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Liabilities of an Auditor

An auditor of a public limited company may be liable for his/her actions at the entity
audited. The liability may be defined as the financial and other obligation to the entity
concerning the damages caused by the auditor while conducting the audit. Different types of
Liabilities are as under:

A. Civil Liability

1. Liability for Negligence

An auditor to a limited company is an agent of the shareholders. He is required to exercise


reasonable care and skill in the performance of the work entitled to him, and if he fails to
do, then the question of his liability with reference to the negligence arises. This matter is
discussed in the light of legal provisions as under:

(a) Where an auditor is proved to be negligent but no loss is sustained by his client arising
out of his negligence, he is not liable

(b) An auditor cannot restrict his liability by entering into an agreement as his duties are
defined and laid down in the Companies Act and therefore any such agreement (if
executed) would be against the law and will be void. He will be liable for damages in spite of
such an agreement.

(c) An indemnity clause inserted in the articles of a company, by which the directors,
managing agents, auditor and other officers of the company are relieved from liability has
been declared void. However, the court may relieve an auditor of liability for negligence, or
misfeasance if it is proved that he acted honestly and reasonably.

(d) If the auditor fails to perform his job with reasonable care and skill and consequently his
client suffers a loss due to his negligence, he is liable to make good the loss on an action
being taken against him by the company.

Major legal decisions

(i) Arthur E. Green & Company Vs Central Advance & Discount Corporation Ltd.
(1920):

It was held that auditor is guilty of negligence. Auditor accepted the schedule of bad debts
furnished by the client, though it was apparent that debts were not recoverable.

(ii) The London Oil Storage Co. Ltd. Vs Sear Hasluck & Co.

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In this case, auditors were held liable for negligence. Auditors failed to verify the physical
existence of cash in hand. Cash balance as per books did not agree with the physical
balance, the difference was misappropriated by the cashier.

(iii) Irish Woolen Co. Ltd. Vs Tyson and Others.

In this case auditors were held liable for negligence. Profits were overstated by not
recording purchase invoices. He was held liable for having failed to exercise reasonable care
and skill.

(iv) Kingston Cotton Mills Co. Ltd.

In this case auditors were not held liable for negligence. It was held that it is not the duty of
auditors to take stock, if they accept certificate in the absence of any suspicion, he has
carried out reasonable care and skill.

2. Liability for Misfeasance

The term misfeasance means breach of duty involving company at a loss. If auditor does
something wrong in the performance of his duties resulting in a financial loss to the
company, he is guilty of misfeasance. For example if auditor does not perform his duties
properly and the company suffers loss he is liable for misfeasance. After a company has
gone into liquidation, misfeasance proceedings can be instituted against the liquidator,
creditor, A contributory of the company. When a company goes on liquidation, its past and
present directors, promoters, managing agents and auditors are liable to make good all
losses sustained by the company on account of negligence of duty or breach of trust if
misfeasance proceedings are initiated against him within the prescribed time.

Important Case Decision

(i) London and General Bank Ltd.

In this case auditors were held liable for misfeasance. The auditors failed to report that
Balance Sheet was not properly drawn:- Large sums were advanced to the customers and
interest thereon was accrued, in fact neither advance nor accrued interest was receivable.
No provision for bad debts was made and the company paid dividend. 2) According to the
Companies Act if the auditors fail to report to the members material misstatement of facts
or give untrue picture to the members, and the default is willful, auditors shall be punishable
with fine which may extend to Taka two thousand.

3. Legal liabilities of auditors

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Auditors are supposed to perform their work in an honest and careful manner since they can
be held liable for negligence in the following ways:

a) They don't carry out their work as required by the ISA

b) They fail in the duty of protecting the interest of the various users of the financial
statements i.e. any person who relies on his work.

c) They don't carry out their work with due care and skill i.e. what an ordinary skilled man
or woman would do in that circumstance.

4. Liability to the third parties

An auditor may be liable for negligence not only under the law of contract but also in the
law of tort i.e. if a person to whom he owed a duty of care has suffered financial loss as a
result of the auditor's negligence. The auditor is expert in finding out the errors and frauds
and is aware how to check the books of accounts. Many third parties as the shareholders,
investors, tax authorities, creditors and government rely upon his reports. So if he makes
any type of error or fraud, he is liable to pay the damages. According to the case decision of
the historical case Derry vs. Peek (1889), for the third party liability the following things
must be proved:

(i) That the financial statement signed by the auditor was materially untrue;
(ii) That the auditor knew the statement was untrue;
(iii) That the statement was prepared with an intention that third party act on it; and
(iv) That the third party acted on the financial statement and suffered a loss.

B. Criminal Liability

According to the Companies Act 1994 an auditor shall be criminally liable if he willingly
makes a material false statement in any report, certification or in the financial statement
with the intention to deceive and mislead. Examples of criminal liabilities include:

The auditor accepts appointment when he is ineligible to do so or continue in office


after becoming ineligible;
The auditor obtains the advantage of deception;
The auditor falsifies accounting records or documents;
When the auditor publishes misleading statements intended to deceive members;
When an auditor misappropriates a clients' property.

1. Misstatement in Prospectus

The criminal liability of an auditor may arise due to misstatement in prospectus. Where a
prospectus invites person to subscribe for shares or debentures of a company, the auditor
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shall be liable to pay compensation to every person who subscribe for a purchase any
shares or debentures on the faith of the prospectus for any loss or damage be may reason
of any untrue statements. Here a prospectus containing any untrue or misstatement is
issued with the consent of auditor who shall be punished the with imprisonment which may
extend up to two years or with fine which may extend up to TK. 5,000/- or both.

2. False statement in any return

Where the auditor makes any false statements in any material respect in any return report,
certification, balance sheet etc, he shall be imprisoned which may extend up to 2 year and
shall also be liable to fine. If any person provides false evidence he is punishable up to two
years and liable for fine also. The evidence may be affidavit oath or some affirmation etc.

3. Disqualified Auditor

The company ordinance has clearly stated the persons who are not qualified as auditor, but
if an unqualified auditor may act as auditor of the company. He is liable to fine up to TK.
5,000.

4. Auditor Report

If the auditor makes the report with the extent to profit himself and the third party for any
loss for a material consideration it is a criminal liability. He may be punished for six months
and fine upto TK. 2,000.

5. Professional Misconduct

If the auditor fails to follow the rules of their own profession he is liable for the criminal
liability. For this default the council can with draw the certificate of practice. The council can
also go to the court of law for prosecuting the concerned auditor. The auditor can suffer the
jail or fine or both.

6. Liability for libel

At times it so happen that an auditor in the course of his duties and in his audit report finds
it necessary to criticise the action of officials of a company or the other undertaking, he
should submit his report in a manner which may not result in exposing him to action on
grounds of defamation. Otherwise he will be liable for libel.

(C) Other Liabilities

1. Honorary Audit
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The auditor on the honorary basis may also accept an audit work. After the completion of
the audit work he is bound to submit his report. The honorary auditor cannot relive himself
of liability on the plea that the agreement was not supported by consideration.

2. Joint Audit

When the two auditors carried out the work of audit it is called as the joint audit. It is
possible by the two independent auditors under the agreement. Sometimes, a business
concern may have two or more than two business places in different cities or countries
conduct the audit by one auditor. In such a case the auditors are liable for their actions
jointly and severally.