STANDARDS AND PRACTICES

GENERAL STANDARDS
(Generally Accepted Auditing Standards)

Auditor should always in their line of work ensure:

Adequate technical training and proficiency Independence in mental attitudes to be maintained Due professional care is to be exercised

STANDARDS AND PRACTICES

STANDARDS OF FIELD WORK
(Generally Accepted Auditing Standards)

1.

2.

3.

Work is to be adequately planned and properly supervised. Sufficient understanding of internal control is to be obtained. Sufficient competent evidential matter is to be obtained to afford a reasonable basis for the opinion.

STANDARDS AND PRACTICES

STANDARDS OF REPORTING
(Generally Accepted Auditing Standards)

1.

2.

3.

4.

State whether financial statements are presented in accordance with standards. Identify circumstances in which principles have not been consistently applied. Informative disclosures are adequate unless otherwise stated in the report. Report should clearly stated the degree of responsibility assumed by auditor.

STANDARDS AND PRACTICES

Auditor Responsibility for Detection of Errors and Fraud
Assess the risk of errors and fraud that may cause financial statements to contain material misstatements.

1.

2.

Based on assessment, plan + perform audit to obtain reasonable assurance material misstatements whether caused by errors and fraud, will be detected.
Exercise due care in planning, performing, evaluating results of audit procedures, and exercise proper degree of professional skepticism to achieve reasonable assurance that material misstatements due to errors and fraud will be detected.
4

3.

STANDARDS AND PRACTICES

Elements of Quality Control
1. 2. 3.

4. 5.

Independence, Integrity, Objectivity Personnel Management Acceptance and Continuance of Clients and Engagements Engagement performance Monitoring

STANDARDS AND PRACTICES

Approaches to Auditor Common Law Liability
Ultramares

Approach Liable to client and third party beneficiaries for ordinary negligence
Restatement

of Torts Approach Liable to client and foreseen third parties for ordinary negligence
Rosenblum

Approach Liable to client and all foreseeable third parties for ordinary negligence
Note: Beside Common Law, cases related to auditors liability may also be found under statutory law, criminal law and also civil law.

STANDARDS AND PRACTICES

Observation 1 Auditors must have been aware that the financial statements were to be used for a particular purpose by a known third party, to be liable to that party for ordinary negligence.

STANDARDS AND PRACTICES

Ultramares Corporation VS Touche (1931)
1.

Touche (defendant i.e auditor) failed to discover fictitious transactions that overstated assets and stockholders equity by $700,000 in the audit of Fred Stern & Co. On receiving the audited financial statements, Ultramares loaned Stern large sums of money that Stern was unable to repay because it was actually insolvent. Ultramares sued the CPA firm (Touche) for negligence and fraud.

2.

3.

Court found auditors guilty of negligence (should not be liable to any third party EXCEPT to a primary beneficiary)

STANDARDS AND PRACTICES

Credit Alliance Corp. VS Arthur Andersen & Co (1985)
1.

2.

3. 4. 5.

Plaintiffs were major financial service companies engaged in financing purchase of capital equipment through installment sales or leasing agreement. Plaintiff granted additional credit to L.B. Smith Inc. based on Andersens unqualified annual audit reports for 3 years ending Feb. 1979. In 1980, Smith filed for bankruptcy after defaulting several millions of obligations to plaintiff. Plaintiff argued they relied on Smiths statement which overstated assets, net-worth and financial health of company. Charged Andersen with both negligence and fraud because they knew Smith would utilize the financial statements to gain additional credit.

Court found there were neither a relationship of contractual privity between plaintiff and defendant or relationship sufficiently intimate to be equated with privity. Court dismissed the charge of fraud.

STANDARDS AND PRACTICES

Observation 2 To be held liable for ordinary negligence, auditors must have been aware that the financial statements were to be used for a particular purpose, although the identity of the third party need not necessarily be known.

10

STANDARDS AND PRACTICES

Rusch Factors Inc. VS Levin (1986)
1.

2.

3.

4.

Plaintiff had asked defendant accountant (Levin) to audit the financial statements of a corporation seeking a loan. Certified statements indicated that potential borrower was solvent when in fact it was insolvent. Rusch Factors sued the auditor for damages resulting from its reliance on negligence and fraudulent misrepresentations in the financial statements. The defendant (Levin) asked for dismissal on the basis of lack of privity of contract. Court ruled in favour of the plaintiff (Rusch Factor) because in this case, defendant knew his certification was to be used for potential financiers of the company.

11

STANDARDS AND PRACTICES

Observation 3 Open the door to liability for ordinary negligence, to virtually all third parties who rely on the financial statements.

12

STANDARDS AND PRACTICES

Rosenblum VS Adler (1983)
1.

2.

3.

4.

5.

Plaintiff, Harry and Barry Rosenblum acquired common stock of Giant Stores Corporation, publicly traded corporation, in conjunction with sale of their business to Giant. The stocks were subsequently found to be worthless after Giants audited financial statements were found to be fraudulent. Defendant (Adler) was a partner at Touche, Ross & Co. that audited Giants financial statements. Plaintiff claimed negligence in conduct of audit and negligence was a proximate cause of their loss. Defendant (Adler) argued for dismissal of suit as plaintiff (Rosenblum) were not in privity with auditor (Adler) and they were not a foreseen party.
Court denied dismissal. Irrespective of whether defendant (Adler) had actual knowledge of Giants proposed use of audited statements in connection with the merger, it was reasonably foreseeable that Giant would use statements in connection with merger.

13

STANDARDS AND PRACTICES

Tenants Corporation VS Max Rothenberg and Co (1971)
1.

2. 3.

Plaintiff (Tenant), a corporation owning apartment house, sued defendant (Rothenberg), a CPA firm for damages resulting from failure of defendant to discover embezzlement by plaintiffs (Tenant Corp) managing agent, Riker. Riker had orally engaged Rothenberg at annual fee of $600. Plaintiff (Tenant) maintained Rothenberg had been engaged to perform all accounting + auditing services. Defendant (Rothenberg) claimed he was only engaged to do write-up work and prepare financial statements and tax returns. As evidence: plaintiff (Tenant) booked the accountants fee as auditing expenses and defendant marked (Rothenberg) each page of financial statements as unaudited.

The court found CPA firm (Rothenberg) negligence in performance, defendant was engaged to perform an audit. Regardless audit or write-ups, it was a duty to inform client of known wrong-doings. The worksheets indicated defendant did perform some audit procedures.

14

STANDARDS AND PRACTICES

Tenants Corporation VS Max Rothenberg and Co (1971)
Landmark case for accountants liability when they are associated with un-audited financial statements.
1.

2.

The case demonstrated the importance of engagement letters to clearly establish an understanding with client regarding nature of services to be provided. It also demonstrated the need to follow up on unusual findings even when the CPAs are not performing audits.

15

STANDARDS AND PRACTICES

Preventing Litigation
1.

2. 3. 4. 5. 6. 7.

8.

9.

Place emphasis within the firm on complying with standards and professional ethics. Retain legal counsel that is familiar with CPAs legal liability. Maintain adequate professional liability insurance. Investigate prospective clients thoroughly. Obtain a thorough knowledge of the clients business Use engagement letters to prevent misunderstandings with clients. Carefully assess risks of errors + irregularities, including indicating of internal control weaknesses. Carefully prepare and review working papers. Exercise extreme care in audit of clients with high degree of business risks.

16

Companys Act 1965

NOTE For the following notes, please refer to Companys Act 1965 and related text book for details.

17

Companys Act 1965

Section 4 Interpretation

Accounting records
(invoices, receipts, bills of exchange, vouchers etc)

Accounts
(P&L, balance sheets, notes to the accounts etc)

Annual general meeting (AGM)

(A meeting of the company required to be held by section 143)

Approved company auditor

(A person approved as such by the Minister under section 8 whose approval has not been revoked)

18

Companys Act 1965

Section 8
1.

Company auditor to be approved by Minister charged with responsibility for finance. The Minister charged with responsibility for finance may delegate all or any of his powers under this section to any person or body of persons charged with the responsibility for the registration or control of accountants in Malaysia. (if dissatisfied, may appeal to Yang Di Pertuan Agong who may in his discretion confirm, reverse or vary the decision)

2.

19

Companys Act 1965

Section 9 Company Auditors.
1)

A PERSON shall not knowingly consent to be appointed, and shall not knowingly act, as auditor for any company and shall not prepare, for or on behalf of the company, any report requires by this Act to be prepared by an approved company auditor:

a) b)

c)
i. ii. iii. iv.

If he is not an approved company auditor If he is indebted to the company or to a corporation that is deemed to be related to that company by virtue of section 6 in an amount exceeding RM2500 If he is
An officer of the company A partner, employer, or employee of an officer of the company A partner or employee of an employee, of an officer of the company A shareholder or his spouse is a shareholder of a corporation whose employee is an officer of the company.
20

Companys Act 1965

Section 9 Company auditors.
d)

If he is responsible for or he is the partner, employer or employee of a person responsible for the keeping of the register of members or register of holders of debentures of the company

(Penalty: RM30,000)

21

Companys Act 1965

Section 9 Company Auditors.
2.

A person shall be deemed to be an officer of the company, if he is an officer of a corporation that is deemed to be related to the company by virtue of section 6 or except where the Minister if he thinks fit, if he has, at any time within the preceding period of 12 months been an officer or promoter of the company or such a corporation. A person shall not be deemed to be an officer by reason only of his having been appointed as auditor of a corporation.

3.

22

Companys Act 1965

Section 9 Company Auditors.
4)

A FIRM shall not knowingly consent to be appointed, and shall not knowingly act, as auditor for any company and shall not prepare, for or on behalf of the company, any report required by this Act to be prepared by company auditor UNLESS:
a)

b)

All partners of the firm resident in Msia are approved co. auditor. Where firm is not registered as firm under any law for the time being in force, a return showing full names and addresses of all partners has been lodged with the Registrar. No partner is disqualified under (1)(b), (c ), or (d) from acting as auditor. If a firm contravenes subsection 4), each partner of firm shall be guilty of offence. Penalty: RM30,000

5)

23

Companys Act 1965

Section 9 Company Auditors.
6.

No company or person shall appoint a person as auditor of a company UNLESS that last-mentioned person has, prior to the appointment, consented in writing to act as such auditor. No company or person shall appoint a firm as auditor unless firm has, prior to the appointment, consented in writing under the hand of at least one partner of the firm, to act as auditor. The appointment of firm in the name of the firm as auditors of a company, shall take effect and operate as an appointment as auditors of the company, of the persons who are members of that firm at the time of the appointment.

7.

24

Companys Act 1965

Section 166A Compliance with approved accounting standards
(the approved accounting standards shall apply to the accounts of a company or the consolidated accounts of holding company..)

Section 167 Accounts to be kept.

(Every company and the directors and managers thereof shall cause to be kept such accounting and other records ..)

Section 167A Systems of Internal Control

(.the directors of a public company or subsidiary of a public company shall have in place a system of internal control that will provide reasonable assurance..)

25

Companys Act 1965

Section 169 Profit and Loss Account, Balance Sheet, Directors Report
(Directors of every company shall, at some date not later than 18 months after the incorporation of the company and subsequently, once at least in every calendar year at intervals of not more than 15 months, lay before the company, at AGM, a P&L)

Section 171 Penalty if fail to comply with section 169

Imprisonment for 5 years OR RM30,000

26

Companys Act 1965

Section 172 Appointment and Remuneration of Auditors
(Before first AGM, directors or company may appoint person (s) to be auditor, hold office until the conclusion of first AGM)

Section 172(4)
Removal of Auditor (Company Auditor may be removed from office by resolution of the company at general meeting of which special notice has been given but not otherwise)

27

Companys Act 1965

Section 172(5) Removal of Auditor
Where special notice of resolution to remove auditor is received by a company:
a) b)

Send a copy of notice to auditor and to the Registrar; and Auditor may, within 7 days after receipt of notice by him, make representation in writing to the company and request that, prior to meeting at which the resolution is to be considered, a copy of representations be sent by company to every member of the company to whom notice of meeting is sent.

Section 172(6) Removal of Auditor

Company shall send copy of representations as so requested and auditor may require that representations be read out at the meeting

28

Companys Act 1965

Section 172(7) Removal of Auditor

Where auditor is removed from office in pursuant of subsection (4) at general meeting of the company:
a)

b)

Company may, at meeting, by resolution passed by majority of not less than of such members of company as being entitled to vote (in person or proxies) appoint another person nominated at the meeting as auditor; OR The meeting may adjourned to a date not earlier than 20 days, not later than 30 days after meeting, and the company may, by ordinary resolution, appoint another person as auditor, being a person notice of whose nomination as auditor has (at least 10 days before resumption of adjourned meeting) been received by the company.

Section 172(8) Removal of Auditor Company shall after removal of auditor from office, give notice in writing to Registrar and if company does not appoint an auditor, Registrar shall appoint an auditor.

29

Companys Act 1965

Section 172(14) An auditor of a company may resign:
a) b)

If he is not the sole auditor of the company; OR At general meeting of the company

Section 172(15) An auditor of a company may resign:

If an auditor gives notice in writing to directors that he desires to resign, directors shall call a general meeting of the company as soon as practicable for the purpose of appointing an auditor in place of the one resigned, and on appointment of another, the resignation shall take effect.

30

Companys Act 1965

a)

b)

Section 172(16) Fees and expenses of an auditor of the company In the case auditor is appointed by company at general meeting, shall be fixed by company in general meeting OR if so authorized by members at the last preceding AGM, by directors. In the case auditor appointed by directors or Registrar, fees and expenses may be fixed by directors or Registrar. If not so fixed, shall be fixed as provided in paragraph (a) as if auditor is appointed by the company. Section 172A Duty to inform upon ceasing to hold office as auditor Within 7 days of submission of written representations or submission of notice of resignation, auditor need to submit a copy of written representation or written explanation of resignation, to Registrar and to Stock Exchange where companys stocks are traded.

31

Companys Act 1965

Section 173 Auditors Remuneration
If company is served notice sent by or on behalf of At least 5% of total number of members of company OR Holders in aggregate of not less than 5% in nominal value of companys issued share capital requiring all emoluments paid or receivable by auditor (including by partner, employer, employee.of auditor); by or from company or any subsidiary in respect of services other than auditing services rendered to the company, the company shall forthwith:
c)

d)

e)

Prepare or cause to be prepared a statement showing particulars of all emoluments.. Forward a copy of statement to all persons entitled to receive notice of general meeting Lay statement before company at general meeting

Defaults by company and every director of company in default, guilty of offence leading to penalty of RM 2500.
32

Companys Act 1965

Section 174 Powers and Duties of Auditors to Report on Accounts Section 174(2) An auditor shall in his report, state:
a)

Whether accounts (consolidated accounts where applicable) are in his opinion properly drawn up: i. So as to give true and fair view of matters required by section 169 ii. In accordance with the provisions of this Act so as to give true and fair view of companys affairs iii. In accordance with applicable approved accounting standards

33

Companys Act 1965

Section 174 Powers and Duties of Auditors to Report on Accounts Section 174(2)
(aa) If in his opinion the accounts (if applicable, consolidated accounts) have not been drawn up in accordance with particular applicable approved accounting standards:
i.

ii.

iii.

Whether if drawn up in accordance with standards, would give true and fair view If in his opinion, accounts would not, if so drawn up, have given true and fair view, reasons for holding that opinion If directors have given particulars of quantified financial effect under subsection 166A(5)( ie whether accounts or consolidated accounts are not made out according to standards), of failure to so draw up the accounts or consolidated accounts.

34

Companys Act 1965

Section 174 Powers and Duties of Auditors to Report on Accounts Section 174(2) An auditor shall in his report, state:
b)

Whether the accounting and other records and registers required by Act to be kept by company (or by subsidiaries which he has not acted as auditor) have been in his opinion, properly kept in accordance with provision of Act.
In the case of consolidated accounts .(name of subsidiaries, accounts accounted for, whether auditor report of subsidiaries subject to any qualification etc)

c)

35

Companys Act 1965

Section 174 Powers and Duties of Auditors to Report on Accounts Section 174(2) An auditor shall in his report, state:
d)

Any defect or irregularity in accounts (or consolidated) If he is not satisfied as to any matter referred to in paragraph a), b), c) and his reasons for not being satisfied.

e)

36

Companys Act 1965

Section 174 Powers and Duties of Auditors to Report on Accounts Section 174(3)
It is the duty of an auditor to form opinion as to each of the following matters:
a)

b)

c) d)

Whether he has obtained all information and explanations that he required Whether proper accounting and other records have been kept by company as required by Act. Whether returns received from branch offices of the company are adequate Whether procedures and methods used by holding or subsidiary in arriving at amount taken into any consolidated accounts were appropriate to circumstances of consolidation.

(State in report particulars of any deficiency, failure, shortcomings regarding the above).

37

Companys Act 1965

Section 174 Powers and Duties of Auditors to Report on Accounts Section 174(4)
Auditor has right of access at all reasonable times to accounting and other records, entitled to require from any officer of company and any auditor of related company such information and explanations as he desires for audit purpose. Section 174(5) Rights as above applicable to auditor of holding on consolidated accounts. Section 174(6) Auditors report attached to, endorsed on accounts or consolidated accounts shall be read at general meeting, open for inspection at any reasonable time.

38

Companys Act 1965

Section 174 Powers and Duties of Auditors to Report on Accounts Section 174(8)
Auditor in course of performance of duties, if he found breach or nonobservance etc by company, shall forthwith report the matter in writing to the Registrar. Section 174(8A) Auditor should report when discovered fraud and dishonesty against company. Section 174(9) Failure of officer of corporation without lawful excuses to allow auditor access to records, explanations etc, delay or obstruct auditors performance of his duties or exercise of his power, led to guilty of offence against Act. Penalty: 2 years imprisonment OR RM30,000 OR Both

39

Steps in Accepting Audit Engagement

1. Evaluate integrity of management

Communicate with predecessor auditor Make inquiries of other third parties Review previous experience with existing clients (before deciding to continue engagement) Identify intended users of statements Clients legal and financial stability Auditability of entity Identify audit team Consider need for consultation and specialist

2. Identify special circumstances and unusual risks

3. Assess competence to perform audit

4. Evaluate independence 5. Determine ability to use due care

Assess timing of appointment Consider the scheduling of field work (interim, year-end, budget, clients personnel)

6. Prepare engagement letter

40