Limited Companies and Auditors

"Limited Company" means "Limited Liability".

If you are a "sole proprietor", or a "partnership", your liability is UNLIMITED. The creditors may sue you and get the very last penny out from you. President Lincoln of America once failed in a partnership, and he had to work several years to repay the debt.

Several years ago, a supermarket Company failed in Hong Kong. Guess who suffered most ? The employees of the company ?

No. Those who suffered most were : the fresh fruit/vegetable suppliers who supplied the Supermarket, the canned-food suppliers who supplied canned food to the Supermarket.


The suppliers to the supermarket, they are the main creditors of the supermarket. They suffered most. They all lost millions.

Because of this "limited liability", the Law usually requires the limited company to hire outside accountant to be auditor, and make the company publish the year-end accounts in the newspaper, and the year-end accounts have to be accompanied with auditor's comment. (Usually, the auditor's comment is positive -- the account is a "true and fair view" of the financial status of the company. Even if the auditor found mal-practices, the auditors today would definitely not explicitly say so, but add some "qualification statements" which is usually one or two sentences to accompany his report, and his "qualified comment" would be totally un-intelligible to ordinary people unless they have training in accountancy and auditing.)

Guess who appoint the auditor of a limited company -- the Government ? the creditors ? the investors ? No. The company hires its own auditor.

There happened many times before that the auditor disagreed with the company, and the company fired the auditor and hired new auditor. What auditor dares to speak out if its earning depends on the goodwill of the company ? (Note : some responsible accountancy firms take pain not to be blackmailed by working for many companies at one time, so that the income from one company would not go above 10% (say) of the total income.)

In USA, the situation is even worse. Auditor can be "financial consultant" to the company at the same time. It should be noted that "merger and acquisition" are usually done by issuing new shares, and not through actual cash payment (At most only a part of the acquisition is paid in cash, the rest paid by issuing new shares.) Therefore in "merger and acquisition", a company can grow bigger and bigger, and bigger, without the shareholders putting in a penny. ([Click to read more on accounting in Merger and Acquisition]).

There is another question : auditing is terribly difficult today when the transactions per day may run up to thousands (or tens of thousands, or millions of transactions). If you were an auditor, how are you to ensure that the transactions are real, and not "manufactured" ?

P.S.

In the old days, auditing involved checking the accuracy of the book-keeping entries, and fraud prevention.

Gradually, it evolved into "system audit" -- making sure that the SYSTEM OF FINANCIAL CONTROL is sound, fool-proof, and easy to detect fraud should there be one.

Also, as the transactions of a company is huge today, it is impossible to check every transaction, and so there came "statistical audit" -- utilizing the "Statistical Sampling Theory" to audit a small percentage of the transactions only, and use "sampling theory" to infer about the accuracy of the rest.

If you want to know more about auditing, I would suggest you read some OLD text-books, preferably those published in the last century, and which had run into many editions. If you start reading auditing books published today, it is very likely that you will waste a lot of time without gaining much insight into auditing.