Why is Auditor Liability a Problem - Assignment Example

Auditor Liability Short Introduction For many years, auditor liability remains a constantly increasing concern within the field of auditing profession. Auditor liability can be dealt with common law, tort law or both. It is the common law that rules for the civil liability related to the breach of contract, tort, or the breach of a statutory duty as stated in the Statutory Audit Directive 2006/43/EC. (Implementation of Directive 2006/43/EC, 2007) Auditor liability occurs when an auditor practice ‘unfair’ and ‘unjust’ remarks on a company’s actual financial standing. (Lambe, 2007) Approving a defective account on behalf of a company is a good example that may result to fraudulent actions. Why is Auditor Liability a Problem? Auditor liability, also known as dishonesty or fraud by the auditor, is a major problem. Auditor’s failure to detect and report illegal acts or misstatements on the client’s financial statements is a serious problem because false audit could create a significant damage over the shares of the company; the primary and secondary markets of the shareholders; and the consumers. (Schaefer, 2004) Aside from the moral hazzards attached with the auditor liability, auditors should consider auditor liability as a serious problem because the British Serious Fraud Office has imposed penalities for swindlers as well as the white collar criminals to shut down or suspend a suspicious business; the possibility of a monetary loss or penalty through punitive fines; the confiscation or loss of license to practice. (Country Updates, 1997) When and to Whom will a Duty of Care be Owed? “The auditors in United Kingdom has to include a special duty of care to a liable third party.” (Poorter, 2008) Auditors working for a public company owes no duty of care outside the company’s existing shareholders who purchase stocks in reliance on a statutory audit. In line with this matter, Caparo Court states that the audited financial statements fulfils the auditors’ statutory duty to the shareholders collectively. ‘Adviser’ and ‘advisee’ should be fair, just and reasonable. All decisions made by both parties should be equally fair and just to third parties. Auditors should foresee possible damage that may arise between the adviser and third parties. Therefore, auditors should make use of their best professional knowledge to protect the interests of not either the ‘adviser’ nor the ‘third parties’; but both. The case of Al Saudi Banque v Clarke Pixley ([1990] Ch 313) is a good example whereby the court decided that no duty of care could exist between an auditor to the credit institution in case the auditor (defendant) has not yet issued his report to his client during the period when the complaints were filed in the court. (Poorter, 2008: p. 70) Liability Under Contract and Tort Law Under a contract law, auditor held liable for pure economic loss is a simple negligence and should be held responsible for compensated loss. In case violation on auditing guidelines is present under tort law, auditor(s) accused will not be held responsible for a compensation since tort law excludes liability of a pure economic loss. (Schaefer, 2004) The victim of a wrong audit can demand a claim against those people guilty behind the a wrong audit. (Ewert, 1999) In case the general public proves that both auditor(s) and upper management of a company collude against the outside stakeholders, stakeholders can demand a claim against both the parties involved. What is the Extent of the Auditor Liability? Auditor liability occurs when auditor(s) and the company agree to over-evaluate the company value upon its registration for IPO or the company and auditors decide to understate the company’s annual revenue to avoid paying right taxes. Thus, the extent of liability given to the auditors varies depending on the degree of their proven violation. Auditors are held responsible for a partial liability for damages that occurs on the victim regardless whether they have committed negligent act or without. (Kahan, 1998) The rule of the Continental Europe on the difference principles of auditors’ liability can be distinguished in three ways. First, when the buyer buys the shares before the beginning of period one and still keeps them after the end of period one, the difference principle states that the auditor(s) will not be held liable even if the buyer suffers a loss due to a sudden depreciation of the stock value. (Schaefer, 2004: p. 9) This statement is true in case the auditors did not make any actions that could trigger the decline in the stocks’ value. Since public investors are expected to practice a due diligent of care prior to making his/her investment right from the start, the loss that may occur in the process will not be recoverable. In case the major cause of the company’s stocks depreciation is due to the managements’ decision to invest the money outside the company, the court may decide on making the company partially liable for the loss. Second, if fraud occurs between the periods when the buyer has bought the shares from the beginning until the end of period one, partial liability on the part of the auditor is not applicable because the auditor is responsible in computing for the true parameter between the value of the stock price until the market reveals its true market value. Therefore, the auditor will be held fully responsible loss of the public investors. (Schaefer, 2004: p. 10) Third, in case the buyer has sold his share at an overvalued price for the reason that the auditor was not able to accurately detect the true market value of the shares, the person who bought the stocks will have to suffer from the loss due to overpayment for the stocks he bought. The negligence of the auditor in this case enabled the buyer who sold his shares at a high price to receive an extra monetary gain. How can Auditors Protect Themselves and Reduce Liability? Internal auditors can protect themselves and reduce the risk of liability by knowing the updated situation and provisions on auditor liability within the country. Internal auditors should take into consideration the service of external auditor since they are not directly related to the owner of the company as well as the company’s public investors. Thus, external auditors could perform a better objective and unbiased conclusions with regards to auditing the company’s financial statement. (Standing Advisory Group Meeting, 2006) What is the Present Scenario of Auditor Liability in UK / Europe? In line with the harmonised Audit Directive, Europe plan to implement a unified rule with regards to the ethical standards, legal system on auditing, and establish a unified auditing profession throughout EU members. Based on the Directive that was established back in June 29, 2006; the new Directive is expected to be fully implemented by June 29, 2008. (Implementation of Directive 2006/43/EC, 2007: p. 6) The new EU Directive is concentrated on statutory auditors as well as the auditing companies. It also includes some list of optional exemptions as well as other additional requirements for auditing companies that focuses on rendering their services to the public.. In UK, the Government’s general preference has made its own detailed standards with regards to the statutory framework and the IFAC ethical standard rules that has been agreed upon by the Professional Oversight Board. What are the Benefits and Problems that may Arise from Restricting Auditor Liability? In the absence of a strict auditor liability, big multinational companies and auditors could easily collude at the expense of the public investors. It will also be easier for them to avoid paying taxes. Therefore, the government budget would go below the expected annual budget needed in the promotion of the country’s economic growth. On the other hand, the general public will also suffer from huge loss associated with the easy financial gains of the business owners. Conclusion Strengthening the provision on auditor liability is essential for the economic growth of the country. Without a strict provision, auditors and business owners can easily avoid paying taxes and taking advantage of public investors’ money. Thus, indirectly hurting the country’s economy. *** End *** References: Collings, Matthew. “The Law Society v (1) KPMG Peat Marwick (sued as KPMG Peat Marwick McLintock) (2) Stephen Ingleby Cawley (3) Neil Spencer Chapman (2000) LTL 29/6/2000 : [2000] 1 WLR 1921 : [2000] 4 All ER 540 : [2000] PNLR 831 : Times, July 6, 2000.” 29 June 2000. Maitland Chambers. 6 January 2008 . “Country Updates: UK Fraud Squad Gets Tough.” 1997. Ewert, E. “Auditor Liability and the Precision of Auditing Standards.” JITE (1999): Vol 155; pp. 181 - 206. “Implementation of Directive 2006/43/EC on Statutory Audits of Anual and Consoliated Accounts (8th Company Law Directive).” [Online] August 2007. Government of Gibraltar, Ministry of FInance, Finance Centre Department. 6 January 2008 . Kahan, M. “Causation and Incentives to Take Care under the Negligence Rule.” 18 Journal of Legal Studies (1989): pp. 427 - 447. Lambe, Aidan. “Auditor Liability - Time for Reform.” Accountancy Ireland (2007): Vol. 37, No. 5. Lee, Chi-Wen Jevons and Zhaoyang Gu. “Low Balling Legal Liability and Auditor Independence.” The Accounting Review (1998): Vol 73, No. 4, pp. 553 - 555. Poorter, Ingrid de. “Auditors Liability Towards Third Parties within the EU: A Comparative Study between the United Kingdom, the Netherlands, Germany and Belgium.” Journal of International Commercial Law and Technology (2008): Vol. 3, Issue 1, pp. 68 - 75. Schaefer, Hans-Bernd. “Efficient Third Party Liability of Auditors in Tort Law and in Contract Law.” German Working Papers in Law and Economics (2004): No. 9. Standing Advisory Group Meeting: Emerging Issue - the Effects on Independece of Indemnification, Limitation of Liability, and other Litigation-Related Clauses in Audit Engagement Letters. Washington, DC: PCAOB - Public Company Accounting Oversight Board, February 9, 2006. Read More