AF4228

Auditing and
Assurance
2020/21 S1

Class 2
Rights, Duties and Liabilities
of Auditors in Hong Kong

1
Learning Objectives
2.1 Sources of rights, duties and
liabilities of auditors
2.2 Summary of statutory provisions
2.3 Quasi-legal duties under professional
requirements
2.4 Audit contract
2.5 Duty of care – Common law
2.6 Avoidance of litigation

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2.1 Sources of rights, duties and
liabilities of auditors
Statute
• Companies Ordinance (Cap. 622) (“CO”)
• Has commenced operation on 3 March 2014.
• Accounts and audit (Part 9)
• http://www.cr.gov.hk/en/companies_ordinance/docs/part9-
e.pdf
• CO Part 9 Division 5 – Audit
• Companies (Winding Up and Miscellaneous Provisions) Ordinance
(Cap. 32)
• Professional Accountants Ordinance (Chapter 50)
Common law
• Past Judicial Decisions
Rules and regulations (HKICPA)
• HKICPA Standards including Code of Ethics
Audit contract (Engagement letter)
• Implicit or explicit terms

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2.2 Summary of Statutory
Provisions
Appointment of Auditors
An auditor must be appointed for each financial year of a company
(s394)
• by a resolution passed at the annual general meeting (“AGM”) held in
respect of the previous financial year
• by a resolution passed at a general meeting if
• it is not required to hold an AGM (s396)
• no person is deemed to be reappointed as auditor of the company for the financial
year (s396)
• no auditor appointed at an AGM (s396)
• first auditor not appointed by directors (s397)
• by the directors
• for the first auditor of the company at any time before the first AGM / before the
appointment period (see s392) before the next financial year if no AGM is required
(s395); and
• to fill casual vacancy (s397)
• by the court
• where auditors are not appointed or reappointed as mentioned above, then any
member may make application for the appointment of auditors directly to the court
so as to fill the vacancy

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2.2 Summary of Statutory
Provisions (Cont)
Renewable tenure to auditors
• Free from untoward managerial interference
Auditors resigned/removed/retired
• To give the company a statement of circumstances connected to the
resignation/removal/retirement or a statement of no such
circumstances (to enhance transparence and corporate governance)
• To request the statement to be sent to members
• Auditor has to send a copy of the statement to Registrar for
registration
• For resignation and retirement, to be given notice of general meeting,
to attend general meeting and be heard at such meeting on business
that concerns the auditor or former auditor
Additional right related to resignation
• To request for holding a general meeting to explain the resignation
Additional right related to removal
• Be compensated or may seek damages

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 2.2 Summary of Statutory
Provisions (Cont)
Statutory rights
• In the absence of malice, not liable to any action of defamation in
respect of any statement made and document prepared for publication
by the auditor in the course of performing the duties as auditor (s410)
• To attend any general meetings and be heard in such meetings on any
part of business that concerns the person as auditors (s411)
• Access to accounting records and obtain information and explanation
deemed necessary (s412)
• An offence if information and explanation deemed necessary are not
provided or misleading, false or deceptive information and explanation are
provided (s413)
• Liable to a fine and imprisonment (s413)
• http://www.cr.gov.hk/en/companies_ordinance/faq_auditor-rights.htm
• Remuneration
• fixed by the company in general meeting or by any ways as the company
determined
• normally fixed by directors if the auditor is appointed by the general
meeting
• by directors or the court
• amounts, including expenses, disclosed
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 2.2 Summary of Statutory
Provisions (Cont)
Statutory duties
• Duty to report – must prepare an auditor’s report
• An auditor’s report must be signed and state the auditor’s name
• To state in the auditors’ opinion
• whether the financial statements have been properly prepared in compliance with the CO
• whether the financial statements give a “true and fair view”
• To examine and state the auditor’s opinion if not the case
• Adequate accounting records kept
• Financial statements are in agreement with accounting records
• Obtain all information or explanations that are necessary and material for the purpose of the
audit
• Director Report – consistent with financial statements (and bring that opinion to the members’
attention at a general meeting)
• Additional information
• Directors’ emoluments, retirement benefits, termination payments and benefits
• Loans, quasi-loans to directors and those controlled by/connected with such directors
• Material interests of directors in transactions, arrangements or contracts entered into by the company or
another company in the same group of companies
• An offence (a fine of $150,000) if the auditor knowingly or recklessly causes the
following statements to be omitted from an auditor’s report (s408)
• Financial statements are not in agreement with accounting records
• Failure to obtain all information or explanations that are necessary and material for the
purpose of the audit
• An offence and liable to a fine if the auditor’s name not stated on the auditor’s report
to members (s409)
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 2.3 Quasi-Legal Duties under
Professional Requirements
Preface to HKSQC
• Explains the scope and authority on Hong Kong Standards on Quality Control,
Auditing, Assurance and Related Services

HKSQC 1 – CPA firm to establish a system of quality control to ensure

• compliance with professional standards and regulatory and legal requirement
• that reports issued by the auditors are appropriate in the circumstances

Hong Kong Framework for Assurance Engagement

• defines and describes the elements of an assurance engagement (including auditing)
and identifies engagements to which HK Standards on Auditing (HKSAs) apply

Failure to comply with HKSQC and HKSA – liable to be enquired into; leading to
disciplinary actions
• HKSA 200 – Para 18: The auditor should conduct an audit in accordance with
HKSAs

Auditing Guidelines (AGs) and Practice Notes (PNs)

• assist auditors in applying Auditing Standards of general application to particular
circumstances and industries.

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2.3.1 Whether Non-compliance with Auditing
Standards Constitutes a Breach of Duty?

In Lloyd Cheyham & Co. Ltd v Littlejohn Co. (unreported case), Justice
Woolf:
“While they are not conclusive, so that a departure from their terms
necessarily involves a breach of duty; and while they are not clear,
rigid rules they are very strong evidence as to what is the proper
standard which should be adopted, and unless there is some
justification, a departure from this will be regarded as constituting a
breach of duty.”
There is evidence that auditing standards have some legal status –
compliance with auditing standards could be a defence to a negligence
action.

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2.4 Audit Contract (engagement
letter)
Express terms:
• a detailed description of the work done
• a definition of the degree of skill and care

Implied term:
• act with a reasonable skill and due care

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2.5 Duty of Care – Common Law
Duties in Contract
• Duty only owed to client with whom auditor has
a contract
• Contract may be explicit (written, e.g.
Engagement Letter) or implicit (unwritten but
understood)
Duties in Tort
• Duty may be owed to client and to third parties
who do not have privity of contract. (privity of
contract means only parties to contracts should
be able to sue to enforce their rights or claim
damages as such)

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2.5.1 Duty of Care in Contract
Explicit duty
○ Contract should contain:
○ Description or work to be done
○ Definition of degree of care and skill
Implicit duty to perform work with reasonable care
and skill even if not explicitly stated in the contract
Reference to past judicial decisions:
Kingston Cotton Mill Co (1896):
• Expected of a reasonably competent, careful and cautious
person
• Auditor is a watchdog, not a bloodhound
• Entitled to assume that management is honest
• Have to probe to the bottom where suspicion is excited
• Not liable for intended fraud where suspicion is not aroused

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2.5.1 Duty of Care in Contract (Cont)
Thomas Gerrard & Son Ltd (1967)
• Not enough to accept MD’s explanation
• Even if auditor misguidedly trusted MD
• When suspicious, probe to bottom until
• Satisfied that there is no fraud, or
• Report when not satisfied
• If invoices found altered
• Examine all invoices
• Contact supplier for confirmation
Pacific Acceptance Corporation Ltd (1970)
• Changing expectation of an auditor’ responsibility, with the
standards of reasonable care also being altered
• Due regard to possibility of fraud – structured plans and procedures,
warn and inform appropriate level of management
• Supervision and review of inexperienced staff
• Proper documentation
• Audit the whole year
• Rely on satisfactory internal controls

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2.5.2 Duty of Care in Tort
A civil wrong independent of contract
• E.g., an auditor’s conduct falls below normal standard
It serves the function of providing financial
compensation
It is wider than duty of care in contract
Tort of negligence is most applicable to auditors
Negligence
• Careless or unintentional misconduct
• Entails a breach of contractual duty or a duty of care in tort
An auditor is liable to the:
• parties for whom the audit is being prepared
• third parties who may be affected by the audit

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2.5.3 Claims for Negligence
To be successful in a claim for negligence, a plaintiff must
prove that:
• duty was owed to the plaintiff by the defendant (duty of
care)
• a breach of the duty of care (negligent conduct) occurred
• loss or damage was suffered by the plaintiff
• a causal relationship existed between the breach of duty by
the defendant and the harm suffered by the plaintiff.

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2.5.4 Reasonable Skill and Care
• An auditor has a duty to exercise the reasonable care and
skill expected of a professional.
• Requires adherence to regulatory and professional
standards in all aspects of an audit.
• ‘The professional man owes a duty to exercise that
standard of skill and care appropriate to his professional
status’ (Caparo, 1990).

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2.6 Avoidance of litigation
• Investigate prospective clients thoroughly
• Use engagement letters
• Not be negligent / exercise reasonable skills and
care
• Comply fully with professional pronouncements
• Recognise limitations of professional
pronouncements
• Establish and maintain high standards of quality
control
• Maintain adequate professional indemnity cover

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Summary
• Laws & Regulations protecting auditor
independence
• Statute
• Rules and Regulations (HKICPA)
• Common Law
• Auditor’s duties and responsibilities
• Statute
• Rules and Regulations
• Common Law
• Law of Contracts
• Law of Torts
• Liabilities to Third parties
• Avoidance of litigation

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Review Question
As the audit senior for Apple Hardware Ltd (“AHL”), you are happy with the smoothness of the audit
for the year ended 31 December 2019. Today, your audit partner tells you that AHL has just gone
into liquidation. The financial controller was diverting company funds into a Swiss bank account and
has left the country to live in Maldives. The lawyers for the creditors of AHL are taking action
against the partner for not performing an appropriate audit. They believe that a properly conducted
audit should have detected such a fraud.
The fraud was substantial; however, it was not material from the company's point of view. You
explain to the partner that the audit was performed in accordance with all auditing standards and
nothing was found to arouse suspicion during the audit. The audit took the same amount of time as
last year's and all appropriate work steps were performed. Your work was reviewed by a manager
and the entire file was reviewed by the audit partner.
The audit partner is still concerned. He rings an audit partner in an associated office accounting firm
and asks her to review the audit file. She agrees and spends a day reviewing the file. After
completing her review, she is satisfied that the audit was performed properly.

Required
Explain whether your accounting firm has acted with due care. What do you think will be the court's
decision if the case goes to trial?
Even if the partner is convinced he acted with due care, explain why he may offer the creditors of
AHL a substantial settlement amount.

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