TOPIC 2: LEGAL AND PROFESSIONAL ENVIRONMENT/FRAMEWORK

Legal framework

Under the legal framework qualifications of the company auditors

a) Must be a qualified professional accountant i.e. a holder of CPAK, ACCA or CFA.

b) He must be a registered accountant with RAB, he must be a practicing accountant with
the financial qualification.
c) He must not have been disqualified in any manner from in the subsidiary company
d) Any other person who is recommended by the registrar.

Disqualification of a company auditor (ineligibility)

a) The financial entities are ineligible for appointment even if they are qualified.
b) An officer or servant of the company being audited
c) Any person in partnership /employment with an officer or a servant of the company
d) A body corporate or a ltd company. This is because it is made up of many shareholders
who cannot express a personal opinion and who cannot assume a liability.

Appointment of the company auditor

It is outlined by section 159 of the company’s act i.e.

i) Appointment by shareholders (section 159 sub-section (1).

Shareholders are empowered to appoint company’s auditor on each annual general meeting to
oversee the affairs of the company.

ii) Automatic reappointment

Section 159 subsection (2) this provides for a retiring auditor to be automatically reappointed
unless

He is not qualified for reappointment

He has given notice not to be re-appointed.

Members intend to appoint someone else

iii) Appointment by the registrar

Section 159 subsection (3). The registrar of a companies is hereby empowered to appoint the
company auditor following an annual general meeting where members have failed to appoint
one

iv) Appointment by board of directors (BOD)

Section 159 (4). Board of Directors is empowered to appoint the first auditors of the company.
This is in case of a newly formed company.

Filling a casual vacancy

Board of Directors is empowered to appoint a company auditor to fill a casual vacancy arising in
the auditor’s office due to

a) Sudden death
b) Sudden resignation
c) Sudden incapacitation.

Removal of company’s auditor

Section 160 (1)

a) Disagreement with the management

b) Lack of qualification
c) If the auditor has been negligent with the client work
d) Desire by management of parent company to consolidate subsidiary audits under one
auditor
e) Where the auditor has threatened to expose the management extravagance to the
shareholders
f) If the auditor is changing high fee

Procedure for removal

a) The company must issue a specific notice not less than 28 days so as to inform for the
intended removal
b) The company must give permission to the auditor to circulate copies of representation
to the shareholders to reach them before the intended annual general meeting
c) The company must ensure that representations are not defamatory
d) Requisite for an annual general meeting for within not less than 21 days for members to
discuss the removal of the auditor.
e) Incase representations were not send on time the auditor will read the representation in
the annual general meeting.
Resignation of the company auditor

Reasons for resignation

a) Disagreement over the accounting policies

b) Where the auditor lacks qualifications.
c) If the clients have demonstrated ability to delay the audit fee contrary to the terms of
engagement.
d) Where members of the company has intention to pass a resolution and get someone
else

Procedure or resignation

a) He must tender a resignation letter to the company head office stating the date and
time.
b) company the letter with a statement of circumstances stating the matters he would like
to bring to the attention of the shareholders regarding the resignation.
c) Requisite for an extraordinary general meeting for members to discuss the resignation
d) The company must ensure the resignation has been accepted by the members.

Casual vacancy

Procedures of filling a casual vacancy

a) In case of death of an auditor issue a special notice to the deceased firm of not less than
28 days to inform them the intention to replace them
b) Nominate another firm of auditors to take over
c) Discuss and agree with the nominated firm the terms of work
d) Confirm through the engagement letter.
e) Present the nominated firm through an extraordinary general meeting for approval by
the firm.

Procedure by the nominated firm

i. Obtain clients permission to communicate with the outgoing firm for professional
courtesy.
ii. Review the work done by the outgoing firm to check for any risk exposure
iii. Consider possibility of incorporating staff from the deceased firm
iv. Accept the appointment and commence the audit work.

Remuneration of the company auditor (section 159 (7)

a) Auditor’s remuneration is fixed by the parties who have appointed the auditors i.e.
 b) If appointed by the shareholders in the annual general meeting, they shall fix the
remuneration.
c) In case of automatic re-appointment, the auditor’s continuous to receive the same
remuneration unless otherwise stated.
d) If appointed by the directors in case of first auditors then the Board of directors shall
discuss and fix the remuneration.
e) If appointed by the registrar, he shall fix the remuneration in consultation with Board of
directors.
NB: the term auditor’s remuneration shall be deemed to include
a) All money paid to the auditor for expenses and shall be separately disclosed
b) If auditors are providing extra/non audit services, this shall be remunerated
separately.

Rights and duties of a company auditor

Duties of a company auditor

1. Duty to write a report to the company members

2. Duty to state in the report whether

a) Proper books have been kept

b) Whether accounts comply with accounting requirements.
c) Whether all information and explanation have been rendered
d) Whether accounts reflect true and fair view

3. Duty to maintain working papers and provide them when required to assist in company’s
investigation.

4. Duty to call for information on company’s securities and whether they do cover the loans.

5. Duty to certify the P&L and balance sheet in the prospectus. Prospectus – document issued
to the public before a company issues shares.

6. Duty to include in his report, any information he feels was committed or any contradicting
information.

7. Duty to certify all statutory reports prepared by the company.

Rights of the company auditor

 a) Right to access at all times books of accounts and records of the entity.
b) Right to enquire any information and explanation they consider to be necessary for the
audit
c) Right to receive notices to attend all the annual general meeting held by the company
i.e. 21 days notice before an ordinary annual general meeting 7-14 days notice before
an extra ordinary annual general meeting.
d) Right to remuneration
e) Right to lien i.e. withhold all audit materials until the audit fee has been paid
f) Right to visit the branches and examine all the branches accounts.
g) Right regarding removal

Qualities of a company auditor (fundamental principles)

a) Integrity
b) Independence
c) Confidentiality
d) Objectivity
e) Professional behaviour
f) Due care and skills

Professional framework

Professional ethics

It is a system of discipline by a professional institute on its members in order to regulate their

behavior and conduct while on the practice.

Accountants have got their own professional ethics instituted by ICPAK and they cover wide
such as objectively, confidentiality, technical standards etc.

Role of professional ethics

a) Regulates conduct and behavior of the accountants in the practice

b) Maintain discipline among accountants
c) Enhance independence and objectivity
d) Reduce auditor’s exposure to risk and liabilities
e) To unify the reporting responsibilities over the financed statements.
Ethical statements /consideration

To ensure accountants are competent enough in their reporting responsibilities, ICPAK has
issued certain ethical guidelines

a) Integrity
b) Due and skills
c) Professional independence
d) Competence
e) Objectivity
f) Advertising and publicity
g) Professional fee
h) Change in professional appointment
i) Technical standard
j) Obtaining professional work

Confidentiality

A guide to professional ethics states that, information acquired in the course of the audit must
not be shared or disclosed to 3rd party without client consent

Circumstances where auditors are allowed to disclose client’s information.

a) Where the information is required by regularity body e.g. KRA

b) In a court proceeding if the auditor is giving evidence
c) Where auditors have a public duty to disclose for public interest.
d) Where information is required by receivers and liquidations

Advertising and publicity

a) Guidelines and ethics that a member must not advertise for his professional service and
skill. A member is only allowed to place an advert in the media on the following cases.
b) When recruiting staff or partnership
c) When informing the public about changes in address
d) When advertising on behalf of the client
e) When advertising for seminar and workshop or in a professional magazine.

Obtaining professional work

Guidelines state that it is unethical for any auditor to obtain work for himself in non-
professional manner. He should not give any commission any reward or gift in order to be
introduced with the client. However, auditors can obtain work through rendering of such
services where they shall be invited if they are qualified.

Change in professional appointment

A member shall respect the wish of the client to a point whoever he wishes to be the auditor.
When an auditor is appointed to occupy an office that was previously occupied by another
auditor, he should take following steps

a) Request permission to communicate with the outgoing member for ethical clearance
and courtesy. If such permission is denied, decline the appointment.
b) The outgoing member shall obtain consent from the client to communicate with the
incoming member. If denied, he shall inform the incoming member about it.
c) When both permission and consents are granted, the two shall communicate freely and
the outgoing member shall communicate all the important matters that will enable the
incoming member to decide whether or not to accept the appointment.

Professional fee

Audit fee must not be charged on the % basis of the clients profit unless be authorized by a
statute. Auditors must not obtain a significant portion of the income of a single client as this
will result to over dependence of such clients. This may also compromise independence and
objectivity.

NB: auditors must not earn more than 15% of the client’s gross revenue.

Factors that determine audit fee charge.

a) Time to be spent by the audit while auditing

b) The engagement of experts if any
c) Nature of the engagement contract
d) Location of the assignment and the risk involved
e) Size of the audit firm
f) Technicalities and the nature of the work done
g) Prevailing market rate.
h) Status or seniority of the person to be involved

Actions auditors should take if the client has refused to pay fee

a) Sue the client for nonpayment

b) Exercise the right to lien
c) seek advice from disciplinary committee within ICPAK
 d) request the incoming auditor to assist your recover the money

LOW BILLING

It is a common practice by small firms or newly established firms to charge a lower fee than the
prevailing market rate. This practice is unethical and tends to violate the rules of the market.

Consequences of low billing

a) Compromises auditors independence

b) Violates the rules of the market
c) Makes the auditors ability to practice to be doubted.
d) Makes it difficult for other auditors to convince their client about the market rate.

Auditor’s independence

It refers to the remoteness of mind, status and outlook that enables the auditor to exercise
objectivity or to act without bias.

Importance of the concept auditor’s independence

a) It is a legal requirement by the company act that auditors must be independent

b) It is a professional requirement by the body ICPAK
c) Shareholders expect auditors to be independent in order to safeguard their interest
d) Third party also expects the auditor to be independent in order to express unbiased
opinion.

Audit itself is an independent practice and whoever who practice it must be independent

It is through independence that auditors are able to express true and fair view.

Circumstances that may compromise auditor’s independence

a) Where a small audit firm is engaged to audit a large company. This is because it will
over depend on the client for financial support.
b) Where auditors own shares in the client company. They will be reluctant to qualify the
report as they are part of the owners.
c) When the auditor is indebted to the company he has either accepted or given loans or
guarantee of the company debt.
d) Where family or personal relationship exist between the auditor and the client
company.
 e) Where auditors have been provided with goods and services at more favourable terms
than it is given to another.
f) Where there is conflict of interest
g) Where the auditor has accepted to practice low billing

How the auditors independence can be safeguarded.

a) Safeguard by the audit firm

b) Safeguard by the provision

Safeguard by the audit firm

i. The auditor should ensure that their audit work is clearly defined
ii. Auditors must take actions to resign where the independence is compromised
iii. Auditors must not accept appointment where a conflict of interest will arise
iv. Auditors must not accept undue favours or goods or services at favourable terms than it
is given to other employees.
v. Auditors must rotate their audit staff regularly to avoid familiarity threats.
vi. Auditors must not derive significant portion of their income from a single client
vii. Auditors should strictly adhere to the auditing standard and guidelines

Safeguard created by professional body

a) Regulating and controlling the issue of practicing certificate.

b) Though qualification, education and training requirements before joining the profession
c) Though the disciplinary measures instituted by ICPAK on those who fail to comply
d) Though introduction of auditing standard and guidelines
e) Though workshops and seminars on matters of independence.

Others

a) Requiring the auditors to be rotated after a specific period of time (3 years)

b) Ensuring audit firms has another experienced partner who can check the work of the
other partner
c) By discouraging and prohibiting the auditors from undertaking two months of non-audit
services
d) By enacting rules that protect auditors from unfair removal and this enable them to act
with confidence without influence.
Auditing standards and guidelines

Formulation of auditing standards

Audit standards are formulated by the international audit assurance standard board (ISAAB)
which is a subcommittee of international federation of accountants committee (IFAC)

The role of IFAC is to identify special areas that require the establishment of new standards

They constitute a sub-committee responsible of preparing a draft standard. This draft is then
considered and discussed by IAASB and if approved it is then distributed to member bodies of
IFAC then comment and suggestion are taken from different members and representatives
from different countries.

The new suggestions are accepted and revision done if need be

The draft is then approved and issued as an ISA (international standard of Auditing) or a
standard.

Role of ISA

a) Provides a framework or a basis for auditing the financial statements.

b) They provide specific guidelines to be followed in an audit
c) They are applied when reviewing material matters and incase of any departure from the
standard, then it must be justified by the auditor.
d) They provide support to the auditors regarding the amount of work to be carried out by
the auditor.

Advantages of ISA

a) Enhances the quality of audit work

b) Increases the public awareness on matters of the audit
c) They have to bring about the uniformity of the reporting process
d) Helps auditors to determine on what is material or not material
e) They provide guidelines on material disclosure and representation
f) Minimizes auditor exposure to risk and liabilities

Disadvantages

a) Makes the audit work to be mechanical i.e. following the standard for the sake
b) Makes audit work to be expensive especially for small firms
c) Inhibits auditors creativity and initiative in the long run
d) The standard may not adapt to all circumstances.