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Ref: (i) ICAI Material (ii) Tondon

Categories of Liabilities
Liability towards client Liability towards third party Liabilities under special cases

Liability Towards Client

Under Law of Torts (i) Liability for Negligence Under Companies Act (i) Civil Liability
Liability for Negligence Liability for Misfeasance

(ii) Criminal Liability

Liability for Negligence

The three elements of negligence
Existence of duty by one party to another to perform some act with certain degree of care and competence Occurrence of breach of duty Loss being suffered by party to whom duty is owed

Liability for Negligence

Reasonable degree of care and skills not exercised Breach of duty towards auditee Failure to follow professional standards

Specific negligence w.r.t. audit

Dividend paid out of capital Provisions of A/A not complied with Cash/stock misappropriated which could have been discovered with ordinary skills Assets/liabilities shown as existed while actually not existing

Negligence Case Laws

Hudson vs. official liquidator, Dehradun Mussoorie Electric Tramway Co.
Robberies committed by mgt. Auditor did not examine cases even when there was suspicion Auditor passing over illegal payments by mgt. as correct Auditor held responsible

Commissioner of IT vs Dandekar
The firm in question maintained two separate books of accounts (for usual business and for black market transactions) Auditor (Dandekar) signed financial statements as correct Income tax dept found assessees income manipulated Auditor not held responsible as they were appointed to prepare IT returns and not to audit accounts

Negligence Case Laws

Martin vs Isitt
Monthly audit of the client was delayed Auditor held responsible as client suffered losses

Lakshmi Narain Saxena

Delay in submission of audit report for statutory requirement Auditor held responsible

When auditor is not liable for negligence?

If auditor proves otherwise If auditor acted honestly If company has not suffered losses Remote damages are not recoverable
Courts need to take into account the contributory negligence by directors and other officers of the company

Liability Under Companies Act

Civil Liability
Civil liability gives a person rights to obtain redress from another person e.g. the ability to sue for damages for personal injury

Forms of civil liability

Liability for negligence Liability for misfeasance

Liability for Negligence

Making untrue statement in prospectus as expert (Sec 63 of Indian Companies Act) Liability in circumstances where losses are suffered by client (already discussed under liability for negligence)

Liability for Misfeasance

Misfeasance means breach of trust or duty Auditor liable of misfeasance if breach of duty causes loss or damage to company or its property

Liability for Misfeasance

Duty imposed on auditor (Sec 227[3])
Whether he obtained info and explanation Whether in his opinion B/S and P/L exhibit true and fair view

So failure to comply with above duty is misfeasance

Liability for Misfeasance

Duty imposed on auditor (Sec 229)
Audit Report to be signed by person appointed as auditor or partner if firm is appointed as auditor Such a person must inform the RoC within stipulated time about signing of report.

So failure to comply with above duty is misfeasance

Case Laws
The London and General Bank (1895)
Auditor submitted detailed report to directors on loans to customers where security was insufficient However, he did not disclose it to shareholders No mention in the audit report about it Auditor held liable for misfeasance Auditor was asked to refund the amount of second dividend declared by company

The Irish Woolen Co vs Tyson & others (1900)

Purchase invoices suppressed by company though goods included in closing stock Auditor could have detected fraud through creditor ledger balances and cross check of payments Auditor held responsible

Case Laws
City Equitable Fire Insurance Co (1924)
B/S of company described debts due by companys broker as cash at bank and in hand The sums due by broker to the company was more than what was shown in B/S The broker pledged companys securities which were in its custody. Auditor did not detect this. Auditor obtained certificate from brokers rather than bank in respect of securities held Auditor NOT held liable

Westminster Road Construction & Eng Co (1932)

Auditor failed to detect overvaluation in work in progress and omission of liabilities Auditor held liable and was asked to refund dividend wrongfully declared

Criminal Liabilities
There is both a mental element and physical element to the offence The penalties for criminal offences are fines and imprisonment

Criminal Liabilities for Auditor

Sec. 63 making untrue statement in prospectus Sec. 539 if auditor with intent to defraud
Destroys or falsifies evidence Makes fraudulent entries in books

Sec. 628 in any document prepared auditor

Makes false statement knowing it is false Omits material facts knowing it is material

Liability Towards Third Party

Liability Towards Third Party

No privity to contract
Ultramares Corp vs. Touche, Niven & Co. (1921) Auditor did not know that financial statements will be used by bank for loan Candler vs. Crane, Christmas & Co. (1951) Auditor knew but no privity to contract Commissioner of IT vs. Dandekar (1952) Auditor did not owe any duty to Department De Savvary vs. Helden, Howard & Co. (1961) Auditor employed by bank and not by plaintiff (MD) Auditor NOT held liable

Liability Towards Third Party

Derry vs. Peek
Statement is untrue Auditor knew it is untrue Statement made to cause action Plaintiff acted upon it Plaintiff suffered loss due to such action

Liability Towards Third Party

Hedley Byrne Principle
Audited statements prepared for specific purpose and auditor knows it Creditors for funds can claim damages if there is proof of negligence and knowledge of use Individual shareholders cannot claim damages for investment decisions Auditor gives disclaimer

Liabilities in Special Cases

Liability of Honorary Auditor
As much responsible for negligence as a paid auditor

Liability of Joint Auditors

Divide work to the extent possible Division of work can also be on time basis Each auditor responsible for his own work Client to be informed of mutual agreement Separate audit report to be provided in case of differences No question of majority or minority in differences in opinion

Liabilities in Special Cases

Audit of subsidiary companies
Auditor of holding company not responsible for work performed by auditor of subsidiary company

Liability of local auditor

Auditor of Head Office not responsible for work done by local auditors in foreign countries Auditor makes clear mention in audit report on reliance of such figures supplied by local auditors

Liabilities in Special Cases

Liability for Libel
Not liable if statement made was bonafide

Liability for Unaudited Accounts

Specific mention of the fact that accounts are not audited can absolve auditors from liabilities towards client or third party Draft clear cut engagement letter and define scope of work accordingly Report should be titled as Accountants Report and should not include any opinion The word Unaudited can be added on each page of the report

Case Laws
Dambell Banking Co. (1900)
False B/S prepared, fact of bad O/D not disclosed with intent to defraud shareholders

Official Liquidator Karachi Bank vs Directors etc Krachi bank (1932)

P/L falsified to show profits by crediting interest that was never paid

Rex vs Lord Kylsant and Another (1931)

Trading profits inflated by including non-trading incomes/profits Case brought changes in phraseology of auditors report from true and correct to true and fair