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Hi Mike,
Having just watched the part 2 tort lecture I am a little confused as to the value of an audit report. If, for whatever reason the financial statements are materially misstated and the auditor is negligent in his opinion then tough?
How is that in any way just or equitable for an investor or creditor of the company?
I appreciate that the financial statements are produced by the directors of the company and that the auditors are giving their opinion to the shareholders on the truth and fairness of the FS but if the duty of care of the auditors is to the members as a whole only and even then they are unable to take individual action for negligence then in reality an audit report is not worth the paper it is written on?
Or have I completely misunderstood the situation?I’m afraid that my light-hearted cynicism may have come through too much.
Auditors and auditing ( and accountants generally ) are reputable professionals who work to the best of their ability and bring to their assignments “such degree of skill, care and diligence that one could reasonable expect from a person of that age, experience and qualification”
There is without doubt the everlasting impression that auditors are ( in the minds of the public ) confirming that the figures on which they are reporting “correct” This is clearly a misconception among ( the majority of ) the public. The public, in their ignorance may then seek to take legal action against the auditors when, subsequently, a company fails and these very people have mistaken an unqualified opinion as an affirmation of “correctness”
As was stated by the judge in ( I believe ) the case Ultramares Corporation v Touche “it is unreasonable to hold the auditors liable to an indeterminate group of people for an indeterminate amount for an indeterminate period of time” and common sense dictates that there should therefore be a limit on that potential liability.
An auditor is in contract with the company which appointed the auditor and that company is represented my the majority of members. And it is that very majority which appointed the auditors. Why then should the auditors be burdened with an extension of that liability to person or persons unknown who, ill-advisedly, believe that the audit opinion is a positive statement of correctness.
Tort is a different kettle of fish. Anyone has a duty of care to their legal neighbours – “those people who are so directly affected by one’s acts that one should have them in mind as likely to be so affected when one commits those acts”
Where there are indications that, for example, a company is in financial trouble, it would be reasonable for an auditor to foresee that an audit opinion would be shown by the company to prospective white knights in an effort by the company to secure further financial assistance.
But that is NOT the purpose of an audit report nor an audit opinion. It is never intended for third parties to use that opinion to support an investment decision. If a third party unknown to the auditor chooses to use the audit opinion for such investment decisions then, yes, tough.
The disciplinary board has the authority to investigate audits, auditors and audit reports to determine the quality of professional work. If the board consider the report or opinion of the auditor to have been negligently carried out or issued, then the company acting through its majority is able to take such action as the company may decide.
But it would be inconceivable to allow individual stakeholders to take such action.
And that is why there is nowadays a restriction of liability paragraph of an auditor commonly found within the body of an audit report. This clearly explains that an audit is carried out because it is a requirement by law. But because it is infeasible for any audit firm to verify 100% of transactions or balances resulting from a client’s activities, there must always be a caveat stating that the auditors have obtained through their work reasonable assurance that the figures presented within the financial statements appear to be free of material misstatement.
If that opinion is found to be negligently arrived at or negligently expressed then, yes, let the company acting through its majority take the appropriate action. But that action should not be available to any individual shareholder.
As to “not worth the paper it’s written on” I believe that that is too harsh a conclusion. The professional has brought to the assignment “such degree of skill and …..” and it is not in dispute that auditors lend that extra degree of credibility to financial statements. Occasionally, thankfully, it may be shown that the opinion is negligent. But in the vast majority of situations, the opinion is justifiable.
You say “…and even then they are unable to take individual action …” but precede that with an acknowledgement that the duty “….is to the members as a whole…”. If you are accepting the duty is to the members as a whole, then you are arguing against yourself when you suggest that an individual should be able to take remedial action
Acceptable?
Thank you for your reply.
I was thinking of Caparo v Dickman, Caparo Industries plc being the individual shareholder.
Quoting from Smith and Keenan, “Auditors do not owe a duty of care to potential investors even if they already hold shares in the company since, although they are shareholders and the auditors are under a statutory duty to report to shareholders, the duty of the auditor is to the shareholders as a whole and not to shareholders as individuals.”
Ultramares Corporation v. Touche is a US case if Wikipedia is to be believed and if that makes a difference. As a student with limited knowledge of their Lordship’s greater knowledge and experiences I fail to see their argument. The cost of the general public bringing a claim for negligence against an auditor for an incorrect opinion in comparison to the losses Joe Public has suffered would restrict the number of claimants to those who have suffered substantial losses. On that basis the indeterminate number would be very few, the amount finite to the losses suffered and the period would be from the initial investment until the actions of the investors had time to affect the company.
By including a disclaimer in the audit opinion, the auditor is saying the FS show a true and fair view but don’t take our word for it because there may be a fraud or error that we have missed and the company accounts may be completely false and meaningless. Hence my original statement of not being worth the paper they are written on.
I have read the ACCA’s code of ethics and the majority of accountants show great skill, care and diligence and no doubt most audits are performed with due care and professional scepticism but how are the users of financial statements to know the difference between a competent audit report and a negligent report?
If the FS are a deliberate work of fraud created by the directors then they should be personally liable for the losses of the investors but if there are genuine errors which have escaped the attention of the auditor who has then given an incorrect opinion they should be accountable.
Harm must be reasonably foreseeable as a result of the defendant’s conduct.
Would an incorrect opinion cause harm?
The parties must be in a relationship of proximity.
For an individual to invest in a company based on the audited FS, then the duty of care is owed to investors thus creating a relationship.
It must be fair, just and reasonable to impose liability.
Speaks for itself.I have law and audit exams in the next two weeks, which is why I am looking too deeply into this question.
Thanks again.
Sorry Mike, I was not trying to open up a legal dispute relating to a particular case or the rights and wrongs of the legal decisions made, nor was I questioning the ethics and competence of accountants in general. Having reread your answer it is appreciated and more than acceptable and my reservations relating to the audit report are in the overwhelming majority cases unfair.
Thanks again.
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