The accountant's certificate in connection with the accountant's responsibility

              (
INTERNATIONAL
ACCOUNTANTS' CONGRESS
AMSTERDAM 1926
SIR WILLIAM PLENDER Bt., G s E., F.C.A.
LONDON
Member of the Council of the Institute of Ghartereu Accountants
in England and Wales
THE ACCOUNTANT'S
CERTIFICATE IN CONNECTION
WITH THE ACCOUNTANT'S
RESPONSIBILITY
11
•f
mm.
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1
Koninklijk NIVRA
THE ACCOUNTANT'S CERTIFICATE IN CONNECTION WITH
THE ACCOUNTANT'S RESPONSIBILITY.
BY Sir WILLIAM PLENDER
Bart., G. B. E., F. C. A. Past President of the Institute of Chartered
Accountants in England and Wales and Member of the Council.
The subject upon which I have been asked to address you at
this Conference is comprehensive in scope and character. The
duties undertaken by the Professional Accountant in Great Britain
to-day, cover a wide field and are of varied nature, but it is true to
say that to a very considerable extent, the result of the Accoun­tant's
work is embodied, and finds its expression, in the form of a
Report or Certificate. Indeed, if any evidence were required of the
extent to which the investing Public and business community as­sociate
the Accountant's duties with his Report or Certificate, it
is to be found in the frequent use and acceptance of the phrase
"The Accountant's Certificate", as indicating the bona fides of
figures which the Accountant has reported upon or certified, or in
respect of which his investigation and confirmation are desired.
A clear conception by Accountants of their duties and respon­sibilities
in connection with certificates issued by them is thus of
vital importance. An exhaustive treatise dealing with the matter
in all its aspects would occupy much more time than has been al­lotted
to me and occupy more space in your transactions than can
be spared: neither do I imagine you would wish me to enter upon
a detailed dissertation on the many and varied circumstances lead­ing
up to the issue of Certificates. I therefore propose, in my re­marks,
to deal with the subject broadly and in general outline, in
such a manner as to indicate the fundamental principles which
every Accountant should bear in mind, when called upon in the
exercise of his professional duties, to prepare and attach his sig­nature
to a Certificate.
In Great Britain, the profession of an Accountant is not exer­cisable
under any legal enactment, and the Accountant has there­fore
no legal status in the same way as a Lawyer. So far as I know,
<
X\<^ 7 V' . --29TI
• * * ^ - .
2 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
no country has accorded the profession legislative sanction as such.
The practice of the profession of an Accountant by Members of
recognised bodies with disciplinary powers, has, however, long
been accepted and regarded in Great Britain by the Courts and the
business community, as one of high standing and responsibility.
Neither do the duties or responsibilities of Accountants as such form
/ the subject of any Act of Parliament. It has, however, become ne-cessary
from time to time for the Courts to consider the question
I of the duties and responsibilities of Accountants, and the judg-
( ments given in cases which have been adjudicated upon, are avail­able
as a source of information and guidance. But whilst the Ac­countant
must have regard, for his own protection, to the legal
aspect of his duties and responsibilities, no such limitation should be
permitted to lessen the duty, prescribed by a code of professional
honour, which he owes not only to his client but to the Public, to
the profession and to his own reputation. And perhaps in no other
circumstances is a due sense of this moral duty and responsibility
required in such high degree as when the Accountant is engaged in
framing a Certificate.
Having thus briefly defined the sense in which I speak of the
Accountant, it is necessary to consider the various forms of Cer­tificates
which Accountants are called upon to give. Broadly, these
Certificates may be said to fall under two heads, namely:
[a) Those given in accordance with statutory requirements, and
(Ö) Other Certificates.
The former in the main comprise Certificates or Reports by
Accountants as Auditors of Public- and other Companies. Amongst
the latter may be cited those given in connection with:—
(1) Raising Share and Debenture Capital by means of a Prospectus
or otherwise.
(2) Absorption or amalgamation of Companies or Firms.
(3) Trade Agreements between groups of Companies for sharing
profits or losses upon a specified basis.
(4) Determination of Profits available for defined purposes such
as: Sums payable to different classes of Share- or Debenture
Holders; Management Commission; Profit Sharing Schemes, etc.
(5) Expenditure upon Contracts.
(6) "Fair Value" of Shares under terms of Articles of Association and
WITH THE ACCOUNTANT S RESPONSIBILITY. 3
Valuation of Shares for purpose of assessment to Death Duties.
(7) Ascertainment of relative shares of Capital and Labour in pro­fits
of an Industry under joint agreement.
The instances I have noted by way of example, whilst including
some of the more important circumstances in which certificates
are frequently given, are, by no means exhaustive. Other illustra­tions
could be furnished but it seems unnecessary, for my present
purpose, to add to the list.
Whilst the same standard of duty and conduct should be ob­served
and the highest degree of proficiency exercised in the pre­paration
of all certificates, the measure of the Accountant's respon­sibility
varies considerably and is dependent upon a combination
of factors and circumstances. As exemplifying cases to which the
heaviest responsibility attaches, I propose in this paper to consider
and deal with two classes of certificates well known to the general I
public in Great Britain, namely, certificates given by the Accoun­tant
qua Auditor in fulfilment of statutory requirements under the
Companies (Consolidation) Act, 1908, and certificates appear­ing
in Prospectuses inviting public subscription to issues of Share-and
Debenture Capital. And as both these certificates have relation
to the affairs of Joint Stock Companies it may not be inappropriate
at this stage if I refer briefly to the radical change which has taken
place during the last 50 years in the financial structure of Industry.
This transformation is chiefly apparent in the aggregation and
transference of immense amounts of capital from the hands of in­dividuals
to Joint Stock Undertakings administered under Boards
of Directors. The following figures extracted from the last published
Return of the British Board of Trade dealing with the affairs of
limited liability Companies in Great Britain show the rapid develop­ment
and expansion of Joint Stock enterprise:—
Year
1885
1895
1905
1915
1924
Number of LimitecJ
Liability Companies
8.924
18.607
38.317
63.969
90.918
Total paid up Share Capital
£ 482.000.000
I 1.037.000.000
£ 1.912.000.000
£ 2.606.000.000
£ 4.356.000.000
4 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
The figures quoted are exclusive of capital — running into many
hundreds of millions of pounds — embarked in what are known as
Parliamentary or statutory companies incorporated under special
Acts of Parliament, mainly of a public utility character such as
Railways, Canals and Gas- and Water undertakings. No official
statistics are available of the aggregate amount of Debenture Ca­pital
raised and employed by Joint Stock Companies or of the ac­cumulations
of undistributed profits retained as free reserves or
otherwise but the combined amount thereof must be very consider­able.
And apart from permanent Share Capital, Free Reserves and
Debenture Capital — either irredeemable or of fixed maturity, —
financial obligations to creditors are contracted in the ordinary
course of trade in respect of which vast sums are owing at any given
date. These facts sufficiently indicate the importance of the finan­cial
interests of shareholders and creditors and the responsibilities
involved in the administration of Joint Stock enterprises. The part
played by the Accountant in the capacity of Auditor and expert
financial adviser has materially contributed to the growth and pre­sent
standing of the profession as carried on to-day in Great Britain,
and the position the Accountant has thus attained in the public
confidence, whilst enhancing his authority, has also widened his res­ponsibilities.
Compulsory audit of the Accounts of Limited Companies —
other than Banks — was not imposed by the legislature until the
year 1900, but the appointment of auditors under a Company's
own regulations (Articles of Association) was customary and re­garded
as an essential safeguard by the majority of reputable Pu­blic
Companies before that date. The statutory obligation requiring
the appointment of auditors in the case of all registered companies,
was first contained in the Companies Act 1900 and the duties of the
Auditor were therein laid down in the following terms:—
"Every auditor of a company shall have a right of access
"at all times to the books and accounts, and vouchers of the
"Company, and shall be entitled to require from the directors
"and officers of the company such information and explanation
"as may be necessary for the performance of the duties of the
"auditors; and the auditors shall sign a certificate at the foot
"of the Balance Sheet, stating whether or not all their re-
WITH THE ACCOUNTANT'S RESPONSIBILITY. 5
"quirements as auditors have been complied with, and shall
"make a report to the shareholders on the accounts examined
"by them, and on every Balance Sheet laid before the Company
"in general meeting during their tenure of office, and in every
"such report shall state whether in their opinion the Balance
"Sheet referred to in the report is properly drawn up so as to
"exhibit a true and correct view of the state of the company's
"affairs as shown by the books of the company, and such report
I "shall be read before the company in general meeting."
^ In practice the certificate and report of the Auditor became merg­ed
and, subject to reservations and enlargements as circumstances
required or justified, usually appeared as one document at the foot
of the Balance Sheet in the following general terms:—
"In accordance with the provisions of the Companies Act
^ 1900, I certify that all my requirements as Auditor have been
complied with, and I report to the Shareholders that I have
audited the books of the Company, and in my opinion the Ba­lance
Sheet is properly drawn up so as to exhibit a true and
correct view of the state of the Company's affairs as shown by
the books of the Company".
^---/'The distinction between the Auditor's "Certificate" and "Re-,
,•'' port" thus became more apparent than real; and although in the
section of the Companies (Consolidation) Act 1908 which now go­verns
the duties of Auditors the word "Certificate" has entirely
disappeared and the Auditor's Report alone is mentioned, the habit
previously acquired of referring to the Auditor's Certificate still
largely obtains.
1 • The statutory rights and duties of Auditors of Limited Companies
are now embodied in the Companies (Consolidation) Act 1908 — an
I Act, as its title implies, consolidating and codifying previous le-
:• gislation — as under:—
113. (1) "Every Auditor of a company shall have a right of access
"at all times to the books and accounts and vouchers of the
"company, and shall be entitled to require from the directors
"and officers of the company such information and explana-
"tion as may be necessary for the performance of the duties
"of the auditors.
j (2) "The auditors shall make a report to the shareholders on the
6 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
"accounts examined by them, and on every balance sheet laid
"before the Company in general meeting during their tenure
"of office, and the report shall state —
(a) "whether or not they have obtained all the information
"and explanations they have required; and
(b) "whether, in their opinion, the balance sheet referred to in
"the report is properly drawn up so as to exhibit a true and
"correct view of the state of the company's affairs according
"to the best of their information and the explanations given
"to them, and as shown by the books of the Company.
(3) " the auditors' report shall be attached to the
"balance sheet, or there shall be inserted atthefootof thebalan-
"ce sheet a reference to the report, and the report shall be read
"before the Company in general meeting, and shall be open to
/ "inspection by any shareholder".
,. ' I t is the exception, rather than the rule, for the auditor's report
' to constitute a separate document apart from that appended to the
Balance Sheet, and the form in which the report is most frequently
framed follows closely the wording of the Act. When the auditor
is satisfied as a result of his examination that there are no exceptio­nal
or special circumstances to which the attention of the sharehol­ders
need be directed, he gives an unqualified report usually in the
following terms:—
"I have audited the above Balance Sheet and have obtained
all the information and explanations I have required. In my
opinion such Balance Sheet is properly drawn up so as to ex­hibit
a true and correct view of the state of the Company's af­fairs
according to the best of my information and the expla­nations
given to me and as shown by the Books of the Company.
I No attempt has been made in the Act — nor indeed would it
i' be possible in the varying circumstances and conditions under
which business is carried on — to define even in general terms, the
extent or limits of the auditors duty. The legislature has placed at
the disposal of the auditor ample and adequate means of enquiry
to supplement the direct evidence afforded by the books and ac­counts
and has not restricted in any way the scope of his report. It
is thus left to the auditor himself, with his professional training
and experience, to determine both the extent of his examination
WITH THE ACCOUNTANT'S RESPONSIBILITY. 7
and the nature of his report by reference to the necessities of each
particular case. The general principles which, according to legal
interpretation, the auditor should bear in mind and follow, have
been enumerated with great distinctness by the British Courts in
three well-known and familiar cases in which auditors were accused
of neglect in the performance of their duties, and the judgments
delivered may be summarised thus: —
(a) An auditor is guilty of misfeasance (that is,breach of duty)
z ^ who when dissatisfied with the accounts of a Company does not
^ plainly draw attention to the grounds for his dissatisfaction
in his Report (the case of the London and General Bank Ltd.).
(b) An auditor is not guilty of breach of duty who, in the absence
of suspicious circumstances relies upon statements made by
trusted officers of a Company (the case of the Kingston Cotton
Mill Co. Ltd.).
(c) An auditor is liable if falsification in the accounts of a company
might have been discovered by the exercise of reasonable care
and skill (the case of the Irish Woollen Co. Ltd. v. Tyson and
^thers).
,- ' Widely as individual circumstances may differ in practice the
•^ measure of the auditor's legal responsibility in connection with his
certificate may be said to rest upon the practical interpretation of
these three decisions. I therefore propose to examine the principles
applied by the Court in determining whether an auditor has proper­ly
fulfilled his statutory duties.
The development of the office of auditor is a natural corollary
to the expansion of joint stock enterprise and although he is appoint­ed
by and reports to the shareholders as a body, the nature and
object of the office involve in special degree a duty to the sharehol­ders
concerned solely as investors as distinct from shareholders
engaged in the management and direction i. e Directors. This dis­tinction
has been recognised judicially in the following words: —
"Possibly he" (the auditor) "did not realise the extent of
"his duty to the shareholders, as distinguished from the Di-
"rectors, and he unfortunately consented to leave the Chair-
"man to explain the true state of the Company to the share-
"holders instead of doing so himself It is impossible
"to read the Companies Act without being struck
8 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
"with the importance of the enactment that the Auditors are
"to be appointed by the shareholders, and are to report to them
"directly, and not to or through the Directors. The object of
;l "this enactment is obvious. It evidently is to secure to the
jl "shareholders independent and reliable information respecting
U "the true financial position of the company at the time of the
11 "audit" (re London and General Bank Ltd).
y The object of the audit is thus defined in judicial language, and
/ the view expressed may be regarded as an adequate and clear in­terpretation
of the intention underlying the statutory requirements.
These requirements involve two essential and inter-dependent as­sumptions.
First the exercise of independent judgment as conveyed
by the words "In my opinion", and secondly, the possession of a
high degree of professional skill and ability in ascertaining the facts
justifying the opinion expressed that the Balance Sheet is properly
drawn up so as to exhibit a true and correct view of the state of the
Company's affairs according to the best of the information and ex­planations
given to the auditor and as shown by the books of the
„Company. As will be seen hereafter, the protection afforded to the
auditor by the use of the phrases "In my opinion" and "According
to the best of my information and the explanations given to me and
as shown by the books of the Company", is dependent upon his
own professional efficiency and the extent of his examination and
inquiries. Nor would it be in the best interests of the profession to
' avoid responsibility — either legal or moral — by attaching a too
literal meaning to the words I have quoted.
\ As exemplif}ang the scope and limits in law of the auditor's
; iuties and responsibilities, the Judges have laid down the following
dicta, which for convenience, I have arranged under four headings:
ll) The general nature of the Auditor's duties.
2) The scope of the Auditor's investigation and enquiries.
(3) Limitations of the Auditor's responsibilities.
(4) Considerations affecting the Auditor's Report.
I am led to give in some detail the views of British Judges
which bear on an Auditor's duties and responsibilities as my au­dience
here may not be so familiar with them as would be the case
with an audience exclusively British. But their value is to no small
extent international.
WITH THE ACCOUNTANT'S RESPONSIBILITY. 9
(1) — THE GENERAL NATURE OF THE AUDITOR'S DUTIES.
"His business is to ascertain and state the true financial position
"of the Company at the time of the audit and his duty is confined
"to that. But then comes the question: How is he to ascertain that
"position ? The answer is: By examining the books of the Company.
"But he does not discharge his duty by doing this without enquiry
"and without taking any trouble to see that the books of the Com-
"pany themselves show the Company's true position. He must take
"reasonable care to ascertain that they do. Unless he does this his
"audit would be worse than an idle f a r c e . . . . His first duty is to
"examine the books not merely for the purpose of ascertaining what
"they do show but also for the purpose of satisf3n.ng himself that
"they show the true financial position of theCompany." (ReLondon
"and General Bank Ltd.).
"The words "as shown by the books of the Company" seem to
"me to be introduced to relieve the auditors from any responsibility
"as to the affairs of the Company kept out of the books and concealed
"from them but not to confine it to a mere statement of the corres-
"pondence of the Balance Sheet with the entries in .the books"
"(Re London and General Bank Ltd).
"Auditors of a Limited Company are bound to know or make
"themselves acquainted with their duties under the Articles of
"the Company whose Accounts they are appointed to audit and
"under the Companies Acts for the time being in force." (Re Re­public
of Bolivia Exploration Syndicate Ltd.).
"That it is the duty of a Company's Auditor in general to satisfy
"himself that the securities of the Company in fact exist and are
"in safe custody, cannot I think, be gainsaid An Auditor is
"not, in my judgment, ever justified in omitting to make personal
"inspection of securities that are in the custody of a person or com-
"pany with whom it is not proper that they should be left The
"duty of the Auditor is to verify the facts which it is proposed to
"state in the Balance Sheet and in doing so to use reasonable and
"ordinary skill" (Re City Equitable Fire Insurance Co. Ltd).
(2) THE SCOPE OF THE AUDITOR'S INVESTIGATION AND ENQUIRIES : —
"An auditor however is not bound to do more than exercise
10 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
"reasonable care and skill in making enquiries and investigations
" What is reasonable care in any particular case, must de-
"pend upon the circumstances of that case. Where there is nothing
"to excite suspicion very little enquiry will be reasonably sufficient;
"and in practice I believe business men select a few cases haphazard,
"see that they are right and assume that others like them are correct
"also. When suspicion is aroused more care is obviously necessary;
"but still, an auditor is not bound to exercise more than reasonable
"care and skill even in a case of suspicion". (Re London and General
Bank Ltd.).
"An auditor is not bound to be a detective or to approach
"his work with suspicion or with a foregone conclusion that there
"is something wrong. He is a watch-dog but not a bloodhound.
"He is justified in believing tried servants of the Company in whom
"confidence is placed by the Company. He is entitled to assume that
"they are honest and to rely upon their representations provided
"he takes reasonable care. If there is anything calculated to excite
"suspicion he should probe it to the bottom, but in the absence of
"anything of that kind he is only bound to be reasonably cautious
"and careful. The duties of Auditors must not be rendered too
"onerous. Their work is responsible and laborious and the remunera-
"tion moderate." (Re Kingston Cotton Mill Co. Ltd.).
"The duty of an auditor is verification and not detection
"it is for the auditor to use his discretion and his judgment and his
"discrimination as to whom he shall trust: indeed that is the right
"way to put a greater responsibility on the auditors I throw
"a burden upon him in respect of which the test of common sense
"and business habits can be applied rather than impose on him a
"rigid rule which is not based on any principle either of business
"or common sense In my opinion it would not be right that
"auditors should deliberately adopt a standard of verification below
"the ordinary standard because the persons with whom they are
"dealing are persons of specially high reputation". (Re City Equit-
"able Fire Insurance Co. Ltd.).
"The auditor cannot shelter himself from any breach of duty
"under the neglect of the Directors: he is there to do his duty to the
"Company". (London Oil Storage Co. Ltd. v. Seear Hasluck & Co.).
WITH THE ACCOUNTANT'S RESPONSIBILITY. II
(3) LIMITATIONS OF THE AUDITOR'S RESPONSIBILITIES:—
"It is no part of an auditor's duty to give advice either to direc-
"tors or shareholders as to what they ought to do. An auditor has
"nothing to do with the prudence or imprudence of making loans
"with or without security. It is nothing to him whether the busi-
"ness of a company is being conducted prudently or imprudently,
"profitably or unprofitably: it is nothing to him whether dividends
"are properly or improperly declared provided he discharges his
"own duty to the shareholders.... He is not an insurer; he does not
"guarantee that the books do correctly show the true position of a
"Company's affairs; he does not even guarantee that his Balance
"Sheet is accurate according to the books of the Company. If he did
"he would be responsible for an error on his part even if he were
"himself deceived, without any want of reasonable care on his part
"— say by the fraudulent concealment of a book from him. His
"obligation is not so onerous as this. He is perfectly justified in
"acting on the opinion of an expert where special knowledge is
"required". (Re London and General Bank Ltd).
"It is no part of an auditor's duty to take s t o c k . . . . He must rely
"on other people for details of the stock-in-trade on hand. Auditors
"must not be made liable for not tracking out ingenious and care-
"fully laid schemes of fraud when there is nothing to arouse their
"suspicion and when those frauds are perpetrated by tried servants
"of the Company and are undetected for years by the Directors.
"So to hold would make the position of an auditor intolerable."
(Re Kingston Cotton Mill Co. Ltd.).
(4) CONSIDERATIONS AFFECTING THE AUDITOR'S REPORT:
"He must be honest — that is, he must not certify what he does
"not believe to be true and he must take reasonable care and skill
"before believes that what he certifies is true A person whose
"duty it is to convey information to others does not discharge that
"duty by simply giving them so much information as is calculated
"to induce them or some of them to ask for more. Information and
"means of information are by no means equivalent terms. An au-
"ditor who gives shareholders means of information instead of in-
12 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
"formation respecting a Company's financial position does so at
"his peril and runs the very serious risk of being held judicially to
"have failed to discharge his duty. Sjill there may be circumstances
"under which information given in the shape of a printed document
"circulated amongst a large body of shareholders, would by its
"consequent publicity, be very injurious to their interests and in
"such a case I am not prepared to say that an auditor would
"fail to discharge his duty if instead of publishing his report
"in such a way as to ensure publicity, he made a confidential
"report to the shareholders and invited their attention to it and
"told them where they could see it". (Re London and General
Bank Ltd.).
"In reporting upon the accounts submitted to them the auditors
"do not, of course report as to the details of accounts to which they
j "find no cause to take exception. Their duty is to call attention to
I "that which is wrong, not to condescend upon all the details of that
"which is right Those who are engaged in commerce are
"familiar with the fact that undue publicity as regards the details
"of their trade or as to their financial arrangements may often be
"very injurious to traders having regard to the rivalry of competi-
"tors in trade, to complications sometimes arising from strained
"relations between capital and labour and the like. There are legi-
"timate reasons for ensuring secrecy to a proper extent. It is not,
"I think, necessary, nor having regard to the great utility of these
"Acts, is it desirable to expose persons who trade under these Acts
"to the necessities of a publicity from which their competitors are
"free unless such publicity is required to ensure commercial inte-
"grity". (Newton v. Birmingham Small Arms Co. Ltd.).
"When it is shown that audited Balance Sheets do not show
"the true financial condition of the Company and that damage has
j "resulted the onus is on the Auditors-to show that this is not the
"result of any breach of duty on their part." (Re Republic of Bolivia
Exploration Syndicate Ltd).
That the practical application of these principles is frequently
a task of great difficulty is self-evident from the language used, and
recognition of this fact has been expressed by the Courts in more
than one case as the following extracts taken from the remarks of
the Judges will show: —
/
WITH THE ACCOUNTANT'S RESPONSIBILITY. 13
"It is quite easy to lay down to you in general terms what
"the duty of an auditor is; it is very much more difficult.... to
"apply that duty to the particular case." (London Oil Storage
Co. Ltd. V. Seear Hasluck & Co).
"They "(the auditors)" had to exhibit a standard of pro-
"fessional skill, and if they did not come up to that standard
"that was for the Judge or J u r y . . . . to say and that was always
"a difficult matter to try". (Arthur E. Green&Co. v.The Central
_^-' Advance & Discount Corporation Ltd.).
A dishonest Auditor renders himself liable to prosecution under
Criminal Law for wilfully making a statement knowing it to be
false in any material particular. Proceedings may be brought against
him: —
(a) Under section 281 of the Companies (Consolidation) Act, 1908,
which reads: —
"If any person in any return, report, certificate balance sheet
"or other document, required by or for the purposes of any of the
"provisions of this Act specified in the Fifth Schedule hereto,
"wilfully makes a statement false in any ma,terial particular
"knowing it to be false, he shall be guilty of a misdemeanour,
"and shall be liable on conviction on indictment to imprison-
"ment for a term not exceeding two years, with or without hard
"labour, and on summary conviction to imprisonment for a
"term not exceeding four months, with or without hard labour,
"and in either case to a fine in lieu of or in addition to such im-
"prisonment as aforesaid:
"Provided that the fine imposed on summary conviction shall
"not exceed one hundred pounds".
(b) Under section 84 of the Larceny Act 1861 which enacts: —
"Whosoever, being a director, manager or public officer of
"any body corporate or public company, shall make, circulate
"or publish, or concur in making circulating or publishing, any
"written statement or account which he shall know to be false
"in any material particular, with intent to deceive or defraud
"any member, shareholder, or creditor of such body corporate
"or public company, or with intent to induce any person to
"become a shareholder or partner therein, or to entrust or ad-
"vance any property to such body corporate or public company
14 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
"or to enter into any security for the benefit thereof, shall be
"guilty of a misdemeanour, and being convicted thereof shall
"be liable at the discretion of the court, to any of the punish-
"ments which the court may award as hereinbefore last men-
"tioned".
In this paper, however, I am concerned only with the penalties
to which the auditor is exposed in civil proceedings by reason of
errors of omission or commission amounting to breach of duty on
his part. Such proceedings may be brought (1) under Common Law
on the ground of negligence for which every Agent is liable through
lack of reasonable care or diligence, or (2) when a Company is
being wound up by way of misfeasance Summons, under Section
215 of the Companies (Consolidation) Act 1908, which enacts: —
(1) "Where in the course of winding up a Company it appears that
"any person who has taken part in the formation or promotion
"of the Company, or any past or present director, manager or
"liquidator, or any officer of the Company has misapplied or
"retained or become liable or accountable for any money or
"property of the company, or been guilty of any misfeasance
"or breach of trust in relation to the Company, the Court may,
"on the application of the official receiver, or of the liquidator,
"or of any creditor or contributory examine into the conduct
"of the promoter, director, manager, liquidator, or officer and
"compel him to repay or restore the money or property or any
"partthereof respectively with interest at such rate as the Court
"thinks just or to contribute such sum to the assets of the
"Company by way of compensation in respect of the mis-
"application retainer, misfeasance or breach of trust as the
"Court thinks just."
(2) "This section shall apply notwithstanding that the offence is
"one for which the offender may be criminally responsible".
It is interesting to note the views of one of the Lords of Appeal
upon the terms of Section 165 of the Companies Act of 1862 which
corresponds in almost precise words with the section of the Act of
1908 which I have just quoted. He says: —
"That Section creates no new offence and it gives no new
"rights, but only provides a summary and efficient remedy in
"respect of rights which apart from that Section might have
WITH THE ACCOUNTANT'S RESPONSIBILITY. 15
"been vindicated either at law orin equity. It has also been settled
"that the misfeasance spoken of in that Section is not misfeasance
"in the abstract, but misfeasance in the nature of a breach of
"trust resulting in a loss to the Company". (Bentinck v. Fenn).
The measure of the Auditor's responsibility under the above
section is therefore the loss sustained by the Company — direct
or consequential — due to failure on his part to point out a state
of affairs the disclosure of which would have either prevented the
initiation of a wrongful or mistaken course of action or conduct or
have resulted in its discovery and discontinuance.
Legal proceedings brought against Auditors of Limited Com­panies
by way of Misfeasance Summons or otherwise have been
comparatively few in number. In the majority of reported cases
relating to misfeasance, it has been sought to make the Auditor
liable, on the ground of breach of duty, to refund jointly with Di­rectors
dividends alleged to have been wrongfully paid out of
capital owing to failure on the part of the Auditor to detect and
report either the non-existence, misdescription or overvaluation
of assets or the omission of liabilities, disclosure of which would
have shown that profits were not available for distribution. Having
regard to the fundamental basis of limited liability it would seem
equitable that the Auditor ought not to be called upon solely on the
ground of payment of a dividend, to implement assets in the hands
of a Liquidator, except to the extent required to meet claims of
creditors (and possibly to indemnify holders of after acquired shares)
bearing in mind the fact that the then existing shareholders them­selves
received the dividend in question. Such a limitation of the
Auditor's liability does not, however, appear to be regarded by the
Court as a defence available to the Auditor; when, however, the share­holders
who received the dividends knew at the time that they were
improperly paid, the Auditor, apparently, has a right of recovery
from them. The extent of the Auditor's liability in the circumstances
mentioned, is not however, necessarily limited by the amount dis­bursed
in dividends. He may be held accountable for loss or damage
suffered by the Company resulting from the cumulative effect
or repetition of initial wrongs or errors for which he was originally
in no way responsible, but which he failed to bring to the notice of
the shareholders.
16 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
Having regard to the decisions of the Courts which I have at­tempted
to summarise, the auditor cannot, I think, complain that
they place too heavy a burden upon him. The legal standard of duty
expected is high, but not too exacting having regard to the pro­fessional
status which practising accountants have attained. It is
true to say that the reputation enjoyed by the professional Account­ant
does not rest upon his adherance to legal principles, however
important; it is mainly by reason of the Accountant's regard for
his much wider moral duty and responsibility that he enjoys the
confidence of the business community and the public generally.
The mere observance of legal requirements may develop into a for­mality
and render easy the evasion of responsibility upon technical
grounds. No such limitation of our responsibilities should be per­mitted
to influence the conduct of our professional business.
Although the auditor is responsible primarily to the shareholders
yet in the light of modern Company development a somewhat wider
view should, I think, be taken by the auditor himself. He should re­member
that Balance Sheets of Public Companies are, for practical
purposes, public documents: they are studied by the Stock Ex­change
and the prospective investor when forming an opinion as
to the value of the share and debenture capital; they are made avail­able
to traders as an indication of financial stability and they are
used by the Companies themselves when raising Bank Loans and
making other financial arrangements. Bearing in mind the variety
of purposes for which an audited Balance Sheet may be used, the
auditor should refrain from taking too narrow a view of his respon­sibilities,
and his object should be not merely to shield himself from
legal consequences, but to realise and accept as the basis of his duty
• the more important moral responsibilities which the position in­volves.
It is not the duty of the auditor to prepare the Balance Sheet:
that is the responsibility of the Directors assisted by the Officials
of the Company. The auditor is concerned to see that the Share­holders
are given a true and correct view of the state of the Com­pany's
affairs and the sole medium of his communication with the
Shareholders is his report. He is not accountable to individual Share­holders
or groups or classes of Shareholders, but to the Shareholders
as a body. Primarily the Shareholders look to the Directors for in-
WITH THE ACCOUNTANT'S RESPONSIBILITY. 17
formation as to the financial position of the Company and rely
upon the auditor to point out in what way the Balance Sheet may
fail to reflect a true and correct view of the state of the Company's
affairs. Hence qualifications^in the auditor's report are apt to be \\
regarded with disfavour by Directors and with suspicion by Share- I
holders. In practice, therefore, the auditor may be able to exercise 1
considerable influence — by advice or persuasion — over Directors 1
in regard to the form in which accounts are presented to the Share­holders.
Every Balance Sheet is a summation of facts and opinions. It
should represent what, in the judgment of the Directors, is a fair
statement of the financial position of the Company, having regard
to the object for which it was formed and-to the existing circum­stances
and future maintenance of its business. It should be drawn
up in such a manner as to afford Shareholders an adequate means
of ascertaining, by perusal and enquiry, the value of their interests
without disclosing information likely to cause loss or injury to the
business. It is the province of the auditor to apply his trained mind
to a critical examination of the Balance Sheet with a view to seeing
whether, in his opinion, it substantially fulfils these conditions. He
is not required to certify to an exact state of affairs, but he must be
satisfied, in the light of the evidence available to him, that the Ba­lance
Sheet is properly drawn up in accordance with customary
usage.
The auditor will naturally be largely guided in the opinions he
forms by the proved ability and character of the Directors and Of­ficials
entrusted with the management and conduct of the Company's
affairs; more particularly must he rely upon them in connection
with matters involving expert and specialised knowledge of the in­dustry
concerned which he himself cannot-reasonably be expected
to possess. In the main, however, the financial problems of every
business are much the same and differ only in degree, and in con­sidering
such questions the auditor is able to bring to bear a mind
capable of impartial and expert judgment and discrimination.
The duties of the auditor, as laid down by Statute may conven- '•.
iently be summarised in two words — Verification and Report
— He has first to examine ihe books and obtain information and
explanations: thereafter he has to submit a Report setting forth
18 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
the conclusions at which he has arrived as the result of his investi­gation
and enquiries. The first stage of his duty concerns the as­certainment
of facts; the second stage necessitates the expression
of an opinion based upon the exercise of independent judgment.
Now in regard to the former, it may be said, subject always to
exceptional circumstances, that there are certain facts which an
auditor is bound to verify independently, viz: —
(1) The existence of such of the physical assets as are capable of
verification by inspection or trustworthy confirmation from
sources other than the Company's officials. Such assets would
include Cash in hand. Investments, Bills Receivable, Freehold
and Leasehold property, Security held against advances and
the like.
(2) The amounts of Balances owing by or to the Company's Ban­kers
and other debts and liabilities of exceptional character,
not arising from normal trading operations.
The auditor must, generally speaking, satisfy himself as to the
existence of other assets, if any, and the extent of the liabilities
by the evidence of the books and records verified as far as necessary
or practicable, having regard to the volume of the business and its
internal organisation, and supplemented by information and ex­planations
obtained from the Company's officials. And in this con­nection
it may be noted that the practical application of scientific
accountancy to all classes of business has largely minimised the
risks of fraud by means of defalcation and embezzlement.
Any inability on the part of the Auditor so to verify the existence
of assets or any doubts he may entertain as to the omission of lia­bilities
and commitments should be clearly stated in his report.
Instances are common of companies whose operations abroad
render it impossible for the auditor himself to examine accounts kept
locally, and in such cases reliance must to a considerable extent be
placed upon Returns either audited locally or certified by the of­ficials
in charge. The fact that the Balance Sheet incorporates ac­counts
not under the immediate purview of the auditor should be
specifically referred to by the auditor in his Report. I do not pro­pose
to enlarge upon these basic principles except to say that res­ponsibility
cannot be evaded by self-imposed limitation of duty
which the circumstances do not warrant even if the auditor reports
WITH THE ACCOUNTANT'S RESPONSIBILITY. 19
the extent to which he has restricted his examination. His duties
are statutory.
Having satisfied himself as to the correctness of the transactions '
recorded in the books and the existence of the assets, the Auditor
has to consider whether the Balance Sheet submitted to him by the
Directors is presented in such a form as will justify him in reporting
thereon in the words of the Statute without qualification or sup­plemental
observations. The legislature has rightly considered the
conduct of private enterprise to be the concern of business men, and
has refrained from undue interference in matters of domestic
policy affecting shareholders as a body. The form and contents of
the annual Balance Sheet and Accounts presented to the sharehol­ders
by the Directors, are not prescribed by law except in certain
cases (e. g. Life Assurance Companies, Building Societies, Railways
and other public utility undertakings governed by special Acts
of Parliament) where the nature of the business and privileges en­joyed
are such that special financial information is necessary in
the public interest. Apart from these exceptional instances, the
question of the information to be disclosed by the Balance Sheet
and the form in which it is submitted to the shareholders, are except
to the extent that the directors may be bound to comply with any
directions duly given by the Company in general meeting matters
within the sole discretion of the Directors subject to any regulations
contained in the Articles, of Association. In the words of Lord Justice
Lindley "it has been very judiciously and properly left to the com­mercial
world to settle how the Accounts were to be kept." The Di­rectors
alone are responsible for the administration of the Com­pany's
affairs and are accountable to the shareholders for their
acts.
Undoubtedly, there has been a growing tendency during the
past few years to curtail — in some cases unreasonably — the in­formation
afforded to shareholders. The remedy is in the hands of
the shareholders themselves. The auditor has no power to insist
upon a fuller disclosure of details by Directors, and yet, unless the
Balance Sheet be in his opinion actually misleading, he cannot well
report that it is not properly drawn up so as to exhibit a true and
correct view of the state of the Company's affairs. So to do would
be to confuse his duties and ÏNesponsibilities with those of the Direc-
20 THE ACCOUNTANT S CERTIFICATE IN CONNECTION
tors; the auditor should be careful to distinguish between what may
appear to him to be desirable as opposed to what is essential, re­membering
that a mistaken view of his duties might be the cause
of embarrassment and loss to the shareholders, whose interests
he is appointed to protect. When, however, the auditor is not sa­tisfied
that the Balance Sheet discloses a true and correct view of
the state of the Company's affairs, and considers that it is incorrect
or misleading, he should convey his views in clear and unambiguous
terms to the shareholders.
The Auditor should have a clear conception of the attitude he
should take up in regard to the values placed upon the various as­sets.
Whilst he is not a valuer in the ordinary sense of the word and
cannot be expected to place values upon fixed assets, such as Land,
Buildings and Plant — indeed such assets are not, in the ordinary
way, revalued for Balance Sheet purposes — yet he can generally
obtain sufficient information to enable him to form an opinion as
to the adequacy of the provisions for the amortisation of the book
values of wasting assets. If he is not satisfied on this point it might
be his duty, but only after reviewing the whole circumstances, to
make a qualification in his report. In regard to many liquid assets,
however, he should be able to form, and, if necessary express, a
view as to the values adopted in the Balance Sheet. Otherwise
the opinion he is required to give as to whether the Balance Sheet
exhibits a true and correct view of the state of the Company's af­fairs
will be of little or no value to the shareholders. Qualifications
in Auditor's reports largely arise in connection with values placed
upon the assets by the Directors, and in this connection it is of the
utmost importance to appreciate the bearing which such valua­tions
have upon the financial position of the Company as disclosed
and the profits shown as available for dividend.
•^f In Great Britain, the Auditor is confronted with a series of some­what
involved legal decisions given as a result of applications to the
Courts to determine to what extent it is necessary for the Share
Capital of companies to be preserved intact as an essential condition
to be fulfilled before a dividend can be paid. Each case necessarily
has reference to the specific facts and circumstances before the Court
and in particular to the Company's own domestic regulations so
far as such regulations are not inconsistent with the Statute; the
WITH THE ACCOUNTANT'S RESPONSIBILITY. 21
decisions therefore, cannot be regarded as laying down any unal­terable
or fixed rules which should be slavishly followed. In the
words of the Lord Chancellor (Lord Halsbury) in the case of "Dovey
V. Cory": —
"The mode and manner in which a business is carried on,
"and what is usual or the reverse, may have considerable
"influence in determining the question what may be treated as
"profits and what as capital It is easy to lay down as
"an abstract proposition that you must not pay dividends
"out of capital, but the application of that very plain propo-
"sition may raise questions of the utmost difficulty in their
"solution. I desire, as I have said, not to express any opinion,
"but as an illustration of what difficulties may arise the exam-
"ple given by the learned counsel of one ship being lost out of
"a considerable number, and the question whether all dividends
"must be stopped until the value of that lost ship is made good
"out of the further earnings of the Company or partnership,
"is one which one would have to deal with. On the one hand,
"people put their money into a trading concern to give them
"an income, and the sudden stoppage of all dividends would
"send down the value of their shares to zero ahd possibly in-
"volve its ruin. On the other hand companies cannot at their
"will and without the precautions enforced by the statute re-
"duce their capital; but what are profits and what is capital
"may be a difficult and sometimes an almost impossible pro-
"blem to solve. When the time comes that these questions come
"before us in a concrete case we must deal with them, but until
"they do, I, for one, decline to express an opinion not called
"for by the particular facts before us, and I am the more averse
"to doing so because I foresee that many matters will have
"to be considered by men of business which are not altogether
"familiar to a Court of law."
In the same case, Lord Macnaghten said: —
"I do not think it desirable for any tribunal to do that
"which Parliament has abstained from doing — that is, to
"formulate precise rules for the guidance or embarrassment
"of business men in the conduct of business affairs. There never
"has been, and I think there never will be, much difficulty
22 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
"in dealing with any particular case on its own facts and cir-
"cumstances and speaking for myself, I rather doubt the wis-
"dom of attempting to do more."
Nevertheless, observations made by Judges in -summing up evi­dence
and facts before them in specific cases, are useful and in­structive
and enable us to contrast what may be held to be legally
sufficient with what is regarded as financially sound and commer­cially
prudent. I have extracted from the Judgments the following
passages as illustrative of the way in which the Courts approach
these questions: —
^ ^ "But if the Court sees that the Directors and the Company
"have acted fairly and reasonably the Court is very un-
"willing to interfere with the discretion exercised by directors
"who have the management of the Company The Act
"does not say what expenses are to be charged to Capital and
"what to Revenue. Such matters are left to the shareholders;
"they may or may not have a sinking fund or a deterioration
"fund, and the articles of association may or may not contain
"regulations on those matters; if they do, the regulations must
"be observed; if they do not, the shareholders can do as they
"like so long as they do not misapply their capital. . . . The
"Companies Acts do not require the capital to be made up if
"lost I cannot find anything in them which precludes
"payment of dividends so long as the assets are of less value
"than the original capital The Act says nothing to make
"the loss of the capital a ground for winding-up
"The proposition that it is ultra vires to pay dividend out
"of capital is very apt to mislead, and must not be understood
"in such a way as to prohibit honest trading. If you treat it
"as an abstract proposition, that no dividend can be properly
"paid out of moneys arising frotn the sale of property bought
"by capital you find yourself landed in consequences which
"the common sense of mankind would shrink from accepting.
"On the other hand if the working expenses exceed the current
"gains, you cannot divide your capital under the head of pro-
"fits when there are no profits in any sense of the term
"It is said that a Company is not to be at liberty
"to pay a dividend unless they can show that their available
WITH THE ACCOUNTANT'S RESPONSIBILITY. 23
"property at the time of declaring the dividend is equivalent
"to their nominal or share capital. In my opinion, such a con-
"tention is untenable". (Lee v. Neuchatel Asphalte Co. Ltd).
"The broad question is whether a limited Company
"which has lost part of its capital can lawfully declare or pay
"a dividend without first making good the capital which has
"been lost. I have no doubt it can — that is to say, there is
"no law which prevents it in all cases and under all circumstan-
"ces. Such a proceeding may sometimes be very imprudent,
"but a proceeding may be perfectly legal and may yet be op-
"posed to sound commercial principles there is a vast
"difference between paying dividends out of capital and paying
"dividends out of other money belonging to the Company,
"and which is not part of the capital mentioned in the com-
"pany's Memorandum of Association. The capital of a Com-
"pany is intended for use in some trade or business, and is
"necessarily exposed to risk of loss if the capital is lost
"the company is under no legal obligation either to make it
"good or, on that ground only, to wind up its affairs. If, there-
"fore, the Company has any assets which are not its capital
"within the meaning of the Companies Acts, there is no law
"which prohibits the division of such assets amongst the share-
"holders.... There is no law which prevents a company from
"sinking its capital in the purchase or production of a money-
"making property or undertaking, and in dividing the money
"annually yielded by it without preserving the capital sunk so as
"to be able to reproduce it intact It would, in my judg-
"ment, be most inexpedient to lay down a hard and fast rule
"which would prevent a flourishing company either not in debt
"or well able to pay its debts from paying dividends so long
"as its capital sunk in creating the business was not represented
"by assets which would, if sold, reproduce in money the capital
"sunk Moreover, when it is said, and said truly, that
"dividends are not to be paid out of capital, the word "capi-
"tal" means the money subscribed pursuant to the memoran-
"dum of association or what is represented by that money....
"But, although there is nothing in the statutes requiring even
24 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
"a limited company to keep up its capital, and there is no pro-
"hibition against payment of dividends out of any other of the
"Company's assets, it does not follow that dividends may be
"lawfully paid out of other assets regardless of the debts and
"liabilities of the Company. A dividend presupposes a profit
"in some shape if the income of any year arises from a
"consumption in that year of what may be called circulating
"capital, the division of such income as dividend without re-
"placing the capital consumed in producing it will be a pay-
"ment of a dividend out of capital within the meaning of the
"prohibition which I have endeavoured to explain the
"word "profits" is by l^o means free from ambiguity. The law
"is much more accurately expressed by saying that dividends
"cannot be paid out of capital than by saying that they can
"only be paid out of p r o f i t s . . . . Perhaps the shortest way of
"expressing the distinction which I am endeavouring to ex-
"plain is to say that fixed capital may be sunk and lost, and
"yet that the excess of current receipts over current payments
"may be divided, but that floating or circulating capital must
"be kept up,, as otherwise it will enter into and form part of
"such excess, in which case to divide such excess without de-
"ducting the capital which forms part of it will be contrary
"to law Capital lost must not appear in the accounts as
"still existing intact; the accounts must show the truth and
"not be misleading or fraudulent". (Verner v. The General and
Commercial Investment Trust Ltd.).
" Where a Company has made losses in past years
"and then makes a profit out of which it pays a dividend, the
"question is a different one. Such a dividend is not paid out
• "of paid-up capital. If it were, the paid-up capital would be
"still further reduced by the payment. In fact, the assets re-
"presenting the paid-up capital remain the same or of the same
"value as before the payment of the dividend. It may be that
"the balance to the credit of Profit and Loss Account ought to
"be applied in making up lost capital, and it may be that the
"directors are liable for neglecting to apply it in this way. But
"such a payment does not involve a reduction of capital, it
WITH THE ACCOUNTANT'S RESPONSIBILITY. 25
"involves a failure to make good capital which has already
"been lost If payment of dividends out of the balance
"to the credit of Profit and Loss is open to attack, it is, I think,
"on the ground (omitting any question of dishonesty) that the
"course adopted is one which is contrary to the practice which
"governs all competent business men in the keeping of their
"accounts. This is possibly another aspect of the distinction,
"on which stress has sometimes been laid, between the two pro-
"positions that dividends must not be paid out of capital and
"that dividends can only be paid out of p r o f i t s . . ..
" What is circulating capital and what is fixed ca-
"pital is a question which in many cases may well embarrass
•'the business man and the accountant, as well as the lawyer.
"According to some of the definitions the same asset may be
"fixed capital in one company and circulating capital in another
" I am not satisfied that the proposition that it is con-
"trary to all principles of commercial accountancy to utilise
"an increase in the value of a fixed asset for the purpose of
"getting rid of a debit which represents loss of paid-up capital
"is not too wide. It may be a precept of prudence and yet be
"far removed from the sphere of the categorical imperative.
"Assuming that a Company ought to keep the value • of its
"assets up to the amount of the liabilities and paid-up capital
"or, in other words, to see that its paid-up capital is intact, why
"should it be absolutely precluded from stating the true value
"of its assets ? If it is necessary or proper that a Com-
"pany shall maintain its assets at the amount of its paid-up
"capital liabilities, there would not appear to be anything
"illegitimate in showing that the assets are equal to the paid-up
"capital and liabilities. Nor for this purpose can it matter that
"the increased value is due to the fixed assets. The paid-up
"capital is represented by both fixed and circulating capital,
"and it seems somewhat arbitrary that circulating capital
"may be shown at its true value while fixed capital must not.
"Take the case of a depreciation fund. The effect is that the
"value of the assets as shown in the account is diminished by
"the amount of the depreciation fund. If the assets in fact in-
"crease in value to the extent of the depreciation fund, there
26 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
"is no rule which prohibits a Company from wiping out the
"depreciation fund from the liabilities side of the account
"Directors would no doubt, not be justified in ascribing to a
"fixed asset a value which is the result of purely temporary
"fluctuations. It is one thing to treat an unrealised increase
"in value of a fixed asset as profit and to pay dividends out
"of it as profits; but it appears to me to be a different question
"whether in considering whether there is a deficiency in.paid-
"up capital owing to past losses, which ought to be made good
"out of future profits the real value of the assets can be as-
"certained with the object of discovering if, in fact, there is
"a deficiency in the paid-up capital
"The directors, no doubt, would have been better advised if
"they had obtained a revaluation from some expert valuer,
"although if one may judge by the evidence on the subject
"which I have heard, the margin of difference between the
"views of values on the subject is very great. But there is no
"rule of law which requires directors to obtain outside assistan-
"ce in such matters or prevents them from valuing the property
"themselves, provided, of course, that they act honestly in
"doing so." (The Ammonia Soda Co. Ltd. v. Arthur Chamber­lain
and Others).
"I proceed on a principle as old as the beginning of Company
Law — the principle, namely, that in matters of the kind
"here in question, — matters necessarily of estimate and opi-
"nion — a Company is presumably the best judge of its own
"affairs a manufacturer requires or resolves to discard
"certain machinery and to replace it with other machinery
"more effective or more economical. Here again, the sacrifice
"in the case of the old machinery is simply an item in the cost
"of the change And although it may be a prudent and
"proper thing to provide for the recurrence of such expenditure,
"and to set up a renewal fund, that is a question which the
"trader considers for himself, and one as to which even in the
"case of limited companies. Courts of Law are not accustomed
"to interfere". (Cox v. Edinburgh and District Tramways
Co. Ltd.).
WITH THE ACCOUNTANT'S RESPONSIBILITY. 27
"It is necessary, however, to consider whether the deprecia-
"tion in goodwill and leases is to be treated as loss of "fixed"
"capital or of "floating or circulating" capital Depre-
"ciation of goodwill seems to me to be loss of "fixed" capital.
"It closely resembles the loss which a railway company might
"be said to sustain if it were found that a line, which had been
"made, say ten years ago, at a certain cost, could now be made
"for a very much smaller amount and consequently would not
"yield if it were sold the price expended in making i t" (Wilmer
"v. M'Namara & Co. Ltd.).
" the periodical ascertainment of profits in a business
"is an operation of such practical importance as to be essential
"to the safe conduct of the business itself. To follow out the
"strict consequence of the legal conception in making out the
"acdounts of the year would often be very difficult in practice.
"Hence the strict meaning of the word „profits" is rarely ob-
"served in drawing up the accounts of firms or companies."
(the Spanish Prospecting Co. Ltd).
Although the courts confine themselves to the interpretation
and administration of the law it will be seen that practical considera­tions
are not unheeded. If legal requirements are complied with the
judges are disinclined to interfere with or restrict the discretion of
business men in a course of action, which, whilst exceeding legal
requirements may be sanctioned by custom and dictated by pru­dence.
On the other hand, if directors prepare accounts solely on the
basis of legal requirements the Court will not regard their action
as blameable even if it be recognised that prudence should or might
have dictated another policy.
Assets as a rule cannot be specifically earmarked as representing
the Share Capital, neither does the expenditure on fixed assets ne­cessarily
correspond to the share capital subscribed. The proposi­tion
that floating or circulating assets must be kept up or be shown
at their true value is, generally speaking, not at variance with com­mercial
practice. Instances arise which give great concern to an au­ditor
— such as the value of securities owned or lodged as collateral
against Loans where the securities are not quoted or it is extremely
28 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
difficult to ascertain their immediate or ultimate worth, where a
loan is entirely unsecured and repayment is not made within the
period of its currency as arranged with the borrower, where trade
debts are over due and Bills Receivable are repeatedly renewed.
No exact rules for the treatment of such cases can be laid down.
The auditor must reach his own conclusions from the available
facts, as to whether he is justified in giving an unqualified report
if no adequate inner reserves exist to protect the institution in the
event of the Directors' and Management's views as to values in the
instances cited perhaps proving to be optimistic.
It is in regard to the treatment of fixed asset values that con­siderable
divergence of opinion may arise between the legal aspect
and the business conception of the Balance Sheet. Neither has nor
should have regard to break-up values: the function of the Balance
Sheet is to show the position of an undertaking as a going concern
and not to show the probable result of liquidation, a fact not always
apreciated by those who are inclined to criticise published Accounts.
The value of fixed assets such as Buildings, Plant, Machinery etc.
acquired for the purpose of producing profits should not be regarded
for Balance Sheet purposes as dependent upon their cost of repla­cement
or upon earning capacity. The intrinsic value may, for va­rious
reasons fluctuate widely from time to time: the only stable
and known factor so far as the Company is concerned is their cost.
Cost may therefore be said to be the correct initial basis of value:
but the auditor must have regard to the maintenance of the fixed
assets and provision for their ultimate renewal and in this connec­tion
temporary falls in value are not by themselves ground for
adverse report. There is no obligation upon Directors to have assets
valued by independent experts. Indeed, unless a sale be contemplated,
it is frequently a matter more of academic than practical interest
to attempt to estimate any variation in value. Any depreciation so
computed could hardly be regarded as lost capital or capital un­represented
by assets provided a systematic and adequate provision
for depreciation had been set aside: the effect of such a provision
should go far to- rectify any probable shrinkage in value and should
adjust to appreciably their correct relationship the value of the
fixed assets with that part of the share capital sunk in the under­taking.
WITH THE ACCOUNTANT'S RESPONSIBILITY. 29
The expediency or otherwise of writing-off Goodwill out of pro­fits
and making provision against other capital expenditure not
represented by tangible assets is a question of policy and as such
does not concern the auditor; but the Balance Sheet should show
the facts in these respects. Practically the only fixed assets to which
a market value can be attached, consist of permanent investinents
as for example Shares possessing stock exchange quotations; but
the size of the holdings and benefits derivable there-from in ad­dition
to dividend income, may have a material bearing upon their
real worth apart from their purely investment value.
The extracts from judgments of the Court to which I have al­ready
drawn attention show an appreciation by the Judges of the
difficult and delicate nature of our duties and there is legal reco­gnition
of circumstances which may justify secrecy and the adoption
of a course of action dictated by prudence. The latitude allowed
to Directors is illustrated by the following definitions by Judges
of what a Balance Sheet should convey: —
"A full and fair Balance Sheet must be such a Balance Sheet
"as to convey a truthful statement as to the Company's po-
"sition. It must not conceal any known cause of weakness in
"the financial position or suggest anything which cannot be
"supported as fairly correct in a business point of view". (Re
London & General Bank Ltd.).
"If the Balance Sheet be so worded as to show there is an
"undisclosed asset, whose existence makes the financial po-
"sition better than that shown, such a Balance Sheet will not
"in my judgment be necessarily inconsistent with the Act of
"Parliament. Assets are often, by reason of prudence, estimated,
"and stated to be estimated, at less than their probable real
"value. The purpose of the Balance Sheet is primarily to show
"that the financial position of the Company is at least as good
"as there stated, not to show that it is not or may not be
"better." (Newton v. Birmingham Small Arms Co. Ltd.).
These judicial utterances are helpful as indicating that the legal
perception of the Balance Sheet is not wholly uninfluenced by prac­tical
considerations of business expediency. Not seldom is it the fact
that there are undisclosed reserves whose existence is a necessity for
the well-being and security of the institution. To publish those re-
30 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
serves might be not only inexpedient but damaging, and the dicta
of the learned judge just quoted is a justification for reasonable
reticence and business prudence honestly exercised. An auditor
who issues a report whose terms are ill-judged and without a due
sense of proportion by a confusion of his duties with those of the
Directors and Management against whose probity and business
capacity there is no reflection of allegation, may do infinite and
irreparable harm. And on the other hand by an easy compliance
with the views of others and by subordinating his own judgment to
that of men whose management of an institution has been indifferent
and faulty, as disclosed by the books, he would injure those who look
to him for protection. An auditor in such cases must not only exer­cise
sound judgment, but display courage regardless of consequences
if he believes himself to be in the right. If the auditor's judgment
be attacked the onus rests upon him to show that the facts and cir­cumstances
of the particular case justified the report he has signed.
And therein lies the responsibility; an opinion will not by itself afford
protection to the auditor if the view he acts upon and expresses is
subsequently held to have been formed carelessly or without suf­ficient
inquiry.
I now pass on to a brief review of the responsibility attaching to
the Accountant in connection with certificates issued for inclusion
in Prospectuses or Offers for Sale inviting the'public to subscribe
for or purchase shares and debentures in Industrial undertakings.
The development of joint stock enterprise in Great Britain,
great and beneficial as has been its effect, was not unattended
by some disadvantages, as it afforded scope for the activities of'
dishonest persons seeking to enrich themselves at the expense of
the unwary. Much has since been done by the legislature to protect
the investing public by making compulsory the disclosure of ma­terial
information and by rendering directors and promoters per­sonally
liable in respect of incorrect or erroneous statements ap­pearing
in Prospectuses offering Share- and Debenture Capital for
subscription. And apart from such legislation, the Stock Exchanges
in Great Britain have greatly assisted in safeguarding investors by
withholding quotations, and thus rendering securities largely unne-gotiable,
in cases where Prospectuses do not comply with their re­quirements.
WITH THE ACCOUNTANT'S RESPONSIBILITY. 31
There is no statutory obligation upon Companies to publish,
in prospectuses, a record of trading profits for a series of years, or
a statement of their financial position at a recent date. It has,
however, become the almost regular practice for such infor­mation,
when available, particularly as regards profits to be given
in the form of an Accountant's Certificate, for two reasons —
(1) the certificate generally speaking relieves directors and pro­moters
from responsibility in regard to the facts it conveys, and
(2) the certificate serves as an assurance to the public that the
figures are reliable.
The vast amount of capital subscribed each year for the develop­ment
of industrial undertakings is both an indication and a justi­fication
of the value attributed to such certificates. The Accountant
who furnishes such a certificate whether or not he thereby incurs
any legal liability is at any rate morally responsible, first to pro­moters
and directors who, relying upon the results of the accoun­tant's
investigation as embodied in the proposed prospectus cer­tificate,
proceed with the formation and flotation of an existing
business as a public company, and secondly to investors who apply
for and take up shares and debentures in established or in newly
formed companies, and may have been influenced in doing so by
the indication of earning capacity as reflected by the certified profits
of past years.
It is I think, true to say that no class of Accountant's certificate
has greater publicity than the Prospectus Certificate or is wider in
its influence and appeal. The Auditor is not responsible for the pre­paration
of Accounts or the form in which they are presented to
shareholders: his report thereon follows the wording of the Act sub­ject
to necessary qualifications. In the case, however, of Prospectus
Certificates he is solely responsible for the manner in which they
are framed: they are his entire creation, and his sense of responsi­bility
should prevent him from signing a certificate whose terms,
whilst technically correct and sufficient, may nevertheless be pre­sented
in such a manner as to render the true results obscure and
lend themselves open to wrong construction and inferences. A
certificate liable to criticism on such grounds is none the less re­prehensible,
because the impression it conveys was unintentional
on the part of the certifying Accountant. It is his duty to exercise
32 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
all necessary care and caution to prevent possible misunderstanding,
and whilst endeavouring to comply with the reasonable wishes of
his client, the Accountant should remember that his first concern
— which is not inconsistent with his client's true interests — must
be for the public. The responsibility for the form of the certificate
must therefore rest entirely with the Accountant and he should re­ject
any suggested modification of the form of certificate which in
his judgment the circumstances do not warrant.
It is a truism to say that the Accountant in such a certificate
must confine himself to facts: it is not within his province to make
or certify estimates, neither should he express an opinion as to the
probabilities or possibilities of the future. But the facts stated should
be adequate and sufficient. The period in respect of which it is
desired to quote the profits is a factor of considerable importance.
A short period of exceptional prosperity clearly due to abnormal
circumstances in the specific business or trade would by itself be
an unfair criterion to adopt; whilst on the other hand, unfavourable
results attributable to price cutting and trade strikes or other de­pressing
influences, might also by themselves not do justice to the
merits of the security offered. The detailed explanation which the
bearing of such unfavourable conditions has had on Profits is more
a matter for the Directors to deal with in the prospectus than the
Accountants in their certificate. In such circumstances, the period
selected should be sufficiently long to enable the financial effects
of abnormal prosperity or depression to be viewed in their true per­spective.
The manner of arriving at the profits should be suitably
described to indicate the adjustments considered necessary and made
in the figures as shown by the books and Accounts in order to arrive
at the desired result, namely, the balance of Profit which remains,
(after providing for prior charges, if any), to meet appropriations
to free reserves and interest or dividend upon the security offered.
It is, of course, true that the results for a past series of years do not
take into account the increased profits which the employment of
Additional Capital is likely to yield. But the Accountant should
refrain from attempting to prophesy the annual benefit likely to be
derived therefrom, and should leave the Directors responsible for
the carrying on of the business to make their own estimate in this
respect.
WITH THE ACCOUNTANT'S RESPONSIBILITY 33
Many important questions of accounting arise in the adjustment,
for the purpose of a Prospectus certificate, of the profits shown by
the books and the annual Accounts. It is permissible to delete charges
which can properly be regarded as capital outlays but which for
reasons of prudence have been written off against profits, and re­serves
made by a company for contingencies which have not arisen
may properly be eliminated. Thp re-allocation of expenditure charg­ed
in any one year over a series of years to which they properly
apply, is frequently necessary. On the other hand there may be ex­penditure
of an exceptional and non-recurring nature which whilst
properly provided for out of profits is not an annual charge, and the
income itself may have been augmented by extraneous profits
not arising from the normal trading activities of the company.
The extent to which the Accountant must qualify his certificate
in all or any of these respects can only be determined by a review
of individual circumstances. The trend of the profits is of great im­portance
and for this reason, the figures for each year should be
fetated separately. Where the results reported upon include those
of a broken period they should be stated separately: it may be mis­leading
to compute the yearly profits by reference to those earned
during a portion of a year.
The natural desire for brevity in Certificates should not, of course,
be allowed to curtail a statement of all necessary figures and expla­nations.
Conciseness is very desirable, but it is sometimes found that
both the interests of the Company and the Public will be served by
figures giving additional information bearing on the amount of the
profits, such as the gross turnover; dividends paid; the amount of
share capital outstanding from time to time; the annual expenditure
upon repairs and renewals and the provisions for depreciation.
One occasionaly sees an Accountant's Certificate which does not
state the profits of each year, but attempts to convey what is the
earning capacity by indirect means such as, for example, a statement
that the average annual net profits over a given number of years
are sufficient to pay the interest or dividends on the new capital se­veral
times over and that the net profits of the last j^ear exceeded
such average. In such cases the Accountant accepts undesirable/
responsibilities and often constitutes himself a judge of circumstances
upon which the investor himself should be placed in the position
34 THE ACCOUNTANT'S CERTIFICATE IN CONNECTION
t
to form his own opinion by a full and frank disclosure in the
Prospectus.
Whilst it may be said that the responsibility of the Accountant
in regard to Prospectus certificates is largely a moral responsibility,
he does incur the risk of having to justify before the Courts the state­ments
made bij him in such a certificate. I can only recall one case
(MaynardsLtd. v. Maynard & Others) in which action has been taken
in respect of a prospectus certificate and the certificate in that case
was in the following terms:
"We have examined the accounts of the forty-six retail bu-
"sinesses proposed to be acquired by your Company, the ma-
"jority of which have been established for several years. The
"accounts show that the businesses have been steadily in-
"creasing, the sales now being at the rate of •£ 39.542. 7.5. per
"annum. We have also examined the accounts of the wholesale
"businesses carried on in connection with these retail shops,
"and find that the sales are at the rate of £ 17.795. 11.7. per
"annum, of which by far the greater portion is for goods supplied
"to customers other than the retail businesses, the total sales
"of the combined retail and wholesale businesses above referred
"to being at the rate of £57.337. 19.0. per annum. Owing to
"the absence of figures showing the expenses of some of the
"businesses we are unable to ascertain the exact net profit of
"the whole of them, but from our knowledge of the extremely
"profitable nature of the confectionery trade and from the
"facts disclosed during our investigation we are satisfied that
"the profits of the businesses are large, and that after payment
"of the interest on the preference shares there will remain a
"profit sufficient to pay a substantial dividend upon the ordi-
"nary shares."
The Plaintiffs alleged that the Accountants had knowingly made
false statements as to the profits, but the Court held that they had
acted honestly and were honestly satisfied as to the correctness of
their certificate, and the action against them was dismissed, but the
mere fact that they were called upon to substantiate the opinions
expressed indicates the danger in practice of constituting oneself an
expert as to possibilities.
No one if* free from the frailties which are the heritage of men and
WITH THE ACCOUNTANT'S RESPONSIBILITY. 35
no one is infallible. But in the last half century which has witnessed
the rise and the development of Accountancy as a profession, there
have been comparatively few reported cases in which it has been
shown that practising accountants have failed in discharging ade­quately
their onerous and responsible duties.
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