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GAZETTE

DECEMBER 1988

Legal audit

Are t he cus t oma ry aud it procedures, as car r i ed out by

aud i t o rs and ce r t i f i ed by t hem, su f f i c i ent f or t he

p r o t ec t i on of shareho l ders and o t hers dea l i ng w i t h

l imi t ed l i ab i l i ty compan i es? Mr . Neil Frish Thompson,

in a paper prepared f or t he C.C.B.E. (Counc il of t he Bars

and Law Soc i e t i es of t he European Commun i t y)

proposes t hat an ex t ra t ier of i nves t i ga t i on be i nc l uded

in annual aud it procedures i nvo l v i ng t he legal as we l l

as t he ac coun t ancy pro f ess i on.

P r eamb le

The approach of the accounting

profession to audit is one that is

directed primarily to verifying the

accounting records of the company

and to expressing a view as to the

annual Balance Sheet and Profit

and Loss Account.

Insofar as the subject matter of

the business for wh i ch accounts

are being prepared falls readily into

an annual cycle this presents no

problem; the farmer and the retailer

by and large operate over definable

(although not definitive) seasons.

However, in relation to industry

where, for example, the life of a

product f r om its inception in

research and development through

its launch, to the establishment of

market share and then decline

through obsolescence, the audit

system runs into difficulty. The

problems are compounded by

auditors, in practice, being selected

and dismissed at the volition of the

d i r e c t o rs

and

not

of

t he

s ha r eho l de rs for w h om t he

auditors are supposed to be watch-

dogs. At the present time the

situation has become even more

confused because only about half

t he r emune r a t i on of aud i t o rs

derives from audit. The rest comes

f r om being entrusted by the Board

or senior management w i th further

wo rk on behalf of the company. In

order to avoid conflicts of interest

within accountancy firms, some

firms even erect "Chinese Wa l l s"

round their audit departments in

order to ensure that audit partners

are not aware of what their

collleagues may be advising the

company. Another problem to be

considered is the introduction of

accounting standards, including

current cost accounting, wh i ch

itself depends on going concern

assumptions which may or may

not be valid in terms of the

c omp a n y 's

c o n t r a c ts

and

ownership.

Increasingly auditors are asking

that the solicitors to the company

confirm the whereabouts of the

company's title deeds, even, in

some cases, asking wha t, if any,

transactions have taken or are

taking place in relation to them.

Auditors now enquire (in varying

by Neil Frish Thomp s on

depth) as to the disputes and

litigation in wh i ch a company is or

may be engaged. These tasks are

not made any easier because it

may be extremely difficult to

identify wh i ch firms of solicitors

may be involved.

Legal A u d i t

This article proposes that, in the

light of p r o b l ems, of w h i ch

company fraud is perhaps only the

tip of the iceberg, the audit process

should not be left to accountants

alone. In the first instance, the

company's solicitors should be

registered; that is to say, the

company should keep a record of

the solicitors it instructs. Once so

appointed, a company solicitor

wo u l d be answe r ab le to t he

auditors and under a duty at the

time of audit to give a report, from

the date of the last audit report, of

each job undertaken on behalf of

the company and t he result,

indicating wha t, if any, financial

reserves it wou ld be prudent to

make. Solicitors w i th such a duty,

as officers of the Court, could be

relied upon not to cover up

activities. Similarly, in relation to

company assets, the solicitor

emp l o y ed

on

t he

o r i g i nal

acquisition or last dealing would at

audit time be required to report as

to whether the asset was still held

and the state of it. Local land

charge searches and the usual

enquiries wou ld be made to check

if there had been developments or

changes wh i ch added or sub-

tracted to the information on which

its value was based.

As to company contracts, it

would be the duty of the company

solicitor to peruse these (or at least

those important to the business of

the company) whether formal or

made informally by letter, to see if

these wou ld justify assumptions

about the state of the company's

business and its expectations. In

t he cou r se of such perusal,

solicitors wou ld be expected to

report whether renewals were due

or required and whether supporting

agreements for supplies or services

we r e in place, as we ll as

app r op r i a te

c o n t r a c ts

w i t h

c omp e t e nt

e x e c u t i v es

and

employees.

Much of this work is done in

practice when a company is to be

the subject of quotation on the

Stock Exchange, or some similar

major transaction but, and this

goes to the root of the problem,

there is no systematic legal annual

review and this, in turn, leaves

broad areas for misunderstandings

or o u t r i g ht d e c e p t i o n. Mo re

important still is that the necessity

for such a review would make

boards and senior management

conscious of problem areas wh i ch

they would not otherwise have to

cons i de r, as we ll as mak i ng

commerce and industry as a whole

much more scrupulous in arranging

and documenting their affairs.

If legal audit became obligatory,

then systems to limit its costs

could be developed.

As a preliminary paper on the

subject, detailed consideration of

the various heads for audit have

299