THE MODERN COMPANY AUDITOR—A NINETEENTH‐CENTURY WATCHDOG?
| Published date | 01 July 1970 |
| Author | R. Baxt |
| Date | 01 July 1970 |
| DOI | http://doi.org/10.1111/j.1468-2230.1970.tb01284.x |
THE
MODERN COMPANY AUDITOR-
A
NINETEENTH-CENTURY WATCHDOG?
WHEN Lopes L.J. in describing a company auditor faced with
the possibility
of
the discovery
of
fraud and deceit in preparation
of its accounts, equated
him
to a watchdog and not
a
bloodhound,’
he would not have realised that his formulation was to become,
not
only
the most popular formulation
of
the function of a com-
pany auditor, but also was to be relied
on
by the profession in
the twentieth century as a basis for the standard expected of audi-
tors. And from this base most allegations
of
breach
of
auditor’s
duties were and have been met.a Much water has flowed under the
bridge since
1896
and yet in a recent decision of Pennycuick
J.
in
the Chancery Court the classical formulation
of
Lopes L.J. was
the basis upon which the court chose to assess the role
of
a company
auditor faced with similar questions of fraud and deceit. Those
in
favour
of
a continued development, in line with desirable standards,
of the principle that shareholders of companies should
be
given
better and more carefully assessed information about their com-
panies,
so
that they may reach informed decisions about its manage-
ment and their participation in
it,
would, it is suggested, and as will
be seen from the ensuing discussion, wish to see a departure from
the
“
watchdog
’’
formulation.
The various organisations responsible for the setting down
of
accepted accounting principles lay down
no
specific rules relating
to auditing standards.
It
can be ascertained from the evidence in
the case of
Re
Thomas
Gerrard
Ltd.,
a‘that the particular require-
ments expected by the profession in individual cases may be high but
the standard texts of auditing reveal a heavy handed reliance
on
the watchdog test.‘
It
is proposed in this article to examine the formulation by the
courts of the standards of care required of a company auditor in
checking for errors, fraud and other discrepancies whilst complying
with
his
statutory obligations (and where appropriate his contractual
obligations) ‘to audit the company’s accounts. We shall discuss how
1
In
Re Kingston Cotton Mill
Co.
(No.
2)
[l896]
2
Ch. 279,
288.
2
See
R.
Buchanan-Dunlop
“The
Duty
and
Liability
of
an
Auditor,’’
The
Accountant,
November 19, 1966, p.
672.
The reference
to
this expremion in the
cases
is
almost irresistible. See
e.g.. Henry Squire (Cash Chemist) Ltd.
v.
Ball Baker
d
Co.,
The Accountant L.R.,
Vol.
XLIV,
p.
25
9rs
reproduced
in
Dicksee’s Auditing
(17th ed.)
at
p. 666 and
cases
discumed therein pp. 307
et seq.
and
International Laboratories Ltd.
v.
Dewar et
al.
[1933]
1
D.L.R.
34,
41.
Re Thomas Gerrard
a?
Son
Ltd.
[1967]
2
All
E.R.
626-see note 17
infra.
4
Dicksee’s Auditing,
op.
cit.,
at pp. 907
et seq.; Irish Auditing
(3rd ed., 1966).
Chap. 17.
413
414
THE
MODERN
LAW REVIEW
VOL
88
far the company auditor
is
expected to ferret out fraud, inconsisten-
cies and errors in the preparation of the company's accounts.
It
will
not, however, be
our
concern to discuss in general terms the
auditor's
(or
accountant's) duties according to the recognised prin-
ciples of his profession superimposed upon the provisions
of
the
relevant Companies Act.
In
evaluating the usefulness of the
"
watchdog
"
formula one
must refer to the provisions of the relevant companies legislation.
It
is not in this regard intended to discuss all of the auditor's duties
either
in
respect
of
the annual audit
or
in relation to specific require-
ment6e.g.
his
obligations under the prospectus provisions.s Our
task is made
a
little more difficult because
of
the lack of many cases
specifically concerned with the duty of auditors to inquire where
fraud
or
errors are apparent. The available decisions have been
concerned primarily with allegations of failure
by
auditors to satisfy
their obligations under general rules
of
company law, some
of
which
are and were reinforced by specific provisions
of
relevant companies
legislation,6
or
their obligations pursuant
to
contracts.
THE
FUNCTION
AND
QUALIFICATIONS
OF
AUDITORS
The prime function of the auditor of
a
company
is
to audit the
annual balance-sheet and profit and
loss
statement
of
that com-
pany.' How far
his
function has been reduced by accepted
(if
not
openly approved) practice to a mechanical check of the figures
on
which these documents are based and how inadequate such a role is
are issues, inter
ah,
we shall be specifically concerned
with
here.8
The
relevant section of the
U.K.
Companies Act
1967O
pro-
vides that the auditor's report shall state, inter
alia:
whether the
accounts have been properly prepared and whether they give
a
true and
fair
view of the state of affairs and profit and
loss
picture
of
the company. The auditor is required to
carry
out investigations
to reach an opinion
on
whether proper books have been kept
and
whether the accounts comply with the entries. Failure to comply
should be noted. The auditor is given almost unlimited rights of
"
inspection
"
and
any failure
on
the part of the officers to assist
is
required to be noted.
S
U.K.
Companies Act
1948,
s.
38-Sched.
4,
Part
11.
6
Apart from breaches under the specific amounting provisions of wmpnies
legislation,
many
cMes relate
to
the alleged approval of payments of divldends
out of capital. See
e.g., Lee
v.
Neuchutel Asphulte
Co.
Ltd.
(1889) 41
Ch.D.
1
and see
Dicksee's Auditing,
op.
oit.,
Chap.
X.
7
This involves the auditor in checking for the following: (i) fraud;
(ii)
technical
errors;
(5)
errors of principle. See
Dicksee's
Auditing,
op.
Cit.,
p.
27.
8
The
"
accounting principles
"
relied
on
are referred
to
later
and
see
notee
39
and
40.
0
e.
14
(3).
The whole section replaces,:.
169
of
and
bhed.
9
to the
Cempanies
Act
1948.
The relevant
''
Australian
provision
is
8.
167
of the various State
Acts which correspond quite closely. The provisions are
almoat
identical
in
each state
and
the legis ation is often referred to
as
the Uniform Companies
Ads.
The relevant part
of
thia provision
(8.
14
are set out herewith
:
(3)
The report
,shall
.
.
.
(a)
state w
h
ether in the auditors' opinion
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