Question

Explain the legal basis for a cause of action against an auditor. What are the defenses available to the auditor to rebut such charges.

Answer 1

The main causes of action against an auditor include negligence, fraud and breach of contract. Auditors are a highly important asset to every company and they are held up to very high standards.

Auditors are trusted to report fairly and are responsible for enhancing the reliability of financial statements so it is extremely important for auditors to not be negligent, get involved in fraudulent activities or breach their contracts.

When a client is trying to sue an auditor they must prove that the auditor accepted the duty to exercise with care and diligence. If the auditor were to breach their duty of professional care through negligence, that would be a cause of action against the auditor.

Defenses available to the auditor:

• An auditor can argue that the audit is performed in according to GAAS.
• In particular, the audit gives no complete assurance that material errors or irregularities will be detected.
• According to AU 240 Consideration of Fraud in a Financial Statement Audit, the auditor is responsible for designing the audit to provide "reasonable assurance of detecting errors and fraud that are material to the financial statements".
• In addition, it states, "Because of the characteristics of frauds, particularly those involving forgery and collusion,
• a properly designed and executed audit may not detect a material fraud."
• The auditor's working papers are critical in this defense.
• An auditor can argue that the client's management contributes to its own loss by its own negligence, e.g., the management has withheld critical accounting information from the auditor during the audit.
• An auditor can argue that the duty in question is not explicitly stated in the audit engagement letter.