The Need for an Audit

If you take an example of a modern large liability company, we can clearly distinguish between the providers of funds and those who control those funds.  The providers of funds are the shareholders, creditors, and other third parties who have given loans to the company.  Those charged with the responsibility of controlling those funds are usually called directors and management.  We can also clearly see that the company has resources, (assets), and claims against those resources, (Liabilities and capital.)

Since the providers of funds are divorced from the control of those funds it would seem logical that the controllers should on a regular basis give a report to the providers of the funds on changes in the resources and claims.  This report of the controllers or directors according to the Kenya Companies Act should be in the form of annual accounts which consist of the balance sheet and the profit and loss account.  The accounting profession has extended the accounts by requiring that a Cash Flow Statement be also appended to the accounts as part of the accounts. 

The report of the directors in the form of accounts lacks credibility, in that:

          a)       It may contain errors;

          b)      It may fail to disclose frauds;

          c)       It could be misleading inadvertently;

          d)      It could be misleading deliberately;

          e)       It may fail to disclose all relevant information.

A further point to note is that modern companies can be very large with multinational activities.  Preparing accounts for such a group becomes a very complex operation that could involve bringing together and summarizing the accounts of subsidiaries with differing accounting systems.  All accounts are required to conform to very detailed and complex requirements of the Companies Act (CAP 486) and also to the requirements of the many International Financial Reporting Standards (IFRSs). Taking these points into consideration therefore, it becomes necessary that to give credibility to the accounts an independent qualified expert be appointed to objectively investigate the accounts and then report his findings to all interested parties, primarily the shareholders as required by the Companies Act, but also to other providers of funds and relevant regulatory authorities.

         a)       The directors who produce them;

          b)      The shareholders to whom traditionally they are addressed;

          c)       Lenders and debenture holders;

          d)      Potential investors;

          e)       Employees;

          f)       Customers;

          g)      Suppliers;

          h)      Accountants;

          i)       Stock-brokers;

          j)       Credit rating agencies;

          k)      Financial Journalists;

          l)       Trade Unions;

          m)     Statisticians;

          n)      Competitors;

          o)      The Government, including the Tax Authorities and the;

          p)      Ministry of Finance for Economic Policy Decisions;

          q)      The general public.

All these people must be sure that the financial statements can be relied upon.

It should be noted that:

1. The auditor himself must be independent to have credibility.

2. He must have the primary objective of producing a report of his opinion on the truth and fairness of the accounts, so that any person reading and using them can believe in them.

3. Subsidiary objectives can be seen to be the detection of errors and fraud, the prevention of errors and fraud by the deterrent and moral effect of the audit and the ability to provide other benefits to his clients such as:

          • Assistance with accounting;

          • Systems;

          • Taxation;

          • Financial and other problems.

The Companies Act was designed to protect shareholders from directors hence the need for an audit as contained in the Companies Act mainly relates to limited liability companies, but as we shall see any organization can benefit from an audit.