The auditor has no responsibility in regard to the creation of general reserve or its amount. But it is the duty of the auditor to see that a specific reserve has been created and its amount is adequate. Auditor’s Duty re: General Reserve It is a matter of financial policy of an enterprise to create a general reserve. The auditor has nothing to say about the adequacy or otherwise of the amounts of profits set aside to reserve.
The matter rests entirely with the management of enterprise. The auditor, however, must see that the amounts have been properly taken, and do show a bona fide surplus. He must also see that reserves are clearly and properly stated in the Balance Sheet and Profit and Loss Account. Sometimes fictitious reserves may be created through over-valuation of stock or the insufficient provision for depreciation and bad debts. Under such circumstances the auditor must deal with the whole question in his report. If the accounts are in order and disclose profits; the auditor cannot insist upon the creation of revenue reserves, for that is a matter entirely outside his province.
In the case of a joint-stock company, the auditor is to see the Articles of Association in order to ensure that its provisions have been complied with. According to the Companies Act, before ascertaining the amount of divisible profits a company must first provide for the current year’s depreciation on fixed assets and then declare dividend after setting aside 10 per cent of the divisible profits to reserve. The Act further lays down that a company can set aside a higher portion of the divisible profits to reserve, if the Central Government so directs.
Auditor’s Duty re: Specific Reserves In case of specific reserve, the auditor has special duty and responsibility. He should see that the amount set aside to specific reserve is adequate and reasonable. Secondly, he should see that specific reserve is utilised for the purpose for which it is created. Thirdly, he must consult the company’s Articles and Directors’. Minutes and recommendation in regard to specific reserve.
Where the reserve made is, in his opinion, materially inadequate, and he cannot persuade his client to increase them, he should report the fact to the members. Should the auditor fail to perform his duty he would be held liable for negligence of duty. In Arthur E. Green and Co. v. The Central Advance and Discount Corporation Ltd (1920), the auditors were charged with negligence because they relied upon the manager’s certificate of the provision for bad debts which was insufficient. The court held that the auditors had been negligent in their -duties.