Auditors must include in their report their opinion on whether the financial statements they report on give a true and fair view. It is generally felt that in order for accounts to show a true and fair view there must be compliance with the IAS / IFRS. There may be situations where compliance with IAS / IFRS may result in a true and fair view not being given but this is rare. So effectively, the auditor is being asked to give an opinion on whether all IAS / IFRS have been complied with in the preparation of the accounts he is auditing. The auditor therefore must know and understand the IAS / IFRS in detail. Auditing students are also expected to know the IAS / IFRS in detail because invariably, there will be an examination question that requires this knowledge and students are advised to quote from the IAS / IFRS and state which of the IAS / IFRS is relevant to their answer.
International Financial Reporting Standards are intended to be applied to all financial statements which show a true and fair view. They set out the main assumptions underlying statements and they prescribe which accounting policy should be used when more than one are possible. They also specify disclosure requirements in many areas including the disclosure of accounting policies. Again they are not intended to be a comprehensive code of rigid rules. It is recognised that such a code sufficiently elaborate to cater for all business situation and circumstances and for every exceptional and marginal case is impossible. The benefits of IAS / IFRS are:
1. They lead to a degree of uniformity and comparability among accounts.
2. They assist understanding by providing readers of the accounts greater information about the preparations of the accounts.
3. They assist accountants and auditors by aiding in the process of determining what is a true and fair view. They therefore help refine the meaning of true and fair view.
4. They describe a method of accounting and or disclosure requirement approved by the institute.
5. Members of the institute are obliged to secure adherence to IAS / IFRS whenever they are concerned with financial statements be they directors, accountants, company secretaries, auditors or in any other role.
Negligence in General
There is no recorded case in Kenya against auditors and this makes it difficult to be precise as to where the auditor’s legal liability falls. We need therefore to refer to decided cased in other countries. But even in those countries there are in fact very few decided cases against auditors. In those countries, the vast majority of actions against auditors are settled out of court. This saves what could otherwise be very expensive court costs. It is also significant to note that this saves dragging the professional firm's name through the courts and most likely through the newspapers. Firms are of course anxious to avoid such bad publicity.
It is however generally known that the auditor's liability falls under three specific headings:
(a) To his clients under contract law;
(b) To third parties under the law of tort;
(c) Civil and criminal liability under statute law and we will deal with each in turn:
To his clients: The auditor is under duty to report to the members in general meetings on all accounts examined by him and laid before them. His contract is therefore with the company as a whole and not with individual shareholders. The auditor can therefore be accused of negligence if:
(a) he fails to detect fraud or error which he should reasonably have detected;
(b) if he fails to comply with generally accepted auditing standards and practices.
However, it is also generally held that for an auditor to suffer actual financial loss, the following conditions must be met.
i. he must be proved to have been negligent;
ii. the complainant must have suffered a loss;
iii. the loss must be as a direct consequence of his reliance on the auditor's report and the auditors negligence.
Therefore if the auditor fails to detect a fraud which is immaterial to the accounts and unless there are suspicious circumstances which he had noticed or should reasonably have noticed, it is unlikely that he will be held negligent.
Even if the fraud was material to the accounts, he may still escape liability if detection could not reasonably have been achieved using normal audit procedures. It must be admitted however this is a very dubious area of law.
The auditor has no duty to individual shareholders. A shareholder who makes an investment decision by relying on the auditor's report and suffers loss cannot claim under the law of contract. Only if the company as a whole has suffered, can the whole body of shareholders claim from the auditor.
In a number of cases it appears that claims have arisen as a result of some misunderstanding as to the degree of responsibility which the accountant was expected to take in giving advice or expressing an opinion. It is therefore important, to distinguish between disputes arising from misunderstanding regarding the duties assumed, and negligence in carrying out agreed terms.
The Use of Engagement Letters
There is a contractual relationship between an accountant and his client. The accountant should therefore ensure that at the time he agreed to perform certain work for the client, the scope of his responsibilities is made clear preferably in writing, in that the terms of his contract with his client are properly defined. Where possible a letter of engagement should be prepared setting out in detail the actual services to be performed, and the terms of engagement should be accepted by the client so as to minimise the risk of disputes regarding the duties assumed.
Liability to third parties
For a long time liability to third parties existed only in respect to physical injury. Liability for financial loss is a recent development. Examples of occasions when an accountant may run the risk of insuring a liability to third parties may include the following:
(a) Preparing financial statements or reports for a client when it is known or ought to be known that they are intended to be shown to and relied upon by a third party even if the identity of the third party is not disclosed.
(b) Giving references regarding a client's credit worthiness or an assurance as to his capacity to carry out the terms of a contract or giving any other reference on behalf of the client.
Again, it must be shown that the accountant was negligent, third parties suffered a financial loss, the financial loss occurred as a result of the accountant's negligence and that the accountant knew the purpose for which his report or accounts were to be used.
Liability under statute
Civil liability: Section 206 of the Companies Act provides that officers of the company and for these purposes auditors are considered as officers, may be liable for financial damages in respect of the civil offences of misfeasance and breach of trust. This section which is only relevant to winding up refers to a situation where officers have misused their position of authority for the purposes of personal gain.
Criminal liability: Section 46 of the Companies Act states that an auditor shall be criminally liable if he wilfully makes a materially false statement in any report, certificate, financial statement etc. Wilfully implies fraudulently and can be difficult to prove. Whereby, it is held that where an officer of a body corporate with intent to deceive members or creditors, publishes or concurs in publishing a written statement of account which to his knowledge is or may be misleading, false or deceptive in a material particular he shall on conviction be liable to imprisonment for a term not exceeding 7 years.
Other relevant issues to be considered under this section include:
• The auditor with errors and irregularities;
• The auditor with illegal acts by client or client's staff;
• Questionable payments;