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Auditing 1

Auditing 1. Lecture 4 Auditors Legal framework/The Liability of the Auditor. Introduction. Litigation against auditors is virtually unknown in Ghana.

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Auditing 1

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  1. Auditing 1 Lecture 4 Auditors Legal framework/The Liability of the Auditor

  2. Introduction • Litigation against auditors is virtually unknown in Ghana. • However, most of the major cases brought against auditors in the other countries have arisen because of alleged failure of auditors to detect fraud resulting in company failures and leading to loss of investment by creditors, shareholders and other investors.

  3. Introduction • The serious effect of litigation against auditors lies in the fact that audit firms have traditionally been sole traders or partnerships with unlimited liability status. • Firms guilty of causing loss to their clients may have damages awarded them and all the partners and are held jointly and severally liable up to the limit of the partners’ personal estates. • This led to the firms taking PII policies to cover possible damage claims.

  4. Relationship between the auditor and the company/3rd parties. • The auditor has no direct contract with shareholders but with the company ( the company acts through them) • Shareholders are relegated to a 3rd party status. • (Directors, Creditors and officers are all 3rd parties to a large extent)

  5. Any relationship between auditor and the public at large? • Auditors have no connection with the public unless the individual becomes user of the audited Financial Statement.

  6. As agent of the shareholders • May be looked at as an agent of the members who appointed him for the purpose of (audit) • Can only bind the members only for the purpose of the audit • Case: SpackmanV Evans in the 19thCentury by eminent Judge, Lord Gramworth

  7. As officer of the company • Although not mentioned in the definition of officers in the Company’s legislations, auditors can be regarded as officers of the company for determining liability in the case of winding up of a company resulting from any loss occasioned by misfeasance or breach of trust. • In civil and criminal cases in company’s legislations, auditors may be held liable.

  8. Auditors liability • Auditors liability can be categorised under the following; • (a) Liability under statute (civil or criminal) • (b) Liability arising from common law to; • (i) Clients under contract law (and possibly law of tort), • (ii) Third parties under law of tort

  9. Civil or Criminal liability • Civil; • Some of the circumstances under which the auditor may be held liable are; • (a) 3rd parties who suffer loss as a result of relying on a negligently prepared audit report; and • (b) Cases of tax fraud which comes to the notice of the auditor. • Criminal liability; • The auditor, in the course of his audit engagement, is subject to various legislations which hold citizens to criminal action.

  10. Common law:Liability under contract • There is a contractual relationship between the auditor and his client. When carrying out his duties, the auditor should exercise reasonable care and skill. • The degree of skill and care required will depend principally on the nature of the work undertaken. • The fundamental principles require that the auditor carries out his professional work with skill, care, diligence and expedition and with proper regard for the technical and professional standards expected of him as member of the profession.

  11. Liability under contract • The Act also requires the auditor to act in such manner as faithful, diligent, careful and ordinarily skilful. • The Courts, when considering the adequacy of the work of the auditor, is likely to take into account any pronouncements or publications of the accountancy profession including ISAs. • A guiding statement; In the “Professional Liability of Accountants and Auditors” issued in UK & Ireland, states that unless an express agreement is made between the parties, the standard of work required is defined by section 13, Supply of Goods and Services Act 1982, that the supplier will carry out the service with reasonable due care and skill. • All contractual arrangements should be clarified in a letter of engagement.

  12. Auditors’ Guiding Principle • As an expert providing personal service and an agent, he should exercise reasonable due care and skill in discharging his duties (the guiding principle) • Failure to exercise reasonable due care and skill in the execution of duties is guilty of negligence and can be held liable for damages resulting for that negligence.

  13. Liability under Tort to a client • A tort is a wrong, not based on the agreement of the parties, for which the remedy is unliquidated damages. • There are a number of distinct torts of which negligence is one. Negligence refers to a breach of duty to take care. • Auditor can be charged with negligence where some act or omission occurs because the auditor fails to exercise that degree of professional care and skill, appropriate to the circumstances of the case.

  14. Liability under Tort to a client • For a client to be successful in action against the auditor, he must satisfy the court in three areas that; • (i) The auditor owes a duty of care enforceable at law under statute or common law. • (ii) The auditor has been negligent. • (iii) The client has suffered damages/loss

  15. Liability under tort to 3rd parties • As a general rule, liability in negligence to a third party may only arise in circumstances where the auditor carries out work for an entity knowing; • (a) That his work will be relied upon by a third party; • (b) The purpose for which that third party intends to rely on it; and • (c) That the third party may suffer financial loss if the report is relied on having been negligently prepared

  16. Disclaimer of liability • An express disclaimer of liability normally provides protection against an unforeseen liability to a third party. • It would be a defence by the auditor to an action for negligence to show; • (a) That no negligence has occurred; • (b) That the auditor owed no duty of care to the plaintiff; and • (c) No damage of financial loss was suffered by the plaintiff.

  17. Liability under tort to 3rd parties • CIRCUMSTANCES: • There should be a clear case of negligence • Financial loss has resulted from reliance on the negligently prepared FS (document) • It is clear that the financial loss is attributable to reliance upon the negligently prepared document and to no other cause • The party issuing the document knows the purpose for which it was being prepared and knew that it was to be relied upon in that particular content.

  18. Factors for duty of care is owed • Lord Justice Neil in the James McNaughton case identified the following; • The purpose of the statement made • The purpose for which it was communicated • The relationship between the advisor, advisee and the third party • The size of the class to which the advisee belongs • The advisee’s state of knowledge; and • The degree of reliance the advisee placed upon the statement.

  19. Test cases • In the cases below, state what the rulings of the judges were; • CaparoIndustries v Dickman (1990) Gps 1 & 10 • Hedley Byrne & Co v Heller & Partners Limited (1963) Gps 2 & 9 • Jeb Fasteners v Marks Bloom and Co. (1981) Gps 3 & 8 • Twomax Ltd and Goode v Dickson (1983) Gps 4 & 7 • Hedley Byrne and UltramaresGps 5 & 6

  20. Unlawful acts or defaults by appointed auditor’s clients • Auditor is likely to come across certain private and very sensitive matters, which may reveal certain unlawful acts and defaults by his clients • Implied confidentiality should be strictly observed.

  21. Unlawful acts or defaults by appointed auditor’s clients • Appointed auditor should not disclose actual or intended civil wrong or crime except: • A. Cases of treason, legally obliged to disclose • B. Where disclosure is expressly authorized by client • C. Interest of appointed auditor requires disclosure • D. There is public duty because non-disclosure will result in some damage to the public • E. Compelled by court

  22. Auditing 1 Lecture 5

  23. Engagement process • ACCEPTING /REJECTING AN OFFER • Companies or individuals extend an invitation to auditors for appointment as an auditor or to offer certain professional services. • Before accepting, the auditor must comply with professional etiquette, respect and strictly adhere to them within the profession • He must communicate to existing auditor (if any) about the invitation.

  24. Purpose of such communication • Professional courtesy and comply with ethical rules • Enquire if there are professional reasons why prospective auditor should not take up the appointment (Reason for the change) • Enquiry to the would-be client as to whether he objects to contacting the old auditor. • If objects to, don’t accept. • If no objection, write to existing auditor for (professional/ other reasons) for the proposed change. • Existing auditor upon receiving the request should seek the consent of the client to discuss client’s affairs freely with the auditor

  25. Purpose of such communication • If authority is refused existing auditor should inform the new auditor accordingly, who should decline the appointment. • If authority is given, new auditor will decide to accept or decline • If existing auditor could not reply, go ahead for the offer.

  26. Letter of Engagement • Client and auditor should understand fully the statutory obligations of both parties under company’s legislations so as to eradicate from their minds any misconceptions on the conduct of the audit. • Auditor should explain his statutory duties under the company’s legislations or as agreed between them. • Such explanation is given in a letter of engagement.

  27. Letter of Engagement • A letter of engagement is a letter which the auditor sends to his client on his appointment. • The letter sets out the extent of the work the auditor will undertake for the client, and reminds the client of the liability of both parties. • It is a follow up of the verbal discussions/arrangements, and other agreements entered into at the preliminary interview with the client, and seeks to affirm the terms of the appointment.

  28. Main points in a Letter of Engagement • 1. Functions of Auditor and Responsibility of the management (Directors). • Statutory obligation with special emphasis of primary responsibilities of the auditor. • That the preparation of the accounts rests on the directors.

  29. Main points in a Letter of Engagement • 2. Discovering fraud and defalcations • That the audit will be planned to enable auditor express opinion and should not be relied upon to detect all defalcations or other irregularities. • The disclosure of frauds would be as a result of effective audit planning and tests applied

  30. Main points in a Letter of Engagement • 3. Details of other services • Other services requested by the client and agreed upon by the auditor should be specified. Eg tax computations should be separately charged for. • Inform client in the letter about services he can offer. • 4. Fees / Remuneration • Basis for charging fees be indicated (ISA 240) • Fees charged should be based on; • (i) Degree of responsibility • (ii) Skills involved • (iii) Time expected • It is unethical to charge contingent fees or fees based on turnover

  31. Main points in a Letter of Engagement • Conclusion • Client to acknowledge receipt by signing a copy as having read and understood the contents of the letter. • Signed copy is returned to the auditor. • Client to state his comments if contents are not in accordance with his understanding • ENGAGEMENT LETTER ISA 210

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