XRB: Directors responsibility for financial statements

Introduction

At the end of last week XRB published a short note announcing an amendment by the New Zealand Auditing and Assurance Standards Board (“NZAuASB”) on the standard to describe the responsibility of those charged with governance (i.e. directors) for the preparation of an entity’s financial statements.

The amendment is described as having been issued as a result of legislative changes describing the statutory responsibility for the preparation of an entity’s financial statements – and is required to be applied (by auditors) for audits of financial statements for periods ending on or after 15 December 2016.

A brief review of the material indicates that the key change heralded by this amendment is to clarify that the sign-offs and confirmations given by “those charged with governance” is that they have responsibility (in respect of the financial statements) on behalf of the entity.

Background

The background is provided by the recent legislative changes to New Zealand’s financial reporting regime as a result of the enactment of the Financial Reporting Act 2013 (and the associated amendments to other Acts providing financial reporting obligations). The effect of these amendments has been to shift the statutory (and direct legal) responsibility for ensuring that financial statements are prepared from those charged with governance (the directors) of an entity, as was the case under the Financial Reporting Act 1993, to the entity itself.

The NZAuASB considered the effect of the changes to the legislative regime on the International Standards on Auditing (ISAs) and concluded that the directors continue to have responsibility (albeit not as a matter of express legal duty relating to the approval of financial statements) for ensuring that compliant financial statements are prepared in respect of an entity.

The Board said that this view is supported by:

• section 128 of the Companies Act – which provides that the business and affairs of a company must be managed by, or under the supervision of, the Board (on the basis that the preparation of financial statements falls within the “affairs of the company”).

• directors’ duties under the Companies Act, including the duty (under section 134) not to act, or agree to the company acting, in a manner that contravenes the Companies Act or the constitution – and the knock-on concern that, if financial statements were not prepared in accordance with the requirements of the Companies Act, the directors may have breached their duty under section 134.

• commentary (in turn referring to case authority) that, in common with other business organisations, a company is an artificial legal construct, it must be the human beings involved with a company who deal with others on behalf of the company.

Consequently, where a company is required by law to do something, the individuals in the company who have the power or authority to do that thing in the name of the company are the persons who (effectively) are responsible for ensuring that it is done – by doing it themselves. In such a case, they are acting as the company (because a company is not self-propelled). In the case of the statutory obligation to prepare financial statements, this obligation would ordinarily be performed by the directors, or by management under the supervision of the directors. Importantly, it is the Board that ultimately considers, approves and adopts the financial statements for the company.

The view that directors remain responsible in practice for ensuring that financial statements are prepared is also supported by the liability regime for breaches of the financial reporting provisions in both the Companies Act and Financial Markets Conduct Act.

Liability for breaches of financial reporting obligations, together with the responsibility of directors to manage the affairs of a company and the artificial nature of a company all support the view that directors remain responsible in practice (and at law by virtue of the offence regime in the Companies Act and the Financial Markets Conduct Act) for ensuring that a company’s financial statements are prepared in accordance with the applicable statutory requirements – despite the recent legislative changes.

Amendments required

A number of modifications were identified to reflect the shift in the statutory (and direct legal) responsibility for ensuring financial statements are prepared from the directors to the company.

As a result, amendments have been made to the illustrative engagement letter, representation letter and auditor reports by adding the words “on behalf of the entity” – to make it clear, as between the auditor on the one hand and the Board on the other, who is responsible for what in the process of preparing the financial statements.

Early adoption

In publishing the statement last week, XRB noted that early adoption (prior to the 15 December 2016 date) is permitted. Because the changes better reflect the relevant law – it must be likely that most entities that are the subject of an audit requirement will wish to start a dialogue with their auditor with a view to early adoption.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.