1. LIABILITY OF NEGLIGENCE :-
A person who is appointed auditor, he should perform his duties by using the reasonable skill and diligence. If auditor is found negligent in performing his duty then he may be sued in the Civil Court for damages.
Negligent liability arises when auditor has been negligent in examining the book of account. He is also liable if he fails to detect deflections or does not discover the errors which he should discover. Because he fails to exercise a reasonable care and skill in the performance of his duties.
i. Liability In Case Of Loss :- Auditor will be liable to compensate the loss which is suffered by client due to his negligence.
ii. Liability Case Of No Loss :- The auditor will not be held liable if no loss is suffered by the client even auditor is proved to be negligent.
iii. Legal Case :-
Leeds Estate Building Society vs Sphephered 1887 : In this case auditor did not care to see the provisions of carried out articles. Profits were inflated by including the fictitious terns. Due to the auditors negligence dividends were paid out of capital. Action was taken by the company and auditor was held liable for damages.
2. LIABILITY FOR MISFEASANCE :-
Misfeasance means the breach of duty breach of trust involving the company in loss. The company may proceed against the auditors by way of regular suit in case of misfeasance. Company can claim damages suffered. Misfeasing proceedings can be taken against die auditor by the directors. Promoters, managing agents when company is in liquidation.
Generally misfeasance liability arises in the case of winding up a company.
Legal Case :-
Westminister Road Construction and Engineering Company (Ltd) 1932 : The work in progress was over stated and liabilities were understand but auditors did not point out about it to the shareholders. The dividend was paid out of the capital. In regard to the valuation of work in progress.
It was held that the guilty of the auditor was to "Check the figures at which work in progress was brought into the balance sheet."
The auditors were found guilty of misfeasance and were ordered to refund the amount of dividend with interest to the company.
3. CRIMINAL LIABILITY :-
During the course of audit, auditor may commit various offenses and he becomes criminally liable.
Offenses Criminally Liable :-
1. If auditor's report does not comply with the requirements of law.
2. If the default was done knowingly and willfully by the auditor.
3. If it is proved that auditor has falsified the accounts or made any report, statement, balance sheet or any document false he will be held criminally liable.
Legal Cases :-
Res vs Kylsant 1931 : In this case, the real story is that company created excessive secret reserves in boom years under the heading "Taxation Reserves". But these reserves were not shown on the balance sheet for several years company suffered heavy losses. During these year losses were concealed on the other hand secret reserves were used and profit was shown to the shareholders.
The chairman and auditor were criminally prosecuted on the following grounds :
1. Chairman of the company issued the false annual receipts with the intention of deceiving the shareholders.
2. Auditor of the company aided and asked in the issue of false reports. So it is decided that an mourn should be disclosed on the balance sheet and shareholders should be informed about the utilization of secret reserves.
4. LIABILITY OF HONORARY AUDITOR :-
Liabilities of paid and honorary auditors are same. In case of negligence or misfeasance honorary auditor can not relieve himself from the liability. If the negligence is proved then auditor will be held responsible and he has no excuse to say that he is not being paid or receiving less amount.
5. LIABILITY FOR LIABLE :-
Sometimes auditor criticises the officers of the company in his audit report. His report should be such type that it may not defame or disgrace any person. On the other hand if the report of the auditor injures the good will and reputation of any person then he will be held responsible on the grounds of the defamation. Auditor is not liable.
If the criticism is based on facts audit report is considered a privileged document. It should contain only facts otherwise auditor will be held responsible. Auditor's report should contain the following qualities :
1. It does not miss state the facts.
2. It is not actuated malice.
3. It does not go beyond what is relevant to its subject.
4. Statement should be bonafide.
Legal Case :-
Lawless vs The Anglo Egyptian Cotton and Oil Company Ltd. 1869 :
In this case the plantiff was a manager of the company and auditors of the company gave the following statement about the manager in the report.
"The shareholders will observe that there is a charge for 1306-0-0 for deficiency for which the manager is responsible. His accounts have been badly kept and have been rendered to us very irregularly".
The manager brought an action for liable. It was found by the injury that there was no evidence of malice.
6. LIABILITY TO THE THIRD PARTY :-
Auditor has no contract with the third parties. He is not employed by the third party so he has no duty to them. But the point is that as the accounts are audited by the audit, third party may also see the report, third party rely the report without the further inquiry. For example bank only study the certified balance sheet and lends the money to the company. Tax department and others also rely on the audited statements. "Now the question is that whether the auditor is liable if they rely on the accounts certified by him and suffered a loss should he compensate the loss.
Answer is that in following cases he will be responsible to the third party.
1. If the statement signed by the auditor was not true infect.
2. It was known to the auditor that statement was not true infect.
3. Third party suffered a loss by relying on the statement of auditor.
4. If the statement was made with the intention that the other party should act on it.
5. If auditor gave his consent for the inclusion of such statements in the prospectus.
Legal Cases :-
1. Canndler vs Crave Chrismas & Co. 1951 : In this case, legally it was admitted that auditor has to perform his duty for the client only. He can not be held responsible for the loss of third parties that they relied on his audited accounts. Even negligence may be proved but he will not be held responsible by the third parties for any loss.
2. De Srvary vs Holden Howwerd & Co. 1960 : In this case also the judges that auditor owed no duty of case to the third party out side his contractual relationship existing between those who have appointed him to audit the accounts.
3. Perry vs Peek : In this case it was held that an auditor may be liable to the third parties, if the auditor acted fraudulently i.e. he made false statements with a view to deceive the third party and third party actually buffered a loss by relying on it.