Civil Liabilities of an auditor

Civil liabilities of an auditor are briefly explained under the

following topics

1. Liability for Negligence

An auditor is expected to perform his duties with reasonable care
and skill. Of course, no person can promise to always use highest
degree of skill and display extraordinary knowledge while
discharging their duties.

An auditor is liable to the following persons for negligence while

discharging his duties.

a. To his client, with whom he has contractual relationship.

b. To Third parties, if the auditor knows or had reasonable
opportunity to know that he (the third party) is relying
on the skill and judgement of the auditor.
c. However, in case of Fraud, the auditor is liable to all
persons.
What are the Consequences of Negligence?
1. Compensatory Damages
a. The auditor has to pay damages for the loss resulting
directly out of negligence on the part of the auditor.
b. Such compensatory damages are not called for, if any
remote or indirect loss is suffered by the client.
2. Special Damages
If the auditor has agreed to be liable at the time of entering into a
contract and has had knowledge of the prevailing circumstances,
special damages can be claimed for his negligence.

2. Liability Under Companies Act

Under Section 477, the court may summon and examine the
auditor (or any officer of the company) and order him to produce
books or documents of the company that are kept under his
custody. This power is enforceable only after the appointment of
liquidator or passing of winding up order of the company.

When a company is wound up by the order of the court and if the

Official Liquidator is of the opinion that a fraud has been
committed and has made a report thereon, the court may examine
the auditor (or any officer of the company) in public on an
appointed day.

Misfeasance
Misfeasance implies breach of duty or negligence in the
performance of duties.

The liability for misfeasance arises only if any loss is suffered due
to negligence or breach of duty. If no loss is suffered due to
misfeasance, liability does not arise. Action for misfeasance can be
initiated within 5 years –

i. from the date of order of winding up.

ii. from the first appointment of the liquidator or
iii. of the cause of action having arisen, whichever is longer.
Action for misfeasance can be initiated only when the company is
being wound up. Compensatory damages can be claimed from all
the officers of the company, including an auditor, for the loss
suffered due to misfeasance.

Misstatement in Prospectus
A prospectus is an invitation extended to subscribe for shares in
or debentures of a company.

An auditor becomes liable if, he had made an untrue statement as

an expert and a person has relied on the statement made by the
auditor and subscribed for any shares or debentures and incurred
loss or damages as a result.

However, an auditor is not liable

 i. if he can prove that the prospectus was issued without
his knowledge or consent and on becoming aware of the
same, he has issued a public notice that it was issued
without his knowledge or consent or
ii. if he withdrew his consent in writing before the delivery
of the prospectus for registration or
iii. after delivery of the prospectus tor registration but
before allotment of shares, on becoming aware of the
untrue statement, if he withdrew his consent in writing
and gives reasonable public notice of his reasons for
withdrawal or
iv. If he has reasonable grounds to believe that the
statement was true and did believe the statement was
true upto the date of allotment of the shares or
debentures.
3. Liability under Consumer Protection Act
The following points should be borne in mind:

1. The auditor gives his opinion or advice on payment of

fees. Therefore, they come under the purview of
Consumer Protection Act.
2. If any chartered accountant gives opinion or advice
contrary to the provisions of law or any opinion not
supported by any judicial decisions, he may be called
upon to compensate by paying damages for the loss
suffered as a result of his opinion or advice.
4. Liability for Unaudited Statements
A chartered accountant may accept assignments other than his
audit work. For example, a chartered accountant may accept to
write the books of accounts and prepare the financial statements
for a client. He may not have actually audited the client’s
accounts.

However, since he has associated himself in the preparation of

financial statements, there is every possibility of a third party to
presume that he is the auditor of the company to which he had
prepared financial statements and that
the books of accounts were duly audited.

In such an event, a chartered accountant becomes liable.

However, to avoid such misinterpretations, the chartered
accountant should be very careful while entering into a contract/
agreement with a client. Actually, when he is not required to audit
the books of accounts, or where he is not required to perform a
complete audit, such facts should be clearly stated in the letter of
appointment.

Precautions to be taken by an auditor for unaudited

Statements
When an auditor gives a report on certain specific matters, where
his scope of engagement is quite limited, he is advised to take the
following precautions while reporting to avoid liability.

1. The title of the report should clearly state the

purpose/scope of report.
2. Ambiguous terms such as review, general review, or
check should not be used in describing his engagement.
3. In his correspondence with the firm or in any other
document, the auditor should not use the term ‘audit’ or’
audit fee.
4. The report should clearly state that the books of
accounts are unaudited.
5. Liability For Negligence of Assistants
An auditor is entitled to rely on the work performed by the
assistants. But he should ensure that his assistants are not
negligent and the audit is conducted with due care and skill.
However, he will continue to be responsible for forming and
expressing his opinion on the financial information.

Criminal liability
Person can be guilty of fraud in 3 ways:

1. Fraud by false representation

2. Fraud by failing to disclose

3. Fraud by abuse of position

Failure to provide certain circumstances as required by the

Companies Act

Civil liability

• Auditors add credibility to financial statements

• If clean opinion given & then proved later that fin stats were
not true & fair, a user who loses as a result of reliance on the
statements may blame the auditor for the loss.

• The auditors’ liability towards the client is based on the

contractual obligation per contract signed by both parties