Question

5.30     Liability to shareholders and the company

Maxref Ltd is a new dotcom company specialising in online trading in multimedia items such as DVDs, music, online reports and celebrity commodities. It has been listed on the Australian Securities Exchange since last year. As auditor for Maxref’s first year’s financial statements for the year ended 30 June 2009, you note that the accounts show a turnover of about $10 million, shareholders’ funds of $3 million, and a profit before tax of $ 250 000. During the course of your audit you discover that the balance of the sales ledger control account is $500 000 and that about 80 per cent of the accounts receivable are from new customers who bought items online without full details of the banking particulars. You further discover that all online transactions were reported and executed without proper security checks. Moreover, half of the items listed as stock for sale cannot be located. The share price of the company stands at $1.50. You raise the issue with the director of Maxref and he tells you that this is not uncommon with this type of e-business and that he is concerned only that the Australian Securities Exchange allows it to go on trading. He assures you that nothing major will happen; an unqualified auditor’s report is all that is necessary. However, you are worried about your own liability.

Required

Discuss the potential liability of the auditor to:

1. the shareholders
2. the company.

You may refer to any relevant case law in your answer.

Answer 1

(a) Liability to shareholder's-

The House of Lord had determined that auditor owe's a duty of care to general body of shareholder's but not individual shareholders. Auditor's are appointed by the Shareholder as a body to opine on the veracity of the financial statements and on its truth and fairness. Management through financial statement asserts before the auditors, shareholders and other stake holders about the true and fair view. It is the duty and obligation of auditor to review the financial statement, perform suitable audit procedures and provide an opinion whether financial statement gives a true and fair view.

An auditor's liability include providing a reasonable assurance that a reporting entity's financial statements are free of material misstatements, whether due to error or fraud.

An auditor can be sued in court of law for both civil as well as criminal charges when auditor willfully makes a false statement either in the balance sheet or any other document.

(b) Liability to Company-

An auditor faces civil liability towards the Company where a company faces any loss caused by auditor’s negligence of responsibility and breach of faith. The auditor is required to maintain client confidentiality of the Company's business.

An auditor can be called upon to reimburse any damages borne by the Company which arises out of action, inaction, negligence of the auditor. Further, an auditor can face criminal chages as well for leaking any client specific information or data to third parties.