FINANCIAL STATEMENTS, AUDITS AND DIVIDENDS

What is meant by financial statements? Why is the issue so important in the context of company law? The preparation and publication of financial statements inevitably ties back to the concept of corporate governance. In terms of the preparation and publication of financial statements, the basic statute that applies to all companies is the Corporate and Allied Matters Act (CAMA). The Act prescribes the minimum requirement in respect of financial statements.
 What is a financial statement? In very simple terms, a financial statement is a statement that records the financial activities of a company or of a particular business organization. Essentially, it is the book-keeping and the recordation of ledger accounts, trial balances and then the final account. It gives both the directors and the shareholders a clear view of the financial state of a company.
Primarily a financial statement has a purpose of giving information and this enables the management and the board of directors to evaluate the performance of the visit and the FS also assists the company in making future plans for the business because a clear idea of the financial state of the company would enable the company to determine how and where they would be financially in future. It determines whether the shareholders should input more funds or whether the company must resort to seek loans from the banks in form of loan capital.
A typical complete set of financial statement comprises:
The balance sheet which is essentially a statement of the financial position of the company.
The income statement and this is basically a statement about the financial performance of the company.
The statement of changes in equity that is shareholder movement in terms of people buying and selling shares
The statement of changes in financial position, that is, the cash flow statement.

The Balance Sheet:
Essentially, this is a statement of the financial position of the company. It sets out or consists of all the assets of the company. The assets may be physical assets like land and they may also include intangible assets such as intellectual property, trademarks, goodwill, patents etc. Typically, in the balance sheet we have short term assets and long term assets.
The income statement:
Basically, this is a statement about the financial performance or affairs of the company. This is the aspect of the financial statement that tells the present performance of the company; how the company is doing in its business operations on a daily, monthly or whatever basis for that particular year. It gives an idea of the financial operations of the company for that particular operating year so that the company can know whether it has operated profitably that particular year.
This has got nothing to do with the balance sheet. A company may have assets worth billions of naira or substantial assets but still has during the operations of a particular year, the company has recorded significant loss so that that they didn’t make any profit; in fact, they made loss because the money they paid out was significantly more than the money they earned as income so that really they have operated at a loss and can’t declare any profit. The fact that a company has operated loss for a year doesn’t necessarily mean the company is insolvent. This is where the relevance of the issue of the assets of the company comes to play. It has significant assets yet it has operated at a loss and that is why today there are companies operating at a loss but still have creditors who are just watching that company and not necessarily going into that company to recover their money because they know that such companies still have substantial assets that outweigh all the liabilities of the company. It is when the liabilities of a company exceed its assets that the creditors worry that the company is on the verge of insolvency. Thus, the fact that for a particular year, the income statement of a company shows that the company is operating at a loss doesn’t mean the company is insolvent because the next year they may hit a jackpot and record substantial surplus.
The income statement would talk about net sales, net payment, administrative expenses; virtually everything a company does to operate. Asides payment of salaries, there are so many things a company does in terms of expenses to ensure the smooth running of the company. Some could even be as simple as the company purchasing stationery. All these things would come within the income statement.
The cash flow statement:
 Essentially, the cash flow statement is the liquidity of the company. Has the company earned enough cash to meet its daily or monthly obligations? How much has come into our account from our sales and how much money do we have in terms of our obligations to our suppliers, employees etc. This gives the company the opportunity to plan the affairs of the company.
What does CAMA tell us about financial statements? Our starting point is S. 331 CAMA. What are the essential components of S. 331 CAMA? First, every company must keep accounting records. Secondly, the accounting records must be sufficient to show and explain the transactions of the company in such a way that it discloses with reasonable accuracy, at any time, the financial position of the company and it must enable the directors ensure that the financial statements prepared comply with the requirements of the Act as to form and content. Thirdly, the records shall contain in particular entries from day to day of all sums of money received and expended by the company and the matters in respect of which the receipt and expenditure took place; and a record of the assets and liabilities of the company. Fourthly, if the business of the company involves dealing in goods, the accounting records shall contain statements of stocks held by the company at the end of each year of the company; all statements of stock takings and except in the case of goods sold by way of ordinary retail trade, statements of all goods sold and purchased, showing the goods and the buyers and sellers in sufficient detail to enable all these to be identified.
The above are the things we have talked about as regards the balance sheet, the income statement, the cash flow statement. They are all in line with the requirement of S. 331(1) -(4) CAMA.
Whose obligation is it to prepare financial statements for a company? By virtue of S. 334 CAMA, it is the duty of the directors of a company to prepare financial statements every year. We can see that CAMA imposes a duty on the directors to prepare financial statements. However, in practice, it is the chief financial officer of a company that prepares accounts. But legally, this obligation rests upon the directors. This is why you would see that the accounts are signed typically by two directors of the company; one of them would usually be the MD of the company. As a matter of practice, the Financial Reporting Council which is like the head of them all now requires the chief financial officer to also append his signature on the account. Thus, at the minimum we would find three signatures, the chairman, the MD and the chief financial officer (also known as Executive Director of Finance).
S. 334(2) provides what a financial statement must contain at the minimum. A statement of the accounting policies, that is, the accounting policies the company has used in preparing the account. The government agency saddled with the responsibility of stipulating the accounting policy is the Financial Reporting Council of Nigeria. Essentially, the rule is for every company to be complaint with the International Financial Reporting Standards (IFRS). Most public companies today publish their accounts along the lines of the IFRS which is an internationally accepted mode of financial reporting. It talks about the balance sheet, the directors’ report which the chairman would make a statement about the affairs of the company for that particular operating year and the challenges in that operating year and the prospects and plans of the directors in terms of the operations. The group financial statements dealt with in S. 336-338 CAMA. Please pay close attention to S. 338 CAMA because it gives us the definition of a holding company, a subsidiary company and a wholly-owned subsidiary company. But what are these sections about? We have talked about the principle of lifting the veil of an incorporation and we also talked about the single economic unit theory and the group structure and Lord Denning’s decision in DHN’s case where it was noted that simply because a company is a subsidiary of a holding company means the holding or principal company may be accosted where an issue arises as to the liability of the subsidiary company. We remember that this rule was rejected. We also remember the case of Adams v Cape Industries. But for the specific purpose of accounting and reporting of financial affairs of a group company, the holding company is by law mandated to also report the financial affairs of its subsidiary companies. This is what sections 336-338 is all about. If you see a typical holding company with a number of subsidiaries, the financial statements of the holding bank must reflect that of all its subsidiaries. Thus, the financial statements would include one for the whole group structure and another for just the holding company. Where this happens, it means that all the financial statements of the group have been consolidated into one. Why do these companies need to do this? Because a company standing alone might not be doing well. But if it reports as a group and the subsidiary companies are doing fantastically well, you would not know that the bank itself has financial issues.
After the financial statements have been prepared and the directors are happy with it and they have signed it, there is then the question of: who is entitled to receive these financial statements as of right? S. 344 CAMA tells us the persons who are entitled to receive it as of right. First, every member is entitled to receive it. Secondly, every holder of the company’s debentures. Thirdly, all persons other than members and debenture holders, being persons so entitled. Please note S. 334(5) CAMA for the penalties for failing to comply with section 345.
S. 344 tells us the time within which these shareholders and debenture holders must receive the financial statements before the financial statements are actually laid before them at a General Meeting. Not only do directors have a duty to prepare financial statements, they have an additional duty to lay the financial statements before shareholders and let them know the financial state of affairs of the company. The persons so entitled to receive the financial statements not less than 21 days to the GM at which the statements would be presented to them.
S. 345 CAMA deals with laying the accounts before the shareholders at the GM. As a matter of practice, it is the management that would typically prepare the accounts for the directors to go through and satisfy themselves that the accounts have been properly done. It gives a true and clear view of the financial state of the company. But as a governance issue, company law doesn’t just allow the managers of the business and the board of directors to lay the accounts before shareholders without putting some form of oversight mechanisms through an independent person to also have a look at those accounts. This independent third party who has a look at the accounts and also makes a confirmatory statement that the accounts have been prepared in accordance with the law and represents a true and clear view of the financial state of the company are the auditors of the company. So this third party who also looks at the account are the external auditors of the company and they are distinct from the internal auditors of the company. Both perform totally different functions. The internal auditors of the company are essentially the internal police men that ensure that all the internal controls of the company mostly in terms of financial appearance and operations are complied with. S. 357 deals with the appointment of auditors. S. 358 talks about the minimum requirement for qualification as an auditor. But the more important section regarding the function of the auditor is S. 359 CAMA which provides that the auditors of a company shall make a report to its members on the accounts examined by them and copies of such report are to be laid before the company in the general meeting during the auditor’s tenure of office. But also note that if a company is a public company, there is an additional requirement under S. 359(3) CAMA that the auditors must present their reports to the audit committee of the company. So this additional requirement doesn’t apply to private companies. In a public company, there is always an audit committee which comprises equal number of directors and representatives of the shareholders of the company (subject to a maximum number of six members) who would also vet the account and issue an audit committee’s report. S. 359(6) CAMA lists objectives and functions of the audit committee which are made subject to such other additional functions and powers that the company’s articles may stipulate. Because as a governance issue, the independence of the auditors is extremely important. Remember we have noted that the requirement to even prepare an audit financial statement is a fundamental governance issue. As part of ensuring the integrity of that process of preparing, issuing and publishing financial statements to shareholders, there is also the additional requirement of giving auditors vast powers in terms of requesting for documents, reviewing documents before they give their auditors’ statement. So during the audit process, after the board of directors has given only the auditors the management account, the auditors also have a right to request for any document as part of the process of their work and the management can’t decline on the ground that the document is confidential because if the management is allowed to decline, what would the auditors do, they would qualify the accounts and once they start putting qualifications in the account of the company to a discerning reader of those accounts, there is a problem. It means that those accounts might not be a true and fair view of the financial state of the company. Thus, no company wants its accounts to be qualified and that is why they would ensure that whatever information required by the auditors is made available to them. In terms of the auditors’ duties and powers, see S. 360 CAMA. The auditors have been given extensive powers with regard to the exercise of their functions. Note also S. 363 CAMA which gives the auditors the right to attend the company’s general meeting and to receive notice of the GM of the company.
What are the benefits of the preparation of financial statements? First, it shows a true and clear view of the financial position of the company. Secondly, it sounds as an instrument for giving account of stewardship by the directors of the company. Thirdly, Shareholders are able to determine by reading the accounts how the affairs of the company have been conducted by the management. Fourthly, the financial statements enable creditors to determine whether or not the company is in the position to meet and redeem its obligations to them. By the time they look at the balance sheet which gives them an idea of the total assets of the company, and they look at the income statement, they are able to see how well a company is performing in terms of its working capital management. Fifthly, a financial statement enables the directors who are not involved in the day to day running of the company to assess the state of affairs of the company.
As noted earlier, CAMA stipulates the minimum requirement in terms of the obligation to prepare and publish financial statements but there are also other statutory regimes that apply to different companies in different sectors of the economy. For example, insurance companies have an additional statutory requirement in terms of the approval of their accounts by NAICOM. Banks also have a similar regime….in terms of the approval of their accounts by CBN. Public companies that are quoted on the stock exchange must also send their accounts to stock exchange for approval before they are published. Sitting at the top of all these bodies is the Financial Reporting Council of Nigeria which is a government agency set up pursuant to FRC Act of 2011. The Act is available in the internet. You are not expected to read all the provisions of the Act but you are expected to have a proper understanding of what the Act is all about. Look up sections 11 which talks about the object of the financial reporting council. S. 8(1)(k) which talks about the function of reviewing the financial statements and reports of public interest entities. Look at (q) which is to develop, adopt and keep up to date auditing standards by relevant bodies. What is a public interest entity? Look at S. 77 of the Act. It means government organizations, quoted and unquoted companies and all other organizations which are required by law to file returns with regulatory authority and this excludes private companies that routinely file returns only with CAC and FIRS. This simply means that all the government organizations including CAC itself must present their accounts to FRC for approval. It is only the small private companies that do not need to deal with the FRCN. But more importantly, we must consider the provision of S. 59 of the Act. The section clearly gives primacy to the FRCN. It provides that all the other Acts like CAMA, BOFIA etc. which deal with anything that has to do with financial statements are subject to the FRCN Act. Also, look at the sections on sanctions for failure to comply with any pronouncement of the FRCN Act or any prescribed statement of accounting standards by the FRCN Act. The Act provides for penalties not less than ten million naira unlike other banking Acts or statutes which prescribe 250 naira… The Act is reflective of the current situation in Nigeria.
The next question is what if these financial statements were negligently prepared. What are the legal issues involved where the directors in preparing the financial statements were negligent? And the auditors who should be the independent checks also didn’t pick up a big gaping hole in the financial affairs of the company simply because they were negligent as it happened in Cadbury where the managers were falsifying statements and the auditors kept on approving the accounts. It was until the problem arose and prosecutions commenced that the level of negligence of the negligent accounting firms became clear. Apart from the important of financial statements to the board of directors in terms of shaping the direction of the future of the company, it also shows the current performance of the company. A lot of people make decisions on these financial statements. For example, we said S. 334 requires secured creditors to have a copy of these statements. If the account is showing a sound financial state when in actual fact, the company is insolvent such that unsecured creditors are relying on those ‘false financial statements’, they would have done so to their detriment. It may be that some people have decided to make a massive investment on the company on the basis of the account. In any event, no one will make substantial events in a company without looking at the audited accounts. A shareholder might even decide to increase his shareholding in the company based on the apparent state of the company. Had he known the true state of affairs of the company, he wouldn’t even think about towing that path. It is evident that there are so many people or stakeholders that potentially could be impacted by negligently prepared financial statements.
At this point we start thinking about negligence and the duty of care and the damages that would arise from the duty of care. What you would see from the authorities is that there is a danger if the duty of care aspect and its neighbour principle are not effectively circumscribed. Because if you give it an expansive definition, it means that almost anybody can make a present a negligent claim.
When we discussed law of torts, we talked about the case of Hedley Byrne v Heller & Partners. This case was about negligent misstatement and it was in this context. This case remains an important one in the context of liability for negligently prepared financial statements. But there is no direct Nigerian authority (as far as this writer is concerned) on this point about negligently compiled financial statement and someone who has suffered loss as a result of reliance on the statement and has now approached the court to sue the auditor. More importantly in this context, is the issue of liability for economic loss because someone who has relied on a negligent statement would have suffered economic loss. In Hedley Byrne’s case, Hedley Byrne were a firm of advertising agents. A customer, Easipower Ltd, put in a large order. Hedley Byrne wanted to check their financial position, and creditworthiness, and subsequently asked their bank, National Provincial Bank, to get a report from Easipower’s bank, Heller & Partners Ltd., who replied in a letter to the effect that Easipower was ‘considered good for its ordinary business engagements’ but the letter was headed “without responsibility on the part of this bank”. The letter was sent for free. Easipower went into liquidation, and Hedley Byrne lost 17,000 pounds on contracts. Hedley Byrne sued Heller & Partners for negligence, claiming that the information was given negligently and was misleading. Heller & Partners argued that there was no duty of care owed regarding the statements, and, in any case, liability was excluded. The court found that the relationship between the parties was ‘sufficiently proximate’ as to create a duty of care. It was reasonable for them to have known that the information that they had given would likely have been relied upon for entering into a contract of some sort. That would give rise, the court said, to a ‘special relationship’, in which the defendant would have to take sufficient care in giving advice to avoid negligent liability. However, on the facts, the disclaimer was found to be sufficient enough to discharge any duty created by Heller’s actions. In other words, if, in the ordinary course of business or professional affairs, A seeks information or advice from B, who is not under any contractual or fiduciary obligation to give information or advice, in circumstances in which a reasonable man asked would know he was being trusted, or that his skill or judgement was being relied on, and B chooses to answer without qualifying it as to show that he does not accept responsibility, then B accepts a legal duty to exercise such care as the circumstances require in making his reply; and for a failure to exercise that care an action for negligence will lie if damage results.
The locus classicus in this regard is Caparo Industries v Dickman. This case will show you the potential difficulties that a court now has in trying to control and rein in the duty of care concept. If it is not reined in, then potentially anybody can walk up and say that he relied on the account and as a result he has suffered loss. For the purpose of our discussion, let’s narrow it down to two stakeholders that could potentially want to make a claim for negligent misstatement in the financial statement. First, we have the shareholder of the company whose account was presented by the company and then somebody who is an outsider but for some reason he relied on the audited account and suffered loss. From the lower court all to the House of Lords, it seemed that the courts were very clear of the fact that if the claimant is an outsider, he doesn’t have a claim. The courts just felt there was no proximity to establish that duty of care (the neighbor principle). The question before the court was whether where a shareholder relies on the statement, there exists a duty of care. the court of Appeal answered this question in the affirmative though there was a dissenting judgement. In the House of Lords, the answer was No! In fact, the House approved the dissenting judgement in the Court of Appeal to the effect that the fact that one is a shareholder doesn’t mean that automatically a duty of care is owed and that though the auditors are under a duty by law to look at the accounts and make a statement about it, it is only for the purposes of the law. In essence, it can’t mean that statement by the auditors in the account can also be used by the shareholder for the purpose of investment since this was not the purpose of the statement in the first place. That was the position of the House of Lords in Caparo’s case. Please bear in mind that the position in this case can’t be used for example where an investor wants to invest in the company and it is about the time the auditors are preparing the account and the auditors are aware that that investor will rely on those accounts. In this situation, it is clear that the investors know that somebody intends to rely on those accounts so that a duty of care is established so that where there is a misstatement and the investor relies on it, it may be said that a duty of care exists. Caparo’s case is to the effect that the category of persons that can potentially come within the purview of the duty of care are very circumscribe unless it is known that those accounts are being used for a particular purpose.
The case of Caparo concerned an auditor (Dickman) who had negligently approved an overstated account of a company’s profitability. A takeover bidder (Caparo) relied on these statement and pursued its takeover on the basis that the company’s finances were sound. Once it had spent its money acquiring the company’s shares, and company control, it found that the finances were in poorer shape that it had been led to believe. Caparo then sued the auditors for negligence. At the Court of Appeal, it was held that a duty was owed by the auditor to shareholders individually but no duty was owed to outside investors who had no shareholding. The court noted that the very purpose of publishing accounts was to inform investors so that they could make choices within a company about how to use their shares; thus, a duty was owed to shareholders directly. But for the outside investor, a relationship of proximity could hardly be established. O’Connor LJ (dissenting) noted that no duty was owed to either the inside investor nor the outside investor in that case. The House of Lords stated that the purpose of the statutory requirement for an audit of public companies was the making of a report to enable shareholders to exercise their class of rights in general meeting. It did not extend to the provision of information to assist shareholders in the making of decisions as to future investment in the company. With regard to external investors, the court relied on Lord Denning’s dissenting judgement in CANDLER v CRANE, CHRISTMAS & CO where Denning noted that the relationship must be one where the accountant or auditor preparing the accounts was aware of the particular person and purpose for which the accounts being prepared would be used. In essence, foreseeability alone is not a sufficient test of proximity. It would seem from this case that the individual shareholders would have no claim against the negligent auditors if they chose to dispose of their shares on the basis of the negligently prepared accounts.

DIVIDENDS
Dividend is treated in S. 379-386 CAMA. What is dividend? Dividend is the return a shareholder gets for investing in a company. Typically, it is the GM that will declare dividend based on the recommendation of the Board. But note some essential elements you’d see in all the various sections. First, it is the directors that would recommend at a GM that a dividend be declared. Secondly, a company can only declare dividend if it has made profit; it can’t declare dividend where it has made a loss. If the company doesn’t make profit but declares dividend, it reduces the company’s capital. This is another aspect of corporate governance that ensures creditors are protected. Another important element is that the fact that a company has made profit doesn’t compulsorily mean it must declare dividend; it is the discretion or prerogative of the directors. Thus, the directors may declare otherwise. Once they make this decision, shareholders can’t insist they declare dividend. But where the directors have recommended dividend, the shareholders may reduce (but not increase) the dividend. Also, once dividend is declared at the GM, the dividend then becomes a debt due from the company to the shareholders which would entitle the shareholders to sue on the debt.
S. 382 CAMA deals with unclaimed dividends and this is a major phenomenon in Nigeria where unclaimed dividends which have declared by Nigerian companies are running into several billions of naira. The section imposes a responsibility on the company at the next GM to list the names of those that have not claimed their dividends and then three months after this period, the company may invest the unclaimed dividend for its own benefit in an investment outside the company and no interest shall accrue on the dividends against the company. This implies that the company won’t account for the interest made on the investment of the unclaimed dividend. The only exception is where dividend has not been sent out when it ought to have been to the GM.
S. 386 CAMA deals with liability for paying dividend out of capital. All directors who knowingly pay or are party to the payment of dividend out of capital shall be personally liable jointly and severally to refund to the company any amount so paid. However, the directors have the right to recover the dividend from shareholders who receive it with knowledge that the company had no power to pay it. Thus, where no distributable profit has been made by the company and the director declares dividend, all the directors who had the knowledge….will be jointly and severally liable.

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