CHAPTER 7 : AUDITING ISSUES AND LEGAL LIABILITIES

GROUP 7
MOHAMAD ARIF B. HERJON MOHAMMAD IQKRAM B. MOHAMAD MUHAMAD IRSYADUDDIN B. ZAINUL ISMAIL KHAIRUL FAHMI B. MD SAYUTI LIM CHUN HOW 03DAT11F1072 03DAT11F1011 03DAT11F1070 03DAT11F1149 03DAT10F2196

OBJECTIVE
Understand

the nature of audit liabilities. Understand the audit legal liabilities.

DEFINE THE FRAUD

The terms fraud and irregularities are used to refer to : Fraud which involves the use of deception to obtain an unjust or illegal financial advantage

1)

2)

Intentional misstatement in, or omissions of amounts or disclosure from, an entitys accounting records or financial statements ; and
Theft

3)

DEFINE THE ERROR

Error is used to refer to unintentional misstatements in, or omissions from an entitys accounting records or financial statements. Unintentional misstatements in the financial statement due to ignorance or lack or knowledge of an employee and can also be caused by weakness in internal control of an organization that causes the financial statements provided not accurate. Usually this error could easily be detected.

DIFFERENTIATE BETWEEN FRAUD AND ERROR

No. 1. Fraud Usually been planned or done intentionally. Error Happen unintentionally and no planned by the employee.

2.

Involving one person or more than one person. Fraud done for personal gain.

Involving only one employee. The error that occurred does not give interest to any parties.

3.

DEFINE THE LEGAL LIABILITIES

Shareholders rely on the auditor to audit the financial statements and as per the auditors report, the auditor is reporting to the shareholders. However, when companies become public entities, the audited financial statements become public documents and readers and users from all over the world are able to access the financial statements, especially since most public listed companies make their audited financial statements available on their websites.

LEGAL ACTS THAT GOVERN AUDITORS LIABILITIES

Legal acts that govern auditors liabilities

Report to members

Report to debenture holders

Report in the prospectus

1) Report to members

According to section 174 of the Companies Act 1965, state auditors duties should not be restricted by any agreement between the auditor to its shareholders or directors of the company. The liability is subject to the act and the law which means if convicted; the auditor may be fined or sentenced under the Code Act.

Companies Act 1965 requires auditors performing their duties with regard to 2 aspect.

1.

Prepare a report and give an opinion on these financial statements and report should state the following :
Balance sheet and profit and loss account have been properly prepared in accordance with the requirements of the act and give a true and fair view. The accounting records and other records are adequate and properly kept as required by the act. Directors report which states the matters contained in the accounting records and accounting books give a true and fair view of the companys financial position and the report should be consistent with the knowledge of the auditor.

a)

b) c)

2.

Auditors should state in his report when he is not satisfied about the following : If the auditor is difficult or does not get any information needed. If the records are not kept properly. If the information obtained from the branch is not adequate. If the profit and loss statement is not consistent with the accounting records. If the balance sheet does not show the actual value of the company affairs. If the director does not meet the reporting requirements of the act and not in line with the auditors knowledge.

a) b) c) d) e) f)

2) Report to debenture holders

Section 175 of the Company Act 1965, the auditors appointed by the financial institution has the responsibility to send a copy of the financial statements to each trustee for debenture holders of the company within a week of the statement was issued.

3) Report in the prospectus

Section 46 of the Companies Act 1965 provides for civil liability for the misstatements in prospectus. It provides that an auditor, as an expert who authorises and causes the issue of the prospectus is liable to pay compensation to persons who purchase shares or debenture on the faith of the prospectus for any loss sustained by reason of untrue statements.

TYPE OF LABILITIES

There are 2 types of auditors liability : Liability under common law Client Third party Criminal liability under statutes

1) o o

2)

1) Liability under common law

Liabilities under common law are known as general liability. General liability based on general principles; if the auditors are given the task then he should be responsible to it. Auditors negligence in carrying out these task will lead to auditors be liable, this means that the auditors is responsible for paying back the compensation of losses suffered due to negligence of auditors in performing their duties.

Auditors negligence means :

failed to use the skills/ knowledge/ experience as a professional auditor. The auditor gives an appropriate report.

a) b)

Two types of liability under common law :

Liability under the law of contract. Liability to third party tort

a) Liability under the law of contracts (client)

There is a contractual relationship between the auditor and his client. Under this contract it is implied that the auditor will carry out the work with reasonable degree of skill and care. The degree of care and skill required will mainly depend on the nature of work undertaken. Generally if the auditor has complied with ISA it is difficult to prove that he was negligence. In the absence of suspicious circumstances the auditor will not be liable for failing to uncover fraud and error which could not be discovered by exercise of normal skill and care.

Examples of cases
Case

1 : Wilde & others VS Cape Dalgelish - Failed to discover fraud caused by

cash.

Case

2 : Smith VS Sheard - Failed to discover fraud because

there was no inspection made.

b) Liability to third parties Tort

An auditor may liable for negligence not only under the law of contract but also in the law of tort i.e if the person to whom he owed a duty of care has suffered financial loss as a result of the auditor negligence.

For the third party to succeed, he must prove the following: The auditor owed him a duty of care. He has suffered financial loss resulting from the auditors negligence.

1. 2.

Tort means auditors responsibilities to third parties who do not have contract and this happen in the two circumstances:
Bodily injury. Financial losses.

1. 2.

Example of cases

Case 1 : Candler Christmas VS Crane & Co. - Financial statements prepared

negligence by the auditor.

Case 2 : Ultramares corporation VS Touche & Co. - Auditor negligent in carrying out its
responsibilities.

2) Criminal liability under the statute

Section 46 of the Companies Act provide that an auditor shall be criminally liable if he willingly makes a material false statement in any report, certification or in the financial statement with the intention to deceive and mislead. Examples of criminal liabilities include : The auditor accepts appointment when he is ineligible to do so or continue in office after becoming ineligible.. The auditor obtains the advantage of deception. The auditor falsifies accounting records or documents. When the publishes misleading statements intended to deceive member

1) 2) 3) 4)

Example of cases
Case

1 : United States VS Andersen

The government charged Andersen with destruction of documents related to the firms audit of Enron.

Factors that help to minimize the auditor liabilities

1)
o

Deal only with clients possessing integrity

There is an increase likelihood of having legal problems when a client lacks integrity in dealing with customers, employees, units of government and others A CA firm needs procedures to evaluate the integrity of clients and should dissociate it self from clients found lacking.

2)

Hire qualified personnel and train and supervise them properly

a considerable portion of the most audits is done by young professionals with relatively little experience. Given the high degree of risk CA firms have in doing audits, it is important that these young professionals is also essential.

3)

Follow the standards of the profession

a firm must implement procedures to ensure that all firm members understand and follow the auditing standard.

4)

Maintain independence
Independence in fact requires an attitude of responsibility separate from clients interest. Much litigation has arisen from a too-willing acceptance by an auditor of a clients representation or of a clients pressures. The auditor must maintain an attitude of healthy skepticism.

5)

Understand the clients business

the lack of knowledge of industry practices and clients operations has been a major factor in auditors failing to uncover misstatements in several cases. It is important that the audit team be educated in these areas.

6)

Perform quality audit Quality audits require that auditors obtain appropriate evidence and make appropriate judgements about the evidence. Improved auditing reduces the likelihood of misstatements and the likelihood of lawsuits. The document work properly The preparation of good audit documentation helps the auditor organise and perform quality audits. Quality audit documentation is essential if an auditor has to defend an audit in court.

7)

8)

Obtain an engagement letter and a representation letter

These 2 letters are essential in defining the respective obligations of the client and the auditor. There are helpful especially in lawsuits between the client and auditor, and also in third party lawsuits.

9)
o

Maintain confidential relations

Auditors are under and ethical and sometimes legal obligation not to disclose client matters to outsiders.

10)

Carry adequate insurance

it is essential for a CA firm to have adequate insurance protection in the even lawsuits. Although insurance rates have been risen considerably as a result of increasing litigation, professional liability insurance is still available for all CAs.

11) Seek

legal counsel

When serious problems occur during an audit, a CA would be wise to consult experienced counsel. In the event of a potential or actual lawsuit, the auditor should immediately seek an experienced attorney.

12)

Exercise professional skepticism

Auditors are often liable when they are presented with information indicating a problem that they fail to recognise. Auditors need to strive to maintain a healthy level of skepticism, one that keeps them alert to potential misstatements, so that they can recognise misstatement when they exist.

THANK YOU.