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7/28/2019 Liabilities of an Auditor (New)
http://slidepdf.com/reader/full/liabilities-of-an-auditor-new 1/27
LIABILITIES OF AN
AUDITOR
Ref: (i) ICAI Material
(ii) Tondon
7/28/2019 Liabilities of an Auditor (New)
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Categories of Liabilities
• Liability towards client
• Liability towards third party
• Liabilities under special cases
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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
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Liability for Negligence
• Reasonable degree of care and skills not
exercised
• Breach of duty towards auditee
• Failure to follow professional standards
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Specific negligence w.r.t. audit
• Dividend paid out of capital
• Provisions of A/A not complied with
• Cash/stock misappropriated which couldhave been discovered with ordinary skills
• Assets/liabilities shown as existed while
actually not existing
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Negligence – Case Laws
• Hudson vs. official liquidator, Dehradun MussoorieElectric 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 assessee’s income manipulated
– Auditor not held responsible as they were appointed to prepareIT returns and not to audit accounts
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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
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Liability Under Companies Act
• Meaning
– Civil liability gives a person rights to obtainredress from another person e.g. the ability to
sue for damages for personal injury
• Forms of civil liability
– Liability for negligence
– Liability for misfeasance
Civil Liability
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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
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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
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Case Laws
• The London and General Bank (1895) – Auditor submitted detailed report to directors on loansto 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 thoughgoods included in closing stock
– Auditor could have detected fraud through creditor ledger balances and cross check of payments
– Auditor held responsible
C L
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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 morethan what was shown in B/S
– The broker pledged company’s securities which were
in its custody. Auditor did not detect this. – Auditor obtained certificate from brokers rather thanbank 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 dividendwrongfully declared
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Criminal Liabilities
• There is both a mental element and
physical element to the offence
• The penalties for criminal offences are
fines and imprisonment
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Criminal Liabilities for Auditor
• Sec. 63 – making untrue statement inprospectus
• Sec. 539 – if auditor with intent to defraud
– Destroys or falsifies evidence
– Makes fraudulent entries in books
• Sec. 628 – in any document preparedauditor
– Makes false statement knowing it is false
– Omits material facts knowing it is material
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Liability Towards Third Party
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Liability Towards Third Party
• No privity to contract – Ultramares Corp vs. Touche, Niven & Co. (1921) -
Auditor did not know that financial statements will beused 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
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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
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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
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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 inopinion
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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
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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 towardsclient or third party
– Draft clear cut engagement letter and define scope of work accordingly
– Report should be titled as “Accountant’s Report” andshould not include any opinion
– The word “Unaudited” can be added on each page of
the report
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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 etcKrachi 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”
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Concluded