Auditor’s liability is a serious issue that every auditor should be weary about. Auditors should know the basics of mitigating themselves against auditors’ liability. An auditor can be liable under the common law, to the client or to third party.
Under the common law, liabilities can be brought against the auditor for breach of contract. Breach of contract in auditing is established when an auditor fails to exercise due care and professionalism in the discharge of his duties. The case of Smith v. London assurance corp. (1905) was the first US case involving an auditor and a client. Auditors may be liable to clients for tort liability. Auditors have a high responsibility to their client because of the relationship they establish with their clients. Third party can file a lawsuit against auditors if they can prove the following:
- They suffered an economic loss
- Auditor has failed to exercise appropriate professional care (ordinary negligence, gross negligence, and fraud)
- The financial statement was materially misstated.
- The loss was caused by reliance on the financial statements by the third party.
The effects of auditors liabilities was at a point relaxed but was later re-ignited. Hence, there is every need for auditors to take every precaution to safeguard them self from legal liability. Below are some tips that will help you as an auditor avoid being indicted.
- Being competent: the best way to mitigate yourself against auditors’ liability is to be competent in your work. Competency entails a lot of other qualities, it goes with; professionalism, due care and diligence. Competent auditors will have all the necessary qualifications needed to be an auditor. Know when to bring in as expert and do so, e.g., insist that management brings in a Fraud Examiner whenever case of fraud is established.
- Being conversant with the provisions of the law: Enactments like Sarbanes-Oxley Act has placed some restrictions on the activities of auditors. Auditors should equip themselves with the provisions of this Act as ignorant of the law is not an excuse.
- Operating under a limited Liability Partnership: having the word ‘limited’ in an accounting firms’ name will make the firm enjoys some benefits that accrue to Limited Liability Company.
- Careful wordings in the engagement letter: substantial amount of clients and third party liability can be avoided if auditors limit their exposure by choosing words to be included in the engagement letter carefully. Avoidance of ambiguous words should be your watchword – make sure the phrase “exclusion of punitive damage” is included in the engagement letter.
In as much as auditors’ liability cannot be completely mitigated, the above tips when correctly applied will help significantly reduce the incidence of legal actions against auditors. Rise up and face the future of auditing squarely.
To your liability free auditing career!