Posted at 11.19.2018
Audits are completed to see the validity and consistency of the company's information especially financial information and offer an diagnosis on the effectiveness of the inner control system. Auditors are liable to express appropriate audit view on the financial claims in order to provide a true and reasonable view of the business's financial position based on the audit information they obtained throughout the audit steps performed. Although auditors need not purposely design audit types of procedures to detect fraudulence, they are required to disclose the scam they have determined immediately.
Recently, audit responsibility has become a global issue that draws in the concern of practitioners and academicians equally. Auditor's responsibility is the possible legal obligation associated with an auditor for breach of deal or neglectfulness. Auditor's liability can be derived from contract legislations where auditor is bound by the agreement or engagement letter and auditor's liability is based on breach of agreement; common law where in fact the auditor's liability principle is based on auditor's neglectfulness, gross neglect or fraudulence that are developed through courtroom decisions; or statutory regulation where liability is developed through express statutes or Government securities laws.
An auditor can be held responsible for breach of contract, negligence, gross neglect or fraudulence. Breach of contract will cause the auditor to be liable to their clients while neglect, gross carelessness or scam will lead to the auditor's responsibility towards clients and also third parties.
This report will in essence discuss on the tendency of auditor responsibility to third celebrations in United Kingdom (UK) and USA (US) as the responsibility pressure in both of these countries is predominantly intense. The pattern of auditor liability to clients will never be discussed in this record as it generally does not change much. This is because the auditor's liability to clients occurs only when there is certainly breach of contract, i. e. when the auditor does not meet up with the requirements which were established in the deal or normally in the engagement letter.
Prior to 1970s, promises against auditors were relatively rare although the issue of auditor's liability to clients and certain third people is definitely there. Nowadays, the number of lawsuits against auditors and open public accounting company have upsurge in the countries such as US, Canada, UK and Australia. Hence, the auditing vocation faces litigation crisis and needs to spend a lot of time and costs defending up against the lawsuits.
The increase in litigation has brought about some negative effects. For instance, the litigation cost and cost of professional liability insurance of an audit company has increased which will affect the ability and going matter of the audit organization, and increasing number of competent and experienced accountants departing the profession which might lead to the issue of lack of accounting specialists in future. Unless action is taken, the future of auditing is under risk; this is evidently not in the public's interest (Ward, G. , 1999).
As there a wide range of negative effects from the litigation, many studies have been done and suggested that the auditor liability's opportunity should be limited to decrease the litigation risk of an audit firm. The most frequent suggestions include upgrading of joint and many liabilities with proportionate responsibility, capping of auditor responsibility to a specific limit and so forth. The opportunity of auditor's responsibility is expected to be limited in future if the suggestions have been carried out. Relating to Pacini, C. , Hillison, W. & Sinason, D. (2000), the craze of the legal liability of auditor to third functions has emerged towards a narrower scope.
The issue of auditor liability in UK can be driven at the national level where in fact the decision that binds on all the courts in the country is manufactured at the highest national courtroom.
Before 1964, it is relatively problematic for a third party to sue an auditor for negligent misstatements. However, the situation has change in 1964 credited the truth of Hedley Byrne & Co. vs Heller & Partners Ltd. (1964). After Hedley Byrne case, there was an apparent development in the expanding of the scope of work of auditor to third parties.
The case of Hedley Byrne generally provides certain checks that must be satisfied for increasing the auditor's responsibility of attention to third parties: (1) the auditor must aware that the financial claims are to be used for a specific goal, (2) a known party was designed to rely on financial statements for that purpose, and (3) there will need to have been some do on the part of the auditor linking him to that party, which implies the auditor's knowledge of that party's reliance (Messier, W. F. , 2007).
This case has taken about the concept of reliance where in fact the auditor will be liable if they had been negligent in conducting audit and the 3rd party had relied on the financial claims audited by them. For auditor to be liable to third get-togethers, it must be reasonable for a third party to put reliance on the auditors' survey and that the auditors were alert that the individual would depend on the report.
Next, the situation of JEB Fasteners Ltd. vs Grades Bloom & Co. (1981) and Twomax Ltd. and Goode vs Dickson, McFarlane & Robinson (1982) experienced emphasize on the concept of foreseeability which seems to lead to the view of unlimited auditor responsibility. The auditors can anticipate that alternative party will use the audited financial record as a guide in decision making process. Both circumstances had led to the growing amount of third parties that have a legal right to sue auditor for neglectfulness. In other word, auditor's liability to third gatherings has increased.
According to Pacini, C. , Hillison, W. & Sinason, D. (2000), the widening region of auditor responsibility to third gatherings was practically reversed by the decision of the House of Lords in the Caparo Market sectors plc. vs Dickman & Others (1990) circumstance. From Caparo case, it was held that three necessary exams must be done in order to determine whether a responsibility of treatment by auditor can be imposed. First, the foreseeability of the incident of damages because of the misstatement must can be found. Secondly, a romance of closeness must can be found between auditor and the suing get together. Last but not least, it must be just and acceptable to place into effect the work of health care on the one party for the benefit for the other. Auditor will only be liable to the third get-togethers if these three standards have been fulfilled.
Since Caparo case, several cases involving alleged auditor's neglectfulness have happened and the UK courts continuing to limit the auditor's responsibility to alternative party. The bottom line is, the Caparo decision has lessened the range of auditor liability to third gatherings for negligent misstatements and cutting back the trend of stretching the auditor liability to the endless class of investing public.
In US, the problem of auditor's liability is determined by the state of hawaii courts or talk about legislatures individually where different judicial reasoning are applied in various jurisdictions which results in various rules of rules in different claims.
Four different legal expectations have evolved in various states folks to guage the auditor responsibility to third people which include privity guideline, near privity standard, restatement standard and finally acceptable foreseeability standard. Different areas will choose different standard which will lead to a different result.
Until the middle 1980s, the trend of the auditor's responsibility in US still shown a propensity toward widen opportunity of auditor responsibility to third functions. 1986 is the turning point of auditor's liability in america when Illinois handed an accountant privity statute and since then a development has surfaced toward a far more narrow opportunity of duty to third functions (Pacini, C. , Hillison, W. & Sinason, D, 2000).
As a final result, the evidence supports a trend towards restricting auditor liability to third-party in both UK and US.
The extend of auditors' responsibility largely is determined by the liable that is borne by a particular auditor. However, the responsibility stresses enforced to auditor has been increasing in several countries. The current public perspective is that auditors are no longer merely sensible to provide true and good view on financial record, but also sensible of detecting scams on the business operation (Reffett. A, 2010). Auditor's carelessness may therefore cause them to get involved in legal suits. A research has shown that the legal environment in five main countries, which include UK, Canada, Australia, New Zealand and USA, has reviewed the legal weather in relative to the auditor's liability because third celebrations in those countries are filling up lawsuit against auditor's negligent misrepresentation in the financial statement. Therefore, current legal platform is wanting to thin down the responsibility of auditors to lessen their litigation risk (Reffett. A, 2010).
In addition compared to that, auditor is now currently refusing to simply accept high risk customer audit engagement and increase the cost for professional responsibility insurance to be able to reduce their liability. That is because they have to protect their occupations. Otherwise, auditors' liability will become gradually heavier as if they will be sued when they didn't detect fraud. Yet, should auditor clear of their negligence on the financial statement as their scope of obligations are mainly not discovering scam? (Hassink. H, Meuwissen. R, Bollen. L, 2010).
To clarify that, some researches have been done. Research shows that there is certain level of fraud that may be detected by auditors. Therefore, if auditor fails to detect certain level of fraud, he's said to be liable for neglect. There are a certain standard which has been placed to determine auditor's responsibility. Those will be the level of information for the sort of fraud circumstances to be discovered by auditors; determine whether auditors have complied with auditing requirements regarding fraud to the impact on various context variables that has been recognized by auditors.
Another issue raised is that whether or not auditors who are able to gather more fraud proof are believed to be doing the right things. The answers are still involved and it is very based on judgments from the public (Pacini. C, Hillison. W, Sinason. D, 2000).
Because of that, expectation distance somehow exist while carrying out the audit work.
Auditor is in charge of expressing view on the heading matter position of consumer. If auditor fails to express the view, auditor will be liable for neglectfulness. However, in simple fact, auditors are expressing judgment predicated on the sufficient information provided by the accountants. However, if auditors express an judgment on the presence of the company for another a year, auditors become involved into decision making procedure for an organization (Pacini. C, Hillison. W, Sinason. D, 2000). These responsibilities should be borne by accountants of that company. That's because the time structure provided by auditor to gain access to the going matter of a business will be too short. Therefore, the opinion provided might not exactly be accurate. Yet, as the problem of going matter for a company is important for users, especially lenders and suppliers, they could file lawsuit against auditors due to auditors' neglect.
Auditors will often make their professional common sense while making decisions. Yet, sometimes, they could fail to foresee anticipated financial problems or any deceptive act of the client. However, judges is becoming bias for assessing your choice made and responsibility borne by auditors, especially following the failing of Arthur Anderson in discovering that its consumer has significantly understated the quantity of obsolete inventory (Anderson. J. C, Jennings. M. M, Lowe. D. J, Reckers. M. J, 1997). For legal reasons, auditor will be responsible for their negligence as though they do not exercise due care and attention while performing an audit. However, when judges tend to assume that auditors purposely breach its occupations and professional need, they may make wrong judgments while determining the responsibility of auditor.
To decrease the auditors' liability, accounting career has enacted the audit standards to increase auditors' responsibilities to eliminate the amount of audit failures. However, these work won't help a lot as if they are done alone. Most of all, we must debias the judges in their decision making process.
There are tons of methods which may have been used to debias or even to reduce the view errors. That is because judges play important tasks in handling important element of the trial. For example, there are some specific methods suitable for judges to look for the liability borne by auditors. Therefore, the correct common sense can be come to. However, the truth is, judges do not necessarily believe in due diligence of auditor because of the increase in number of corporate scandals in recent years.
Despite the bias view by judges, UK government has conversation on contributory carelessness to reduce the liability against negligent auditors. In addition to that, US Private Securities Litigation Reform Work enabled auditors to obtain negotiation on proportional liability so as to protect auditors from their liability towards shareholders.
However, the enforcement of those acts appears to be the main cause of US audit failures. It really is said that auditors are given substantial protection. That is because the problem has made the investor has no way to sue gatherings like regulation and accounting organization which may get involved in deceptive activities (Anderson. J. C, Jennings. M. M, Lowe. D. J, Reckers. M. J, 1997).
To reduce the electricity of manipulation of directors, auditors are indirectly becoming the agent appointed by shareholders to be impartial functions of company and directors. Yet, shareholders at the same time doubt the independent of the auditors while they perform their audit work. That's because they do not know the magnitude of the auditors' honesty and integrity (Sikka. P, Filling. S, Pik Liew, 2009).
However, as shareholders are constrained by a lot of liability layout which can guard auditors' occupations, shareholders hold on to the opinion that auditors contain the responsibility to find any irregularities in the company and any inconsistency increased. Therefore, auditor holds a responsibility that they have to be able to assess the effectiveness of the inner control inside the organization, supported with relative substantive types of procedures within a brief audit period. After carrying out all the audit work, it's the responsibility of auditor to attain to a precise conclusion, especially those regarding financial challenges and going matter of the client's company.
Auditors are liable for shareholders according of the truthfulness of the display of financial record. Their liability is going to be heavier as a result of increase of complexness of the accounting environment and practices (Sikka. P, Filling. S, Pik Liew, 2009).
As a whole, it continues to be a question whether less liability for auditors in certain areas will encourage more accurate financial statement. These are still challenges ahead for the auditor, especially facing legal suits submitted by third parties credited to misrepresentation of financial statement.
During the 1990s, Enron is a comparatively small home Texan energy company. Then, Enron become one of the most significant US corporations with an array of international energy trading and power operations. Enron has a strong profits grew and its market value has already reached $70 billion (Accountancy as cited in Unerman & O'Dwyer, 2004).
However, concerns relating to Enron's profitability and the major talk about sales by mature executives have driven a poor but continual decrease in talk about prices in August 2000. In Oct 2001, US currency markets was shocked by the announcement of Enron about the accounting 'adjustments' leading to a significant loss for its third quarter of $618 million and a decrease in its reported online property value of around $1. 2 billion. (BusinessWeek cited in Unerman & O'Dwyer, 2004). At the following weeks, the hostile earnings management procedures by concealing large scale loss and liabilities on off balance sheet was exposed. The senior executives of Enron experienced created about 3500 off balance sheet partnerships (Special Goal Entities (SPEs)) (Sloan cited in Unerman & O'Dwyer, 2004). Enron filed for Chapter 11 within 2 weeks. It is among the most largest organization to enter Chapter 11 personal bankruptcy with $55 billion estimates of exceptional liabilities. Many standard inquiries into Enron where started out following the company was collapsed (McLean cited in Unerman & O'Dwyer, 2004).
Arthur Andersen, one of the best Five global auditing firms, was auditor of Enron. In January 2002 allegation surfaced that, Andersen experienced shattered almost all of its working documents with Enron when the Securities and Exchange Commission payment (SEC) initiated the investigations into accounting tactics at Enron (THE BUSINESS ENTERPRISE cited in Unerman & O'Dwyer, 2004).
Further investigations disclosed that Andersen had played a key role in expanding the aggressive earnings management techniques carried out by Enron. Andersen was exposed to conflicts appealing because it made more fees in 2000 from providing consulting services to Enron ($27 million) than it does from auditing the Enron's accounts ($25 million) (McLean cited in Unerman & O'Dwyer, 2004). Many clients of Anderson were turned to other big auditing organizations because they lost faith in Andersen after these revelations. Andersen was collapsed due to this withdrawal of trust. As a result, there are only Big Four global auditing organizations after Enron case.
Sarbenes-Oxley Action (SOX) was enacted after the collapse of Enron. A lot of major advancements in auditors' responsibility have arisen in US therefore of SOX. The main reason for SOX is to boost the transparency of financial reporting by improving corporate and business disclosure and governance techniques and also to encourage an honest climate (Toda & McCarty as cited in Chung, Farrar, Poonam & Thorne, 2010).
Auditors' liability to third gatherings has increased because SOX specifies the scope of third celebrations to whom an auditor owes a work of care, and requires accounting company to concern additional financial reviews, add disclosure in financial records or issue new studies about themselves (Chung et al. , 2010). Since third gatherings could rely on this new information which is not previously required when coming up with investment or credit decisions, it increases auditors' responsibility to third gatherings. Furthermore, SOX has higher fines for violations of it when compared with earlier legislation. This amendment enhances significantly the legal liability of auditors rehearsing in US.
In response to SOX, many countries all over the world for example Canada, U. K. . , Australia and New Zealand have enacted their legislation. New oversight systems have been created in U. S. and Canada (Chung et al. , 2010). Additionally, the legislation in U. K. and Australia has been modified, and the Institute of Chartered Accountants in New Zealand has given corporate governance recommendations (Chung et al. , 2010). The quick actions considered by countries are to fulfill shareholders' demand after numerous failures on trying to improve the auditors' liability to third parties.
In Malaysia, Malaysian regulators have made a more arranged and disciplined financial confirming composition to ensure conformity and provide more self confidence to the general public (MIA Editorial Team, 2002). Hence, Malaysia's auditor responsibility has increased in post-Enron era.
Nevertheless, numerous fraudulence events were learned in local companies such as Transmile, Megan Press and the Port Klang Free Zone lately. Thus, then-Prime Minister Tun Abdullah Ahmad Badawi declared the necessity to create an audit oversight mechanism to regulate and administer the financial reporting of the Public Interest Entity (PIE) in his Budget Conversation 2008. In season 2010, Parliament of Malaysia has approved the Securities Percentage (Amendment) Function 2010 gives the permission to create the Audit Oversight Mother board (AOB).
The AOB's objective is to oversee the auditors of PIE and protect investors' interest by promoting assurance in the product quality and reliability of the audited financial record (Gomes, 2010). In addition, AOB will ensure that Malaysian regulatory construction for auditors are consistent with international methods. The establishment of AOB practically increases auditors' responsibility.
Article entitled "Scope of Auditors' Responsibility, Audit Quality, and Capital Investment" stated that the accounting career has been facing increasing quantity of third-party lawsuits since 1960s.
Lawsuits against auditors have led to direct financial results as well as other non-financial results to the job and modern culture. Audit firms are experiencing increased costs to stay lawsuits such as the management time and insurance premiums. Moreover, audit businesses have experienced negative effect on reputation because of the negative publicity arising from litigation.
Also, from this article entitled "Auditor liability to third functions: an international focus", it is said that the increase in litigation for auditors has resulted in some detrimental effects. One of the effects is accounting companies will have became more consistent in rejecting the engagement with clients that are seen to have high-litigation-risk. Besides that, there's a decrease in the availability and upsurge in the cost for professional responsibility insurance. Eventually, lots of the experienced accountants slowly but surely depart from the vocation.
In addition, Bialkin and Cooper (1986) warned that the pattern of broadening the range of auditors' responsibility to third parties will cause a semester in the quality level as well as the opportunity of services provided by the profession.
Therefore, there's a need to reduce auditors' legal responsibility. We have to decrease the legal liability of auditors because if the legal liability of auditors goes on to rise without any control enforced, the job might face a severe lack of experienced people in the profession. Accountants and auditors begins quitting the field fearing that they might be the next to handle litigation due to negligence. This will likely eventually leads to a chaos in the corporate world when your day where no competent auditors can be found to audit the financial statements arrived.
In order to reduce auditors' legal liability, steps have been considered by the experts and by individual firms.
A special committee was shaped by the North american Institute of Certified Public Accountants in the past due 1985 to be able to develop a legislative program for liability reform. The program centers to limit the range of auditors' responsibility to third celebrations by keeping the privity standard.
Privity approach, Restatement strategy, Foreseeability approach
Derek K. Chan (2002) concluded in his newspaper that from an efficiency methodology, the privity methodology is the foremost method of confine an unbiased auditors' work if in comparison to Restatement methodology and foreseeability approach. It is because privity approach supplies the firm a credible system where the firm can identify lenders into two categories within its own discretion - 1. Lenders who meet the criteria to recover their loss from the auditors; 2. Lender who are excluded from recovering their problems from the auditors. Restatement way provides less overall flexibility for the company to choose which lenders meet the criteria, hence expands auditors' responsibility. The foreseeability approach offers no overall flexibility by any means to the firm as this approach broadens auditors' liability to include foreseeable third people who will count on the audited financial claims.
In our view, the privity way is in fact the best procedure thus far to be able to limit auditors' liability.
Furthermore, to be able to reduce auditors' liability, auditors should be preparing proper audit programs and perform the best audit strategy. They ought to follow meticulously every audit rules provided, rather than cross over the forbidden lines.
Generally, auditors nowadays are quick to issue standard unqualified judgment on financial assertions due to the legal safety system. Furthermore, although litigations are enforced to auditors, because of the limited liability, auditors are carrying on with their inclination to issue the standard unqualified statement.
Example of legal safeguard system
According to this article entitled "Auditors' liability-no need to identify fraud", the author figured fraudster is not likely to sue his auditors for failing woefully to detect his fraudulence. Making use of ex turpi causa non oritur actio, if some may be engaged in unlawful activity, one cannot sue another for damages that arose out of this illegal activity. In the event Moore Stephens (a company) v. Stone & Rolls Ltd. (in liquidation)  UKHL 39, the House of Lords has chose that the illegality security still applies. Quite simply, it is set that Rock & Rolls Ltd cannot rely on its own illegal serves to promise for damage from its auditor.
However, inside our opinion, this concept "ex turpi causa non oritur actio" cannot universally pardon auditors of the duty to discover fraudulence nor to totally protect them from any litigation. Auditors should undergo a good trial and be judged reasonably if they were found guilty of conspiracy in the scams case.
Additionally, co-operation between auditors and directors raise the trend of auditors to issue the standard unqualified opinion. Improvements and adjustments are created for the great things about management and auditors at the expense of shareholders.
As a result, in addition to the effort to minimize the auditors' responsibility, in our opinion, there's still a need to impose appropriate legal actions on auditors who are involved in fraud situations because this is the right thing to do in order to maintain the fairness in the corporate world as well as to place emphasis on the value of ethics and integrity in the profession.
Therefore, from our group's perspective, the current condition of auditors' responsibility indicates an important need to reach a balance between imposing litigation on auditors who commit fraud or who fail to adhere to the approved auditing specifications and minimizing auditors' legal responsibility at the same time.
In addition, auditors should be well alert to their real experts which are the shareholders. They must get on the work and disclose the fraudsters if any were found. Auditors should be taking the burden to be in charge of pensioners' and shareholders' lost cash.
Our group thinks that it is time to attack a change in the auditing industry. Auditors should chuck away their old habits and ensure that figures are appropriately offered. Moreover, auditors who experienced committed scams should be blacklisted. Audit organizations should be brave to simply accept blames and consequences whenever any fraud is found due to neglect of auditors.
Last however, not least, we should encourage perfect market competition in this industry. More auditing companies should rise and it's really time to stop large businesses' oligopolistic position.
Increased auditors' liability poses an advantage for the shareholders and other third get-togethers who use the audited financial claims. It is because with an increase of auditors' liability, auditors will tend to be more careful in their works. They will place emphasis on the importance of executing appropriate audit steps and also to disclose any discrepancy found. Besides that, they will abide by the law and follow the auditing criteria closely to avoid any unneeded litigation.
However, as reviewed, it is proven an upsurge in the auditors' responsibility brought a whole lot of negative impact on the auditing and accounting job. People started to response with techniques that will protect themselves such as quitting the job or reject risky audit proposal.
Hence, it's still an issue as whether less responsibility or more liability for auditors using areas will encourage more accurate and better confidence in the audited financial claims.