LIABILITIES OF AN AUDITOR

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.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 .r.

official liquidator. – – – – Robberies committed by mgt.Negligence – Case Laws • Hudson vs. Auditor did not examine cases even when there was suspicion Auditor passing over illegal payments by mgt. Dehradun Mussoorie Electric Tramway Co. 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 assessee’s 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 .

the ability to sue for damages for personal injury • Forms of civil liability – Liability for negligence – Liability for misfeasance .Liability Under Companies Act Civil Liability • Meaning – Civil liability gives a person rights to obtain redress from another person e.g.

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 .

• 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.

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 .

– 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 . Auditor did not detect this.Case Laws • City Equitable Fire Insurance Co (1924) – B/S of company described debts due by company’s 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 company’s securities which were in its custody.

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

628 – in any document prepared auditor – Makes false statement knowing it is false – Omits material facts knowing it is material . 63 – making untrue statement in prospectus • Sec.Criminal Liabilities for Auditor • Sec. 539 – if auditor with intent to defraud – Destroys or falsifies evidence – Makes fraudulent entries in books • Sec.

Liability Towards Third Party .

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

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 “Accountant’s Report” and should not include any opinion – The word “Unaudited” can be added on each page of the report .

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 auditor’s report from “true and correct” to “true and fair” . (1900) – False B/S prepared.Case Laws • Dambell Banking Co.

Concluded .

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