness to users.
Information disclosed as notes to the accounts
Auditing is a systematic and a scientific examination of the books of accounts and financial statements of a company. It is a critical review of the system of accounting and internal control. Auditing is performed with the help of source documents, vouchers and explanations received from third parties. Auditing is undertaken by an independent person or body of persons (external auditors).
An auditor must be a qualified accountant who has a thorough knowledge of general principles of law, taxation and computer information systems. An auditor is recommended by directors but appointed by shareholders. The main duties of an auditor are:
The auditor’s report has three main sections:
If in the auditor's opinion, adequate reports have not been kept then the auditor must issue a qualified report. A qualified report will raise points that the auditor considers have not been dealt with correctly by directors. If the points raised by the auditor are not of serious nature, the report may state:
“With the exception of the following items the financial statements do show a true and fair view.”
However if the auditor believes that there has been a serious breach and that the points raised are of serious nature then the report should state:
“The financial statements do not show a true and fair view.”
Advantages of auditing
Disadvantages / Limitations of auditing
True and fair view in auditing means that the financial statements are free from material misstated and faithfully represent the financial performance and position of the entity. True suggests that financial statements are correct and have been prepared according to applicable reporting framework and they do not contain misstatement that may mislead users. Fair implies that the financial statements present the information faithfully without any element of bias and they reflect the economic substance of transactions rather than just their legal form.
Role of directors
The two main purposes of producing and reporting financial statement is the management function and stewardship function. The management function enables the directors to analyse how well the company has performed and to provide information that might highlight areas of improvements (financial statements for internal use.) The stewardship function is to show shareholders that their funds are safe and are being used wisely by the directors (financial statements for external use – published accounts.)
It is the responsibility of shareholders to appoint directors to run and manage the company on their behalf. “Divorce of ownership and control” is the term often used to describe the relationship between shareholders and directors because although shareholders are the owners of the company it is the directors who control the day to day activities of the business. Since directors are appointed by shareholders, they must report financial statements to them. Directors are paid emoluments as their rewards for running the business. The main responsibilities of a director: