Question

What are the liabilities of an auditor and what is the standard of care expected of such an auditor?

Answer 1

Dear Student

LIABILITIES OF AN AUDITOR

Liabilities of auditor of a company differ from those appointed by a firm,

The Companies Act has defined the duties of a company auditor and the liabilities arise on account of these duties.

For the sake of convenience the liabilities are divided under the following headings:

A. Civil Liability;

B. Criminal Liability;

C. Liability towards third parties;

D. Liability for libel;

In all the four cases the auditor can be held liable for one or more causes given hereunder.

(a) Liability for Negligence under the law of Agency;

(b) Liability for Misfeasance under the Statutes—Companies Act and Indian Penal Code. Let us now discuss these liabilities in some detail.

A. Civil Liability

Liability for Negligence: Under the law of Agency the auditor is liable for negligence and in such a case has to pay damages to the aggrieved party or parties.

If the company suffers a loss on account of the acts of the auditor, he has to make good this loss. The auditor shall not be held liable for negligence,

if the company does not suffer any loss. He shall also not be held liable for the loss suffered by the company without his negligence. In order to hold him responsible for negligence, the following points are to be proved by the party (ies)..,...

(a) that he was negligent;

(b) that as a result of his negligence the company has suffered the loss ; and

(c) that the loss was suffered by the person to whom the auditor owed a duty. He cannot be relieved of his liability by an agreement entered in between him and his client.

`Negligence' includes the following acts—

(a) Not to see the Articles of Association and not to object payment of dividends out of capital;

(b) Not to get statements of accounts from the creditors and find out the errors and frauds.

(c) Not to verify Cash and Petty Cash;

(d) Not to report to the client about the insufficient provision for bad and doubtful debts, which results in inflating the profits for dividends, thus paying dividends out of capital.

Liabilities for Misfeasance : The term `misfeasance* implies a breach of trust or duty. Where the auditor performs his duties negligently and the company suffers a loss on this account, the auditor is held liable for Misfeasance and he has to indemnify the company for such loss.

He is also liable for damages u/s 543 of the Companies Act. The court can, on application made by the liquidator of the Company, charge the auditor for misfeasance and ask him to make good the loss. However, the auditor has a right to appeal to the court u/s 633 of the companies Act and he can be excused partly or fully by the court if it is satisfied that he has acted honestly and reasonably. Thus relief can be granted only in the case of Civil liability and not in the case of Criminal liability.

B. Criminal Liability

Criminal liability of the auditor arises under the following Acts:

1. Under the Indian Penal Code ;

2. Under the Companies Act;

3. Under the Income-tax Act;

4. Under the Life Insurance Corporation Act;

5. Under the Banking Companies Act;

6. Under the Chartered Accountants Act.

1. Under the Indian Penal Code : He is criminally liable, when he issues or signs a certificate required by law to be given or signed or relating to any fact for which such certificate is admissible as evidence, knowing or believing that such certificate is false in any material point. He shall be punishable in the same manner as if he has given false evidence. (Section 197).

2. Under the Companies Act: He is criminally liable for the following acts—

(a) for authorising the issue of a false prospectus. The penalty for this act is a fine upto Rs. 50.000/- or imprisonment upto a period of 2 years, or both. (S. 63)

(b) for fraudulently inducing persons to invest money by purchasing shares or debentures of the company. The punishment is imprisonment for a term extending upto 5 years or a fine extending upto Rs. 1,00,000/- or both. (S. 68).

(c) for making a fraudulent report required under section 227 i.e. if the report is made not in conformity with the requirements of Section 227 or any document of the company is signed or authenticated by him which is also not in conformity with the above section or the report is signed or any other document is signed or authenticated by any person other than the auditor himself and such other person is not authorised to do so. The punishment is a fine upto Rs. 10,000 in both the above cases.

(d) For falsification of books. If it is proved that the auditor has been guilty of destroying, mutilating, altering, falsifying or secreting of any books, papers or securities or is privy to the making of any false or fraudulent entry in any register, book of account or document belonging to the company, he shall be punishable with imprisonment extending to seven years and also be liable to fine. (Section 539).

(e) for delinquency i.e. making a false statement wilfully, in the course of winding up of the company or certifying a false return, report, balance-sheet or giving a false certificate or certifying a false document in the course of winding up of a company. All these acts make him liable for criminal offences and the liquidator can directly prosecute him or refer the matter to the Registrar. (Section 545).

(f) For rendering false statements either in the balance sheet or any other document or destroying or mutilating any voucher or document, the auditor shall be punishable with imprisonment upto a period of two years and also shall be liable to fine.

Criminal offences include the following acts, for which he is punishable with fine or imprisonment or both—

(a) Wilfully submitting a false report;

(b) Concealment of frauds in the account books;

(c) Destroying the vouchers and documents concerning account books;

(d) damaging the property of the company;

(e) Abetting in the falsification of the account;

(f) Certifying wilfully the false accounts;

(g) Making a false statement knowingly to be false;

(h) Accepting bribe during the course of discharging his duties as an auditor.

3. Under the Income tax Act: The auditor is criminally liable for encouraging or abetting his client to make a false statement or declaration regarding his taxable income. The liability for such offence is imprisonment upto 6 month or fine or both. (Section 278).

4. Under the Life Insurance Corporation Act: The auditor is criminally liable for making a false statement wilfully on a material point relating to the return, report, balance sheet or any document. The punishment is imprisonment and fine. (Section 104).

5. Under the Banking Companies Act: The auditor is criminally liable, if he makes a false statement knowingly relating to a return, report, balance sheet or any other document or conceals a fact. The punishment is imprisonment upto a period of three years. (Section 46).

Auditor is treated like a public servant and shall be punishable like a public servant for criminal breach of trust. (Section 46 A). He is also liable to Public Examination and if found guilty by a court can be declared unqualified for appointment as an auditor for 5 years. (Section 46 A).

6. Under the Chartered Accountant Act, 1949 : the auditor is liable for misconduct, which is defined under section 122 of the Act. Cases of professional misconduct are dealt in the various schedules of the Act.

C. Liabilities Towards Third Parties

Auditor is not liable to third party or parties as a general rule. He is liable to his employer only. However, if the third parties are able to prove the following points he shall be liable towards thein too—

(a) that the statement was untrue in fact;

(b) that the person making it knew that it was untrue or was recklessly can consciously ignorant whether it was true or not;

(c) that the statement was made with the intention that the third party should act upon it;

(d) that the third party did act on the faith of the statement in the prospectus.

The controversy whether the auditor is liable to the third party is now set at rest and the auditor is now held liable on account of the following reasons

(a) Certifying the improper accounting procedure due to which embezzlement of an
employed of the client could not be detected.

(b) Negligence committed by the employee of the auditor;

(c) Errors committed in the preparation of final accounts,

1) Liability for Libel

A libelous or slanderous statement made by an auditor will not hold him liable if he has made such statement bonafide and without any malice. But if he has made such a statement outside the scope of his duties, he shall be held liable.

Liability of an honorary Auditor

An auditor, whether he is paid or honorary, is liable or his acts and omission. The agreement with his client is very much valid in the eye of the law even though there is no monetary consideration involved.

Liability of a Joint Auditor

The Companies Act is silent over the issue. But the statement issued by the Institute of Chartered Accountants of India, on the subject of the liability of Joint Auditors is to be followed in such cases. The gist of this statement is ; the entire work pertaining to audit is to be divided in between the auditors and they shall be responsible for their part only, where the work cannot be divided in any manner, all joint auditors will be responsible.

Liability of Local Auditors

If a company has many branches in the country as well as abroad arid appoints local auditors for the branches, the auditor of the Head Office shall not be held responsible for the acts of the local auditors, provided the auditor at the Head Office states clearly in his audit report that he had completely relied upon the statements and figure supplied by the local auditors.

Care

Due care generally implies four things:

1. The auditor must possess the requisite skills
2. The auditor has a duty to employ such skill with reasonable care and diligence
3. The auditor undertakes good faith and integrity but is not infallible
4. The auditor may be liable for negligence, bad faith, or dishonesty, but not for pure errors in judgment

Hope this will help you ☺

Thanks