Hawke's Bay Herald. TUESDAY, JULY 21, 1896. THE DUTIES OF AUDITORS.

Hawke's Bay Herald, Volume XXXI, Issue 10360, 21 July 1896, Page 2

Hawke's Bay Herald. TUESDAY, JULY 21, 1896. THE DUTIES OF AUDITORS.

Me J. A. Millar has introdnoed in the House a bill providing for the Government audit of the books of all companies doing business in Now Zealand. After recent revelations, both in Australia and New Zealand, no one can pretend that the present system is satisfactory. Bat It ls questionable whether Mr Millar's proposals wonld resnlt in a better state of things, while they wonld unquestionably prove very expensive to companies. Brlofly pat the manager of every oompany wonld send to 'the Audit Office a balance-sheet for the year, when an auditor licensed by tho Government wonid be sent to check it. An ordinary Government auditor would be qo!t8 unable to oheok the value of stock, and Mr Millar, recognising this, provides that he may demand a valnation of assets by a licensed vainer. Buo one olause wonld to a large extent nullify any benefit from this procedure, for it is espressly provided that no oompany shall be obliged to produce or allow the inspection of its ledgers showing the accounts of any private persons, unless on tho order of a Judge of tha Supreme Court. Now a very large part, often the larger part, of the acoounts of companies oonsist of book debts, and unless these are examined any manager oould retain on bis books as good debts hopelessly bad, or even might largely overstate the amount of the hook debts, The oertifioato of an auditor who bas nob examined, snoh debts would be valueless, and often misleadiog. But, as we have said, the present system of audit is inadequate, A recent English case showed this very clearly, The Kingston Cotton Mills Company employed an eminent firm of London accountants to audit its books. For years profits were shown, and dividends declared, bnt in 1804 a crash came, and it was then found thai for at least four years there had been losses. The auditors were deceived by the manager, wbo.largely over-valned and over-stated the yarns and cotton on hand. Mr Jostloe Vanghan Williams held that on the face of tbe aocouota the auditors S should have suspeoted something wrong,' and ordered thorn to make good to the company the moneys Improperly paid &s dividends, From this tbey op-

pealed, and Lord Justioes Lopez, Lindley, S and Koy nnanimonsly reversed the jndg. ment. In doing so Mr Jnstlco Lindley laid down the duties of auditors as follows :— To decide this qnestion It ls necessary to consider (1) what the duty of the auditors was ; (2) how they periormßd tt, and in what respeots (if any) they failed to perform it. The duty of an auditor genorally wbb very carefully considered by this Court in re the London ond General Bank (189, 2 Ch., 673), and I cannot nsefully add anything to what will he fonnd on psgos 082-84. It was there pointed out that an auditor's duty is to examine the books, and to prepare a balance-sheet showing the tine finanoial position of the oompany at the time to whioh the balancesheet lefers. But it was also pointed out that an auditor is not an insurer, and that in tbe discharge of his dnty he |ls only bonnd to exercise a reasonable amount of care and skill. It was farther pointed out that what, in any particular oase, is a reasonable amonnt of oare depends on the circumstances of that case ; that if there is nothing whloh ought to excite suspicion less core may properly be oonsfdered reasonable than conld be so considered if suspicion was or ought to havo been nrottßßd. These are the general principles j which have to be applied to oases of this description, I protest, however, against tbo notion that an andltor is bound to be suspicions, as distinguished from reasonably carefnl. To substitute the one expression for the other may easily lead to serious error. Mr Justice Lopez spoke la a similar strain, This seems a fair definition. An andltor knowingly affixing his certificate to a false or incomplete balance-sheet, or showing culpable carelessness, should be liable to the shareholders who ara misled. Bat where reasonable care is exercised there shonid be no snoh responsibility. Applying these conditions to the Kingston Mills Company Mr Juatioo Lopez thus explained how the auditors wero misled :— In order to bolster up the company and mako it appear flourishing wben it was tho reverse, the manager deliberately exaggerated both the quantities end values of tbe colton and yarn in the company's mills. He did tbls at the end of tho years 1890, 1891, 1892, and 1893. There was no hook or account (except the stock journal to which 1 will refer presently) showing the quantity or value of the ootton or yarn in the mill at any one time. It wonld not be easy to keep Bach a book. Nor is it wanted for ordinary purposes. There is considerable waste (20 or 25 per cent on the average) in the manufacture of yarn from cotton, and tbe market prioes ot both cotton and yarn are subject to great fluctuations. The balance-sheets of each year contained on tho assets Bide entries of the valnes of tbe stoek-ln-trade at the end of the year, and those entries were stated to ba " qb per manager's certificate," There were also in the balance-sheets entries on the opposite Bide of the valnes of the stock-in-trade at the beginning of the year, The quantities did not appear in either case. The endltors took the entry of the stock-in-trade at the beginning of the year from the last preceding balancesheet, and they took the values of the stock-,ln- trade at the end of tbe year from the stock journal. This book contained a series of acconnts nnder various beads porporting to show the quantities and values of the company's stock-in trade at the end of eaoh year, and a summary of all the acconnts showing the total valne ot such stock-in-trade, The summary was Blgned by the manager, and the value as 6hown by it was adopted by tbe auditors and was inserted as an asset in the balance-sheet, bnt " as per manager's certificate." The summary always corresponded with the accounts summarised, and tbe auditors ascertained that this was the oase. Bnt they did not examine fnrtber into the acenraoy ot the accounts summarised. The auditors did not profess to gnarantee tbe correctness of this item. Tbey assumed no responsibility for it. They took the item from the manager, and the entry in the balanco-sheet. showed that they did so. I confess I oannot see that their omission to check his returns was a breaoh of their dnty to the company. It is no part of an auditor's dnty to take stock. No one contends that it is. He must rely on other people for details of the stock-in-trade in hand. In the oase of a cotton mill he must rely on some skilled person for the materials necessary to enable him to enter tbe stock-in-trade at its proper value in the balance-eheqt. In this oase the auditors relied on the manager. He was a man of high character and of unqnestloned competence. He was trusted by everyone who knew him. The learned Judge has held that the dlreotors are not to be blamed for trusting him. The auditors had no suspicion that he was not to be trusted to give accurate Information as to tbe stock-in-trade in band, and tbey trusted him accordingly ia that matter, Bat it Is said they ought not to have done so, and for this reason : The stock joarnal showed the quantities— that is, the weight in pounds— of the cotton and yarn at the cud of each year, Other books showed the quantities of cotton bought during the year and the quantities of yarn sold during the year. If these books had been compared by the auditors they wonld have found that the quantity of ootton and yarn in hand at the end of the year ought to be mnch less than the quantity shown in the stock joarnal, and so mnch less than the value of the cotton and yarn entered in the stock journal conld not be right, or at all events was so abnormally large as to excite suspicion and demand farther inquiry. This is tho view taken by tho learned Judge. Bat, although it is no doubt true that suoh a process might have been gone through, and that, if gone through, the fraud wonld have been discovered, can it be truly said that the auditors were wanting in reasonable care in not thinking it necessary to test the managing director's return ? I cannot bring myself to think they were, nor do I think that any jary of business men would take a different view. It is not sufficient to say tbat the frauds mnst have been detected if the entries ln the books had been put together in a way which never occurred to anyone before suspicion was aroused. The question is whether, no suspicion of anything wrong being entertained, there was a want of reasonable care on the part of the auditors in relying on the retnrns made by a competent and trusted expert relating to matters on which information from snch a person was essential, I cannot think there was. This jadgment has been differently received, one leading Londun paper declaring tbat it amounts to a decision that auditors are mere counting machinea, to see whether certain figures placed before them are oorreotly added up. We, oannot agree with this view, it is totally unreasonable to expect an auditor, who ls chosen for his abilities as an accountant, to be aa expert to judge the valnes of machinery or stock of whioh he knows nothing. It is still more unreasonable to make him peonniarily responsible for the frauds of others, unless ln the bookß placed before him there Is sufficient to causa an expert accountant to snßpeot fraud. The remedy to us Beems to Ho iv another direction than Government audit. The law should define exaotly how the bookß of companies shonid be kept, epeoify what liabilities and assets are to be separately stated, punish any officer of a oompany making a fraudulent valuation of stock or other assets whioh the auditor oannot be expeoted to cb,eok ob an expert, and punish auditors for certifying to any balance-sheet not in striot accordance with the terms of the Jaw. We have reoently heard with astonishment that at least one large company last year did not show any liability for an enormous amount of bills nnder dlsoount, a large proportion of whioh ultimately proved bad. 16 was with still greater surprise that we heard this defended as a common praotlee. Now no true balance-sheet can be drawn up with suoh omissions. This is one of the Instances where a law such as we have suggested would be effootual. It would provide for the separate showing of bills receivable and payable, and both managers and auditors would be re. sponsible for the omission of suoh details. Tbere would be no difficulty in defining the forms In which books must be kept, or in whioh balance-sheets should be issned. Of course different businesses require different special books io be kept, but they would be outside the speoial books required by law. There shonid be a day-book, ledger, oash-book, and bill, book, showing all transactions of the business, and necessary stock-books certified to by responsible officers who should be held criminally liable for any f a i se valuation. The auditor mußt be left to say what debts are good and bad, and there a Government andltor flying round the'colony would be' utterly incompetent to form a sound jadgment, even If bucb information were not withheld from him as Mr Millar's bill provides. The auditor should, in imort, be' held responsible for matters reasonably within bis ken, but tho offioßrs of a oompany must be responsible for statements of the quantities and values of goods in atook, and other matters which do not borne within the province of bd expert accountant, For

ill > i-i-i.-iiiiinmiiißiiijißMnnnaiii iimiiwiiimm the better proteotioo of shareholders and creditors the law might enable an auditor to demand a valuation of any special assets by an expert; to be ohoson by himself,, but. to expect him to be an expert Sn every branch of commerce would be absurd. **************************