The statutory nature of external audits

The Companies Act of Ghana 2019 (Act 992), requires that the annual financial statement of companies is audited by duly qualified auditors prior to the issue, publishing or circulation of same. Preparation and auditing of the annual financial statements of companies are therefore mandatory and non-compliance shall attract sanctions under the law. Yearly, all companies ought to file their audited financial statement with the Ghana Revenue Authority as well as the Registrar Generals Department.

Given the statutory requirement for all companies irrespective of the size or form to have their financial statement audited annually, I ask; will companies voluntarily prepare audited financial statements if it was not a statutory requirement?

Why external audit?

A company is a separate legal entity distinct from its owners. In large companies (particularly listed companies), ownership (shareholding) is usually distinct from management. The shareholders of the company, employ managers to see to its day-to-day operations, resulting in a Principal-Agent relationship, with shareholders as principals and managers as agents. Due to the fact that managers and not shareholders run the day- to- day activities of the company, there is information asymmetry between the two parties.

The principal (shareholders) entrusts resources to the agent (managers) but has little or no day-to-day input. The agent is the decision-maker but is incurring little or no risk because any losses will be borne by the principal. This relationship is often referred to as the principal-agent problem.

The managers are required to prepare financial statements to account for their stewardship to the shareholders. The shareholders in their quest to satisfy themselves that the financial statement prepared by management is true and fair, appoint external auditors to express an independent opinion on the financial statement. The main purpose of external audit is therefore to express an independent opinion about the truth and fairness of the financial statement primarily to the members/shareholders of the company, reason for which the external auditors of a company are appointed by the members and their report addressed and presented to the members at the Annual General Meeting.

The case of owner-managed companies

A number of companies in Ghana are Small and Medium Sized Enterprises (SMEs) whose owners are directly involved in management. If the owners are directly involved in management, will the agency problem discussed above arise? Will there be the need for the owners to appoint external auditors to express an independent opinion about the truth and fairness of the financial statement the shareholders were involved in preparing?

The value of external audit to auditees

Apart from the statutory requirement for external audit, auditees benefit from these audits in a number of ways.

• Management letters produced by auditors go a long way to improve internal controls and governance in the auditee company. Management letter communicates deficiencies in internal controls observed during the audit and suggest ways in which these deficiencies can be ameliorated. Companies that take management letter issues seriously are able to significantly improve their systems for the smooth running of their operations.
• Auditors are usually skilled and experienced accountants and are able to detect material misstatements in auditee’s financial statements and suggest corrective adjustments. In the absence of these adjustments, a number of companies would have made decisions based on error ridden financial statements to the detriment of the company and incur huge tax liabilities.
• Audit provides management and shareholders of a company an independent assessment of their financial reporting systems. Prior to end of the year when the final account of the company is prepared, management may require different forms of financial reports for either internal or external use. An accounting system that is not properly set up will churn out misleading reports. I have come across clients whose chart of accounts are wrongly set up, producing misleading financial reports and suggested corrective actions. Once the accounting system produces misleading financial reports, the company is at the mercy of tax authorities.
• Auditing gives credibility to the company’s financial statements in dealings with stakeholders. A company’s bankers may require audited financial statements in certain business transactions with the bank. Investors and donor agencies will typically require audited financial statements to make a fair assessment of the state of affairs of the company prior to investing in the company.

Conclusion

External audit is a mandatory requirement for all companies. The fundamental reason why shareholders appoint auditors is for the shareholders to satisfy themselves that the financial statements prepared by management is true and fair. This is because of the fact that in large companies, ownership is usually different from management and the owners would want an independent opinion on the financial statement prepared by management by reason of the agency problem. However, in owner managed companies where the agency problem may not be prevalent, one may be tempted to assume that external audit may not be necessary but for it being a statutory requirement.

This article enumerates the fact that there are other benefits to be derived from external audits.

About the writer

Samuel Osae-Ansah, CA, is a chartered accountant and an audit practitioner. He is an entrepreneurship enthusiast who takes keen interest in the growth trajectory of businesses and provide advisory services in that regard.

E-mail: osaeansah@yahoo.com

Tel: +233 249129198