Auditors' Liability: Repercussions and Penalties

This report talks about the repercussions that the auditors have to face when they are unable to exercise an utmost diligence and due care in the carrying of their duties as professionals. It covers the historical developments, regulations, and examples of cases. The subject is Auditing, and the course code is not mentioned. The college/university is not mentioned.

AUDITING 1
AUDITING

AUDITING 2
Summary:
This report talks about the repercussions that the auditors have to face when they are unable
to exercise an utmost diligence and due care in the carrying of their duties as professionals.
This report throws light on the recent cases that have led to these penalties, the historical
developments and the types of the penalties that exist and that are imposed on the
professionals.

AUDITING 3
Contents
Introduction and background:....................................................................................................4
Current stance on auditor’s accountability:................................................................................4
Regulations on audit liability:....................................................................................................6
Historical developments in law:.............................................................................................6
Examples:...............................................................................................................................7
The following are the examples which deals with the auditors liabilities:.........................7
Barclays Bank v Grant Thornton (High Court, 2015):.......................................................7
Mehjoo v Harben Barker & Ors (Court of Appeal, 2014):.................................................7
Conclusion:................................................................................................................................7
References..................................................................................................................................9

AUDITING 4
Introduction and background:
The auditors are currently responsible for both the civil as well as the criminal offences. The
criminal offences takes place when the companies breaches the rules and the regulations that
have bene imposed by the government. There are mainly 2 types of laws, one being criminal
which deals with the transactions between the entity and the state and the civil law that deals
with the transactions between the individual and the company.
Current stance on auditor’s accountability:
The criminal offences takes place when the auditors follow different laws that exists in the
other countries. These laws confer to the countries in which these companies operate.
Therefore, the auditors are held accountable for the acts of fraud and insider trading.
This include various sections that governs the fact of who could be an auditor and the way in
which these auditors are appointed and the way in which they could be removed and also
include the functions and the duties of the auditors.
One of the most important offence under the companies Act is the section 495 which deals
with the fact of knowingly or recklessly causing a report which includes any matter which
could be misleading or is false or is deceptive in any manner.
Civil offences on the other hand include 2 pieces of civil law. The first piece being contract
law and the other being law of tort. Both of these pieces deals with the liability of the auditor
to the clients and also to the third parties.

AUDITING 5
Under the law of contract, the party could ask for remedy in case the contractual obligations
have not been fulfilled. Hence, the shareholders could seek remedy in case an auditor fails to
comply with the terms that were stated in the letter of engagement. In order to illustrate, an
auditor was sued by the shareholders of the Tyco Company. Whereas under the law of tort,
the auditors could be sued for any negligence in case there is any breach of care wherein a
third party has suffered some loss (ACCA Global, 2018).
The most notable of these include the case of Caparo Industries Plc v Dickman and the Royal
Bank of Scotland vs Bannerman Johnstone MacLay. The first case deals with the purchase of
the shares of another company. It was realised later on that the shares of the company were
purchased on the basis of inaccurate valuation details of the other company. The shareholders
also stated the fact that the auditors did not carry on their duty of care. But then the claim was
not successful.
There are some of the landmark judgments in the cases of Caparo Industries Plc (Caparo) v
Dickman (1990) and Royal Bank of Scotland (RBS) vs Bannerman Johnstone MacLay
(Bannerman) (2002). The House of Lords concluded the case by saying that the books of
accounts were prepared by the auditors without having any knowledge about the purposes to
which the accounts would be put to use.
This was the case which throws light on the duty of care that exists between an auditor and
the third party. Hence, this ruling laid down the following:
 It is due to the conduct of the defendant that the company has suffered a loss
 There is a relationship that exists between the defendant and the pursuer
 The imposition of liability is just, fair and reasonable

AUDITING 6
In yet another case, RBS held APC Ltd of losing £13m on account of overdraft facilities that
were not paid. The facility was given to APC on account of the true financial statements that
were applied. In this case, the court held that the auditor owed no duty since there was no sort
of disclaimer given to the third parties.
The liability was joint. The fact that an auditor could be prone to either criminal or civil law
is highly uncontroversial and is also clear. But the fact of the penalty being the same is still
very much debatable.
Auditors were found to be liable in the cases wherein the auditor had breached the
responsibilities for the work that has been performed with an utmost professional competence
and also independent of the client. It is due to this reason that the auditors must face the
penalty or the repercussions of the acts that have bene suffered by them and the parties that
have been aggrieved due to their failures be compensated for the same (the Australian
government, 2018).
But it is also true that these system have been criticised on the grounds that the amount of the
penalty imposed are very high. This is in the sense that in case, there are multiple culpable
parties, even then the plaintiff could sue any one party and seek entire amount of the damages
(Hein online, 2018). In order to illustrate this, in case, the director used the financial
statements in the wrong manner and the management of the company was not able to detect
the poor controls, then the auditor would perform an inadequate audit leading to an
expression of a wrong audit opinion. This is due to the mistake on the part of a third party.
The shareholders in such cases would try and recover the full amount of loss that has been
incurred from any one of the parties. It is mainly due to the reasons like these that the
penalties are criticised.

AUDITING 7
Regulations on audit liability and Historical developments in law:
The history behind the introduction of these rules is the fact that the authors had started to
take their work for granted or they were not carrying on their duties with utmost diligence.
This led to many audit reports of being reported as clean when they should have been
qualified. This resulted in companies crashing since the books of accounts misled the
investors and the company falsified their books of accounts to report profits. But ultimately
these companies fell and went bankrupt. This all would not have happened if the auditors
would have been vigilant enough in carrying on their duties. It was due to these reasons that
the relevant authorities decided to impose penalties and impeach the auditors when they were
found guilty of misconduct. These events led to the introduction of the rules and regulations
such as have been mentioned in this report.
The perception of the public are greatly affected by the Generally Accepted Auditing
Standards and the Statements on Auditing Standards since the effort and the work of the
auditor is not observable. This is directly proportional to the penalties that are levied for non-
compliance. The profession imposes the penalties of the auditors that are not capable of
carrying on their duties with an utmost efficiency. But in the case, wherein the auditors had
relied on the misstated reports were not prone to any monetary penalties. The connection
between the legal liability and the professional standards are not important. This is in the
sense that in the cases wherein a producer has supplied a defective product, whether he knew
about the same or not was immaterial. Wherein there is a strict liability for the professional
standards, there could be factors that could affect the legal liability to which the members are
exposed. In contrast of thus, the liability of the auditors for the product wherein the opinion
of the auditors is somewhat based upon the theory of negligence and is also limited to the
cases wherein the audit was negligent in the carrying on his duties. Casual review of this is
the fact that in the cases, wherein negligence based theories of liability are applied to the

AUDITING 8
auditors, then the levels of the due care which are connected with the auditors are not clearly
specified (AICPA, 2018).
None of these laws states the definition of due care which is expected of an auditor. Whet
comprises of due care has changed over the period of time. The major proof of the negligence
is the key to the liability of the auditors and also the violation of the auditing standards which
are considered to be the prima facie of a negligent audit. Under a vague specification of due
care, an auditor has some positive probability of being negligent at any level. The violation of
the GAAS is the prima facie evidence of negligence. Therefore, by the way of increasing his
expected liability for any effort which is below the standard would not mean much in the
absence of the relevant standards. Viewing these professional standards as the signals with
regard to the quality of the output is also not specific to the auditors (Schwartz, 1998).
Examples:
The following are the examples which deals with the auditors liabilities:
Barclays Bank v Grant Thornton (High Court, 2015):
There was a company which entered into a facility agreement with the claimant bank by the
name of Barclays for the loan facilities. The company went into administration leading
Barclays to have substantial loss of about £45 million. Later on, Barclays sued Grand
Thornton for their negligence in carrying on their duties and care since GT had provided non
statutory reports to the third parties (Fee, 1999). The reports had failed to report the fact that
the 2 employees of the company had reported false sales and expenses of the company which
led to these losses and claims. The court held that the disclaimers which were included in the
reports were not sufficient enough to preclude GT owing to a duty of care to the Barclays. It
is due to this reason that there are some of the cases wherein the auditors owes their duty to
the third parties, especially when the third parties did not contain such disclaimers (Davis,
1991).

AUDITING 9
Another important case is the case of Royal Bank of Scotland v Bannerman (2003):
The above stated case had caused an alarm for the profession of audit in the creation of the
risk in the creation of the duty of care of the auditors of the company to the bank from which
money has been lent, if they were of an opinion that the bank would consider the audited
financial statements of the client and that they did not explicit disclaim liability (Mondaq,
2018).
Mehjoo v Harben Barker & Ors (Court of Appeal, 2014):
In the above stated case, the house was of an opinion that planning to save taxes could form
the part of the operations in the ordinary course of the business. There is a clear cut difference
between the mitigation of general taxes and in the tax planning advice of taxes. The house in
this case held that the accountant did not possess the apt knowledge about the minimisation
of the taxes provisions and hence the same could not be taken up with the client (Corporate
finance institute, 2018). But the outcome of this case is somewhat assuring. This is because it
was found by the court of Appeal that the scope and the extent of the retainer of the adviser
was somewhat confined to the letter of engagement. But there were certain exceptions and
some of the implied terms that could exist but the court would not be prepared to demonstrate
the duty of the accountants to give specialist tax planning advice when it came to an outside
general expertise along with the scope of the retainer.
Conclusion:
In the nutshell, there have been many cases wherein the auditors have been found guilty since
they did not exercise their duties with an utmost efficiency and care. It is due to cases like
Enron etc. that the auditors are being questioned about their degree of care. And it is for these
reason, that there have been penalties that have come into existence. These penalties include

AUDITING 10
contract law, tory law, civil and criminal offences. But then it is also true that these are not
always correct when levied.
Hence, the facts of each case have to be considered when levying penalties.

AUDITING 11
References:
An Analysis of the Auditors' Liability to Third Parties in Australia 37 Common Law World
Review 2008. (2018). Retrieved from https://heinonline.org/HOL/LandingPage?
handle=hein.journals/comlwr37&div=7&id=&page=
AU-C Section 250. (2018). Retrieved from
https://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-
00250.pdf
Ch 5 R. (2018). Retrieved from
http://archive.treasury.gov.au/documents/403/HTML/docshell.asp?URL=Ch5.asp
Davis, M. (1991). The liability of auditors to third party in negligence. Retrieved from
http://www.austlii.edu.au/au/journals/UNSWLawJl/1991/7.pdf
Fee, C. (1999). Limiting Auditors’ Liability. Retrieved from
https://epublications.bond.edu.au/cgi/viewcontent.cgi?article=1161&context=blr
https://www.accaglobal.com, A. (2018). Auditor liability | ACCA Global. Retrieved from
https://www.accaglobal.com/in/en/student/exam-support-resources/professional-exams-
study-resources/p7/technical-articles/auditor-liability.html
Legal Liability of Auditors - Due Care & the Prudent Person Concept. (2018). Retrieved from
https://corporatefinanceinstitute.com/resources/knowledge/accounting/legal-liability-of-
auditors/
Recent Key Cases On Accountants' Liabilities - Accounting and Audit - Worldwide. (2018).
Retrieved from
http://www.mondaq.com/uk/x/458826/Accounting+Standards/Recent+Key+Cases+On+
Accountants+Liabilities

AUDITING 12
Schwartz, R. (1998). Auditors' Liability, Vague Due Care, and Auditing Standards. Retrieved
from https://link.springer.com/article/10.1023/A:1008220317852