AF3507: Company Law

Accounts, Audits and

Investigations

Topic 9
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Objectives
Explain the legal requirements of company
accounts
Explain the role, duties and liabilities of
company auditors
Explain the legal rules related to investigation
by Inspectors under CO

Company Accounts

The Company Must Keep

Accounting Records
Every company must keep proper books of account (s373)
and those books must:
Show and explain the companys transactions
Disclose with reasonable accuracy, at any time, the companys
financial position and financial performance; and
Enable the directors to ensure that the financial statements
comply with the Companies Ordinance

Types of Accounting Records

The Company must keep records of (s373[3]):
Daily entries of all sums of money received
Companys assets and liabilities

If directors fail to take all steps to ensure compliance, they

commit an offense with fines of HK$300.000 and possibly
imprisonment for 12 months (s373 [5] and [6])
Any directors (not members) have a right to inspect the
accounting records kept by the company (s 375)

Directors Must Prepare Annual

Financial Statements (S 379)
The annual financial statements of a financial year must give a
true and fair view of the financial position and financial
performance of the company as at the end of the year (s380[1])
The financial statements must also comply with the rules of the
Companies Ordinance and professional financial standards
(s380[4])
Financial records must conform with CO Sch 4.
Consolidated B/S and P&L if the company has subsidiaries
Partial exemption for private Cos (s359-366)
Directors must prepare an Annual Report and submit it to GM
(s388-91)
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Reporting Exemption for Private Firms

A benefit of simplified financial and directors report
applies to those private firms that qualify for such a
benefit under ss359-366 and schedule 3 of the Companies
Ordinance

Qualified private firms are referred to in the Ordinance as

companies falling with the reporting exception

Simplified financial reporting

No requirement to disclose the auditors remunerations (s380*3+)
No requirement for financial statements to give a true and fair
view (section 380*7+)
No requirements to include business review in the directors
report (s388[3][a])
No requirement for the auditor to express a true and fair view
opinion on the financial statements (s406[1][b])
Financial statements will be prepared under the SME-FRS and
FRF accounting standards which are more lenient than the HKFRS
standard applicable to listed, public or other companies not
qualified for simplified reporting

Directors Report: Business Review

(s388 and schedule 5)
The directors report must include a section called
business review which provides a more analytical and
forward-looking view of the company
Firms which are not bound to this requirement
Private companies qualified for simplified reporting
Private companies not qualified for simplified reporting can opt
out of business review requirement by SR in GM

Auditors

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Auditors role
Accounts = internal check on finances
Audits = external/independent check on accounts
Audit report is primarily for shareholders
Audit report might be relied on by investors, creditors

Every company must appoint auditors (s394)

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Auditors - powers
Right of access to all books, accounts and vouchers (s412[1])

Entitled to attend general meetings (s411)

Subsidiaries must provide info/explanations to their holding
companys auditors (s412*4+)
An offense for officer to knowingly/recklessly make a false or
misleading statement to auditor (s413)
Statutory immunity (in contract, tort, defamation or
otherwise) (s410).
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Enhanced Auditors Rights to Information

The auditor can ask for information to among other
persons (s412):

companys officers;
HK subsidiary of the company;
the officers or auditors of such a subsidiary;
person holding or accountable for any of the accounting records
of the company or subsidiary;
ask a HK holding company to require information from its non-HK
subsidiaries

Failure of these persons to comply with the auditors

requests entail criminal sanctions (s413)

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Auditors appointment and resignation

First auditors appointed by directors, until first
AGM (s395)
Subsequent auditors appointed at AGM, till next
AGM (s396 and s402)
Auditors may resign at any time by notice, stating
circumstances that need be brought to attention of
members/creditors, if any, and company must
notice Registrar and members in 15 days (s417 and
s424)

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Auditors removal
Company may remove auditors from office at any time, by
ordinary resolution (s419)
If members propose removal, they must give special notice
(s419[2])
If public company removes auditors, it must give notice to the
Registrar within 14 days (s419[4])

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Auditors Statement of Circumstances

An auditors right to make a statement of the circumstances
connected with this separation from the company has now
been granted to
(1) a resigning auditor,
(2) an auditor who has been removed, and
(3) a retiring auditor who has not been reappointed

(s424, s425(1) and s410)

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Auditors duties and liabilities

Duty to prepare a report (s405) stating whether:

the financial statements have been prepared in accordance with the CO

the financial statements give a TRUE AND FAIR value of the financial position
and financial performance of the firm

if a) and b) above are not met the auditor must state this in the report along
with his/her opinion

Duty to investigate (s407) in order to form an opinion as to whether:

Proper books of account have been kept

BS and P&L agree with books of account

Reckless omissions in the report in relation to 1) and 2) is an criminal

offense punishable with a fine of 150.000HK$ (s408)

Obligation to carry out the service as stipulated in the contract with the
client (s415)

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Act honestly, with reasonable care and skill?

In earlier days,
Auditor is a watchdog but not a bloodhound, entitled to
assume managers are honest and rely on their representations
- Re Kingston Cotton Mill (1896)
Where suspicion is aroused more care is obviously necessary;
but still an auditor is not bound to exercise more than
reasonable care and skill - Re London and General Bank (1895)

More exacting care and skill is expected today than in C19th Re Thomas Gerrard & Sons (1968)
Should have investigated more if suspicion

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Auditors duty of whistle blowing

(Common law) May have duty to report fraud/misconduct to
Board/AGM
Sasea Finance Ltd v KPMG (2000)
(Statutory immunity) May have duty to report
fraud/misconduct to regulatory authorities (see SFO s 381)

1919

Auditors - liability
Statutory liabilities:
Criminal liabilities: penalties
Civil liabilities: damages

Liabilities under contract:

to company, in damages, for failure to perform with care and skill

Liabilities in tort (negligence):

to company
to creditors, investors, individual members

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Auditors liability for negligence

Liable to client / company if breach of duty of care in
performing duties
Might be liable to a third party who is shown the accounts
and relies on them Hedley Byrne v Heller (1963)

To be successful to sue for negligence:

Existence of duty of care
Breach of duty of care
Loss

2121

Existence of duty of care

Proximity and foreseeability
Auditors owed duty to existing shareholders as a whole,
but generally not to prospective investors, lenders, or
other persons who rely on the audit report, because of
lack of proximity
Caparo Industries v Dickman (1990)

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Existence of duty of care

Proximity can be found between the auditor and the
person who relied on the auditors report:
Galoo Ltd v Bright Grahame Nurray (1994): if the auditor is made
aware that a particular identified bidder would rely on the audited
accounts, and the auditor intended that the bidder should so rely
Yue Xiu Finance v Agnew (1996): the auditor knew, or should
have known that *the other party+ would rely on their statements
Law Society v Peat Marwick (2000): the accountant knew the
purpose for which the report was required, and that (the other
party) would rely on it

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Investigations

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Investigations and Enquires (Part 19 CO)

Financial Secretary may appoint an Inspector to investigate and
report on the affairs of the company (ss840-841) where:
The members apply for it (100 members or members representing not less
than 10% of the issued shares
The company asks for it through special resolution in GM
On its own initiative where there is fraud or mismanagement involved

Company officers and agents have a duty to produce books and

documents, answer questions on oath. Non-compliance with a
question of the investigator amounts to an offense (s 863) and
the court may order the compliance of such a request (s864)
Inspectors report to the Financial Secretary is not binding but is
admissible as evidence in legal process (s 862).

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Powers of the Companies Registrar

The Registrar has a new power to require the production
of records or documents, to make copies of the record or
documents and to require information or explanations in
respect of the records or documents, for the purposes of
ascertaining the existence of a offence relating to the
giving of false or misleading information in documents
delivered to the Registrar ([ss873-876, s750[6], s895[1])
Refusal by the company to comply with the Registrars
request is an offense (s875)

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