AUDITORS LIABILITY

AUDITORS LIABILITY

Introduction

Auditors perform audits and sign audit reports. These reports are the auditor's opinions on the truth etc. of financial statements. Auditors are known to be competent and honest. So, if the auditors say financial statements show a true and fair view, readers of the financial statements will have faith in it because they have faith in the auditors.

As others rely upon his work, the auditor clearly has a responsibility to do his work honestly and carefully. The judge in the London and general bank case (1895) said "He must be honest that is he must not certify what he does not believe to be true, and he must take reasonable care and skill depending on the circumstances and is very difficult to assess in any given case. What is clear is that:

a)     a, An auditor may fail to exercise sufficient skill and care

b)    As a consequence, some fraud or error maybe undiscovered or he may fail to discover that the accounts fail to show a true and fair view.

c)     As a consequence somebody who relies on the work of the auditors may lose money.

d)    This loss of money follows the failure of the auditor to do his job properly.

e)     e. This point is the vital one, the auditor may have to make good from his own resources that suffered by another person.                                                          .

THE PROBLEMS ARE

a)     What is reasonable care and skill?

b)    To whom does the auditor have a responsibility to do his work properly?

c)     To whom doe the auditor have a legal responsibility? By legal responsibility we mean an obligation to make good from his pocket losses suffered by others, or to be more precise pay damages which flow from his negligence. This is a very difficult question, which when review in due course.

d)    But first we shall consider the criminal law and the auditor.

THE CRIMINAL LAW

Company Act 1948: An auditor commits a criminal offence by willfully making a false statement in a document produced by him for example the auditor's report. Willfully means knowing what you are doing and intending to do it. Thus, if an auditor says .the accounts show a true ad fair view he the do not and says deliberately knowing what he is doing, he commits a criminal offence.

The Theft Act 1968: An auditor commits a criminal Offence if with a view to gain for himself or another.

a)     He destroys, defaces conceals or falsifies any accounting documents;

b)    He knowingly provides information which is false and misleading;

c)     He concurs in the publication by a company of any document e.g. a prospectus, which is false or misleading.

Prevention of fraud (investment)Act 1958: An auditor commits criminal offences if he dishonestly or recklessly makes any false statement, promise or forecast in order to induce anyone to buy or subscribe for securities for businesses, this would most likely occur in prospectuses.

Criminal Liability S. 643 CAMA 1990

If any person in any report, certificate, balance sheet or other documents required for any other section of the legislation willfully makes a statement which is false in any material particular knowing it to the false shall guilty of an offence and liable to 2 years or in lower court N1000 or 4months or both.

Civil Liability under the Companies Acts

The Companies Act 1948 - 333 provides that where a liquidator can prove that the auditor committed a breach of his duty to the company, which resulted in loss to the company, the auditor can -be made to make good the loss.

Civil Liability under the Common Law

Under the ordinary law of contract, an auditor of a company or of any other sort of organisation has a duty t- use reasonable skill and diligence in carrying out his work. If he fails to do so, he will be negligent. If his negligence leads to loss by his client then he will be liable to make good the loss. What is negligence an auditor is hard to establish, but an auditor is expected to carry out his duties with care using all the senior expertise he possesses in the best manner.

Civil Liability S 368 CAMA 1990

A company's auditor shall in performance of his duties exercise due care, skill and diligence as it is reasonably necessary in each particular circumstance. Where company suffers loss or damage as a result of its failure auditors in discharge the fiduciary duty in post on him by this section the auditor shall be liable for the negligence and the director can institute an action against him the court. If the director fails to institute an action any member may do so after the expiration of 21 days notice of the company to institute an action. What is the best modem manner means following manual such as this and the auditing statements of the ICAEW.

The famous case of the London Oil Storage Company Ltd will illuminate this. The petty cash was misappropriated over a period of years so that the balance per the petty cash book was 796 in 1920 whereas there was only $30 in the cash box. The auditor did for count the cash and therefore did not discover the embezzlement. It was established that:

1.     The auditor was negligent in not counting the cash as he should have been put upon enquiry he surprisingly large amount in 1902 of the book balance.

2.     The company suffered loss

3.     The loss was caused by

Ø The auditor's failure to exercise proper control as is heir duty,

Ø The auditors not because they failed to discover the loss already made (clearly a loss cannot caused by failing to discover it) but because their failure to discover a loss in previous years led to further defalcation.

Ø The auditors were ordered to repay the loss caused by their negligence, which was assessed at five guineas only.

TUBE HEDLEY BYRNE v. HELLER AND PARTNERS CASE 1963

The next problem to be considered follows from the modem concept that financial statements with which auditors report are relied upon not only by the persons with whom the auditors have contractual relations (shareholders, for example) but also many other people whom we can call third parties. If the auditor is negligent and fails to discover that accounts do not show a true and fair view then other people who rely on the accounts may suffer loss. Such people may include lenders or people who may want to buy the business.

The question is "Does the auditor have a legal obligation to compensate third parties who suffer loss as a consequence of his negligence"? Such an obligation might arise under the law of Tort. Torts being civil wrongs done to people,

In the case Cadlier V. Crane Christmas and Co. 1959 it was decided that the auditor has w legal obligation in absence of a contractual or fiduciary relationship. However doubt was cast on this judgment in the case of Hedley Byne apd Company Ltd V. Heller and Partners Ltd 1963. The House of Lords decided that the Candlers case was wrongly decided and that the actions for professional negligence can arise if financial loss is suffered by third parties who rely on the professional skill and judgment of persons with an accountant but the principle could extend to accountants and auditors.

The current view is that:

a)     For an action against an accountant to succeed

                                   i.            Negligence must be proved

                                 ii.            It must be shown that the accountant knew or ought to have known that the accounts would be relied upon by the complaint third party.

b)    Individual shareholders who take investment decision on the strength of negligently prepared or audited accounts have no right to redress form the accountant or auditor concerned.

Some authorities have suggested the Hedley Byme givens a very much wider class of personal right of action against auditors than paragraph 16 suggests. The matter is still far from clear and is very worrying for ' professional auditors.

MINIMIZING LIABILITIES

The ICAEW suggest the following actions to minimize liability for professional negligence.

a)     Do not be negligent

b)    Agree the auditor? s duties and responsibilities precisely in a letter of engagement.

c)     By following the precepts of the auditing standards.

d)    By defining in their report, the precise work not undertaking any limitation in the work.

e)     By stating in any report, the purpose of the report and that it may not be-rely for any other purpose.

f)      By identifying the authorized recipient of the report in the engagement letter and in the report.

g)     By limiting or excluding liability by a term in the engagement letter or two third parties by a disclaimer in a report.

h)    By obtaining an indemnity from the client or third party insurance).

i)       By defining the scope of professional competence to include only matters within the accountant competence. Do not take on work you are not proficient at.

You will appreciate that an auditors' .report under the companies act cannot include disclaimers e. t. C now include the work done and the responsibilities of the auditors and the directors. However, the advice holds goods for special investigations and audits for special purpose. You will also appreciate that auditors and accountants are now required to hold professional indemnity insurance.