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    International developments in auditing2 International developments in auditing2 Document Transcript

    • APT Financial Consultants INTERNATIONAL DEVELOPMENTS IN AUDITING 1.0 Auditing practices around the World 1.1 Audit practices in UK 1.1.1 The accountancy profession in UK is unregulated except for certain areas, which are regulated by law. These three areas are; investment advice, insolvency work and company audit work. Individuals wishing to practise as an auditor in the UK are required by law to hold an audit qualification from a Recognised Qualifying Body (RQB). There are five RQB's: Association of International Accountants; Institute of Chartered Accountants of England and Wales; Chartered Accountants of Scotland; Chartered Accountants of Ireland; Association of Chartered Certified Accountants 1.1.2 Until 1991, the responsibility for setting auditing and ethical standards lay wholly with the accountancy professional bodies7. However, in the late 1980's, a number of audit failures led to the UK Government to pressurize those professional bodies to strengthen their processes to improve the quality of auditing. This led to the establishment of the Auditing Practices Board (APB) in 1991 and the commencement of audit inspection activities by the professional bodies. An important feature of the APB when it was established was that 50% of its members were required not to be practicing auditors8. 1.1.3 APB issued its first auditing standards in 1994. These were supplemented and improved over the period to 2004. Many of the initial standards focused on the process of auditing but the APB also undertook innovative work in developing standards on going concern, fraud, compliance with laws and regulations, audit firm quality systems and auditor reporting to audit committees – all of which were areas where, at that time, no auditing standards existed anywhere in the world`. 1.1.4 Following from the financial difficulties in South East Asia (the so called collapse of the ‘Tiger economies’) international regulators put pressure on IFAC to improve the quality of international auditing standards. As a result the International Auditing Practices Committee (IAPC) (the forerunner of the International Audit and Assurance Standards Board (IAASB) commenced a major investment in improving International Standards on Auditing (ISAs). 1.1.5 In 2004, APB took the decision to more clearly base UK auditing standards on ISAs and a suite of ISAs (UK and Ireland) was issued. The ISAs (UK and Ireland) adopted the text of the international standards (ISAs issued by the IAASB) supplemented by additional UK specific standards and guidance. 1.2 Audit practices in USA Sako Mayrick, 2008  Page 1 
    • APT Financial Consultants 1.2.1 The Financial Accounting Standards Board (FASB) is a private, not-for- profit organization whose primary purpose is to develop generally accepted accounting principles (GAAP) within the United States in the public's interest. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards for public companies in the U.S. It was created in 1973, replacing the Accounting Principles Board and the Committee on Accounting Procedure of the American Institute of Certified Public Accountants. The FASB's mission is "to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information 1.2.2 Stocks and Exchanges Commission and the American Institute of Certified Public Accountants (AICPA) established a new authoritative body to set auditor independence standards and that led to the Public Company Accounting Oversight Board (PCAOB) established by the Sarbanes Oxley Act signed into law by President Bush on July 30, 2002. Sarbanes Oxley makes the chief financial officer and chief executive officer responsible for their firm’s accounting records and provides for criminal penalties for those who do not comply with the act. The board, funded by public companies with mandatory fees and overseen by the SEC, will issue, adopt and enforce auditing, ethics, attestation and other standards to protect public interest. There are severe penalties for noncompliance including fees and imprisonment. The goal is to restore investor confidence by preventing misdeeds of corporate executives that lead to investor losses. The act has increased costs for companies. Academically there is increasing emphasis on the study of ethics in business schools and recently the demand for accounting graduates has grown. Significant control of the accounting profession has passed from the private to the public sector. Public oversight will likely become more complex and costly. As confidence is restored investments will increase and profits will rise, employment will expand, and the national economy will benefit from a new era of confidence, trust and fairness. 1.3 Audit practices in SADC and other EA countries 1.3.1 The main aim of audit practices for Sauthern African Development Community (SADC) is to harmonisation of best practices in accounting and auditing standards across the region for sound public financial management is an imperative. Member States are encouraged to implement the programme of harmonisation of auditing and accounting standards coordinated by the Eastern, Central and Southern African Federation of Accountants (ECSAFA). 1.3.2 The Eastern, Central and Southern African Federation of Accountants (ECSAFA) is a regional body of accountants whose objects, inter alia are the co-ordination of the development of the Accountancy Profession and promotion of internationally recognized standards of professional competence and conduct within the region. Sako Mayrick, 2008  Page 2 
    • APT Financial Consultants 1.3.3 ECSAFA was launched in Mauritius in 1989 and a Secretariat established in the offices of the South African Institute of Chartered Accountants in Johannesburg in 1991. Due to the increased workload and the growing importance of the organization, it was resolved to establish an independent Secretariat in Nairobi. The Secretariat was transferred from Johannesburg, South Africa to Nairobi effective 1st January 1999 a decision that has recently been confirmed by Council. 1.3.4 The mission of ECSAFA is to build and promote the accountancy profession in the Eastern, Central and Southern regions of Africa in order that it is, and is perceived by accountants, business financiers and governments to be an important factor in the economic development of the region. 1.3.5 Currently, ECSAFA has 15 full members from fourteen countries in the region. National accountancy bodies in the course of formation are accorded temporary memberships status in ECSAFA while affiliate membership is open to other regional bodies like Common Market for Eastern and Southern Africa (COMESA), South African Development Community (SADC), East and Southern African Association of Accountant Generals (ESAAG), etc while international accounting organizations like the Association of Chartered Certified Accountants (ACCA), Association of Accounting Technicians (AAT), Institute of Chartered Accountants in England and Wales (ICAEW), are accorded Observer status. The World Bank is a non-subscription paying Observer member and we would encourage other organizations like ADB to also join ECSAFA. There is interest among accountancy bodies in-formation in Sudan, Rwanda, Mozambique, Mauritius and Angola to change from temporary to full members as their institutes are formed. ECSAFA has also been monitoring developments in Mozambique where currently consultants have been hired with the assistance of the World Bank to set up a body of accountants. We are also following up other countries in the region like Rwanda where there has been encouraging signs of the development of an accountancy body. 2.0 The role of IFAC The International Federation of Accountants (IFAC) is the worldwide organization for the accountancy profession. Founded in 1977, its mission is “to serve the public interest, IFAC will continue to strengthen the worldwide accountancy profession and contribute to the development of strong international economies by establishing and promoting adherence to high-quality professional standards, furthering the international convergence of such standards and speaking out on public interest issues where the profession’s expertise is most relevant.” IFAC’s governing bodies, staff and volunteers are committed to the values of integrity, transparency and expertise. IFAC also seeks to reinforce professional accountants’ adherence to these values, which are reflected in the IFAC Code of Ethics for Professional Accountants. Sako Mayrick, 2008  Page 3 
    • APT Financial Consultants Primary Activities a. Serving the Public Interest IFAC provides leadership to the worldwide accountancy profession in serving the public interest by: • Developing, promoting and maintaining global professional standards and a Code of Ethics for Professional Accountants of a consistently high-quality; • Actively encouraging convergence of professional standards, particularly, auditing, assurance, ethics, education, and public and private sector financial reporting standards; • Seeking continuous improvements in the quality of auditing and financial management; • Promoting the values of the accountancy profession to ensure that it continually attracts high caliber entrants; • Promoting compliance with membership obligations; and • Assisting developing and emerging economies, in cooperation with regional accounting bodies and others, in establishing and maintaining a profession committed to quality performance and in serving the public interest. b. Contributing to the Efficiency of the Global Economy IFAC contributes to the efficient functioning of the international economy by: • Improving confidence in the quality and reliability of financial reporting; • Encouraging the provision of high-quality performance information (financial and non- financial) within organizations; Promoting the provision of high-quality services by all members of the worldwide Accountancy profession; and • Promoting the importance of adherence to the Code of Ethics for Professional Accountants by all members of the accountancy profession, including members in industry, commerce, the public sector, the not-for-profit sector, academia, and public practice. c. Providing Leadership and Spokesman ship IFAC is the primary spokesperson for the international profession and speaks out on a wide range of public policy issues, especially those where the profession’s expertise is most relevant, as well as on regulatory issues related to auditing and financial reporting. This is accomplished, in part, through outreach to numerous organizations that rely on or have an interest in the activities of the international accountancy profession. IFAC has • 155 member bodies • 2.5 million professional accountants • “to protect the public interest by encouraging high quality practices by the world's accountants” • Standards for: o (External) Auditing and Assurance o Public sector accounting o Education o Ethics The audit standard are issued by International Auditing & Assurance Standards Board (IAASB) and it consist of • 18 members Sako Mayrick, 2008  Page 4 
    • APT Financial Consultants • Full-time chair and 7 full time technical staff • Multi-stakeholder involvement: o Non practitioner members (moving to 50%) o Consultative Advisory Group o Public Interest Oversight Board • Transparent due process: o Meetings open to the public o Official observers from regulators o Agenda papers on website o Full public exposure o Standards etc free on website The International Auditing and Assurance Standards Board (IAASB) develops ISAs and International Standards on Review Engagements, which deal with the audit and review of historical financial statements; and International Standards on Assurance Engagements, which deal with assurance engagements other than the audit or review of historical financial information. The IAASB also develops related practice statements. These standards and statements serve as the benchmark for high-quality auditing and assurance standards and statements worldwide. They establish standards and provide guidance for auditors and other professional accountants, giving them the tools to cope with the increased and changing demands for reports on financial information, and provide guidance in specialized areas. In addition, the IAASB develops quality control standards for firms and engagement teams in the practice areas of audit, assurance and related services. 3.0 International Standards on Auditing (ISA) ( this should be complemented by handout on overview of ISA) Sako Mayrick, 2008  Page 5 
    • APT Financial Consultants 4.0 Sako Mayrick, 2008  Page 6 
    • APT Financial Consultants PRONOUNCEMENTS ISSUED BY THE INTERNATIONAL AUDITING AND ASSURANCE STANDARDS BOARD International Standards on Auditing (ISAs) RISK ASSESSMENT AND RESPONSE TO ASSESSED RISKS Number Description ISA 300 PLANNING. ISA 310 KNOWLEDGE OF THE BUSSINESS UNDERSTANDING THE ENTITY AND ITS ISA 315 ENVIRONMENT AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT. ISA 320 AUDIT MATERIALITY. THE AUDITOR`S PROCEDURES IN ISA 330 RESPONSE TO ASSESSED RISKS.. RISK ASSESSMENTS AND INTERNAL ISA 400 CONTROL. AUDITING IN A COMPUTER ISA 401 INFORMATION SYSTEMS ENVIRONMENT. AUDIT CONSIDERATIONS RELATING ISA 402 TO ENTITIES USING SERVICE ORGANIZATIONS. PRONOUNCEMENTS ISSUED BY THE INTERNATIONAL AUDITING AND ASSURANCE STANDARDS BOARD International Standards on Auditing (ISAs) AUDIT EVIDENCE Number Description ISA 500 AUDIT EVIDENCE. ISA 501 AUDIT EVIDENCE – ADDITIONAL CONSIDERATIONS FOR SPECIFIC ITEMS. EXTERNAL CONFIRMATIONS. ISA 505 ISA 510 INITIAL ENGAGEMENTS – OPENING BALANCES. ISA 520 ANALYTICAL PROCEDURES. AUDIT SAMPLING AND OTHER ISA 530 SELECTIVE TESTING PROCEDURES. ISA 540 AUDIT OF ACCOUNTING ESTIMATES. Sako Mayrick, 2008  Page 7 
    • APT Financial Consultants PRONOUNCEMENTS ISSUED BY THE INTERNATIONAL AUDITING AND ASSURANCE STANDARDS BOARD International Standards on Auditing (ISAs) AUDIT EVIDENCE Number Description ISA 545 AUDITING FAIR VALUE MEASUREMENTS AND DISCLOSURES. ISA 550 RELATED PARTIES. ISA 560 SUBSEQUENT EVENTS. ISA 570 GOING CONCERN.. ISA 580 MANAGEMENT REPRESENTATIONS. PRONOUNCEMENTS ISSUED BY THE INTERNATIONAL AUDITING AND ASSURANCE STANDARDS BOARD International Standards on Auditing (ISAs) USING WORK OF OTHERS Number Description ISA 600 USING THE WORK OF ANOTHER AUDITOR. ISA 610 CONSIDERING THE WORK OF INTERNAL AUDITING.. ISA 620 USING THE WORK OF AN EXPERT. Sako Mayrick, 2008  Page 8 
    • APT Financial Consultants PRONOUNCEMENTS ISSUED BY THE INTERNATIONAL AUDITING AND ASSURANCE STANDARDS BOARD International Standards Auditing Practice Statements (IAPSs IAPS 1000: INTER-BANK CONFIRMATION PROCEDURES. IAPS 1001: IT ENVIRONMENTS – STAND ALONE PERSONAL COMPUTERS. IAPS 1002: IT ENVIRONMENTS – ON LINE COMPUTER SYSTEMS. IAPS 1003: IT ENVIRONMENTS – DATABASE SYSTEMS IAPS 1004: THE RELATIONSHIP BETWEEN BANK SUPERVISORS AND BANKS EXTERNAL AUDITORS. IAPS 1005: THE SPECIAL CONSIDERATIONS IN THE AUDIT OF SMALL ENTITIES. IAPS 1006: AUDITS OF THE FINANCIAL STATEMENTS OF BANKS. IAPS 1008: RISKS ASSESSMENTS AND INTERNAL CONTROL – CHARACTERISTIS AND CONSIDERATIONS. IAPS 1009: COMPUTER-ASSISTED AUDIT TECHNIQUES. IAPS 1010: THE CONSIDERATION OF ENVIRONMENTAL MATTERS IN THE AUDIT OF FINANCIAL STATEMENTS. IAPS 1012: AUDITING DERIVATIVE FINANCIAL INSTRUMENTS . IAPS 1013: ELECTRONIC COMMERCE – EFFECT ON THE AUDIT OF FINANCIAL STATEMENTS. IAPS 1014: REPORTING BY AUDITORS ON COMPLIANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS. PRONOUNCEMENTS ISSUED BY THE INTERNATIONAL AUDITING AND ASSURANCE STANDARDS BOARD International Standards on Review Engagements (ISREs) ISREs 2400: ENGAGEMENTS TO REVIEW FINANCIAL STATEMENTS. Sako Mayrick, 2008  Page 9 
    • APT Financial Consultants PRONOUNCEMENTS ISSUED BY THE INTERNATIONAL AUDITING AND ASSURANCE STANDARDS BOARD Assurance Engagements Other Than Audits or Reviews of Historical Financial Information International International Standards on Assurance Engagement Assurance Engagements Practice Statements (ISAEs) (IAEPSs) 5.0 Professional competence and Duty of Care A member of auditing profession should observe the profession’s technical and ethical standards, strive continually to improve competence and quality of services, and discharge professional responsibility to the best of member’s ability. The principle of professional competence and due care imposes the following obligations on professional accountants: (a) To maintain professional knowledge and skill at the level required to ensure that clients or employers receive competent professional service; and (b) To act diligently in accordance with applicable technical and professional standards when providing professional services. Competent professional service requires the exercise of sound judgment in applying professional knowledge and skill in the performance of such service. Professional competence may be divided into two separate phases: (a) Attainment of professional competence; and (b) Maintenance of professional competence. The maintenance of professional competence requires a continuing awareness and an understanding of relevant technical professional and business developments. Continuing professional development develops and maintains the capabilities that enable a professional accountant to perform competently within the professional environments. Diligence encompasses the responsibility to act in accordance with the requirements of an assignment, carefully, thoroughly and on a timely basis. Sako Mayrick, 2008  Page 10 
    • APT Financial Consultants A professional accountant should take steps to ensure that those working under the professional accountant’s authority in a professional capacity have appropriate training and supervision. Where appropriate, a professional accountant should make clients, employers or other users of the professional services aware of limitations inherent in the services to avoid the misinterpretation of an expression of opinion as an assertion of fact. 6.0 Auditor’s Liability and Auditing case law Auditor’s Liability The auditor is accountable to those who appointed her of his conduct while making his report on the audit .She has to assess whether management to the entity has carried out its fiduciary responsibility in a manner acceptable to owners the business and to improve the accountability in the manner acceptable to the owners of the business. The auditor’s liability is in two folds: • Under statute where by the auditor is criminally liable for publishing her report or similar statements while knowing that these are misleading, false or deceptive; • Under application of the principle of common law to establish the standards of work and reporting expected the auditor. Thus as a failure to exercise due care and skill in conduct of an audit. The former is owed to state and the other to individuals who have suffered loss as a result of audit shortcomings. Implications • An auditor may fail to discover a material fraud or error and deliver unqualified opinion on set of accounts, which in reality is significantly misstated. • An auditor may fail to recognize that the going concern assumption is not appropriate. Some time after the year-end the company may go into liquidation and question may be asked about absence of any warning in the auditor’s report. Liabilities to the state are likely to be “fixed in terms of penalties whereas the liabilities to the clients or third parties have been proven to be open –ended. The auditors are seeking to have the courts allocate blame for the corporate collapse on the basis of actual responsibility rather than the present system where by the deepest pocket carries the heaviest (usually the only) burden. The analogue below presents the Auditor’s liability in contextual layout: contract client-mgt investors Auditor No formal contract third parties -users Sako Mayrick, 2008  Page 11 
    • APT Financial Consultants Whilst an auditor has various statutory duties to perform. There are also non –statutory duties to consider the most important of these being the duty to exercise reasonable care and skill in conduct of an audit examination. This duty was clearly expressed in the of cited Re-Kingston Cotton Mill (1986) and Re- London and General bank (1895). The auditors duties may be summarized as follows (1) the duty to be aware of relevant statutes (2) the duty to be aware of requirement of those statutes (3) a duty to be aware of the written constitution the enterprise under audit Auditor of a limited company are bound to know (ie required to know ) or make themselves acquitted with their duties under the articles of the company, whose accounts they are appointed to audit, and under the companies Acts for the time being in force. Auditors of enterprise such as government Agencies or local authorities would also be subject to these duties and other duties such as (1) a duty to abide by any express terms in the contract (2) specially for non-statutory appointments (3) basing on companies Act As a self-protection exercise the prudent auditor should always explain any limitation through the medium o the audit report and should always clarify in advance the nature of the work to be undertaken. This can vary from a full “audit “engagement (where the auditor expresses opinion as to the truth and fairness of the financial statements to a “review engagement” (where only limited assurance is provided) The duty may comprise of (1) A duty to abide to any implied term of the audit appointments (2) an implied duty to carry out the audit task within a reasonable period (3) an implied duty to exercise reasonable care and skill in conduct of the audit. Duty of Care The more the specialized the work undertaken, the higher the degree of skill and care expected. Generally in the Re-London and General Bank, the duty of reasonable care and skill implies an auditor must be honest i.e she must not certify what she does not believe to be true and she must take reasonable care and skill before she believes what she certifies is true, what is reasonable care in any particular case must depend upon the circumstances of that case. In Re- Kingston Cotton Mill (1896) gives one hint on how the profession should set about determining the meaning of “reasonable care and skill”, it is a duty of an auditor to bring to bear on the work she has to perform that skill, care and caution which a reasonably competent, careful and cautious auditor would use. An auditor is not bound to be detective or to approach his work with suspicion or with forgone conclusion that there is something wrong .She is a watchdog and not a bloodhound. This anticipates by more than half a century the Maultz and Sharaf (1962) auditing postulates which states that; as a working assumption;’ the financial statements and other information submitted for verification are free from collusive and other unusual Irregularities. Auditors must not be made liable for not tracking out ingenious and carefully laid schemes of fraud where they’re nothing there to arouse their suspicion. But when suspicions is aroused the auditor who does not respond by following through the suspicious circumstances in order to full resolve the matter may be liable for negligence ( Thomas Gerard case). Sako Mayrick, 2008  Page 12 
    • APT Financial Consultants Auditing standard and guidelines do not carry statutory power but they must be considered to be persuasive evidence” as to which and auditing procedures constitute best practice. Auditors should institute quality control measures to ensure that their audits (of whatever size) live up to the description of best practices such procedures include; Proper audit planning; the use of analytical review procedures the use of audit programs; the use of checklists; a suitable review procedures Adherence to accounting (as opposed to auditing) standards raises the further possibility of debate over what constitute “reasonable care and skill”, the proof of compliance with generally accepted accounting principles (GAAP’s ) as persuasive but not conclusive evidence’ the financial accounts show a true and fair view. Thus the auditors who simply ensure compliance with GAAPs and fail to examine the broader question of the truth and fairness may not be carrying out their duty with reasonable degree of skill and care. The auditor’s liability in contract (privity of contract) for negligent work will depend on client’s ability to firstly prove negligence and secondly prove actual loss. Auditors negligence will be judged according to accepted standards of reasonable care and skill and these in turn will be judged according to the extent to which the audit or followed according to the extent to which the audit or followed accepted best practice (approved auditing standards) yet nevertheless, retained a professional independence and flexibility which ensured that the ultimate slavish compliance with published professional guidance. It can be concluded from above that an auditor will be liable whenever: (1) a formal contractual relationship exists (2) Negligence by the auditor can be proved (3) a loss by the other party of to the contract is established. However, if some one less closely to the auditor and with whom no formal contractual relationship can be said to exist, but such cases is where the auditor duty of care takes place. In more remote third parties such as: (1) trade creditors who fail to recover their outstanding debts if the debtor company goes into liquidation (2) bankers who have advanced loans or overdraft facilities (3) debenture or loan stock holders (4) investor who subsequent to issue of audited accounts have purchased shares in the company or purchased the company itself. There investment may be reduced or wiped out completely if the company accounts are later discovered to be materially incorrect. Circumstances for Auditor’s liability to third parties 1) It must be shown that a duty of care exists 2) The auditor must know , or should have known , that the financial statements where likely to be relied for the purpose claimed by the plaintiff 3) The plaintiff must be of a class or category likely to rely upon the material concerned. The criteria is often referred as to use of proximity 4) There must be actual reliance on negligently prepared financial statements where contributory negligence on the part of plaintiff can be established damages against a negligent auditor may be greatly reduced. 5) The plaintiff must show that she would have acted differently had the financial statements on which they relied been correctly prepared. e.g. if a set of accounts had shown a true loss; rather than false profit , would the plaintiff still have gone ahead and purchased the company. Sako Mayrick, 2008  Page 13 
    • APT Financial Consultants Auditing case laws Candler V Crane, Christmas and Co (UK, 1951) In this case it was held that there could be no auditor liability for negligence in absence of contractual relationship. Lord Denning delivered a dissenting opinion based on the argument that actual fore knowledge of the specific use to which the accounts would be put created a duty of care even in the absence of a formal contract between the accountant and the third party. Hedley Byrne V Heller and partners (UK, 1963) In this non- accounting case a reference was issued in the fore knowledge that it would be relied upon by third party, for loan or investment purposes. The reference proved “unreliable” and the issues of the reference were proved unreliable and the issuers of the reference were sued. It was held that because of that very foreknowledge a duty care existed towards and third party. Despite the absence of any formal contract Thus Lord Denning’s dissenting decision in Candler V Cranes Christmas and Co was vindicated. The relevance of this case for accountants (rather than as auditors), they often prepare special reports for a client in full knowledge that those reports or accounts are going to be used to persuade and identifiable third part (a bank or prospective purchaser) to adopt a certain cause of action .The Hedley Byrne is often used to represent very narrow view of auditors liability to third parties – Actual knowledge of possible reliance being a necessary condition. Caparo Industries V Dickman and others (1990) In 1984 Caparo industries purchased 100,000 Fidelity shares in the open market .On June 12,1984, the date which the accounts (audited by Touch Ross) were published, they purchased a further 50,000 shares relying on information in the accounts, further shares where acquired. On September 4, Caparo made a bid for remainder and by October had acquired control of Fidelity. Caparo alleged that accounts on which they had relied where misleading in that an apparent pre- tax profit of the some $1.3m should in fact be reported as a loss of $ 400,000. The plaintiff argued that Touch owed a duty of care to investors and potential investors Decision held: • The auditors of a public company’s accounts owed no duty of care to members of the public at large who relied upon the account sin deciding to buy shares in the company. • A purchaser of further shares, while relying upon auditor’s report a shareholder stood in the same position as any other investing member of public to whom the auditors owed no duty. • The purpose of the audit was simply that of fulfilling a statutory requirements of the companies Act 1985 • There was nothing in the statutory duties of company auditors to suggest that they were intended to protect the interest of investor in the market. In particular, there was no reason why any special relationship should be held to arise simply from the fact that the affairs of the company rendered it susceptible to takeover bid. Sako Mayrick, 2008  Page 14 
    • APT Financial Consultants Conclusively, though the above seems to lessen auditor’s duty to use skill and care because auditors are still fully liable in negligence to the companies they audit and their shareholders collectively. Utramares Corporation V Touche (USA, 1930) The auditors should not be made liable for an indeterminate amount to an indeterminate class of people, for indeterminate period of time. Some aspects of this view seem to be more acceptable than others. For example most people would agree that, as time passes after the publication of a set of audited accounts, less and less reliance can be placed of audited accounts, less and less reliance can be placed on them by the users because under lying economic factors may have changed significantly. Thus in determining the auditor’s liability the question the time reliance was placed would be a material consideration. With respect to the likely classes of users there are three possible schools of thought: • When reporting on statutory accounts, the auditor reports to the members of the company and them only. There can be no duty of care to anyone else unless the auditor has been specifically informed of their existence and the intention to provide them with accounts for a stated purpose. • When reporting on statutory accounts the auditor reports to members of the company but may be aware that there exist certain identifiable third parties whom it is reasonable to assume will place reliance the auditor’s opinion. The duty of care should thus extend to cover third parties who can be identified at the time the audit opinion is delivered. When reporting on the statutory accounts the auditor reports to the members of the company but the audit report enters the public domain and becomes an important source of assurance to any third party considering entering into financial arrangement with the client company. The auditor’s duty of care should thus extend beyond shareholders and identifiable third parties who belong to a class likely to rely on financial statements for a purpose which can justifiably be argued to be a reasonable purpose for a person of that class. All this is within timing constraints. Conclusively, The ultramares case suggests the need for some limitation of liability but does not itself provide precise criteria .The concept has been reinforced by Caparo case. Caparo has taken Ultramares decision one step further by placing strict limits on the perceived purpose of the auditors report itself, in turn limiting the opportunity for third parties to establish that a duty of care exists between the auditor and themselves. In many ways, auditors liability is not materially different concept from manufacturer liability for products (DonoghueV Stephenson, UK ,1932) Jebb Fastener’s Vs Mark Bloom Despite the fact that the auditors were not aware of a bid for the client company at the time they signed the audit report they would have been liable to the acquirer for the losses suffered had it not been accepted by the court that the plaintiff would have gone ahead and bought the company whatever he picture provided by financial statements. Clearly, in the view of the court prospective purchasers constituted a “reasonably foreseeable group of users and the auditors would have been well advised to bear them in mind when programming their audit and considering the overall truth and fairness of accounts. Sako Mayrick, 2008  Page 15 
    • APT Financial Consultants It is a case where the “reasonable foresight’ test was accepted and auditors, as a result found themselves liable to third parties who where complete strangers to them at the time the audit took place. Whether the defendant auditors knew or reasonably should have foreseen at the time the accounts for the purpose of deciding whether or not to take over the company, and therefore could suffer loss if the accounts were inaccurate. Two-max Ltd and Goode V Dickson, Mc Farlane and Robinson (UK,1982) This case provided an immediate reinforcement of the judge’s decision in the Jeb Fasteners. The only deference being that of judge believed that the plaintiff would not have acquired the company under consideration had the accounts actually shown a true fair view. The judge in this case commended JEBB Fasteners decision on the grounds that it “combined the simplicity of the proximity or neighbor principle with a limitation which has regard to the warning (see Ultra mares V Touche) against exposing the accounts to interminable liability. Without disagreeing with the basic principle that the auditors had a duty to exercise “reasonable foresight” in carrying out their work. Al Saudi Banque (and others) Vs Clarke Pixley (UK, 1989) In this case it was held that: The auditors of a company owe no duty of care to a bank who lends money to the company, regardless of whether the bank is an existing creditor ( at the time of the audit report signed) making further advances or is only a potential creditor of the company, since either case even if it is foreseeable that the bank might request a copy of company’s accounts and rely on them when making an advance to the company there is not a sufficiently close relationship between the auditors and the bank to give rise to the degree of proximity necessary to establish a duty of care Conclusively, when suing an auditor for negligence it is first has to be established that a duty of care exists. The Jebb Fastener case had appeared to widen the proximity circle by holding auditors liable to the unknown third parties on the basis of a “ reasonable foresight’. The Al Saudi Banque , case and the Caparo case rejects this approach as being to open ended .They proceed to the precedents established in both the Crane Christmas and the Hedley Byrne cases. That actual knowledge of an intention to rely on the accounts should constitute the primary test of Proximity. With regards to the banks who were limited class the judge commended ‘they were limited class , and their identity and the amount of their exposure was know to defendants when they signed their reports. But their position is not all comparable with that of the members. They played no part in appointing the defendants auditors. The defendants were under no statutory obligation to report to them, nor did they send them to the company with the intention or in the knowledge that they would be supplied to them. The judge added that in order to establish sufficiently proximate relationship between parties • What needs to be shown is not knowledge of an intention that the information will be provided to them The basic ground rules for establishing a duty of care owed to a third party are; • It must be reasonably foreseeable that a statement will be relied upon • This relevant degree of proximity between parties • It must be, just and reasonable in all the circumstances to impose a duty of care. Sako Mayrick, 2008  Page 16 
    • APT Financial Consultants Gross and Ordinary Liability Liability for negligence may either ordinary or gross. Ordinary negligence refers to lack of reasonable care, e.g. an auditor who fail together sufficient competent evidence to support the figure of stock in the balance sheet might be accused of ordinary negligence by an injured party if all other phase of the audit conformed to generally accepted auditing standards (GAAS). On the other hand, gross negligence refers to lack of even the slightest care or reckless disregard of duty (constructive fraud i.e. misrepresentation of facts). For example where the auditor fails substantially to comply with GAAS, the auditor may be charged by an aggrieved party. The auditors protects themselves by using (1) Professional standards (2) taking professional indemnity insurance Other forms of liability (i) Civil liability This is a result of breach of trust (Misfeasance), which is improper execution of some lawful act. It arises where the auditor fails to do something, which is correct (e.g. failure by the auditor to discharge his fiduciary duty under contract) The following conditions must be met for this liability: 1) the auditor must have owed a duty of care to plaintiff 2) The plaintiff must have suffered a loss as a result of auditor’s negligence. Relevant cases 1) Re-Kingston Cotton Mill Co and Re-London and General Insurance.(auditor as and officer of the company) 2) Companies Act No. 12 of 2002 3) Westminster Road construction and Engineers Ltd (1932) (ii) Criminal Liability In companies Act No.12 of 2002, the auditor may be sued under miscellaneous offences. if the auditor, in any turn, report or certificate or balance sheet, willfully make a statement false in any material particular, knowing it to be false, he shall be quilt of an offence and shall be liable on conviction for not more than three years with or without hard labour and shall also be liable to fine in lieu of or in addition to such imprisonment as aforesaid. Liability under other Acts (i) Penal code – An auditor may be sued for criminal offences as provide under the Tanzania penal code (ii) Theft Act The auditor can be guilt of a criminal offence under this Act if she aided or abetted management to publish false statements with intent to defraud stakeholders (iii) Prevention of fraud Any person, by statement, promise or forecast, which he knows to be misleading, false or deceptive or by dishonesty concealment of material facts, or by reckless making of any statement, promise or forecast which is misleading, false or deceptive induces or attempt to induce others for acquiring, disposing, subscribing for, or underwriting security shall be guilty of an offence and liable to penal servitude for a term not exceeding seven years. Sako Mayrick, 2008  Page 17 
    • APT Financial Consultants Liability under professional misconduct This is stipulated in a code of ethics for Professional Accountant (disciplinary actions) which are set out by NBAA and TAA as detailed on chapter one. 6.0 Expectation Gap 4.1 The public opinion has become very important in determining what is expected by auditor’s day-to-day practice. Aggressive litigation is a strong driving force behind changes in professional recommendation is to what constituter ‘best practice’. The expectation gap, which is expected to exist, is instrumental in leading to legal actions against auditors. The gap lies between interpretations of their duty as independent auditors and client/shareholders interpretation of that duty. Auditor see their task as Prepares and users of the assembling sufficient accounts expects auditors ( relevant , reliable audit by virtue of their claimed evidence to enable them sills and because the high form an opinion as to the fees they are paid ) to be truth and fairness of effective in discovering or financial statements Expectation detracting material cases of fraud or other irregularity .Auditors are not always noted for being effective in Gap this particular respect Auditors consider fraud Preparer’s and users argue detection as a by product of that auditors should design work they carry out and their tests with the aim of they do not design their making detection of fraud a audit test for the specific more central objective- it purpose of hunting out should not just be an fraud and error occasional spin-off benefit Sako Mayrick, 2008  Page 18 
    • APT Financial Consultants The gap can either be liability, performance or standards gap depending on circumstances. Deep pocket Syndrome Anti- Auditor litigation is also blamed on the ‘deep pocket syndrome’. This means that in the wake of a corporate collapse or significant audit failure, creditors or plaintiffs often look to see which professional advisors involved have the deepest pocket’ in terms of professional indemnity insurance. They may then launch an action against those advisors despite an absence of any good evidence that the advisor was actually negligent. Auditors duty of confidentiality Is an implied term of an accountant’s contract with a client, for this reason an accountant should not, as a general rule, disclose to the other persons, against the clients wishes, information about the client’s affairs acquired during and as a result of their professional relationship. An accountant or auditor who becomes aware that a client has committed default or an unlawful act is normally under no obligation to disclose what she knows to external authorities. But some circumstance may allow e.g. terrorist actions and money laundering as required by statute. The auditors have no direct statutory responsibility to detect and reporting fraud, error and other irregularities but the ISA suggest that “audit procedures should be designed to give an auditor a reasonable chance of detecting any material misstatement .The standard goes on to suggest how the auditor should approach the design of the audit work through adequate planning. Auditors liability- Risk minimization techniques for potential claim/litigation against an auditor 1) Maintain high quality control audit standards a. Personnel with necessary qualification, professional as well as academic ability and willingness to learn b. Regular performance appraisal c. Compulsory on job training and a wide range of exposure and circumstances including attendance to CPD programs. d. Adequate remuneration to audit personnel e. Full documentation of audit work for regular reviews by superiors, including review of audit working papers and programs. f. Close supervision of delegated work including staff competence in specific assignment with adequate guidance. 2) Maintaining high quality Audit Controls and procedures a. Ensure all registered members adhere to the professional standards b. Obtain public confidence in the profession by demonstration concern for high standard of work. c. Demonstrating to the public authorities and other instrument that the profession is discharging its fiduciary responsibilities d. Instituting quality controls within firms e.g. peer reviews 3) Encouraging audit firms to become limited liability companies 4) Setting maximum limits of claims against auditors e.g fixed liability as a factor of the audit fee Sako Mayrick, 2008  Page 19 
    • APT Financial Consultants 5) Setting claims and damages in proportion to respective responsibilities e.g where there is a contributory negligence on party other than the auditor, such party should be made to bear part of the claim 6) Use of sound and complete audit standards and guidance appropriate to circumstances of the specific audit 7) Regular client screening to weed out difficult clients 8) Understanding the client’s business well together associated customers including the integrity of its shareholders 9) Use of carefully drawn engagement letters and where necessary letters of clarification and signing contracts which clients specifying the remedies for each party. 10) Exercising extra caution when dealing with clients with financial difficulties e.g. clients with pending litigation or impending threat of insolvency. 11) Maintain professional independence and integrity all times irrespective of having an assignment with your client 12) Use of sound and complete audit standards and guidance appropriate to circumstances of specific audit. Sako Mayrick, 2008  Page 20