1. PROFESSIONAL LIABILITY & QUALITY CONTROL
LECTURE 3
PROFESSIONAL LIABILITY
&
QUALITY CONTROL

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

3. 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

4. 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)

5. 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

6. 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

7. 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

8. Current issues in Auditor Liability
Proportionate liability
Capping liability
Network firms

9. 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

10. 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

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

12. 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

13. 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

14. Auditors Responsibility for Fraud and Error
Solve question on page 75

15. 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

16. QUALITY CONTROL UNIT 4

17. 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

18. 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)

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

20. OBTAINING AND ACCEPTING PROFESSIONAL APPOINTMENTS CHAPTER 5 Reading Assignment

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