AUDITORS’ LIABILITY

Introduction

The auditor has the responsibility to express an opinion as to the truth, fairness and compliance of the accounts to the legislation. An auditor is therefore held liable if he expresses an opinion which does not reflect the actual accounts

Auditors’ liability fall into three categories. They include:

  Liability to his client under the law of contract 

  Liability to third parties under the law of tort under common law

   Liability under civil and criminal law 

Under the law of contract, the auditor has a duty to report to the client on all the accounts and financial statements examined by him during the Annual General Meeting. The auditor is under a contract to apply the requirements of auditing standards in the course of the audit and if he fails and writes an improper audit report he will be sued for any damages incurred by the company and users of the financial statements. This is because an auditor usually has a contract with the company as a whole and not with individual members. However action by third parties against the auditor is likely to succeed.

Issues against the auditor can arise due to the following issues and circumstances:

  If an auditor prepares false financial reports when he knows or ought to know that they are intended to be shown and relied upon by third parties even if the identity of the third party is not disclosed and action may be brought successfully against the auditor.

 If the auditor gives references for example regarding the client’s creditworthiness or an assurance as to the client’s capacity to carry out the terms of the contract and it turns out that the client did not measure up to those requirements.

Third parties can only claim damages from auditors if they can prove that

    They suffered financial losses after relying solely on the auditor’s report.

    The auditor performed or wrote his report recklessly knowing that it will be used by third parties.

The companies act provides that officers of the company may be liable for financial damage in respect of civil offences of breach of trust that is where the officers have misused their positions for purposes of personal gain. Criminal liability arises where the auditor willfully makes a materially false statement in any report or assists the management to make false reports. Further the Act provides that if the auditor publishes or concerns in publishing a written statement or account which to his knowledge is misleading or may be misleading, false or deceptive and with a particular intention to deceive shareholders, the auditor in this regard may be liable for imprisonment.

Minimizing Auditor’s Liability

Auditors and accountants can minimize their potential liability for professional negligence in several ways. They include;

 By using the requirements of auditing standards and audit guidelines when carrying out all audits for example audit standards require proper planning, controlling, recording and reviewing of audit work.

By agreeing their duties and responsibilities in the engagement letter. The engagement letter spells out the terms of auditing and what you are supposed to do. It includes the statutory provisions. The purpose of this is to reduce the expectation gap

By defining in the audit report the precise work undertaken, the work not undertaken and any limitations to the work. This is so that any third parties will have knowledge of the responsibility that was accepted by the auditor for the work done.

By stating in the engagement letter the purpose of the purpose for which the audit report has been prepared and that the client should not use it for any other purpose apart from that for which it was prepared.

By advising the client in the engagement letter of the need to obtain permission to use the name of the accountant/auditor and withholding permission in appropriate cases.

By identifying the authorized recipients of audit reports in the engagement and also in the audit report.

By registering the audit firms as limited liability companies. The essence of such a plan is to protect partners from effects of litigations.

By instituting high quality control procedures in the audit firm through proper recruitment and training procedures.

By use of standard audit manuals, sending out audit staff for career development activities to gather new knowledge.

By taking professional indemnity cover to transfer liability to the insurance people if any by paying premiums.

By not being negligent in the course of duty. Being very careful while conducting audits.

Auditors and audit firms should only take work that they can do or undertake with competence.

Arguments for extension of auditors’ liability

Third parties do rely on the integrity of audited accounts and would seem right that that a legal liability should reflect that.

Professional men are paid and should therefore be held accountable

If the liability is not extended the public may perceive that the auditor is liable to no one that there is no need for the auditor to exercise skill and care and therefore the accounts are not reliable and thus auditors are of no benefit.

When the company suffers losses from fraud and theft occasioned by auditors’ negligence then current existing legal remedy of the company against the auditor is appropriate. However if the directors overstate the assets and the auditor fails to discover this then the company does not suffer losses. However the shareholder(s) or potential shareholders may suffer loss and it is just right that they should be able to recover from the auditors.

Arguments against the extension of auditor’s liability

  Practical difficulties in deciding whether the accounts were relied upon at the time of that particular financial loss. This might present a gold mine for lawyers.

  It is unreasonable and unrealistic to say auditors have liability in an indeterminate amount for an indeterminate time and to an indeterminate class of persons.

Audit fees would have been so high if full liability for investment decisions are taken on by auditors.

Insurance cover for professional indemnity would be even more difficult and expensive to obtain.

The work required on an audit would need to be greatly extended to an enormous cost which on a welfare economic stand point will be a misuse of scarce resources.

The company pays the auditor and consequently expects to recover if the company loses as a result of the auditor’s negligence. However investors do not pay the auditor and should not expect to recover.

The legal responsibility of producing accounts rests with the directors and it should seem inequitable if the liability arising out of incorrect accounts was transferred to auditors.

The current legal framework sees the purpose of preparing and auditing accounts as assisting shareholders in assessing the stewardship of directors not in assisting investors in their investment decisions.

Business Training in Kenya has more information on this topic.

Conclusion

Auditors are therefore required due diligence and care when carrying out audit work. Auditors’ profession require that they should also ensure his independence is not interfered with in any way