11. Mr. Justice Wallis, in his judgment, remarked the following:-, (1) “Unless the auditors are to be held strictly to their legal liability, the object of legislature in requiring a certificate from them is absolutely defeated. Liability of firm ; Where, in case of audit of a company being conducted by an audit firm, it is proved that the partner or partners of the audit firm has or have acted in a fraudulent manneror abetted or colluded in any fraud by, or in relation to or by, the company orits directors or officers, the liability, whether civil or criminal as provided in this Act or in any other law for the time being in force, for such act shallbe of … He will be charged with imprisonment up to two years with or without fine. Vs. Heller & Partners Ltd. 6. (a) The debts due to the company, from Ellis and Co. (the stockbrokers of the company) and its General Manager were mis-described and shown under wrong account head, viz. He must be honest. The bank credited its profit and loss account with interest on such advances pending actual realisation and did not provide for bad debts either. The Master of the Rolls, in the course of the judgment, said that “the auditor must take a certificate from a person who is in the habit of dealing with, and holding Securities and who he, on reasonable grounds, rightly believes to be, in the exercise of the best judgment, a trustworthy person to give such a certificate.”. (iii) The auditors argued that “in a money lending business it did not matter how old the debts were, because in the long run people would come back and pay in order to be able to obtain further advances.” The Judge decided that the auditors were guilty of negligence in their duties for: (a) Not reporting the insufficiency of the provision for bad and doubtful debts to the shareholders; and. In France the auditor's liability cannot be limited by contract or otherwise. The former occur when individuals or organisations breach a government imposed law; in other words criminal law governs relationships between entities and the state. So there may be terms between auditor and client according to which auditor has to become liable on certain agreed occasions. Audit of sole trading concerns, audit of partnership firms, etc. He should have satisfied himself not only that the accounts were correct but that the books represented the true state of affairs of the Bank.”. Republic of Bolvia Exploration Syndicate Ltd. (1913): (i) The directors of the company made certain payments, such as (a) Commission for placing shares (not to a director) and (b) Costs and also a share of profit to a Solicitor-Director. Generally, the persons other than the client rely on the audited financial statements for various purposes (such as sanction of loan, purchase of shares or debentures, etc. (2) In any affidavit, deposition or solemn affirmation in or about the winding up of any company shall be punishable with imprisonment for a term which may extend to seven years and shall also be liable to a fine. He is liable if he acts as an auditor without holding a valid certificate of practice from the Institute. Hedly Byrne & Co. Ltd. The auditor, in his report to the shareholders, merely stated that the value of the assets as shown by the balance sheet was dependent upon realisation without any comment as to the insufficiency of security. Note that the auditors will not be held responsible if they do errors in judgement but this is not the same in case of dishonesty. Liability of the Statutory Auditor completed in 1996, have shown that there is not yet a European market in audit services and that important differences remain between the national laws and regulations of Member States which deal with the statutory audit. As a result, the accounts had shown unrealized profits. (c) The existence of a large number of the company’s securities, which were in Ellis & Co’s custody and had been pledged by that firm to its customers (i.e. The Court held that the auditors were not guilty of negligence for not inspecting the securities as such fraud might not have been detected in view of their actual knowledge of the state of affairs at the time of each audit. (6) The duty of an auditor is to convey in direct and express terms to the members any information which he thought proper to be communicated. Section 62 and 63 of Companies Act, 1956: If company auditor certifies fraudulent prospectus knowingly he will be charged with imprisonment up to two years with or without fine. An auditor who adopts such a course does so at his peril, and runs a very serious risk of being held judicially to have failed to discharge his duty. Before uploading and sharing your knowledge on this site, please read the following pages: 1. (2) An auditor is guilty of negligence if he fails to detect the over-valuation of work-in- progress when ample materials as evidence are available for testing the accuracy of the figures given to him. (3) The amount against the item ‘advances to Contractors and Others’ included the loans to the managing directors but such loans were not specifically disclosed in the balance sheet. (8) The Court, in its judgment upheld the Magistrate’s order and held that the directors and the auditors were guilty of criminal liability. It was held that the auditor is liable in tort to third parties, if the under mentioned points are proved by the plaintiffs: (a) The auditor’s statement was untrue in fact; (b) The auditor failed to exercise reasonable skill and care to ascertain the truth (a part of his duty) knowing that the statement was untrue; (c) The auditor’s statement was intended that the plaintiff should act on it with sound belief; and. (ii) The auditor confessed that – he would have discovered the criticality of the affairs of the bank and fraud connected with the depositors and creditors, had he examined the books and asked for an explanation. He may conduct partial audit at his own risk. He does not discharge his duty without inquiry and without taking any trouble to see that the books of the company themselves show the company’s true position. Indian Penal Code imposes a criminal liability on the auditor. when the auditor fails to meet the requirements that were established in the contract or normally in the engagement lette… Copyright 9. An auditor, who fails to inquire into the substantial accuracy of the balance sheet and who fails to conclude that the transactions are ultra vires the company’s Articles, is negligent in the performance of his duties and therefore liable for damages. Contractual liability is agreed liability. (7) The Govt. Duty of care and diligence is important for an auditor though there is no remuneration for him. (i) Liability to Clients: Action for negligence can be-. V.18. (5) One of the shareholders brought a criminal suit against the managing directors under Section 282 of the Companies Act 1913 (now Section 628 of Companies Act 1956 which states – Any person who makes a false statement in any returns, balance sheet, etc. There are several conflicting judgements over the auditor’s liability to third parties, i.e., the persons other than the client (e.g. Section 62 and 63 of Companies Act, 1956: If Company auditor unknowingly certifies false prospectus, civil liability arises. (4) An auditor need not be unnecessarily suspicious where there is nothing to excite suspicions. Power and Duties of an Auditor Every auditor has a right of access to the books of account and vouchers of the company at all times, whether they are at the registered office of the company or at any other place. (iii) The directors trusted the dishonest manager for years and also the auditor’s report and declared dividends. So his liabilities are determined by the Companies Act. In the case of the auditor of a sole proprietorship business or a partnership firm, the power and duties A man is entitled to be as negligent, as he pleases towards the whole world if he owes no duty to them. So under current criminal law auditors could be prosecuted for acts suc… 8. (ii) The fraud must have been detected by a thorough examination of the wages sheets by the auditors. 10. (2) “His duty with regard to the ascertainment of unrecorded liabilities must be determined by the nature of the business carried on. (v) The auditor put forth his argument that he was unaware of the articles and that the action was time-barred. Limited Liability Partnership (LLP) shall get its account audited if it crosses the limit of turnover Rs. The judge, in the original trial, disallowed the charge of negligence as there was a lack of contractual relationship between the auditor and the third party creditor. … (3) It was found that the book-keeper manipulated the wages sheets and embezzled money; but the auditors did not give due importance to the matter so as to bring it to the notice of the principal. In the course of his judgment, Mr. Justice Cunliffe remarked the following: (1) “A balance sheet need not be, in fact it must not be a mere inventory. It states the method of appointing an auditor, the eligibility of a statutory auditor and the duties and responsibilities of such an auditor. third parties), was not brought to light and reported by the auditors to the shareholders. But he never asked a question and certified the accounts. The loss arising out of auditor`s negligence should go to share holders. Brewer and Knott (J932): (1) The plaintiff appointed the auditors to have protection against the petty frauds that were suspected to be perpetrated by the book-keeper. He must not certify what he does not believe to be true. The auditor is prima facie liable for ultra vires payments but the extent of his liability for not detecting such payments depends on the existence of special circumstances. Section 543 of Companies Act, 1956: If auditor mis-uses funds of the company at the time of liquidation, he comes across civil liability. The audit firms must make sure that in case of any negligence or bad faith. (2) The directors were bound to make good the losses arising out of the payment of dividend out of Capital and to the like amount the auditor and manager were for damages caused to the business. London Oil Storage Co. Section 539 of Companies Act, 1956: If company auditor destructs records of the company at the time of liquidation, he will be charged with imprisonment up to seven years with or without fine. (ii) The defendant contended that the auditors did not report about the insufficient provision for bad and doubtful debts which resulted in inflated profits and more commission paid to the manager. The accountant, under the Hedly Byrne Doctrine, may incur liability in the following occasions: (a) Preparing financial statements or reports for a client when it is known or expected that they are intended to be shown to and relied upon by a third party, even if the identity of the third party is not disclosed ; (b) Giving reference regarding a client’s credit­worthiness; (c) Allowing the use of the auditor’s name indiscriminately; (d) Accepting the work which is beyond the professional competence, or not obtaining the specialist advice where the report may have to include opinions of a nature outside the field of the auditor’s professional work. In the absence of any written agreement or contract, he is expected to perform a complete audit. (iii) The auditors on this ground are guilty of negligence. (4) An auditor is liable only when he accepts the certificate for investments from persons who are not expected to hold other’s securities and are not trustworthy, irrespective of their status as bankers or stockbrokers. Key Words: Auditor, power, duties, liabilities Introduction: An auditor, to perform his duties must have certain powers, without which it may not be possible for him to perform his duties honestly and thereby, he might be held liable for any loss which the company might suffer. The trend of auditor liability to clients will not be discussed in this report as it does not change much. The officers of the company who are found guilty of the offense including the auditor will be punishable with imprisonment and shall also be liable to fine. He is not an insurer and does not guarantee that the books do correctly show the true position of the company’s affairs or that the balance sheet is accurate according the books of the company. Section 197 of Indian Penal Code deals with Issuing or signing false certificate. An auditor is liable to pay damages for loss to his client in the event of non-fulfillment of the contract. As in case of optional audits company auditor is liable for his negligence. (Id. Liability. The provisions relating to statutory audit and auditors is the sections 139 to 147 of the new Companies Act 2013. 628 of Companies Act): If in any return, report, certificate or other document, he makes a statement: (1) Which is false in any material fact knowing it to be a material and. (iii) The articles of the Company did not contain any provision authorising such payments, and therefore the Companies Act was applicable. The auditor is guilty of negligence of his duty if he fails to perform statutory duties in communicating the true position of accounts to the shareholders although such communication is made to the directors. Although all these payments were ultra vires, the Court was not convinced that the Company suffered damages due to the auditors’ default for not pointing out this fact in the report. Statutory Auditor. Mr. Justice Denning gave a verdict that the auditors were not liable to the third parties in absence of any contractual relationship between them. Ultramares Corporation Vs. Touche, Niven & Co., (1923): The auditors knew that creditors of certain type would use the balance sheet, but they were not aware of the specific creditors. (iv) The Bank, thereafter, went into liquidation. (1) The auditor is liable for damages by reason of falsification in the accounts which might have been detected by the exercise of reasonable care and skill. (iv) The Liquidator of the Company brought an action against the auditors alleging that the auditors were negligent as they certified the payments which were ultra vires. 13. The Statutory Auditor is liable for nonfulfillment of the terms and conditions of an agreement between him and the company who appoints him. The auditors denied the charge for negligence and put forth an argument that the alleged loss was the result of negligence on the part of the Company directors in entrusting so much money to the cashier and in not checking the petty cash from time to time. Liability under Optional Audits. Further, the auditors failed to highlight that some of the debts were time-barred. Superintendent and Remembrance of Legal Affairs, Bengal Vs. Akhil Bandhu Guha and Others (1936): (1) The managing directors of Dhakeswari Cotton Mills Ltd. were also the managing directors of a newly formed company named East Bengal Jute and Cotton Mills Ltd. (2) The amount against the item ‘Deposit by others’ shown in the balance sheet of the first Company was actually arrived at by deducting the loan amount advanced to the other new company. But still an auditor is not bound to exercise more than reasonable care and skill even in a case of suspicion, and he is perfectly justified in acting on the opinion of an expert where special knowledge is required. It is nothing to him whether dividends are properly or improperly declared provided he discharges his own duty to the shareholders. As regards the third charge, the court held that: (i) The auditors should have asked for the Securities instead of accepting the certificate of the Company’s stockbrokers; (ii) The fraud must have been detected had the auditors asked for the securities – which could not have been produced by Ellis & Co.- as the same were charged to brokers against the loan by them to Ellis & Co. ; and. The audits which are legally required are called statutory audits. (1) The profit of the Company was inflated by (a) understating the company’s liabilities by suppression of purchase invoices and (b) overstating the value of work-in- progress; (2) The dividend was paid out of such inflated profit which resulted in payment of dividend out of capital; (3) The auditors also acted as accountants to the company; (4) The company went into liquidation; and. Some important points with respect to the auditor are, This case ultimately ended indecisively, but the following auditing implications were established: (i) An auditor is liable to the client and known third parties for ‘ordinary negligence’ and to unknown third parties for ‘gross negligence’. It is supposed to be a pictorial representation of the trading position of the Company, easily appreciated not by ignorant people but by persons who are reasonably able to understand commercial conditions.”, (2) “A loan and a deposit; being obviously items differing completely in principle from the balance sheet point of view, ought to appear on different sides, one as an asset and the other as a liability and that the act of consolidating the two and presenting them as one item in the balance sheet was a striking case of non­disclosure amounting to suppression of truth.”. Who are eligible to appoint as statutory Auditor? states that whosoever issues or signs any certificate required by law to be given or signed or relating to any fact which such certificate is by law admissible in evidence, knowing or believing that such certificate is false in any material point, shall be punishable in the same manner as if he gives a false evidence’. The auditor argued that the preparation of the profit and loss account and the balance sheet was the Contract and not anything else. Contractual Liability: In case of optional audits rights, duties, liabilities etc of auditor will be of contractual nature. As a result, the frauds of the aforesaid nature could not be detected during audit. Statutory liability provides cover for defense costs, fines and penalties charged against the firm. (4) The auditor was liable for any damage that the Company sustained from the understatement of liabilities in the balance sheet. Section 240 of Companies Act, 1956: If company auditor does not co-operate with government inspectors, he will be charged with imprisonment up to six months with or without fine. It is his/her duty to seek opinions on legal matters or managerial matters from experts to give a better detailed report of the company. 15. The auditor may be held liable for the damages if he fails to perform his duties with reasonable skill and care, i.e., arising out of his negligence. The Judge held that the auditor was guilty of negligence for not performing his duties with reasonable skill and care. The brief outline of the case was that the bank advanced considerable amounts to its customers on loan and current accounts although the securities held were insufficient. But the respondents appealed before the District Judge who reversed the judgment stating that the criminal intention of the directors was not proved. A person whose duty is to convey information to others does not discharge that duty by simply giving them so much information as is calculated to induce them, or some of them, to ask for more. Statutory liability: CPAs have statutory liability under both federal and state securities laws. The noticeable feature of this legal decision and its practical application in auditing scene is that the Institute of Chartered Accountants in England and Wales came out with the following two statements concerning the auditor’s liability to third parties: (1) Statement no. ii) Right to receive information and explanations. (1) An auditor is guilty of misfeasance if he fails to detect the omission of liabilities from the balance sheet even when such omission is apparent. (3) “If the auditor found that a company in the course of its business was incurring liabilities of a particular kind, and that the creditors sent in their invoices after an interval, and that the liabilities of the kind in question must have been incurred during the accountancy period under audit, and that when he was making his audit a sufficient time had not elapsed for the invoices relating to such liabilities to have been received and recorded in the Company’s books, it became his duty to make specific inquiries as to the existence of such liabilities and so, before he signed a certificate as to the accuracy of the balance sheet, to go through the invoice files of the company in order to see that no invoices relating to liabilities had not been omitted.”, (4) “With regard to the Over-Valuation of Work- in-progress, it was the duty of the auditor to check the figures at which work-in-progress was brought into the balance sheet. : Professional Liability of Accountants and Auditors. (3) The company brought an action against the auditors for damages on the ground that the fraud could have been detected by the auditors had they verified the petty cash in hand. The audits which are not legally required are called optional audits. Case law: Official liquidators of Karachi Bank Ltd. vs Directors and Auditors of Karachi Bank Ltd. It is the auditor’s duty to take appropriate steps for verification as to the existence of assets shown in the balance sheet. He is also liable for breach of fiduciary relationship by disclosing confidential matters. The liability of a statutory auditor may be charted as under: The Statutory Auditor is liable for nonfulfillment of the terms and conditions of an agreement between him and the company who appoints him. (d) The plaintiff suffered damages by relying on the auditor’s statement. Plagiarism Prevention 5. The Westminster Road Construction Co. Ltd. (1932): This case is also known as Smith Vs. Offer and Others. He, therefore, sued the auditors for compensation against damages sustained. (a) The extent to which an auditor accepts responsibility should be made clear beyond the scope of misunderstanding; (b) Where an auditor specifically restricts the scope of his report or expresses appropriate reservations in a note attached to and referred to in the financial statements he has prepared or the report which he has made thereon, this can constitute a disclaimer which will be effective against any action for negligence brought against him by third parties; (c) Where an individual shareholder uses the audited annual accounts for investment decisions no action would lie against the auditor as the accounts are not normally prepared for this purpose; (d) Where the audited accounts would be used for tax assessment purposes by the Revenue Department, no action would lie in case of reliance upon accounts negligently prepared since in fact the failure to recover tax is attributable to the death or insolvency or decamping of the taxpayer, not to the negligence of the auditor; (e) The third parties entitled to recover damages will be limited to those who by reason of accountants’ negligence in preparing reports, accounts, or financial statements on which the third parties place reliance suffer financial loss in circumstances where the accountants knew or ought to have known that the reports, accounts, and the financial statements in question were being prepared for the purpose specifically or transaction which gave rise to the loss and that they would be shown to and relied on by third parties in that particular connection. “Thus, it appears that the auditor, in the absence of fraud,-does not incur liability to third parties who suffered damages for the former’s negligence. Liabilities of company auditor are of three types. Loans at call or short notice, and the part of Ellis & Co.’s debt was wrongly included under ‘Cash at Bank and in hand, and the auditor did not disclose these debts to the shareholders. What duty is there when there is no relation between the parties by contract? a) Liability under Companies Act 2013 b) Liability under the Indian Penal Code c) Both a&b d) None of the above 134. The auditors confined their scrutiny to the evidence created and/ or held by the client, such as sales invoices and did not ask for direct confirmation of accounts balance from the customers. It is interesting to note that this judgment was however, overridden by the House of Lords in 1964 in their decisions in another landmark case, Hedley Byrne & Co. Ltd. are examples to optional audits. : Accountants Liability to Third parties – The Hedly Byrne Decision. US. (5) The duty of an auditor is to convey information and not means of information. Section 628 of Companies Act, 1956: If company auditor certifies any false statement knowing that it is false. 2. It is his/her duty to report any fraud. He remains liable for damages if he omits to verify the existence of assets. Authentication of Assets and Liabilities: Verification of assets and liabilities for checking their existence, valuation, completeness and disclosure in financial statements. Auditor Job Duties: Ensures compliance with established internal control procedures by examining records, reports, operating practices, and documentation. In the absence of any written agreement or contract, he is expected to perform a complete audit. (2) The auditor’s committed a breach of duty by not verifying the petty cash in hand and hence were liable to pay damages of a nominal amount. He may be held responsible under the Contract Act ‘in failing to perform the duties’ as laid down in agreement. Terms of Service 7. (a) In contract, by persons to whom the accountant owes a contractual duty of care; (b) In tort, by persons with whom the accountant is not in a contractual relationship but to whom the accountant owes a duty in accordance with the Hedley Byrne decision. Auditors are potentially liable for both criminal and civil offences. This Appeal was dismissed by the Court with cost. Statutory liabilities of an auditor include _____. (1) An auditor is liable where assets are mis-described in the balance sheet if the Company incurs damage as a result of such mis-description. The book-keeper had complete charge of the books of account including the preparation of wages sheets and payments therefor. In India, the term "statutory auditor" refers to an external auditor whose appointment is mandated by law. (iii) The bankers should, therefore, be exonerated from their liability for damages arising out of negligence. Auditing, India, Auditor, Types, Statutory Auditor, Liabilities of a Statutory Auditor. 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