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Fundamentals of Auditing

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Auditors’ Liabilities

Civil Liabilities (arising from law suits/Liability for negligence)
Under law of contract (initiated by the audit client)
Under law of tort (initiated by other users of FS)
Criminal Liabilities
Under sections 157, 255, & 257
Against charges of forgery (evidence created / documents forged etc.)
Against false statement (regarding opinion in report)

Civil Liabilities

Civil liabilities arise in the situation when there is absence of reasonable care and skill that can be expected
of a person in a set of circumstances.
When negligence of an auditor is being evaluated, it is in terms of what other competent auditors would
have done in the same situation

Duty of care under contract Law

The company has a contract with the auditor and hence can sue the auditor for breach of contract if the
auditor is negligent in carrying out the terms of the contract. Note that only the company can sue the
auditor in contract as other people, such as banks, creditors and shareholders are not in a contractual
relationship with the company.
When carrying out their duties the auditors must exercise reasonable care and skill. This is required
by the accountant’s rule of professional conduct.
Members should carry out their professional work with due skill, care diligence and expedition and
with proper regard for the technical and professional standards expected of them as members.
The degree of skill and care expected of an auditor in a particular situation depends on the
circumstances. There is no general standard of skill and care; the auditor is respected to react to the
situation and circumstances he is facing

Breach of contract

A contract breaches when failure of one or both parties in a contract to fulfill the requirements of the
contract arises.
An example is the failure of a CA firm to deliver a tax return on the agreed upon date.
Parties who have a relationship that is established by a contract are said to have privity of contract.
Typically, CA firms and clients sign an engagement letter to formalize their agreement about the services to
be provided, fee, and timing.
There can be privity of contract without a written agreement, but an engagement letter defines the contract
more clearly

Tort action of negligence

Failure of auditors to meet their obligations, thereby causing injury to another party (other than audit client)
A typical tort action against a CA firm is a bank’s claim that an auditor had a duty to uncover material
misstatements in financial statements that had been relied on in making a loan.

page 22

Jeb Fasteners v Marks Bloom (1980)

The plaintiff acquired the share capital of the company. The audited accounts, due to the negligence of the
auditors, did not show a true and fair view of the state of affairs of the company. It was accepted that at the
time of the audit the defendant auditors did know of the plaintiffs but did not know that they were
contemplating a take over bid.
HELD: whilst recognizing that the auditors owed a duty of care in this situation. It was decided that the
auditors were not liable because the plaintiff had not suffered any loss. It was proved that the plaintiffs
would have bought the share capital of the company at the agreed price whatever the accounts had said.
Therefore, whether or not a duty of care existed was not directly relevant to the decision.

How to minimize the liabilities

Not being negligent
Following the ISAs
Agreeing the engagement letter
Defining in report the work undertaken
Defining the purpose for the report
By limiting liabilities to third parties
By defining the scope of professional competence

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