WORDING OF AUDIT REPORT - IAS 700

ISA 700 includes the following:

The directors are responsible for the preparation and fair presentation of the consolidated financial statements in accordance with IFRSs. In a South African legal context I am not sure that this is technically a correct statement and may create some issues down the line for some astute lawyer who is looking for a loophole in the law. Section 30 (1) reads as follows: Each year, a company must prepare annual financial statements. Section 30 (3) (c) reads as follows: The annual financial statements of a company must—be approved by the board and signed by an authorised director. Section 66 (1) reads as follows: The business and affairs of a company must be managed by or under the direction of its board.

In ASIC v Healey: Middleton J held as follows:

-    What is required is that such documents [AFS], before they are adopted by the directors, be read, understood and focussed upon by each director – [this as you know is not being responsible for the preparation, which is a totally different process]. Directors are entitled to delegate to others the preparation of books and accounts and the carrying on of the day-to-day affairs of the company.  What each director is expected to do is to take a diligent and intelligent interest in the information available to him or her, to understand that information, and apply an enquiring mind to the responsibilities placed upon him or her.  Such a responsibility arises in this proceeding in adopting and approving the financial statements.  Because of their nature and importance, the directors must understand and focus upon the content of financial statements, and if necessary, make further enquiries if matters revealed in these financial statements call for such enquiries.

The processes are to be adopted by the directors when approving the AFS. It does not make them responsible for the preparation. This is consistent with section 29 (1) - If a company provides any financial statements, including any annual financial statements, to any person for any reason, those statements must - the name, and professional designation, if any, of the individual who prepared, or supervised the preparation of, those statements.

The question arises as to how can the directors be responsible for the preparation of the AFS when someone else is name other than a director appears as the preparer. If the FM prepared the AFS as his or her name appears on the first page as the preparer, it is quite clear that the FM prepared the AFS on the director. The law is clear – directors generally are not responsible for the preparation of the AFS – they are only responsible for their approval which is a completely different obligation and legal process.

The preparation of annual financial statements requires specialised skills in accounting and the application of International Financial Reporting Standards that are not possessed by all the board of directors. The directors would on behalf of the company recruit such specialists to make sure that the annual financial statements comply with numerous complex legal requirements.

However:

It is important to understand that this “outsourcing” by the board of directors of the preparation of the annual financial statements does not mean that board of directors cannot be held accountable if the annual financial statements have been erroneously prepared as s 66 (1) of the Companies Act, 2008 states that  “the business and affairs of a company must be managed by or under the direction of its board”.

A director may not claim ignorance of “accounting” for not understanding the content of the annual financial statements. This raises the question as to what extent must directors be knowledgeable in accounting and the application of International Financial Reporting Standards to claim that they have acted with requisite degree of care, skill and diligence when approving annual financial statements?

In Ministry of Economic Development v Feeney & Ors the plaintiff [regulator] submitted that the directors should have themselves engaged in a study of the accounting standards. Doogue J placed this request in context by stating:

“This approach necessarily resolves further into an argument that the directors should personally have had the requisite qualifications, expertise and experience to analyse the financial statement from the perspective of the accounting standards and to have reached a conclusion about compliance based on their own judgment. In other words, that they were not entitled to rely on professional expert advice and had to do it themselves”.

Doogue J described the regulator’s “should have done it themselves” proposition as utterly unrealistic and concluded as follows “These directors were entitled to seek and rely upon specialist advice”. Doogue J is clearly indicating that where any director who is not a specialist in accounting and International Financial Reporting Standards would be allowed to rely on the counsel of those who are experts in this field. However Doogue J did emphasize the following: [HOW CAN A DIRECTOR BE RESPONSIBLE WHEN THEY HAVE NO UNDERSTANDING OF IFRS?] “[These directors were entitled to seek and rely upon specialist advice]”

It is submitted that Doogue J is suggesting that this reliance cannot extend to the absolute. Directors would not be able to claim that that they have acted with the necessary care, skill and diligence by obtaining a “third party” confirmation that the annual financial statements contain the required information. This would be an abdication of their responsibilities. Directors would, as a minimum is required to arrive at their own independent judgment regarding the content of the annual financial statements. Included in a director’s own deliberations would be a consideration of the expert opinion obtained from a “third party”. The “third party” opinion cannot be the sole basis upon which the director forms his/her judgment.

Middleton J - Therefore, I do consider that all that was required of the directors in this proceeding was the financial literacy to understand basic accounting conventions and proper diligence in reading the financial statements.

Conclusion – I do not believe in law the directors as a board are responsible for the preparation of the AFS.