The directors of KK Limited, a newly formed company, have written to you with a view to securing your services as auditor. Within their letter you note the following comments.

"Your duties and rights as auditor will be determined by the board of our company. In the main these duties are in line with the requirements of the Companies Act 1962 but in the event of conflict or exclusion we will indemnify you against any legal action brought as a consequence of the position adopted. The board also retains the right to dismiss you at any time without necessarily disclosing the reasons for their action".


(a) Describe what is your understanding of your duties as auditor of KK Limited.

(b) What is your relationship as the auditor to the directors of KK Limited?

(c) Outline your rights under the Companies Act as auditor of a limited company.

(d) Would you agree with the directors that they have the authority to dismiss you?

(e) What steps would you take prior to accepting the appointment as auditor to the company?


It has been suggested that the most important matter affecting the credibility of the auditor is that of `Independence'.


(a) Discuss giving examples, matters other than independence, which might be relevant in relation to the credibility of the auditor and steps that the accounting profession has taken or might take in relation to them.

(b) Comment on the following situations in the context of the independence of the auditor, showing clearly the principles involved:-

i. The audit manager in charge of the audit assignment of Andrew holds 1,000 £1 ordinary shares in the company (total shares in issue - 100,000). The audit partner holds no shares.

ii. An audit partner of a firm of Certified Public Accountants is a personal friend of the chief accountant of James Ltd. The chief accountant is not a director of the company and the audit partner is not responsible for the James Limited audit work.

iii. The audit fee receivable from Janet Ltd is £100,000. The total fee income of the Audit firm is £700,000.

iv. The audit senior in charge of the audit of Margot Bank Ltd has a personal loan from the bank of £2,000 on which she is currently paying 13% interest.

v. The audit partner is responsible for two audit assignments, Harry Limited and Jean Limited. Harry Limited has recently tendered for a contract with Jean Limited for the supply of material quantities of goods over a number of years. Harry Limited has asked the audit partner to advise on the matter.


(a) What should an accountant do about commissions?

(b) Enumerate the areas where conflict of interest may occur?

(c) What restrictions are there on advertising?

(d) How can an accountant obtain publicity in an ethical manner?

(e) May an accountant send a video, showing how he could assist a potential company client, direct to that company?

(f) What are the rules on accountants' remuneration?



Onyango, Kamau and Makokha are partners in a small firm of engineers operating in road construction. Since commencing business 20 months ago they have been quite successful. The accounting records have been kept by Onyango who attended Finance for Non-Accountants Seminar some two years back. Onyango has also prepared the first years accounts.

 On review of the accounts the three partners notice that the accounts show a profit in excess of drawings. Kamau and Makokha suggest that they should divide the excess amongst themselves immediately but Onyango counsels caution, talking about working capital needs which confuses the others.

 Makokha questions Onyango on his interpretation of the partnership agreement which is a very complicated document and suggests that they should pay to have the accounts audited. Onyango becomes heated and says that would be a waste of time and money as he is perfectly capable of producing the accounts and makes no charge to his partners for this work.


 What benefits would the partners derive from employing an independent auditor?

 It is common practice for auditors to send a letter of engagement to new clients and increasingly to existing clients. Set out below are matters usually included in such letters.

 i. Definition and scope of audit

ii. Fraud and irregularities

iii. Accounting, taxation and other services

iv. Fees


 (a) Explain why a letter of engagement is desirable for the auditor

(b) In the case of each matter referred to above show what points will be included.

(15 Marks)


For many years the law had adopted an approach whereby no action for negligence could be brought if the parties concerned had no contractual relationship with each other, unless the negligent act caused physical injury or was fraudulent misrepresentation. Thus, the auditor had a contractual relationship with his client or clients' shareholders only and owed a duty of care to them alone. However, the courts have increasingly sought to extend the liability of the auditor to other (even potential) users of financial statements. The view of the judiciary appears to be that the time is ripe for the auditing profession to assume a greater responsibility for its actions. The risk attached to users of audited financial statements has been reduced and, at the same time, there has been an increase in the risk carried by the auditing profession.

 You are required to

 (a) Describe the judicial decisions, which have altered the range of the auditors' duty of care to third parties.

(b) Explain how the auditor can ensure that the risk attaching to an audit is reduced to a minimum.

(c) Comment on the view that much of the litigation and allegations of negligence directed against the auditors may be more appropriately aimed at the directors of a company.