Professional liability for Auditors

The audit file will have on it the audit plan

Within that plan there will have been an assessment of the controls apparently in force at the client and, in previous years’ files there will most probably be evidence of audit work on payroll

This year, in the pre-audit meeting with the client, the question will have been asked “Has anything changed in the controls exercised over payroll or in the system of producing the payroll?”

The client presumably says “No” (otherwise we would have tested those changed controls / changed system

Based on prior years’ audit assessment of the payroll system and on the client’s confirmation that there have been no changes to the system, we could feel reasonably justified in noting on the file that the payroll application appears not to warrant any detailed audit work this year

Probably we would carry out reduced tests of controls, just to be sure that those apparent controls do in fact appear to continue to be working, but no great depth involved

Now you tell me that a fraud has been discovered (presumably it’s material otherwise no one’s going to get over-excited)

What is the nature of the fraud? Is management involved? Which controls, if any, have been breached? Could that breach have been anticipated? Was our decision not to audit payroll, as witnessed by the pre-audit planning notes, justified?

The potential liability for negligence will depend upon a number of factors including those in the previous paragraph so a straight forward black and white, yes or no, for sure or definitely not answer cannot be given

But one thing the auditor should do is check their professional insurance cover and, importantly, do not comment to the client on this discovered fraud and pass all files to the auditor’s insurers

OK?

‘What would the auditor do then in relation to its audit report once it is issued? He would have to re issue another one right? In that case, the client will be alerted about the fraud I guess…causing trouble for the audit firm’

You’re living in dream-land! As soon as the auditor discovers the fraud (and the high probability is that it will be the client that discovers it) the auditor will notify the client. The client doesn’t find out about it on the occasion of reading next year’s audit report nor even this year’s – if the auditor takes the extremely rare step of withdrawing their previously issued report

Be VERY careful here! ‘however auditors are responsible to provide a correct opinion on financial statements.’

Auditors are NOT responsible for any CORRECTNESS

If you mean by ‘correct’ the word ‘appropriate’, ok.

Auditors plan their assignments with the reasonable expectation that any material error will be discovered.

If there IS such a material error and it isn’t discovered, then on the face of it the auditor is negligent

There is the possibility that management themselves are involved in the fraud and that makes it extra difficult for the auditor to discover

Where fraud is committed and it’s a sophisticated scheme involving collusion amongst employees (and / or management) it would potentially be unreasonable to expect the auditor to have discovered it

The issue boils down to the auditor’s plan for the assignment and whether that plan was prepared and followed through in such a way that there really was a reasonable expectation of discovery of material misstatement caused by fraud, error or other irregularity

If it was, then probably no liability for negligence

If not, and material misstatement should have been discovered (and would have been discovered with a more realistic plan) then there is a strong case for holding the auditor negligent

You’re welcome