PROFESSIONAL LIABILITY & QUALITY CONTROL LECTURE 3 PROFESSIONAL LIABILITY & QUALITY CONTROL

Content Legal Liability Negligence Restricting Liability Current issues in Auditor Liability Fraud and error The expectation Gap

Legal Liability Auditors may have professional liability in the tort of negligence Action for negligence may be brought by The company Shareholders The bank Other lenders and interested third parties

Legal Liability To succeed in an action for negligence, an injured party must prove three things An enforceable duty of care (automatic for the audit client, all other parties must prove) Breach of the duty of care ( must be proved by all claimants) The breach results in a pecuniary loss to the aggrieved party(must be proved)

Legal Liability Auditors duty of care may not clearly be spelt out in the appointment contract of the auditor Case law play a ubiquitous role in shaping extent of auditors’ duty of care and whether this duty has been discharged by the auditor Traditionally, the courts are averse to attributing a duty of care to third parties Caparo Industries plc v Dickman and Others Lord Denning posited that auditors must do their work with inquiring mind, not suspicious of dishonesty

Legal Liability Despite restrictive approach in admitting liability against auditors in Caparo’s case, the doors of the court are not closed against admitting liability for third parties James McNaughton Paper Group v Hicks Anderson & co Third parties can increase their chances of claiming liability against auditors by requesting specific assurance services

Avoiding Legal Liability Auditors can limit/avoid litigation through Due diligence in client acceptance procedures Performance of audit in accordance with audit standards and best practices Adopting effective quality control procedures Issue of appropriate disclaimers Auditors can restrict liability through Taking of professional indemnity insurance Corporate structuring (Incorporation, Limited liability partnerships

Current issues in Auditor Liability Proportionate liability Capping liability Network firms

Auditors Responsibility for Fraud and Error Two types of fraud causing material misstatement are known; fraudulent financial reporting and misappropriation of assets Fraudulent financial reporting Manipulation, falsification of accounting records Misrepresentation of transactions Intentional misapplication of accounting principles Such fraud may be committed through override of controls or recording of fictitious journal entries

Auditors Responsibility for Fraud and Error Misappropriation of assets may be theft of entity’s asset by employees or by management Embezzling of receipts Stealing physical assets or intellectual data Payment to fictitious vendors Using assets for personal benefits

Auditors Responsibility for Fraud and Error Risk factors for both types of fraud are Incentives/pressures Opportunities Attitudes/rationalisation See page 73

Auditors Responsibility for Fraud and Error Management is responsible for preventing and detection of fraud ISA240 however provides various guidelines on expectations from auditors regarding fraud Key among the requirement is the duty to make enquiries of management regarding fraud See page 71

Auditors response to Risk of Fraud Planning of the audit to address risk of material misstatements due to fraud Consider the assignment and supervision of personnel Consider accounting policies used Business rationale for significant transactions Incorporating non predictability into the nature, timing and extent of audit procedures Withdrawal from audit

Auditors Responsibility for Fraud and Error Solve question on page 75

The expectation gap The gap between what users of financial statements perceive as the role of the auditor and what is required of auditors by law Expectation gap reduced through Educating users Extending auditors responsibilities

QUALITY CONTROL UNIT 4

Purpose of ISQC ISQC 1 stated the objectives of establishing and maintaining QC system is to provide reasonable assurance that The firm and its personnel comply with professional standards and applicable legal regimes Reports issued by the firm are appropriate Quality control is considered At a firm level An individual audit level

Quality control at the firm level ISA220- Quality control for Audit of Financial statements At the firm level, quality control systems should cover Firm leadership and responsibility for quality (internal culture of quality) Human resources (recruitment, performance evaluation, promotion compensation, etc) Engagement performance (direction, supervision, review, resolution of disputes) Monitoring (relevant, adequate, compliance, effectiveness)

Quality control at individual audit level Leadership Ethical requirements Client acceptance/continuance decisions Engagement team assignments Monitoring

OBTAINING AND ACCEPTING PROFESSIONAL APPOINTMENTS CHAPTER 5 Reading Assignment

Reading Assigment Read on Why companies change auditors Advertising and fees Tendering Acceptance Terms of engagement