External auditors, the audit committee and the board

By Devanesan Evanson

 

EXTERNAL auditors of public listed companies (PLCs) are appointed by shareholders at annual general meetings to perform their duties of auditing the financial statements of PLCs.

The auditors will then report whether the financial statements, for the financial year-end, are prepared according to the prevailing laws and accounting standards and whether, in their opinion, they present a true and fair view. Such are the requirements of the Companies Act 2016.

The auditor is also bound by law (the Capital Markets and Services Act 2007) to report issues that may have a material impact on the financial statements of a PLC to the Securities Commission (SC). In such instances, the SC will decide if further investigation is warranted.

Typically, the auditors will deal with the company’s management (which includes executive chairman (EC)/executive directors (EDs), CEO, chief financial officer) during their auditing process to iron out issues relating to the financial statements.

There are times when auditors are unable to resolve the issues with management and both parties refuse to budge from their respective positions. This is when the auditor will escalate their concerns to the audit committee (AC).

Per the Bursa Securities’ Listing Requirements (LR), the AC must comprise non-executive directors, with majority of them being independent directors. Meanwhile, the Step-Up practice in the Malaysian Code on Corporate Governance (MCCG) ups the ante by stating that the AC should comprise solely of independent directors.

This means no EC/EDs should sit on the AC. Such requirements are to allow auditors to articulate their concerns candidly, without fear or favour.

The LR states, amongst others, that the AC must review with the external auditor, the audit report and the assistance given by the employees of the audited company to the external auditor.

Since the AC is a sub-committee of the Board, the AC reports back to the Board on these matters. It is the prerogative of the auditor to decide when he should address the AC when there are concerns.

As stated earlier, concerns will likely be raised to the AC only when communications with management have either broken-down or an impasse has been reached.

Under the LR, one of the responsibilities of the AC in relation to auditing a company’s financial statements is to focus on significant matters highlighted e.g., financial reporting issues, significant judgments made by management, significant/unusual transactions, and the measures to tackle these issues.

Removal of auditor

The AC can also recommend to the board, the removal of the auditor based on valid reasons. The Board will deliberate on the recommendation, and if it concurs with the AC, approve such a resolution to be tabled for shareholders’ approval at an AGM or EGM.

But the key ground for the removal of auditors are ‘valid reasons’. It is not good corporate governance practice to remove auditors when issues and concerns are festering and remain unresolved. In such circumstances, changing auditors is akin to ‘opinion-shopping’.

Quite often we hear the grounds given by companies for the removal of their auditors but rarely do we hear from the auditor.

This is probably because the auditor feels that he only needs to communicate through his audit opinion which is included in the annual report. Besides, they will be there at the AGM to address questions anyway.

To allow the shareholders to hear the auditor’s side of the story, the auditors should exercise their rights granted under the Companies Act 2016 by presenting their side of the story and requesting the company to circulate it to the shareholders with the notice of the meeting to remove them.

Some red flags for minority shareholders to watch out for

Extending or changing the financial year-end when nearing the report-issuance deadline may be an indication that things are not going well.

If the audited financial statements can be released in a timely manner in the past, there should be no reason to extend/change the financial year-end this time around.

Of course, there are valid reasons to extend/change a financial year-end e.g., to align the year-ends of all companies within a group to facilitate the preparation of group (consolidated) financial statements.

In addition, auditors resigning in the middle of their tenure is also something to watch out for. Some auditors irresponsibly choose to resign when there are issues and concerns rather than discharging their responsibilities to the shareholders who appointed them; an easy way out leaving the company to appoint a more tolerant auditor – a form of ‘opinion shopping’.

Another red flag is the removal of an auditor mid-stream during their tenure especially when there are issues and concerns in relation to the audit of the financial statements.

Auditors may issue clean audit opinions or modified audit opinions (such as material uncertainty related to going concern).

The risk-averse minority shareholder may prefer to invest in companies that have a clean opinion, and these represent most of the PLCs. – June 14, 2021

 

Devanesan Evanson is the CEO of the Minority Shareholders Watch Group (MSWG).

The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.

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