Corporate Governance Controls in the New Saudi System: Ensuring Profit and Avoiding Loss

Ensuring continued profitability for companies is linked to monitoring the company's financial and accounting position. Strict controls are required to ensure profitability and avoid losses. Therefore, any legal entity must have an auditor to monitor the company's financial position and review its financial statements on a regular basis. Therefore, one of the most important requirements for establishing any legal entity is the presence of an auditor for the company's accounts. The Saudi Royal Commission has set controls for preparing financial statements and the auditor's obligations under Royal Decree No. (M/132) dated 1-12-1443 AH, which we will explain below:

The company's fiscal year and preparation of financial statements.
The appointment, dismissal, and term of office of the company's auditor.
The company's auditor's obligations.
The distribution and allocation of profits and losses.

The company's fiscal year and preparation of financial statements:
The company's fiscal year is 12 months, as specified in the company's articles of association or bylaws. The company's first fiscal year may be no less than 6 months and no more than 18 months from the date of registration in the commercial register. The company maintains accounting records, supporting documents, and financial statements at the company's headquarters or any other location determined by the company's directors or board of directors.
The company's financial statements are prepared at the end of each fiscal year in accordance with the accounting standards of the Kingdom of Saudi Arabia and are filed, as specified by regulations, within six months of the end of the fiscal year in accordance with the provisions of Saudi law.
If, when preparing the interim or annual financial statements, a controlling company or a company that owns shares or stocks in the capital of another company requires information from the controlled company in whose capital it owns shares or stocks, the information must be provided to the extent necessary to prepare the financial statements in accordance with the accounting standards of the Kingdom of Saudi Arabia.
The company's directors or chairman of the board of directors are obligated to file the company's financial statements and the auditor's report with the Saudi Center for Economic Affairs through the electronic filing program for financial statements.

Appointment, Dismissal, and Term of Office for the Company's Auditor:
The auditor must be licensed in the Kingdom. He or she shall be appointed, and his or her fees and term of office shall be determined by the partners, the general assembly, or the shareholders, as the case may be. He or she may be reappointed. The company shall have one or more auditors.
The term of office of an individual auditor shall not exceed 10 consecutive fiscal years, and the term of office of a company auditor shall not exceed 10 consecutive fiscal years. He or she may be reappointed, provided that it does not exceed 20 consecutive fiscal years.
Anyone who has ceased to perform auditing work for a period of less than two fiscal years may be reappointed for the remaining period specified. Anyone who has exhausted these terms may be reappointed after two fiscal years from the date of termination of his or her employment.
The partners, the general assembly, or the shareholders may dismiss the auditor, without prejudice to the auditor's right to compensation for any damages incurred. The director or board of directors must notify the competent authority of the dismissal decision and its reasons within a period not exceeding five days from the date of issuance of the decision. The auditor has the right to resign from his duties by submitting a written letter to the company stating the reasons for his resignation. His assignment shall end on the date of submission or at a later date specified in the letter, without prejudice to the company's right to compensation for any damages suffered. The company's manager or board of directors must convene the partners or shareholders to convene the general assembly to consider the reasons for the resignation and appoint another auditor.

Small and micro-enterprises are not required to appoint an auditor, except for companies whose articles of association or articles of incorporation stipulate otherwise, or companies listed on the financial market, or companies that issue debt, tradable financial instruments, preferred shares, or redeemable shares, or companies that require the appointment of an auditor in accordance with relevant foreign regulations, or companies that own another company or are affiliated with another company, unless the description of a small or micro-enterprise applies to all such companies.

A company is considered small or micro-enterprise during a single fiscal year if two of the following conditions are met:

Its total annual revenues do not exceed 10 million Saudi riyals.
Its assets must not exceed 10 million Saudi riyals.
The number of employees must not exceed 49.
The company is not required to appoint an auditor if it meets the description of a micro or small company during the first fiscal year of its registration in the commercial register, or during two consecutive fiscal years.
One or more shareholders or partners who own 10% of the shares or stocks with voting rights may request in writing that the company appoint an auditor in accordance with the provisions of the executive regulations, which are:

When submitting the company's financial statements, the company's director or chairman of the board of directors must attach a statement indicating that the requirement to appoint an auditor does not apply to the company, and that one or more partners or shareholders representing 10% of the shares or stocks have not submitted a request to appoint an auditor.
The request submitted to the company's director or board of directors must be in writing and must be submitted at least 30 days before the end of the company's fiscal year.
Upon receiving the request, the company's director or board of directors must invite the partners, the general assembly, or the shareholders to vote on the appointment of the auditor in accordance with the provisions of his appointment.
The provision requiring the appointment of an auditor does not apply to a general partnership except in the following cases:
If all the partners are legal persons taking any form of company other than a general partnership.
If all the partners are legal persons taking the form of a general partnership and the partners are legal persons taking any form of company other than a general partnership.
If the appointment is stipulated in the company's articles of association.

Obligations of the Company's Auditor:
The auditor shall abide by the provisions of the Code of Conduct and Ethics of the Accounting Profession approved in the Kingdom, and the relevant instructions issued by the Saudi Organization for Certified Public Accountants.
The auditor's work may not be combined with participation in the establishment, management, or board membership of the company he/she audits, nor may he/she perform any technical, administrative, or advisory work for the company.
The auditor may not be a partner of any of the company's founders, managers, or board members, nor may he/she be an employee or relative of any of their employees. He/she may not purchase or sell shares or stocks in the company he/she audits during the audit period.
The auditor has the right to review the company's documents, accounting records, and supporting documents whenever necessary to verify the company's assets and liabilities and any other matters within the scope of his/her work.
If the auditor encounters difficulty in obtaining these documents, this shall be documented in a report submitted to the manager or board of directors. If this is not facilitated for the auditor, the auditor shall have the right to request that the partners or shareholders be invited to a meeting or general assembly to consider the matter. If the manager or board of directors fails to issue the invitation, the auditor may issue the invitation within 30 days from the date of the auditor's request.
The auditor shall submit to the partners, the general assembly, or shareholders at its annual meeting a report on the company's financial statements, prepared in accordance with the auditing standards of the Kingdom of Saudi Arabia. The report shall include a statement of any obstacles encountered in obtaining company documents and any violations of the provisions of the law, the company's articles of association, or its bylaws.
The auditor shall not disclose company secrets to partners, shareholders, or third parties except during the general assembly. Otherwise, he may be required to pay compensation and may be dismissed.
The auditor shall bear responsibility for the contents of his report and for any damages suffered by the company, partners, shareholders, or third parties due to an error during his work. If the company has more than one auditor, they shall be jointly liable, except for those who prove not to have contributed to the error.

Partners and shareholders have the right to audit the company's accounts in accordance with the provisions of the company's bylaws, articles of association, or articles of association.

Distribution and Allocation of Profits and Losses:
Annual or interim dividends may be distributed from distributable profits to partners or shareholders in joint-stock, simplified joint-stock, and limited liability companies. If the distribution is otherwise, the company's creditors and the company may demand that each partner or shareholder return any dividends they have received, even if the distribution was made in good faith. However, the partner or shareholder is not obligated to return the dividends distributed to them, even if the company incurs losses in subsequent periods.
According to the profit distribution controls in the executive regulations of the Saudi system, the following applies:
A company may distribute interim dividends to partners or shareholders if the company's articles of association or memorandum of association so stipulates, provided the following conditions are met:
The partners, the general assembly, or the shareholders authorize the company's manager or board of directors to distribute interim dividends by an annual resolution.
The company has reasonable liquidity and can predict its profit level.
The company has distributable profits, according to the latest financial statements, sufficient to cover the proposed dividends, after deducting the profits distributed and capitalized after the date of those statements.
Distributable profits consist of the retained earnings balance shown in the balance sheet prepared for the period immediately preceding the period during which the distribution decision is made, in addition to the balance of any distributable reserves.
Distributable reserves include reserves formed from profits, not allocated for specific purposes, or for which the purpose for which they were established has been canceled.
Profits and losses are distributed among partners according to their respective share in the company's capital. If it is agreed that any of them shall be deprived of profits or exempted from losses, this agreement shall be deemed null and void. However, the company's articles of association may stipulate varying partners' shares in profits and losses.
It is permissible to agree to exempt a partner who has contributed nothing other than his work from contributing to losses, provided that he has not been paid for his work.
If a partner's share is limited to his work, and the company's articles of association do not specify his share in profits or losses, his share shall be equivalent to the share of the lowest-paid partner in the company's capital. If a partner contributes, in addition to his work, a cash or in-kind contribution, he shall have a share of the profit or loss for his work contribution and another share for his cash or in-kind contribution.

Finally, the auditor is obligated to exercise the care of a prudent person in preparing the company's financial statements, in order to ascertain the company's profits and losses and avoid the company's bankruptcy.