liabilities of an auditor (new)

7/28/2019 Liabilities of an Auditor (New)

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LIABILITIES OF AN

AUDITOR

Ref: (i) ICAI Material

(ii) Tondon



Categories of Liabilities

• Liability towards client

• Liability towards third party

• Liabilities under special cases



Liability Towards Client

Under Law of Torts

(i) Liability for Negligence

Under Companies Act

(i) Civil Liability

• Liability for Negligence

• Liability for Misfeasance

(ii) Criminal Liability



Liability for Negligence

• Reasonable degree of care and skills not

exercised

• Breach of duty towards auditee

• Failure to follow professional standards



Specific negligence w.r.t. audit

• Dividend paid out of capital

• Provisions of A/A not complied with

• Cash/stock misappropriated which couldhave been discovered with ordinary skills

• Assets/liabilities shown as existed while

actually not existing



Negligence – Case Laws

• Hudson vs. official liquidator, Dehradun MussoorieElectric Tramway Co. – Robberies committed by mgt.

– Auditor did not examine cases even when there was suspicion

– Auditor passing over illegal payments by mgt. as correct

– Auditor held responsible

• Commissioner of IT vs Dandekar – The firm in question maintained two separate books of accounts

(for usual business and for black market transactions) – Auditor (Dandekar) signed financial statements as correct

– Income tax dept found assessee’s income manipulated

– Auditor not held responsible as they were appointed to prepareIT returns and not to audit accounts



When auditor is not liable for

negligence?

• If auditor proves otherwise

• If auditor acted honestly

• If company has not suffered losses• Remote damages are not recoverable

– Courts need to take into account the

contributory negligence by directors and other

officers of the company



Liability Under Companies Act

• Meaning

– Civil liability gives a person rights to obtainredress from another person e.g. the ability to

sue for damages for personal injury

• Forms of civil liability

– Liability for negligence

– Liability for misfeasance

Civil Liability



Liability for Misfeasance

• Misfeasance means breach of trust or duty

• Auditor liable of misfeasance if breach of duty causes loss or damage to company

or its property



Liability for Misfeasance

• Duty imposed on auditor (Sec 229)

– Audit Report to be signed by person

appointed as auditor or partner if firm is

appointed as auditor

– Such a person must inform the RoC within

stipulated time about signing of report.

• So failure to comply with above duty is

misfeasance



Case Laws

• The London and General Bank (1895) – Auditor submitted detailed report to directors on loansto customers where security was insufficient

– However, he did not disclose it to shareholders

– No mention in the audit report about it

– Auditor held liable for misfeasance – Auditor was asked to refund the amount of second

dividend declared by company

• The Irish Woolen Co vs Tyson & others (1900) – Purchase invoices suppressed by company thoughgoods included in closing stock

– Auditor could have detected fraud through creditor ledger balances and cross check of payments

– Auditor held responsible

C L



Case Laws

• City Equitable Fire Insurance Co (1924)

– B/S of company described debts due by company’s broker as cash at bank and in hand

– The sums due by broker to the company was morethan what was shown in B/S

– The broker pledged company’s securities which were

in its custody. Auditor did not detect this. – Auditor obtained certificate from brokers rather thanbank in respect of securities held

– Auditor NOT held liable

• Westminster Road Construction & Eng Co(1932) – Auditor failed to detect overvaluation in work in

progress and omission of liabilities

– Auditor held liable and was asked to refund dividendwrongfully declared



Criminal Liabilities

• There is both a mental element and

physical element to the offence

• The penalties for criminal offences are

fines and imprisonment



Criminal Liabilities for Auditor

• Sec. 63 – making untrue statement inprospectus

• Sec. 539 – if auditor with intent to defraud

– Destroys or falsifies evidence

– Makes fraudulent entries in books

• Sec. 628 – in any document preparedauditor

– Makes false statement knowing it is false

– Omits material facts knowing it is material



Liability Towards Third Party




• No privity to contract – Ultramares Corp vs. Touche, Niven & Co. (1921) -

Auditor did not know that financial statements will beused by bank for loan

– Candler vs. Crane, Christmas & Co. (1951) – Auditor knew but no privity to contract

– Commissioner of IT vs. Dandekar (1952) – Auditor did

not owe any duty to Department

– De Savvary vs. Helden, Howard & Co. (1961) – Auditor employed by bank and not by plaintiff (MD)

Auditor NOT held liable




• Derry vs. Peek

– Statement is untrue

– Auditor knew it is untrue

– Statement made to cause action

– Plaintiff acted upon it

– Plaintiff suffered loss due to such action




• Hedley Byrne Principle

– Audited statements prepared for specific

purpose and auditor knows it

– Creditors for funds can claim damages if there

is proof of negligence and knowledge of use

– Individual shareholders cannot claim

damages for investment decisions – Auditor gives disclaimer



Liabilities in Special Cases

• Liability of Honorary Auditor – As much responsible for negligence as a paid auditor

• Liability of Joint Auditors – Divide work to the extent possible

– Division of work can also be on time basis

– Each auditor responsible for his own work

– Client to be informed of mutual agreement – Separate audit report to be provided in case of

differences

– No question of majority or minority in differences inopinion




• Audit of subsidiary companies

– Auditor of holding company not responsible for work

performed by auditor of subsidiary company

• Liability of local auditor

– Auditor of Head Office not responsible for work done

by local auditors in foreign countries

– Auditor makes clear mention in audit report on

reliance of such figures supplied by local auditors




• Liability for Libel – Not liable if statement made was bonafide

• Liability for Unaudited Accounts – Specific mention of the fact that accounts are not

audited can absolve auditors from liabilities towardsclient or third party

– Draft clear cut engagement letter and define scope of work accordingly

– Report should be titled as “Accountant’s Report” andshould not include any opinion

– The word “Unaudited” can be added on each page of

the report



Case Laws

• Dambell Banking Co. (1900) – False B/S prepared, fact of bad O/D not disclosed

with intent to defraud shareholders

• Official Liquidator Karachi Bank vs Directors etcKrachi bank (1932) – P/L falsified to show profits by crediting interest that

was never paid

• Rex vs Lord Kylsant and Another (1931) – Trading profits inflated by including non-trading

incomes/profits

– Case brought changes in phraseology of auditor’s report from “true and correct” to “true and fair”



Concluded

liabilities of an auditor (new)

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