Liabilities of an Auditor Bcom Notes

Liabilities of an Auditor Bcom Notes:- In this post, I am giving you the notes of Bcom 3rd Year auditing, which is going to be very useful in your examination and you should share this post to all friends and all your groups so that your friends also read this post. Could. Liabilities of an Auditor

Liabilities of An Auditor

An auditor to audit the accounts of a public limited company is appointed under the provisions of the Indian Companies Act. His duties and liabilities are also laid down in this Act. If he fails to perform his duties in accordance with the provisions of the Companies Act, he is held liable. The liabilities of professional accountants broadly falls under the following heads:

I. Civil Liability

(i) Liability for Negligence

(ii) Liability for Misfeasance

II. Criminal Liability

III. Liabilities to Third Parties

I. Civil Liability

Civil Liability of an auditor arises where it is proved that certain financial losses have actually been suffered by the company and the company auditor is liable for those losses. The civil liability of a company auditor may be studied on the following lines:

(i) Liability for Negligence: Negligence means acting carelessly or failing to perform a duty enjoined upon a person. An auditor is appointed by the shareholders and he is expected to safeguard the interests of them. He is an agent of the shareholders and therefore he should exercise reasonable degree of skill and care in the performance of his duties. If he fails to do so and his client have suffered a loss due to his professional negligence, he will be held liable to make good that loss on an action being taken against him by the party.

(a) Legal Cases on Civil Liability for Negligence: (i) Irish Woollen Company Limited vs Tyson and Others (1900): In this case, the auditor was failed to detect the falsification of accounts resulting thereby payment of dividend out of capital due to such falsification.

Due to this, the auditor was held liable for negligence by the court. The Judge give his opinion that if due care and skill has been exercised, the carrying over and suppression of invoices would have been discovered and the auditor is liable for any damage the company has sustained from the understatement of liabilities in the Balance sheet.

(b) London Oil Storage Co. Ltd. Vs. Sheer Hashluk & Co.: In this case, auditor is held liable by the court for not varifying the petty cash book. For this negligence, auditor had to pay damage to the company.

(ii) Liability for Misfeasance: The term ‘misfeasance’ means breach of trust or breach of duty imposed by law or negligence in the performance of duties, which has resulted in some loss or damage to a company or its property. If the auditor does something wrongfully in the performance of his duties resulting in a financial loss to the company, he is guilty of misfeasance. For example, the duties of an auditor have been statutorily laid down in the Companies Act, 1956. If the auditor does not perform his duties properly and as a result the company suffers, he may be held liable for misfeasance. The directors, managing agents and other officials of a company may also be held liable for misfeasance.

Legal Cases for Misfeasance: (a) London and General Bank Ltd.: In this case, auditors were held liable for misfeasance as they failed to disclose full information and true financial position of the company. They had not given any warning to the shareholders regarding the condition of the loan given against insufficient securities.

(b) City Equitable Fire Insurance Company Ltd.: In this case, the auditor was held liable because he had failed to detect and report to the shareholders that a number of company’s securities, which were in custody of Ellis & Co. had been pledged by that firm to third parties.

II. Criminal Liability

Under the Companies Act, an auditor of a company may be found guilty of criminal offences if he wilfully makes a false statement in any report, return, certificate or balance sheet etc.

The criminal liabilities of a company auditor under different sections of the Act are as follows:

Making default in report wilfully, Section 233: If the auditor wilfully makes a default in making his report to the share holders according to the provisions of Sections 227 and 229. If his default is proved wilful, he will be punishable with fine which may extend to Rs. 1,000.
Not helping the Inspector, Section 240: The auditor of a company is required to help an inspector appointed by the Central Government to investigate the affairs of the company. If the auditor does not do so he is punishable with the imprisonment upto six months or with fine upto Rs. 3,000 or with both.
Not assisting the Prosecution, Section 242: When on the basis of report submitted by an inspector, the Central Government takes action and prosecutes any person connected with the company affairs, the auditor is required to assist the prosecution. If the auditor does not do so, he is guilty of contempt of court and punishable with imprisonment upto six months or with fine upto Rs. 500 or both.
In case of not returning the documents, Section 277: In the course of winding up of a company, the auditor is required to return to the court any documents in his possession. If the auditor fails to appear before the court, he can be arrested.
Public Examination by Court, Section 478: On the application of the official Liquidator, the company auditor can be publicly examined in the High Court. The notes shall be taken down and be signed by the auditor. Such signed notes may be used in evidence against him in any civil or criminal proceedings.
Falsifications in Accounts, Section 539: If the auditor is found guilty of distruction, mutilation, alteration, falsification or secreting of any books, papers or sacurities, he may be held responsible. Further, if the auditor makes any false or fraudulent entry in any register, books of accounts or documents of the company, he will be liable for punishment with imprisonment upto seven years and shall also be liable to a fine.
Prosecution of Auditor, Section 545: The auditor can be prosecuted by the liquidator as an officer of the company during the course of winding up of the company, if he is found guilty of any criminal offence in relation to the company.
For deliberate act of commission or omission, Section 628: If any office (including auditor) of a company deliberately makes a statement in any return, report, certificate, balance sheet, prospectus, etc. which is false in any material respect, or deliberately omits any material fact, he shall be punishable with imprisonment for a term which may extend to 2 years, and shall also be liable to fine.

III. Liability to Third Parties

An auditor is liable to the body of shareholders of a company as he is appointed by them to undertake the audit work. But the question is to what extent the third party can hold the auditor responsible for his negligence, if they have suffered any loss by relying on balance sheet or any statement signed by the auditor. It is generally argued that an auditor does not owe any duty to the third party since he has not been appointed by them and there is no privity of contract between the auditor and the third party. The majority judgements did not hold him responsible for negligence on the ground that there was no fraud though statements of accounts in question had been prepared negligently. But the legal position now seems to be that the third party can hold the auditor liable under certain circumstances even though there is no privity of contract between the two.

Liabilities of an Auditor

“An auditor is not liable for loss without negligence or negligence without loss”

An auditor is appointed by the shareholders, hence an auditor is expected to perform his duties as an agent of the shareholders by exercising care and diligence in the implementation of statutory requirements for the maintenance and presentation of the financial statements. An accountant (esp. Chartered Accountant) is considered to be an expert in Accounting, Taxation and Company Law and it is his primary duty to keep himself up-to-date in respect of various legal enactments related to the maintenance and presentation of the financial statements. If he fails to do so, it amounts to the negligence of duty on his part.

Negligence is a breach of the “duty to take care”. In all those employments where peculiar skill is requisite, if one offers his services, he is understood as holding himself out to the public as possessing the degree of skill commonly possessed by others in the same employment. Hence, negligence implies acting carelessly or failing to perform a duty. It is an act of omission or commission which occurs because the person concerned has failed to exercise that amount of professional skill and care which is expected of him under the circumstances of the case.

Liabilities of an Auditor

Liability of An Auditor for Negligence

In the words of Spicer and Pegler, “Liability for negligence springs from the general principle of law that where a person is under a legal duty to take care, whether imposed by specific contract or otherwise failure to exercise a reasonable standard of care will make that person responsible for any resultant damage or loss to those to whom the duty is owed.” As to what shall constitute reasonable care and skill, it was observed that it shall depend upon the circumstances of each case. Where there is nothing to excite suspicion and there in an atmosphere of complete confidence, based on the record of continued success in financial matters, less care and less severity of scrutiny may be considered reasonable. Whereas reasonable care and skill may be regarded as not exercised when, inspite of the presence of unusual features in the accounts or other prime facie reasons for believing that the affairs of the company may not be in order, the examination is perfunctory and not sufficiently detailed. One major aspect, while determining the question of resonable care and skill is whether the auditor was justified in relying upon the statements of the director or the managing director.

However, to make the auditor liable a cause effect relationship between his negligence in performance of the audit and loss to the client must be established. In short damage is an essential ingredient of negligence.

In other words to hold an auditor liable, it should be shown that:

(a) there has been negligence in the performance of his duty,

(b) the loss or damage is the result of his negligence; and

In this way, an auditor is not liable when there is loss without his being negligent or if it is proved that the auditor was negligent in the performance of his duty, he cannot be held liable for damages, if the company has not suffered any loss due to his negligence.

Liabilities of an Auditor

Examples Showing the Negligence with reference to Audit

(i) The dividend is paid out of capital (Leeds Estate Building and Investment Company Vs. Shepherd).

(ii) The provisions of the Articles have not been complied with.

(iii) Cash or stock has been misappropriated by the officers of the company, which could have been discovered with ordinary skille.g., the case Armitage Vs. Brewer & Knot.

(iv) The accounts show overstated or understated results either through an error or by deliberately done falsification.

(v) Liquidity problems are concealed.

(vi) There occurs non-disclosure of fictitious receivables or overvaluation of accounts receivables.

(vii) Liabilities/assets are verified as existing when they do not actually exist.

(viii) There exists nondiscovery of misappropriation of the petty cash balance (London oil Storage Co.Vs. Sears Hasluck & Co.)

(ix) There is non-disclosure of a bad debts schedule which in itself was inaccurate.

Liabilities of an Auditor

Important Legal Decisions as to Auditor’s Liability

Leeds Estate Building and Investment Co. Vs. Shepherd (1897): Holding the auditor liable to compensate the company for dividends paid by it in the last six years out of its capital, the Court observed: “Duty of the auditor is not to confine himself merely to the task of verifying the arithmetical accuracy of the Balance Sheet, but to enquire into its substantial accuracy. It was no excuse that the auditor had not seen the Articles when he knew of their existence…”
London Oil Storage Co. Ltd. Vs. Sear, Hasluck and Co. (1904): In this case it was held that the auditor is liable for any damage sustained because of his omission to verify the existence of assets stated in the balance sheet.
Arthur E. Green and Company Vs. The Central Advance and Discount Corporation Ltd (1920): In this case it was held that an auditor is negligent if he accepts statements of the officials of a company if there are circumstances which call for enquiry.
Armitage V. Brewer and Knott (1932): The auditor was held liable to make the loss suffered by his client for failure to detect defalcations by fraudulent alteration of time sheets and petty cash vouchers.

Liabilities of an Auditor