Transcript Auditing 1 L4 &L5 Legal & Engagment

Lecture 4
Auditors Legal framework/The Liability of the Auditor
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.
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.
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)
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.
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: Spackman V Evans in the 19thCentury by
eminent Judge, Lord Gramworth
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.
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
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.
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.
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.
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.
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.
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
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
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.
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.
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.
Test cases
 In the cases below, state what the rulings of the judges





were;
Caparo Industries 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 Ultramares Gps 5 & 6
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.
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
Lecture 5
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.
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
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.
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.
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.
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.
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
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
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