Question

Question 4 (a) Explain the relationship between the Financial Statements of a company, the shareholders, the directors and the auditors. (8 marks)

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Answer 1

The financial statements of a company are prepared under the overall responsibility of the Board of Directors, who are responsible for the overall running of the company. In the process, they are expected to follow the stipulations in the charter of incorporation of the company, the laws of the country and the accounting standards applicable to their company. As the financial statements consist of the income statement and the balance sheet, they are an evaluation of the functioning of the company for which the board of directors is responsible.

The shareholders are the collective owners of the company and the board is their agent. The board, as agent, is supposed to run the company in the best interests of the shareholders with due compliance of the laws of the country, The financial statements as a whole constitutes the reporting that the board is doing to its principal, the shareholders, on an annual basis.

But, the genuineness and fairness of the financial statements need an independent appraisal for the sake of the shareholders. For this purpose auditors are appointed by the shareholders in their meeting, to audit the financial statements prepared by the board and to give their independent opinion on the genuineness and fairness of the financial statements.

Thus the financial statements constitute a report by the Board of Directors, the agent, to the Shareholders, the principal, which is independently evaluated by an expert, the auditors.