An Evaluation Of Auditors Liability To Third Parties

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An Evaluation Of Auditors Liability To Third Parties

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CHAPTER 1 INTRODUCTION 1.1 BACKGROUND OF THE STUDY

Auditing is now regarded as a sophisticated professional assurance service performed in the interests of a wide variety of parties including companies, shareholders and investors. The practice of auditing has become increasingly important in the corporate market place. According to Maris (2012), the term ‘auditing’ is described as the accumulation and evaluation of information to determine whether a company’s financial report is in compliance with the established criteria and legislative requirements. By conducting an audit, an opinion is formed by the auditor as to the credibility of information contained in a company’s financial statement. Thus, the auditing process ensures that figures in the financial statements are materially correct, which in turn add value to such information. Henderson (2010) described an auditor as an independent professional person qualified to perform an audit. In accounting, an auditor is someone who is responsible for evaluating the validity and reliability of a company or organization’s financial statements. The term is sometimes synonymous with “comptroller”. In latin language the word is ‘audire’ which means ‘to hear’. The word ‘audit’ was derived from ‘audire’ and the person appointed to examine the accounts came to be known as the auditor. An audit of accounts is primarily intended for the use of the audit client, the company whose accounts have been audited. The auditor owes the audit client a duty of care in tort and also (usually) under the terms of the audit contract. Auditing plays an important role in the successful operation of a business unit.  The impetus behind the emergence of an auditor on the business scene was the managerial revolution. Managerial revolution simply means the separation of ownership from management. This development was brought about by the advent of large business organizations that are jointly owned by several individuals where it became practically impossible for the owners to manage the companies on their own. Consequently, the owners of such companies appointed other people to run the companies on their behalf.  Thereupon, a need arose for periodic link between the owners (shareholders) and managers (management) of such corporations. The major link between the owners and management is the periodic reports on financial affairs and level of progress achieved by the business which are made by management (Board of Directors) to the owners (shareholders).

The periodic reports referred to above are the financial statements. To the shareholders, the financial statements prepared by the management are nothing but assertions that need to be authenticated. For this reason, a qualified and independent accountant either as an individual or a firm, is required to examine and attest to the reliability of the information provided in the financial statements by management. Hence, Auditor gives credence to the financial statements in order to protect the interests of the shareholders. Furthermore, it is not only the shareholders that are interested in the reliability of the financial statements. Other parties like potential investors, lenders, security or financial analysts, customers, suppliers, employees, government and the general public are equally interested in the financial statements. On this account, the Auditor as a professional has a duty of care to protect the interests of all these parties in the course of performing his duties for a given client. What makes External Auditor unique to shareholders and users of financial statements is his “independence.” Furthermore, Auditor’s Report (opinion) is one of the most essential aspects in the Auditor’s work.  This is because it is his ultimate opinion on the financial statements that will inform the degree of reliability that should be attached to such financial statements.

However, a variety of parties other than the audit client may also rely on the audited accounts of a company in making an assessment of the company’s value and/or its credit worthiness. Should the auditor be liable to these third parties if he or she negligently audit the accounts? The auditor’s liability, if any, to third parties can arise only in tort, as there is no privity of contract between the auditor and the third party. The central question is one of duty of care: does the auditor owe a duty of care in tort to anyone other than the audit client? This question has attracted considerable attention of late because of the decision of the House of Lords in Caparo Industries Plcv Dickman because the House of Lords restricted the extent to which auditors are liable to parties other than the audit client, the decision has been greeted with some relief by the auditing profession

For an auditor to perform his duties effectively he 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. In the case of the auditor of a sole proprietorship business or a partnership firm, the power and duties depend upon the agreement which is entered in between him and the organization. But in the case of the auditors of Joint-stock Companies, the Companies Act has laid down the powers and duties of an auditor. Although there is no direct mention of specific powers of a company auditor in the Companies Act, the auditor enjoys certain powers in the course of performance of his duties. For example, the auditor has a right to receive notices and attend general meeting, this is an instance of right. Again, the auditor has a right to obtain information and explanation from the officers of the company in the course of his audit work, this right is the nature of powers.

In recent decades, there has been a global upsurge in the number of corporate collapses and litigation claims by third parties which have partly been explained by the economic recession occurring in the late 1990’s. However, auditing professions in both Nigeria and around the world have encountered many challenges and criticisms in recent years, as a result of corporate collapses being linked to allegations of professional negligence and the breach of statutory duties (Stecol, 2009). Examples of high profile collapses overseas include Enron Corporation and WorldCom in the United States. These allegations illustrate the seriousness of the current legal environment for the auditing profession, government and third parties. Thus, there is a continuing interest in understanding the law regarding auditors’ liability, given the large litigation claims brought by third parties and the escalation cost of indemnity insurance cover in North America, Europe and Australia.    The liability of the auditor derives from the nature of his engagement. Being a professional expressing opinion upon which his clients rely, he must apply adequate skill with reasonable care and diligence to avoid misleading his readers. He is not infallible, he cannot be held liable for pure errors of judgment. He can however be held liable for acts resulting from his negligence, bad faith or dishonesty. It is essential therefore that the auditor is fully aware of his duties and makes adequate arrangement to discharge them and mitigate the effect of any claims that could be consequent on accidental failure to properly discharge these duties.

Auditors are subject to all laws that govern behaviour generally.  More specifically, the responsibilities of an auditor are influenced by a combination of relevant professional and legal requirements. In determining what is the necessary professional audit standard and practice, the expertise, knowledge and experience of the auditing profession will be taken into account.  Further, auditors are also accountable with legal responsibility for their examination and reports that they render to the company.  The legal hazards facing auditors are numerous and generally are very difficult to foresee in relation to any particular audit.  Any breaches of their statutory, contractual duties can expose them to potential litigation by injured parties and even to the risk of criminal prosecution under certain circumstances (Crowd, 2009). However, it is the responsibility of the management to apply accounting standards when communicating with investors and creditors through the financial statements prepared by auditors who examine or audit financial statements to express a professional independent opinion. The opinion reflects the auditors’ assessment of the statements “fairness” which is determined by the extent to which they are prepared in compliance with GAAP. Supporting this, Johannes says, auditors examine financial statements and lend credibility to the reports of enterprise verifying that financial and economic facts do portray the entity’s progress and financial position. The quest for developing a means for achieving better and more informative and reliable financial reports is continuous and not static. If financial reports are to be intelligible and of use to different groups, then, there must be a dialogue to shape the basis for accounting “common interest” (Johannes, 2009).

Foulks (2013) posits that the objective of an external audit is to express an opinion on whether the financial statements of an entity are prepared in accordance with Generally Accepted Accounting Principles. This means that the auditors cannot guarantee that the financial statements are free of fraud or error because of the inherent limitations of the audit. GAAP require the auditors to design their audit procedures to reduce the risk of not detecting a material misstatement resulting from error, unintentional misstatements in financial statements, or fraud, intentional misstatement in financial statements, to an appropriate low level. Accordingly, the auditors must exercise due professional care in planning, performing, and evaluating the results of audit procedures. They also must exercise the proper degree of professional skepticism by not assuming unquestioned honesty and good faith on the part of management. Auditors also should report to members of management on whether the financial statements of the company show a “true and fair’’ view of the financial position, and also, specific duties such as to consider whether the information in the management report is consistent with the financial statements and whether proper accounting records have been kept by the company. Such statutory responsibilities impose liabilities if things go wrong. Auditor’s liabilities in most countries can be categorized as liability under legislation either civil or criminal (in counties with civil code legal traditions) and liability arising from negligence under common law (in countries with common low legal traditions).

Some writers conclude that, those who fail to fulfill their professional and legal responsibility satisfactory may be faced with legal action. Thus, public accountants must be keenly aware of their legal responsibility and liability. (Megis, Whittington, Meigs, Pany and Lam: 2009). Hence, this study is designed to describe the auditors’ liability to third parties with reference to private auditors in Nigeria.

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