Today most businesses are operated by limited companies, which are owned by the shareholders and managed by directors appointed by such shareholders. The appointed management is faced with a conflict of interest i.e. whether to act in the best interest of the company and by extension the shareholders’ interest or to act in their best interest. This is what is referred to as the agency problem.

The separation that exists between the owners and management forces the absentee owners to institute control measures to ensure honesty of their company’s stewards (i.e. management). The companies Act attempts to remedy this problem by requiring the management to maintain proper accounting records of all the transactions of the company and to prepare financial statements that show a true and fair view to be presented to the shareholders at the annual general meeting.

However, even with this requirement there still exists the risk that the accounting records maintained and the financial statements prepared by management might not be accurate, free from bias and reflect the true financial position and performance of the company. The companies Act therefore goes further to require that management must have the financial statements subjected to an independent examination and a report issued to the shareholders as to whether the financial statements show a true and fair view. The auditor carries out this independent examination. To ensure independence of the auditor the companies Act gives the power of appointment and removal of the auditor from office to the shareholders.