The liabilities of an auditor are significant, and failing to meet your legal obligations can have serious consequences. By understanding these liabilities, taking proactive steps to mitigate risks, and staying informed on best practices, you can protect yourself and your career from potential legal pitfalls.
Understanding the Liabilities of Auditors: What You Need to Know
Liabilities of Auditors In Case of loss
If auditor is proved negligent and company suffers m loss then he is liable foi the damages.
NO RESTRICI ION ON LIABILITY
Any agreement which relieves the auditor from liability is declared void by the companies ordinance 1984 But court may relieve him from liability of negligence
INDEMNITY CLAUSE INSERT LN ARTICLES
Any indemnity clause inserted in the articles of a company, by which the directors, managing agents, auditors and other officers of the company are relieved Horn liabilities has been declared void by section 194
TIME LIMIT FOR SUIT
Action against the auditor for the negligence can be taken at any time during the life time of company.
In the case of financial losses, particularly those resulting from errors or omissions in financial statements, auditors can face several types of liabilities. These liabilities depend on the nature of the auditor’s engagement, the expectations set by auditing standards, and the legal framework in which the audit is conducted. Here’s a detailed exploration of the liabilities of auditors when their actions or inactions lead to losses:
1. Civil Liabilities
Auditors can be held civilly liable to both their clients (contractual liability) and third parties (tort liability) if their failure to adhere to the standards of the profession results in financial losses.
- To Clients: Under contractual obligations, if an auditor fails to detect fraud or significant errors during an audit, the client can claim damages if these errors lead to financial loss. The liability hinges on proving that the auditor did not perform their duties as per the contract or the generally accepted auditing standards (GAAS).
- To Third Parties: Auditors can also be liable to third parties who rely on their reports, such as investors or creditors. This liability arises if third parties make financial decisions based on inaccurate audit reports. The landmark case of Ultramares Corporation v. Touche set a precedent that auditors could be held liable to third parties for negligence only under certain conditions, notably if the auditors were aware that the third party would rely on the report.
Statutory Liabilities
In many jurisdictions, statutes may impose specific liabilities on auditors. For example:
- Securities Laws: In countries like the United States, under securities laws (e.g., the Securities Act of 1933 and the Securities Exchange Act of 1934), auditors can be held liable for misstatements or omissions of material facts in financial statements used in securities transactions. Auditors can be subject to penalties, including fines and restrictions on practice.
- Sarbanes-Oxley Act: This act increases the accountability of auditing firms to maintain independence and to perform thorough audits that can reasonably detect material misstatements due to error or fraud.
2.CRIMINAL LIABILITY of Auditor
If the auditor is involved in criminal activities then he is liable to shareholders and other people who rely on him.
During the course of audit if the auditor makes a . false statement in his report, return, certificate or balance sheet with the intention of misleading or deceiving the others, he became criminal liable. An auditor may be guilty of a criminal offence under the following provisions of the companies ordinance 1984.
- KNOWN FALSE STATEMENT SEC. 66
If an auditor makes a false statement knowing it to be false, he may be held liable to imprisonment for term which may extend to three years or which may extend to Rs. 20000 or both.
- NOT FULFILLING THE REQUIREMENTS OF ANNUAL REPORT SEC. 260(i)
If the auditor’s report does not fulfill the requirements of annual report, the auditor may be held liable to a fine which may extend to Rs 2000
- INTENTION TO PROFIT SEC. 260 (ii)
If the auditor’s report is made with the intention to profit or to put a person to a loss, he shall be further liable for imprisonment for a term which may extend to 6 months and with fine which may extend to Rs. 2000.
4,FALSIFICATION OF BOOKS DURING WINDING UP
If auditor destroy, mutilate or falsify books and papers for deceiving others during the winding up of company then he is held liable for punishment upto two years or fine of Rs. 20000 or both.
5.FAILS TO FOLLOW THE RULES
If the auditor is failed to follow the rules of his own profession, the -council has a right to cancel the certificate of practice The council may go to court and there may be fine or jail or both.
6.GUILTY OF OFFENCE RELATING TO INVESTIGATION
If the auditor is guilty of offence relating to investigation for which he is criminally liable, the authority may prosecute him for the offence
7.FAIL TO PLACE THE AUDITED ACCOUNTS
If the auditor is failed to place the audited accounts and statement before creditors and shareholders within two months or extend time period then he is liable for fine of Rs. 5000.
3. LIABILITY TO THIRED PARTY
An auditor can not be held liable to third party because he is not the employee of them. But the third party such as bank and tax department rely upon the audited statement So if the auditor has acted fraudulently and third party relied upon the report and suffered the losses then the auditor should compensate the loss
To hold the auditor liable for fraud, the third party must prove the following facts against the auditor-
- UNTRUE STATEMENT _
That the report of statement signed by the auditor was not true in fact.
- KNOWN TO AUDITOR
That it was known to the auditor that the statement was not true.
- INTENTION TO ACT
That the statement was made with the intention that the other party should act on it.
- ACTED AND SUFFERED
That the third party suffered in loss by relying on the statement of auditor.
Conclusion:
In conclusion, auditors play a critical role in ensuring the accuracy and reliability of financial information. However, when auditors fail to detect errors or fraud that result in financial loss for their clients, they may face liabilities for negligence. It is important for auditors to adhere to auditing standards and practices diligently to protect themselves from potential liabilities. By upholding professional ethics and standards, auditors can maintain their credibility and trustworthiness in the auditing profession