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Lesson#8
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LIABILITIES OF AN AUDITOR
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LIABILITIES OF AN AUDITOR
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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