AN EVALUATION OF AUDITORS LIABILITY TO THIRD PARTIES

ABSTRACT

This research work examines the Auditors liability to third parties. The main purpose of this study is to identify the sources of and audit requirement mandated by the international and local organizations. The population of the study is 50, out of the sample size was drawn as 50 managers in the selected organizations.  The study utilized questionnaire administered by the researcher with response supplied by the respondents. The data analysis techniques was presented in table. The findings showed that audit is/are legally responsible for both contractual and statutory agreement(s) made between them and client(s), and the auditors can be sued by the company for breach of contract if/when he simply fails to deliver an audit report, in order to avoid litigation the auditor must comply fully with professional judgment during and at the time of issuing the audit report because they (auditors) can be held liable for negligence of duty. Based on the findings, it was recommended that auditor should avoid taking job where family relative is part of the client company, if he/she knows that emotion will affect the end result of his/her audit assignment and Auditors’ should charge and collect only professional fee as agreed in the discharge of their audit assignment and avoid accepting financial gift or any other package that is not part of the professional pay.

CHAPTER 1

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Auditing is now regarded as a sophisticated professional assurance service performed in the interests of a wide variety of parties including companies, shareholders and investors. The practice of auditing has become increasingly important in the corporate market place. According to Maris (2012), the term ‘auditing’ is described as the accumulation and evaluation of information to determine whether a company’s financial report is in compliance with the established criteria and legislative requirements. By conducting an audit, an opinion is formed by the auditor as to the credibility of information contained in a company’s financial statement. Thus, the auditing process ensures that figures in the financial statements are materially correct, which in turn add value to such information. Henderson (2010) described an auditor as an independent professional person qualified to perform an audit. In accounting, an auditor is someone who is responsible for evaluating the validity and reliability of a company or organization’s financial statements. The term is sometimes synonymous with “comptroller”. In latin language the word is ‘audire’ which means ‘to hear’. The word ‘audit’ was derived from ‘audire’ and the person appointed to examine the accounts came to be known as the auditor. An audit of accounts is primarily intended for the use of the audit client, the company whose accounts have been audited. The auditor owes the audit client a duty of care in tort and also (usually) under the terms of the audit contract. Auditing plays an important role in the successful operation of a business unit.  The impetus behind the emergence of an auditor on the business scene was the managerial revolution. Managerial revolution simply means the separation of ownership from management. This development was brought about by the advent of large business organizations that are jointly owned by several individuals where it became practically impossible for the owners to manage the companies on their own. Consequently, the owners of such companies appointed other people to run the companies on their behalf.  Thereupon, a need arose for periodic link between the owners (shareholders) and managers (management) of such corporations. The major link between the owners and management is the periodic reports on financial affairs and level of progress achieved by the business which are made by management (Board of Directors) to the owners (shareholders).

The periodic reports referred to above are the financial statements. To the shareholders, the financial statements prepared by the management are nothing but assertions that need to be authenticated. For this reason, a qualified and independent accountant either as an individual or a firm, is required to examine and attest to the reliability of the information provided in the financial statements by management. Hence, Auditor gives credence to the financial statements in order to protect the interests of the shareholders. Furthermore, it is not only the shareholders that are interested in the reliability of the financial statements. Other parties like potential investors, lenders, security or financial analysts, customers, suppliers, employees, government and the general public are equally interested in the financial statements. On this account, the Auditor as a professional has a duty of care to protect the interests of all these parties in the course of performing his duties for a given client. What makes External Auditor unique to shareholders and users of financial statements is his “independence.” Furthermore, Auditor’s Report (opinion) is one of the most essential aspects in the Auditor’s work.  This is because it is his ultimate opinion on the financial statements that will inform the degree of reliability that should be attached to such financial statements.

However, a variety of parties other than the audit client may also rely on the audited accounts of a company in making an assessment of the company’s value and/or its credit worthiness. Should the auditor be liable to these third parties if he or she negligently audit the accounts? The auditor’s liability, if any, to third parties can arise only in tort, as there is no privity of contract between the auditor and the third party. The central question is one of duty of care: does the auditor owe a duty of care in tort to anyone other than the audit client? This question has attracted considerable attention of late because of the decision of the House of Lords in Caparo Industries Plcv Dickman because the House of Lords restricted the extent to which auditors are liable to parties other than the audit client, the decision has been greeted with some relief by the auditing profession

For an auditor to perform his duties effectively he must have certain powers without which it may not be possible for him to perform his duties honestly and thereby, he might be held liable for any loss which the company might suffer. In the case of the auditor of a sole proprietorship business or a partnership firm, the power and duties depend upon the agreement which is entered in between him and the organization. But in the case of the auditors of Joint-stock Companies, the Companies Act has laid down the powers and duties of an auditor. Although there is no direct mention of specific powers of a company auditor in the Companies Act, the auditor enjoys certain powers in the course of performance of his duties. For example, the auditor has a right to receive notices and attend general meeting, this is an instance of right. Again, the auditor has a right to obtain information and explanation from the officers of the company in the course of his audit work, this right is the nature of powers.

In recent decades, there has been a global upsurge in the number of corporate collapses and litigation claims by third parties which have partly been explained by the economic recession occurring in the late 1990’s. However, auditing professions in both Nigeria and around the world have encountered many challenges and criticisms in recent years, as a result of corporate collapses being linked to allegations of professional negligence and the breach of statutory duties (Stecol, 2009). Examples of high profile collapses overseas include Enron Corporation and WorldCom in the United States. These allegations illustrate the seriousness of the current legal environment for the auditing profession, government and third parties. Thus, there is a continuing interest in understanding the law regarding auditors’ liability, given the large litigation claims brought by third parties and the escalation cost of indemnity insurance cover in North America, Europe and Australia.    The liability of the auditor derives from the nature of his engagement. Being a professional expressing opinion upon which his clients rely, he must apply adequate skill with reasonable care and diligence to avoid misleading his readers. He is not infallible, he cannot be held liable for pure errors of judgment. He can however be held liable for acts resulting from his negligence, bad faith or dishonesty. It is essential therefore that the auditor is fully aware of his duties and makes adequate arrangement to discharge them and mitigate the effect of any claims that could be consequent on accidental failure to properly discharge these duties.

Auditors are subject to all laws that govern behaviour generally.  More specifically, the responsibilities of an auditor are influenced by a combination of relevant professional and legal requirements. In determining what is the necessary professional audit standard and practice, the expertise, knowledge and experience of the auditing profession will be taken into account.  Further, auditors are also accountable with legal responsibility for their examination and reports that they render to the company.  The legal hazards facing auditors are numerous and generally are very difficult to foresee in relation to any particular audit.  Any breaches of their statutory, contractual duties can expose them to potential litigation by injured parties and even to the risk of criminal prosecution under certain circumstances (Crowd, 2009). However, it is the responsibility of the management to apply accounting standards when communicating with investors and creditors through the financial statements prepared by auditors who examine or audit financial statements to express a professional independent opinion. The opinion reflects the auditors’ assessment of the statements “fairness” which is determined by the extent to which they are prepared in compliance with GAAP. Supporting this, Johannes says, auditors examine financial statements and lend credibility to the reports of enterprise verifying that financial and economic facts do portray the entity’s progress and financial position. The quest for developing a means for achieving better and more informative and reliable financial reports is continuous and not static. If financial reports are to be intelligible and of use to different groups, then, there must be a dialogue to shape the basis for accounting “common interest” (Johannes, 2009).

Foulks (2013) posits that the objective of an external audit is to express an opinion on whether the financial statements of an entity are prepared in accordance with Generally Accepted Accounting Principles. This means that the auditors cannot guarantee that the financial statements are free of fraud or error because of the inherent limitations of the audit. GAAP require the auditors to design their audit procedures to reduce the risk of not detecting a material misstatement resulting from error, unintentional misstatements in financial statements, or fraud, intentional misstatement in financial statements, to an appropriate low level. Accordingly, the auditors must exercise due professional care in planning, performing, and evaluating the results of audit procedures. They also must exercise the proper degree of professional skepticism by not assuming unquestioned honesty and good faith on the part of management. Auditors also should report to members of management on whether the financial statements of the company show a “true and fair’’ view of the financial position, and also, specific duties such as to consider whether the information in the management report is consistent with the financial statements and whether proper accounting records have been kept by the company. Such statutory responsibilities impose liabilities if things go wrong. Auditor’s liabilities in most countries can be categorized as liability under legislation either civil or criminal (in counties with civil code legal traditions) and liability arising from negligence under common law (in countries with common low legal traditions).

Some writers conclude that, those who fail to fulfill their professional and legal responsibility satisfactory may be faced with legal action. Thus, public accountants must be keenly aware of their legal responsibility and liability. (Megis, Whittington, Meigs, Pany and Lam: 2009). Hence, this study is designed to describe the auditors’ liability to third parties with reference to private auditors in Nigeria.

1.2 STATEMENT OF THE PROBLEM

In most cases the users of financial statements of an entity prefer audited financial statements for making rational decisions. However, in developing countries like Nigeria, the awareness creation and efficient practices of the auditors has not yet developed very well. The researcher has observed auditor acting in what may seem illegal during examination of the financial statements of an entity. Thus, believe that some auditors in Nigeria may be releasing misleading audited financial statements. There is a reason of believe that private auditors in Nigeria may have been producing misleading audited financial statements by:

 Reporting assets that do not exist,

 Considering or not disclosing inadequate provision for doubtful debts,

 Reporting stock records disregarding stock inventory counts,

 Treating capital expenditures as periodic expenses,

 Not disclosing misapplication of accounting principles,

 Expressing the audit opinion based on the client’s interest and others.

Generally, as the researcher observed from some trending cases in the country, there is reason to conclude that some private auditors in Nigeria have been violating auditors’ professional responsibilities. That is, most of the time violation of professional responsibilities is for the sake of personal financial interest. Therefore, it is against this background that this study is designed to investigate Auditors’ liability to third parties in Port Harcourt, Nigeria.

1.3 PURPOSE OF THE STUDY

The main purpose of this study is to ascertain Auditors’ liability to third parties. In light of this, the specific objectives of the study ascertained:

1. To identify the sources of and audit requirement mandated by the international and local organizations.
2. To infer the auditors professional and legal responsibilities and rationale therefore.
3. To identify the major legal concepts that relates auditors’ liability to clients and third parties under common law.

1.4 RESEARCH QUESTIONS

In the course of carrying out this research, the following questions were posed as guide to the researcher.

1. To what extent do private auditors exercise their professional and legal responsibilities?
2. Are private auditors subject to legal liability for committing what may be seem illegal audit practices?
3. What constraints exist on private auditors in attempting to exercise their responsibility?

1.5 SIGNIFICANCE OF THE STUDY

Users of financial statements of an entity mostly depend on audited financial statements. During conducting an audit, auditors should exercise due professional care, and should follow auditing standards formulated by international organization as well as local government body. Violation of these standards may subject to legal liability to auditors’.

Hence, the study intends to clarify auditors’ practices in exercising professional and legal responsibility, and the legal liability subject to not fulfilling these responsibilities in Nigeria.

1.6 SCOPE OF THE STUDY

In most developing countries like Nigeria, accounting and auditing profession has not yet developed. Thus, Nigeria is among these countries where there are no locally developed auditing standards.  Supporting the above, Lemma and Assefa argued that to date in Nigeria, there were no nationally promulgated standards to be followed by auditors, but it was widely known that Generally Accepted Auditing Principles (GAAP) have been adopted by practically all auditors in private sector. It is expected that on the basis of GAAP, private auditors plan, control, record their audit work undertaken, review accounting systems and internal control, collect and access audit evidences and, review financial statements to draw reasonable conclusions to form their opinion to culminate in final reports (Lemma Argaw and AssefaDesta: 2014). From the above, one can say that in Nigeria, there is a lack of internally established accounting and auditing standards. Accordingly, private auditors mostly depend on auditing standards established by developed countries especially U.S and U.K. Hence, the study depends on those standards developed by international professional association and those adopted from international standards.

1.8 DEFINITION OF TERMS

Audit: An independent examination of, and expression of opinion on the financial statements of an enterprise by an appointed auditor in pursuance of that appointment and in compliance with any relevant statutory obligation.

Auditor: This is a person who is responsible for evaluating the validity and reliability of a company or organization’s financial statements and signs an opinion about them.

GAAP: This acronym means generally accepted accounting principles.

Liability: This refers to the state of being legally responsible for something.

Third Party: This could be seen as someone who may be indirectly involved but is not a principal party to an arrangement, contract, deal, lawsuit, or transaction.