Development of the company audit

A review of the development of UK company legislation, as it affects
auditors, will help consolidate your knowledge of the background to
the auditing of financial statements in the private sector. Obviously it
is specific to one country but the changes which have taken place there
have tended to reflect or be reflected in similar legislation elsewhere.
The development of company audits is discussed in detail in Chapter 2 of
Porter et al. The main points are highlighted here.

1844 Joint Stock Companies Act

This early legislation was quite far-sighted since it recognised the need for
investors, who might not be involved in the running of their companies,
to receive reliable information from those who did play a part in company
management. The Act required all incorporated companies to produce
an audited balance sheet. The auditor was required to report on whether
the balance sheet showed a ‘full and fair view’ of the reporting company’s
position.
A major problem, however, was that there was nothing in the form of an
organised accountancy or auditing profession in existence at that time.
It was therefore hard for investors to tell whether the auditor was either
competent or independent of management.

1856 Companies Act

This Act withdrew the compulsory annual audit and instead gave the
Board of Trade, a government department, the right to investigate a
company upon the application by one-fifth of the shareholders. It is not
known how many investigations were carried out, but clearly this ad hoc
inspection system was less reliable than regular audits of companies.
The 1856 Act did contain model articles of association (part of the
constitution of companies) which allowed for an audit along the lines of the
1844 Act. The difficulty was that these were not mandatory and companies
could choose to adopt alternative articles with no audit requirement.
During the middle of the 19th century there were financial scandals
involving the management of banks, railways, friendly societies, industrial
and provident societies. Parliament intervened to impose specific
legislation and regulations, including accounting and audit requirements,
on such industries.

1900 Companies Act

This Act introduced a compulsory audit for the generality of companies.
There was no requirement for auditors appointed to audit company
accounts to be professional. There was a bar, however, on directors and
officers acting as auditors, so some attempt was made to ensure auditors
enjoyed a degree of independence from management. In a similar vein,
this Act gave auditors a right of access to all accounting records and
information.
Under the 1900 Act, auditors had to report on whether the accounts
showed a ‘true and correct view’.

1948 Companies Act

The scope of the audit was extended by this Act to cover both balance
sheet and profit-and-loss accounts. In addition, auditors had to be
members of one of the professional bodies. This was the first attempt to
improve the competence of those who acted as auditors to companies in
general.
Auditors were to report on whether the accounts showed a ‘true and fair
view’; whether adequate books of account had been kept; whether the
accounts agreed with the books; and whether all the information and
explanations necessary for the audit had been received.

1967 Companies Act

This Act had the effect of reducing the length of standard ‘unqualified’
(unmodified) audit reports: from now on auditors would only refer to
the additional matters on which they had to form an opinion if they were
not satisfied; for example, if they considered that the financial statements
were not in agreement with the books of account. This meant that
auditors’ reports typically amounted to a single paragraph containing the
opinion on whether the accounts showed a true and fair view.

1976 Companies Act

The 1976 Act strengthened the position of auditors by requiring an auditor
who had been removed or had resigned to make a statement setting out
the circumstances of the termination of the position or a statement that
there were no circumstances which should be brought to the shareholders’
attention. This provision was aimed at ensuring that auditors who had had
serious disagreements with directors and no longer wished to remain as
auditor could not slip away quietly without making their concerns known
to those who were entitled to that information, the shareholders.
The Act also sought to enhance the quality of data that auditors checked
by imposing requirements to improve the adequacy of companies’
accounting records.

1981 Companies Act

This major piece of legislation brought UK company law into line with
that of other European countries. It increased the emphasis on the
need for financial statements to show a ‘true and fair view’ and in fact
made this an overriding requirement, meaning that companies could, in
some circumstances, depart from the detailed requirements of the Act if
compliance would have produced a result which was not true and fair.
The Act extended auditors’ work to require a review of the directors’ report
to ensure that it was not inconsistent with the financial statements which
it accompanied.

1985 Companies Act

The 1985 Act merely consolidated previous acts into one piece of
legislation. No new law was introduced.

1989 Companies Act

The 1989 Act was another Europe-inspired statute. It introduced
requirements for auditors to be more formally regulated than before. It
required disclosure of fees paid to auditors for non-audit services as well
as audit fees and allowed for the indemnity insurance premium of an
auditor to be paid by the audit client.

2004 Companies (Audit, Investigations and Community Enterprise) Act

This Act further enhanced the regulation of, and monitoring of compliance
with rules by, auditors.

2006 Companies Act

The biggest single piece of legislation to be passed by a UK Parliament, this
Act allows companies and auditors to agree to place a ‘cap’ on amounts
that may be claimed against auditors. It also makes it a criminal offence
for auditors knowingly to issue a misleading audit report.

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