Legal Liability of an auditors and audit process

1. Legal Liability of an
auditors and audit process
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2. Appointment of Auditors
Appointment by Directors:
 First Auditors of the company will be
appointed by The board of directors of a
company within one month of the date of
registration of the company by a valid
resolution.
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3. Appointment by shareholders:
In case the directors fails to appoint first
auditor, the shareholders shall appoint the
auditor at a general meeting by passing a
resolution.
Subsequent Auditors – are appointed in the
Annual general Meeting By ordinary
resolution.
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4. RIGHTS OF AN AUDITOR
Right to inspect books of accounts.
Right to ask for information and clarifications.
Right to get notice of general meeting and attend it.
Right to make a statement in the meeting.
Right to visit the Branches.
Right to take legal and technical advice.
Right to ask for remuneration.
Right to sign the audit report.
Right to correction of wrong statements.
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5. DUTIES OF AN AUDITOR
To make report to the shareholders
To sign and certify audit report and statutory
report
To declare the solvency of the company.
To enquire about the true and fair state of affairs
of the company and submit his proper report.
To verify himself cash in hand, inventories and the
ledger accounts.
To perform his task with ability, care and skill.
To acquaint himself with the provisions of the
company law and related accounting standards.
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6. LIABILITIES OF AN AUDITOR
An auditor is expected to discharge his
duties according to Generally Accepted
Auditing Standards or ISA
 In case if he shows negligence in his
professional work he may be held liable.
Liabilities of an auditor differs from the scope
of appointment.
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7. Cont’d
The liabilities of an auditor are divided under
the following headings:
A. Civil Liability,
B. Criminal Liability,
C. Liability towards third parties,
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8. A. Civil Liability
Liability for Negligence:
 Under the law of Agency the auditor is liable for
negligence and in such a case he/she has to pay
damages to the aggrieved party.
 If the company suffers a loss on account of the
acts of the auditor, he has to make good this
loss.
The auditor shall not be held liable for
negligence, if the company does not suffer any
loss.
He shall also not be held liable for the loss
suffered by the company without his negligence.
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9.  In order to hold him responsible for
negligence, the following points are to be
proved
A) That he/she was negligent.
B)As a result of his negligence the company
has suffered the loss. and
C) That the loss was suffered by the person
to whom the auditor owed a duty.
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10. Negligence : Includes the following acts:-
A) Not to see the Articles of Association and
not to object payment of dividends out of
capital;
B) Not to get statements of accounts from the
creditors and find out the errors and frauds.
C) Not to verify Cash and Petty Cash;
D) Not to report to the client about the
insufficient provision for bad and doubtful
debts, which results in inflating the profits
for dividends, thus paying dividends out of
capital. 10

11. Liabilities for Breach of contract :
It occurs when auditor fails to perform a
contractual duty.
Breach actions include
Failing to complete the engagement within the
agreed time
Withdrawing from the engagement without
sufficient justification
Violating client confidentiality
Failing to provide professional quality
work 11

12. B. Criminal Liability
Criminal liability of the auditor arises on the
following Acts:
Willfully submitting a false report;
Concealment of frauds in the account books;
Destroying the vouchers and documents
concerning account books;
Damaging the property of the company;
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13. Cont’d
Certifying willfully the false accounts;
Making a false statement knowingly to be
false;
Accepting bribe during the course of
discharging his duties as an auditor.
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14. He/she is criminally liable, when he/she issues
a certificate required by law to be given and
signed by the auditor – issues knowing or
believing that such certificate is false in
material point.
He/she is criminally liable for authorizing the
issue of a false prospectus and fraudulently
inducing persons to invest money by
purchasing shares or debentures of the
company.
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15.  He is criminally liable for making a fraudulent report,
if the report made is not in conformity with the
requirements of law or any document of the
company is signed or authenticated by him which is
also not in conformity with the law
 He is criminally liable, for falsification of books- If it is
proved that the auditor has been guilty of
destroying, mutilating, altering, falsifying or
secreting of any books, papers or securities or is
privy to the making of any false or fraudulent entry in
any register, book of account or document
belonging to the company, he shall be punishable
with imprisonment extending to seven years and
also be liable to fine.
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16. C. Liabilities Towards Third Parties
Auditor is not liable to third party or parties as a
general rule. He is liable to his employer only.
However, if the third parties are able to prove
the following then auditors shall be liable to
them.
Auditor has understanding as informtion was
untrue or false
That the statement was made with the intention
that the third party should act upon it.
That the third party has acted on the faith of the
audited statements.
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17. Audit process
According to the American Accounting
Association (AAA) defines auditing requires a
step-by-step approach.
 Should be carefully planned and techniques should
be carefully selected and executed.
 Auditing involves client acceptance, planning the
audit, collecting, reviewing, and documenting
audit evidence.
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18. PHASE I: CLIENT ACCEPTANCE
Objective Determine both acceptance of a client and
acceptance by a client. Decide on acquiring a
new client or continuation of relationship with
an existing one and the type and amount of
staff required.
Procedures 1. Evaluate the client’s background and reasons
for the audit
2. Determine whether the auditor is able to
meet the ethical requirements regarding the
client
3. Determine need for other professionals
4. Communicate with predecessor auditor
5. Prepare client proposal
6. Select staff to perform the audit
7. Obtain an engagement letter
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19. PHASE II: PLANNING THE AUDIT
Objective Determine the amount and type of evidence
and review required to give the auditor
assurance that there is no material
misstatement of the financial statements.
Procedures 1. Perform audit procedures to understand
the entity and its environment, including the
entity’s internal control
2. Assess the risks of material misstatements
of the financial statements
3. Determine materiality
4. Prepare the planning memorandum and
audit program containing the auditor’s
response to the identified risks.
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20. PHASE III: TESTING AND EVIDENCE
Objective Test for evidence supporting internal
controls and the fairness of the financial
statements.
Procedures 1. Tests of controls
2. Substantive tests of transactions
3. Analytical procedures
4. Tests of details of balances
5. Search for unrecorded liabilities
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21. PHASE IV: EVALUATION AND REPORTING
Objective Complete the audit procedures and issue an
opinion.
Procedures 1. Evaluate governance evidence
2. Perform procedures to identify subsequent
events
3. Review financial statements and other report
material
4. Prepare Matters for Attention of Partners
5. Report to the board of directors
6. Prepare Audit report
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22. AUDIT PROCESS
In a nutshell the Audit process involves the
following major activities to be performed by
an auditor.
Claint Aceptance/Engagement activities
Planning for Audit
Audit Tests
 Test of controls
 Substantive Testing
Completion of Audit
Reporting
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23. ENGAGEMENT ACTIVITIES
Engagement Activities involves:
 Accepting a New Client or Confirming the
Continuance of a existing or current client
 Communication with predecessor
 Engagement Letters

24. Accepting a New Client or Confirming the
Continuance of a Existing or Current Client:
Professional standards require that audit
firms need to establish policies and
procedures for deciding whether to accept
new clients and to retain existing or current
clients.
If an auditor is associated with clients of
which the auditor is not independent - it can
lead to non-compliance with ethical
requirements, as well as bad publicity.
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25. Cont’d
If clients lacks integrity - the auditor does
not have the skill and competence to
perform the audit, the existence of risk in
material misstatements may not be detected
by the auditor.
After making the proper judgement the
auditor has to accept an appointment to act
as an auditor .
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26. Communication with Predecessor
Auditor should Attempt to communicate with
predecessor about the background of client. and discuss
the issues regarding
Disagreements about accounting principles or audit
procedures.
Information's about fraud, illegal acts, and internal
control recommendations.
Reasons for the change of predecessor auditors
(particularly about the predecessor auditors
termination).
Once the decision for acceptance or continuance has
been taken, the auditor and the client need to
confirm the terms of the engagement by signing an
engagement letter.
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27. Engagement Letters
When a new client is accepted or when an
audit engagement continues from year to
year, an engagement letter should be
prepared.
It acts as a contract between auditor and
client.
Serves as a means of reducing the risk of
misunderstandings with the client and as a
means of avoiding legal liability for claims
that the auditors did not perform the work
promised.
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28. Cont’d
Generally Engagement Letters should include:
 Objectives or scope of engagement
 Responsibilities of Management and
Auditors
The assistance to be provided by client
personnel
The timing of the engagement
 The expected audit fees.
 Any limitations of the engagement
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29. PLANNING FOR AUDIT
Auditing standards requires that, the audit to be
planned properly, this is to ensure that the audit is
conducted in an effective and efficient manner.
Planning involves in developing an overall audit
strategy and audit plan for conducting the audit,
considering all the issues of the client.
The outcome of the auditors planning process is
the written plan, that sets forth the overall audit
strategy and the nature, extent, and timing of the
audit work.
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30. Cont’d
The planning process begins with obtaining
sufficient knowledge of the clients organisation,
including its internal control system.
Thus a audit plan is a comprehensive list of specific
audit procedures, to gather sufficient and
appropriate evidence that needs to perform the
audit, and to give the opinion on fairness of
financial statements.
After performing all these procedures, the auditor
is able to develop the overall audit strategy and the
detailed audit plan, which also referred as the
audit programme.
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31. AUDIT TESTS
The purpose of audit tests, is to allow the
auditor to collect sufficient and appropriate
audit evidence to conclude with reasonable
assurance that the financial statements are
free of material misstatement.
 If sufficient and appropriate audit evidence is
not obtained, or the evidence leads to
material misstatement in the Financial
Statements, the auditor has to modify audit
opinion stating the material misstatements.
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32. Cont’d
Misstatements will find their way in published
financial statements only if three events happens:
 An error is made in the first place. The risk of that
happening is known as ‘inherent risk’, and assessing
that is a very big part of audit planning.
 The client’s internal control system does not prevent,
identify or correct the error. This is known as ‘control
risk’.
 The auditor does not detect the error during the
audit. This is known as ‘detection risk’.
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33. Cont’d
There are therefore two lines of defense
preventing an error that has occurred from
ending up in the published Financial
Statements:
1. The internal control system and
2. The work auditor carries out.
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34. Cont’d
Therefore, the auditor must:
Assess the effectiveness of the internal control
system. This means investigating both its
design and its operation.
 The operation of the internal controls is
assessed by carrying out test control.
Obtain additional, direct evidence about the
amounts shown in the Financial Statements.
 This evidence is obtained using substantive
testing.
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35. TEST OF CONTROLS
A test of controls is an audit procedure
to test the effectiveness of a control used by
a client entity to prevent or detect material
misstatements.
Depending on the results of
this test, auditors may choose to rely upon a
client's system of controls as part of their
auditing activities.
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36. Cont’d
Test of controls are audit procedures to test
the effectiveness of control policies and
procedures.
Key internal controls must be supported by
tests of controls.
The extent to which the test of controls are
applied depends on the assessed control
risk.
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37. SUBSTANTIVE TESTS
Substantive testing is an audit procedure that
examines the financial statements and
supporting documentation to see if they contain
errors.
These tests are needed as evidence to support
the assertion that the financial records of an
entity are complete, valid, and accurate.
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38. Cont’d
Substantive tests are procedures designed
to test for amount or Dollar misstatements
directly affecting the correctness of financial
statement balances.
Substantive tests are the procedures that
the auditor undertakes to detect possible
misstatements that may exist in the financial
statements, that is, testing the amounts or
numbers at the year end.
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39. Cont’d
When carrying out a substantive test, the
auditor is testing to ensure that the figures
included in the financial statements can be
traced back to source documents, and verify
the entries or amounts correctly.
There are three types of substantive tests:
1. Substantive tests of transactions
2. Analytical procedures
3. Tests of details of balances
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40. Cont’d
Substantive Tests of Transactions:
Evaluating the client’s recording of
transactions by verifying the correctness of
monetary amounts.
 Analytical Procedures:
Involves comparison of recorded amounts
to expectations developed by the auditor.
They often involve the calculation of ratios
by the auditor for comparison with previous
years’ ratios and other related data.
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41. Cont’d
Tests of Details of Balances:
Focuses on ending general ledger account
balances of both income statement and
balance sheet to establish the monetary
correctness of the accounts.
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42. COMPLETING THE AUDIT
Once the auditor completed gathering
evidence relating to the financial statement
assertions, the audit enters the completion
phase.
Steps in completion phase:
1.Evaluating the sufficiency and appropriateness
of the evidence gathered.
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43. Cont’d
2.Determine the final materiality figure and
evaluate all misstatements identified. The
auditor then aggregates the total identified
misstatements and determines, if it really
causes the financial statements to be
materially misstated.
3. Identifying possible subsequent events which
have not been correctly disclosed in the
financial statements. By performing quality
control procedures.
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44. REPORTING
The final phase in the audit process is to give
the appropriate audit opinion based on the
nature of evidence gathered.
 The auditor’s report is the main product or
the output of audit.
The audit report communicates the auditor’s
findings to the users of the financial
statements.
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45. Cont’d
The preparation of audit report is the last
work of audit.
 An auditor presents weakness, strength and
details of an organization by preparing audit
report.
Audit report accumulates all the facts of
audit. It is the last outcome of every audit
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46. End of chapter 4
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