International developments in auditing2

APT Financial Consultants

INTERNATIONAL DEVELOPMENTS IN AUDITING
1.0 Auditing practices around the World
1.1 Audit practices in UK
1.1.1 The accountancy profession in UK is unregulated except for certain areas,
which are regulated by law. These three areas are; investment advice,
insolvency work and company audit work. Individuals wishing to practise
as an auditor in the UK are required by law to hold an audit qualification
from a Recognised Qualifying Body (RQB). There are five RQB's:
Association of International Accountants; Institute of Chartered
Accountants of England and Wales; Chartered Accountants of Scotland;
Chartered Accountants of Ireland; Association of Chartered Certified
Accountants
1.1.2 Until 1991, the responsibility for setting auditing and ethical standards lay
wholly with the accountancy professional bodies7. However, in the late
1980's, a number of audit failures led to the UK Government to pressurize
those professional bodies to strengthen their processes to improve the
quality of auditing. This led to the establishment of the Auditing Practices
Board (APB) in 1991 and the commencement of audit inspection activities
by the professional bodies. An important feature of the APB when it was
established was that 50% of its members were required not to be
practicing auditors8.

1.1.3 APB issued its first auditing standards in 1994. These were supplemented
and improved over the period to 2004. Many of the initial standards
focused on the process of auditing but the APB also undertook innovative
work in developing standards on going concern, fraud, compliance with
laws and regulations, audit firm quality systems and auditor reporting to
audit committees – all of which were areas where, at that time, no auditing
standards existed anywhere in the world`.
1.1.4 Following from the financial difficulties in South East Asia (the so called
collapse of the ‘Tiger economies’) international regulators put pressure on
IFAC to improve the quality of international auditing standards. As a
result the International Auditing Practices Committee (IAPC) (the
forerunner of the International Audit and Assurance Standards Board
(IAASB) commenced a major investment in improving International
Standards on Auditing (ISAs).

1.1.5 In 2004, APB took the decision to more clearly base UK auditing
standards on ISAs and a suite of ISAs (UK and Ireland) was issued. The
ISAs (UK and Ireland) adopted the text of the international standards
(ISAs issued by the IAASB) supplemented by additional UK specific
standards and guidance.

1.2 Audit practices in USA

Sako Mayrick, 2008 Page 1

1.2.1 The Financial Accounting Standards Board (FASB) is a private, not-for-
profit organization whose primary purpose is to develop generally
accepted accounting principles (GAAP) within the United States in the
public's interest. The Securities and Exchange Commission (SEC)
designated the FASB as the organization responsible for setting
accounting standards for public companies in the U.S. It was created in
1973, replacing the Accounting Principles Board and the Committee on
Accounting Procedure of the American Institute of Certified Public
Accountants. The FASB's mission is "to establish and improve standards
of financial accounting and reporting for the guidance and education of the
public, including issuers, auditors, and users of financial information
1.2.2 Stocks and Exchanges Commission and the American Institute of
Certified Public Accountants (AICPA) established a new authoritative
body to set auditor independence standards and that led to the Public
Company Accounting Oversight Board (PCAOB) established by the
Sarbanes Oxley Act signed into law by President Bush on July 30, 2002.
Sarbanes Oxley makes the chief financial officer and chief executive
officer responsible for their firm’s accounting records and provides for
criminal penalties for those who do not comply with the act. The board,
funded by public companies with mandatory fees and overseen by the
SEC, will issue, adopt and enforce auditing, ethics, attestation and other
standards to protect public interest. There are severe penalties for
noncompliance including fees and imprisonment. The goal is to restore
investor confidence by preventing misdeeds of corporate executives that
lead to investor losses. The act has increased costs for companies.
Academically there is increasing emphasis on the study of ethics in
business schools and recently the demand for accounting graduates has
grown. Significant control of the accounting profession has passed from
the private to the public sector. Public oversight will likely become more
complex and costly. As confidence is restored investments will increase
and profits will rise, employment will expand, and the national economy
will benefit from a new era of confidence, trust and fairness.
1.3 Audit practices in SADC and other EA countries
1.3.1 The main aim of audit practices for Sauthern African Development
Community (SADC) is to harmonisation of best practices in accounting
and auditing standards across the region for sound public financial
management is an imperative. Member States are encouraged to
implement the programme of harmonisation of auditing and accounting
standards coordinated by the Eastern, Central and Southern African
Federation of Accountants (ECSAFA).
1.3.2 The Eastern, Central and Southern African Federation of Accountants
(ECSAFA) is a regional body of accountants whose objects, inter alia are
the co-ordination of the development of the Accountancy Profession and
promotion of internationally recognized standards of professional
competence and conduct within the region.


1.3.3 ECSAFA was launched in Mauritius in 1989 and a Secretariat established
in the offices of the South African Institute of Chartered Accountants in
Johannesburg in 1991. Due to the increased workload and the growing
importance of the organization, it was resolved to establish an independent
Secretariat in Nairobi. The Secretariat was transferred from
Johannesburg, South Africa to Nairobi effective 1st January 1999 a
decision that has recently been confirmed by Council.
1.3.4 The mission of ECSAFA is to build and promote the accountancy
profession in the Eastern, Central and Southern regions of Africa in order
that it is, and is perceived by accountants, business financiers and
governments to be an important factor in the economic development of the
region.

1.3.5 Currently, ECSAFA has 15 full members from fourteen countries in the
region. National accountancy bodies in the course of formation are
accorded temporary memberships status in ECSAFA while affiliate
membership is open to other regional bodies like Common Market for
Eastern and Southern Africa (COMESA), South African Development
Community (SADC), East and Southern African Association of
Accountant Generals (ESAAG), etc while international accounting
organizations like the Association of Chartered Certified Accountants
(ACCA), Association of Accounting Technicians (AAT), Institute of
Chartered Accountants in England and Wales (ICAEW), are accorded
Observer status. The World Bank is a non-subscription paying Observer
member and we would encourage other organizations like ADB to also
join ECSAFA. There is interest among accountancy bodies in-formation in
Sudan, Rwanda, Mozambique, Mauritius and Angola to change from
temporary to full members as their institutes are formed. ECSAFA has
also been monitoring developments in Mozambique where currently
consultants have been hired with the assistance of the World Bank to set
up a body of accountants. We are also following up other countries in the
region like Rwanda where there has been encouraging signs of the
development of an accountancy body.

2.0 The role of IFAC
The International Federation of Accountants (IFAC) is the worldwide organization for the
accountancy profession. Founded in 1977, its mission is “to serve the public interest, IFAC will
continue to strengthen the worldwide accountancy profession and contribute to the
development of strong international economies by establishing and promoting adherence to
high-quality professional standards, furthering the international convergence of such
standards and speaking out on public interest issues where the profession’s expertise is most
relevant.”
IFAC’s governing bodies, staff and volunteers are committed to the values of integrity,
transparency and expertise. IFAC also seeks to reinforce professional accountants’ adherence to
these values, which are reflected in the IFAC Code of Ethics for Professional Accountants.



Primary Activities
a. Serving the Public Interest
IFAC provides leadership to the worldwide accountancy profession in serving the public interest
by:
• Developing, promoting and maintaining global professional standards and a Code of Ethics for
Professional Accountants of a consistently high-quality;
• Actively encouraging convergence of professional standards, particularly, auditing, assurance,
ethics, education, and public and private sector financial reporting standards;
• Seeking continuous improvements in the quality of auditing and financial management;
• Promoting the values of the accountancy profession to ensure that it continually attracts high
caliber entrants;
• Promoting compliance with membership obligations; and
• Assisting developing and emerging economies, in cooperation with regional accounting bodies
and others, in establishing and maintaining a profession committed to quality performance and in
serving the public interest.

b. Contributing to the Efficiency of the Global Economy
IFAC contributes to the efficient functioning of the international economy by:
• Improving confidence in the quality and reliability of financial reporting;
• Encouraging the provision of high-quality performance information (financial and non-
financial) within organizations; Promoting the provision of high-quality services by all members
of the worldwide Accountancy profession; and
• Promoting the importance of adherence to the Code of Ethics for Professional Accountants by
all members of the accountancy profession, including members in industry, commerce, the
public sector, the not-for-profit sector, academia, and public practice.

c. Providing Leadership and Spokesman ship
IFAC is the primary spokesperson for the international profession and speaks out on a wide
range of public policy issues, especially those where the profession’s expertise is most relevant,
as well as on regulatory issues related to auditing and financial reporting.
This is accomplished, in part, through outreach to numerous organizations that rely on or have an
interest in the activities of the international accountancy profession.

IFAC has
• 155 member bodies
• 2.5 million professional accountants
• “to protect the public interest by encouraging high quality practices by the world's
accountants”
• Standards for:
o (External) Auditing and Assurance
o Public sector accounting
o Education
o Ethics

The audit standard are issued by International Auditing & Assurance Standards Board (IAASB)
and it consist of
• 18 members


• Full-time chair and 7 full time technical staff
• Multi-stakeholder involvement:
o Non practitioner members (moving to 50%)
o Consultative Advisory Group
o Public Interest Oversight Board
• Transparent due process:
o Meetings open to the public
o Official observers from regulators
o Agenda papers on website
o Full public exposure
o Standards etc free on website

The International Auditing and Assurance Standards Board (IAASB) develops ISAs and
International Standards on Review Engagements, which deal with the audit and review of
historical financial statements; and International Standards on Assurance Engagements, which
deal with assurance engagements other than the audit or review of historical financial
information. The IAASB also develops related practice statements.
These standards and statements serve as the benchmark for high-quality auditing and assurance
standards and statements worldwide. They establish standards and provide guidance for auditors
and other professional accountants, giving them the tools to cope with the increased and
changing demands for reports on financial information, and provide guidance in specialized
areas.
In addition, the IAASB develops quality control standards for firms and engagement
teams in the practice areas of audit, assurance and related services.

3.0 International Standards on Auditing (ISA)
( this should be complemented by handout on overview of ISA)



4.0



PRONOUNCEMENTS ISSUED BY THE INTERNATIONAL
AUDITING AND ASSURANCE STANDARDS BOARD
International
Standards on
Auditing
(ISAs)

RISK ASSESSMENT AND RESPONSE TO ASSESSED RISKS
Number Description
ISA 300 PLANNING.
ISA 310 KNOWLEDGE OF THE BUSSINESS
UNDERSTANDING THE ENTITY AND ITS
ISA 315 ENVIRONMENT AND ASSESSING THE
RISKS OF MATERIAL MISSTATEMENT.
ISA 320 AUDIT MATERIALITY.
THE AUDITOR`S PROCEDURES IN
ISA 330 RESPONSE TO ASSESSED RISKS..
RISK ASSESSMENTS AND INTERNAL
ISA 400 CONTROL.
AUDITING IN A COMPUTER
ISA 401 INFORMATION SYSTEMS
ENVIRONMENT.

AUDIT CONSIDERATIONS RELATING
ISA 402 TO ENTITIES USING SERVICE
ORGANIZATIONS.

International
Standards on
Auditing
(ISAs)

AUDIT EVIDENCE
Number Description
ISA 500 AUDIT EVIDENCE.

ISA 501 AUDIT EVIDENCE – ADDITIONAL
CONSIDERATIONS FOR SPECIFIC ITEMS.
EXTERNAL CONFIRMATIONS.
ISA 505

ISA 510 INITIAL ENGAGEMENTS – OPENING
BALANCES.

ISA 520 ANALYTICAL PROCEDURES.

AUDIT SAMPLING AND OTHER
ISA 530 SELECTIVE TESTING PROCEDURES.

ISA 540 AUDIT OF ACCOUNTING ESTIMATES.



International
Standards on
Auditing
(ISAs)

AUDIT EVIDENCE
Number Description

ISA 545 AUDITING FAIR VALUE
MEASUREMENTS AND DISCLOSURES.

ISA 550 RELATED PARTIES.

ISA 560 SUBSEQUENT EVENTS.

ISA 570 GOING CONCERN..

ISA 580 MANAGEMENT REPRESENTATIONS.

International
Standards on
Auditing
(ISAs)

USING WORK OF OTHERS
Number Description

ISA 600 USING THE WORK OF ANOTHER
AUDITOR.

ISA 610 CONSIDERING THE WORK OF
INTERNAL AUDITING..

ISA 620 USING THE WORK OF AN EXPERT.



International
Standards Auditing
Practice Statements
(IAPSs

IAPS 1000: INTER-BANK CONFIRMATION PROCEDURES.
IAPS 1001: IT ENVIRONMENTS – STAND ALONE PERSONAL COMPUTERS.
IAPS 1002: IT ENVIRONMENTS – ON LINE COMPUTER SYSTEMS.
IAPS 1003: IT ENVIRONMENTS – DATABASE SYSTEMS
IAPS 1004: THE RELATIONSHIP BETWEEN BANK SUPERVISORS AND BANKS EXTERNAL AUDITORS.
IAPS 1005: THE SPECIAL CONSIDERATIONS IN THE AUDIT OF SMALL ENTITIES.
IAPS 1006: AUDITS OF THE FINANCIAL STATEMENTS OF BANKS.
IAPS 1008: RISKS ASSESSMENTS AND INTERNAL CONTROL – CHARACTERISTIS AND CONSIDERATIONS.
IAPS 1009: COMPUTER-ASSISTED AUDIT TECHNIQUES.
IAPS 1010: THE CONSIDERATION OF ENVIRONMENTAL MATTERS IN THE AUDIT OF FINANCIAL STATEMENTS.
IAPS 1012: AUDITING DERIVATIVE FINANCIAL INSTRUMENTS .
IAPS 1013: ELECTRONIC COMMERCE – EFFECT ON THE AUDIT OF FINANCIAL STATEMENTS.

IAPS 1014: REPORTING BY AUDITORS ON COMPLIANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS.


International
Standards on
Review Engagements
(ISREs)

ISREs 2400: ENGAGEMENTS TO REVIEW FINANCIAL
STATEMENTS.




Assurance Engagements Other Than Audits or
Reviews of Historical Financial Information

International International
Standards on Assurance Engagement
Assurance Engagements Practice Statements
(ISAEs) (IAEPSs)

5.0 Professional competence and Duty of Care
A member of auditing profession should observe the profession’s technical and ethical
standards, strive continually to improve competence and quality of services, and
discharge professional responsibility to the best of member’s ability.
The principle of professional competence and due care imposes the following obligations
on professional accountants:
(a) To maintain professional knowledge and skill at the level required to ensure that
clients or employers receive competent professional service; and
(b) To act diligently in accordance with applicable technical and professional standards
when providing professional services.
Competent professional service requires the exercise of sound judgment in applying
professional knowledge and skill in the performance of such service. Professional
competence may be divided into two separate phases:
(a) Attainment of professional competence; and
(b) Maintenance of professional competence.
The maintenance of professional competence requires a continuing awareness and an
understanding of relevant technical professional and business developments. Continuing
professional development develops and maintains the capabilities that enable a
professional accountant to perform competently within the professional environments.
Diligence encompasses the responsibility to act in accordance with the requirements of an
assignment, carefully, thoroughly and on a timely basis.

A professional accountant should take steps to ensure that those working under the
professional accountant’s authority in a professional capacity have appropriate training
and supervision.
Where appropriate, a professional accountant should make clients, employers or other
users of the professional services aware of limitations inherent in the services to avoid the
misinterpretation of an expression of opinion as an assertion of fact.

6.0 Auditor’s Liability and Auditing case law
Auditor’s Liability
The auditor is accountable to those who appointed her of his conduct while making his
report on the audit .She has to assess whether management to the entity has carried out its
fiduciary responsibility in a manner acceptable to owners the business and to improve the
accountability in the manner acceptable to the owners of the business. The auditor’s
liability is in two folds:
• Under statute where by the auditor is criminally liable for publishing her report or
similar statements while knowing that these are misleading, false or deceptive;
• Under application of the principle of common law to establish the standards of work
and reporting expected the auditor. Thus as a failure to exercise due care and skill in
conduct of an audit.
The former is owed to state and the other to individuals who have suffered loss as a result
of audit shortcomings.

Implications
• An auditor may fail to discover a material fraud or error and deliver unqualified
opinion on set of accounts, which in reality is significantly misstated.
• An auditor may fail to recognize that the going concern assumption is not appropriate.
Some time after the year-end the company may go into liquidation and question may
be asked about absence of any warning in the auditor’s report.

Liabilities to the state are likely to be “fixed in terms of penalties whereas the liabilities to
the clients or third parties have been proven to be open –ended.
The auditors are seeking to have the courts allocate blame for the corporate collapse on
the basis of actual responsibility rather than the present system where by the deepest
pocket carries the heaviest (usually the only) burden.

The analogue below presents the Auditor’s liability in contextual layout:

contract client-mgt investors

Auditor

No formal contract third parties -users


Whilst an auditor has various statutory duties to perform. There are also non –statutory duties to
consider the most important of these being the duty to exercise reasonable care and skill in
conduct of an audit examination. This duty was clearly expressed in the of cited Re-Kingston
Cotton Mill (1986) and Re- London and General bank (1895). The auditors duties may be
summarized as follows (1) the duty to be aware of relevant statutes (2) the duty to be aware of
requirement of those statutes (3) a duty to be aware of the written constitution the enterprise
under audit

Auditor of a limited company are bound to know (ie required to know ) or make themselves
acquitted with their duties under the articles of the company, whose accounts they are appointed
to audit, and under the companies Acts for the time being in force.

Auditors of enterprise such as government Agencies or local authorities would also be subject to
these duties and other duties such as (1) a duty to abide by any express terms in the contract (2)
specially for non-statutory appointments (3) basing on companies Act

As a self-protection exercise the prudent auditor should always explain any limitation through
the medium o the audit report and should always clarify in advance the nature of the work to be
undertaken. This can vary from a full “audit “engagement (where the auditor expresses opinion
as to the truth and fairness of the financial statements to a “review engagement” (where only
limited assurance is provided)
The duty may comprise of (1) A duty to abide to any implied term of the audit appointments (2)
an implied duty to carry out the audit task within a reasonable period (3) an implied duty to
exercise reasonable care and skill in conduct of the audit.
Duty of Care
The more the specialized the work undertaken, the higher the degree of skill and care expected.
Generally in the Re-London and General Bank, the duty of reasonable care and skill implies an
auditor must be honest i.e she must not certify what she does not believe to be true and she must
take reasonable care and skill before she believes what she certifies is true, what is reasonable
care in any particular case must depend upon the circumstances of that case.
In Re- Kingston Cotton Mill (1896) gives one hint on how the profession should set about
determining the meaning of “reasonable care and skill”, it is a duty of an auditor to bring to bear
on the work she has to perform that skill, care and caution which a reasonably competent, careful
and cautious auditor would use.
An auditor is not bound to be detective or to approach his work with suspicion or with forgone
conclusion that there is something wrong .She is a watchdog and not a bloodhound.
This anticipates by more than half a century the Maultz and Sharaf (1962) auditing postulates
which states that; as a working assumption;’ the financial statements and other information
submitted for verification are free from collusive and other unusual Irregularities. Auditors must
not be made liable for not tracking out ingenious and carefully laid schemes of fraud where
they’re nothing there to arouse their suspicion.

But when suspicions is aroused the auditor who does not respond by following through the
suspicious circumstances in order to full resolve the matter may be liable for negligence (
Thomas Gerard case).


Auditing standard and guidelines do not carry statutory power but they must be considered to be
persuasive evidence” as to which and auditing procedures constitute best practice. Auditors
should institute quality control measures to ensure that their audits (of whatever size) live up to
the description of best practices such procedures include; Proper audit planning; the use of
analytical review procedures the use of audit programs; the use of checklists; a suitable review
procedures

Adherence to accounting (as opposed to auditing) standards raises the further possibility of
debate over what constitute “reasonable care and skill”, the proof of compliance with generally
accepted accounting principles (GAAP’s ) as persuasive but not conclusive evidence’ the
financial accounts show a true and fair view. Thus the auditors who simply ensure compliance
with GAAPs and fail to examine the broader question of the truth and fairness may not be
carrying out their duty with reasonable degree of skill and care.

The auditor’s liability in contract (privity of contract) for negligent work will depend on client’s
ability to firstly prove negligence and secondly prove actual loss. Auditors negligence will be
judged according to accepted standards of reasonable care and skill and these in turn will be
judged according to the extent to which the audit or followed according to the extent to which
the audit or followed accepted best practice (approved auditing standards) yet nevertheless,
retained a professional independence and flexibility which ensured that the ultimate slavish
compliance with published professional guidance.

It can be concluded from above that an auditor will be liable whenever: (1) a formal contractual
relationship exists (2) Negligence by the auditor can be proved (3) a loss by the other party of to
the contract is established.

However, if some one less closely to the auditor and with whom no formal contractual
relationship can be said to exist, but such cases is where the auditor duty of care takes place. In
more remote third parties such as: (1) trade creditors who fail to recover their outstanding debts
if the debtor company goes into liquidation (2) bankers who have advanced loans or overdraft
facilities (3) debenture or loan stock holders (4) investor who subsequent to issue of audited
accounts have purchased shares in the company or purchased the company itself. There
investment may be reduced or wiped out completely if the company accounts are later
discovered to be materially incorrect.

Circumstances for Auditor’s liability to third parties
1) It must be shown that a duty of care exists
2) The auditor must know , or should have known , that the financial statements where likely to
be relied for the purpose claimed by the plaintiff
3) The plaintiff must be of a class or category likely to rely upon the material concerned. The
criteria is often referred as to use of proximity
4) There must be actual reliance on negligently prepared financial statements where
contributory negligence on the part of plaintiff can be established damages against a
negligent auditor may be greatly reduced.
5) The plaintiff must show that she would have acted differently had the financial statements on
which they relied been correctly prepared. e.g. if a set of accounts had shown a true loss;
rather than false profit , would the plaintiff still have gone ahead and purchased the company.



Auditing case laws

Candler V Crane, Christmas and Co (UK, 1951)
In this case it was held that there could be no auditor liability for negligence in absence of
contractual relationship. Lord Denning delivered a dissenting opinion based on the argument that
actual fore knowledge of the specific use to which the accounts would be put created a duty of
care even in the absence of a formal contract between the accountant and the third party.

Hedley Byrne V Heller and partners (UK, 1963)
In this non- accounting case a reference was issued in the fore knowledge that it would be relied
upon by third party, for loan or investment purposes. The reference proved “unreliable” and the
issues of the reference were proved unreliable and the issuers of the reference were sued. It was
held that because of that very foreknowledge a duty care existed towards and third party. Despite
the absence of any formal contract
Thus Lord Denning’s dissenting decision in Candler V Cranes Christmas and Co was vindicated.
The relevance of this case for accountants (rather than as auditors), they often prepare special
reports for a client in full knowledge that those reports or accounts are going to be used to
persuade and identifiable third part (a bank or prospective purchaser) to adopt a certain cause of
action .The Hedley Byrne is often used to represent very narrow view of auditors liability to third
parties – Actual knowledge of possible reliance being a necessary condition.

Caparo Industries V Dickman and others (1990)
In 1984 Caparo industries purchased 100,000 Fidelity shares in the open market .On June
12,1984, the date which the accounts (audited by Touch Ross) were published, they purchased a
further 50,000 shares relying on information in the accounts, further shares where acquired. On
September 4, Caparo made a bid for remainder and by October had acquired control of Fidelity.
Caparo alleged that accounts on which they had relied where misleading in that an apparent pre-
tax profit of the some $1.3m should in fact be reported as a loss of $ 400,000. The plaintiff
argued that Touch owed a duty of care to investors and potential investors
Decision held:
• The auditors of a public company’s accounts owed no duty of care to members of the
public at large who relied upon the account sin deciding to buy shares in the
company.
• A purchaser of further shares, while relying upon auditor’s report a shareholder stood
in the same position as any other investing member of public to whom the auditors
owed no duty.
• The purpose of the audit was simply that of fulfilling a statutory requirements of the
companies Act 1985
• There was nothing in the statutory duties of company auditors to suggest that they
were intended to protect the interest of investor in the market. In particular, there was
no reason why any special relationship should be held to arise simply from the fact
that the affairs of the company rendered it susceptible to takeover bid.


Conclusively, though the above seems to lessen auditor’s duty to use skill and care because
auditors are still fully liable in negligence to the companies they audit and their shareholders
collectively.

Utramares Corporation V Touche (USA, 1930)
The auditors should not be made liable for an indeterminate amount to an indeterminate class of
people, for indeterminate period of time.
Some aspects of this view seem to be more acceptable than others. For example most people
would agree that, as time passes after the publication of a set of audited accounts, less and less
reliance can be placed of audited accounts, less and less reliance can be placed on them by the
users because under lying economic factors may have changed significantly. Thus in determining
the auditor’s liability the question the time reliance was placed would be a material
consideration.
With respect to the likely classes of users there are three possible schools of thought:
• When reporting on statutory accounts, the auditor reports to the members of the company and
them only. There can be no duty of care to anyone else unless the auditor has been
specifically informed of their existence and the intention to provide them with accounts for a
stated purpose.
• When reporting on statutory accounts the auditor reports to members of the company but
may be aware that there exist certain identifiable third parties whom it is reasonable to
assume will place reliance the auditor’s opinion. The duty of care should thus extend to cover
third parties who can be identified at the time the audit opinion is delivered.
When reporting on the statutory accounts the auditor reports to the members of the company but
the audit report enters the public domain and becomes an important source of assurance to any
third party considering entering into financial arrangement with the client company. The
auditor’s duty of care should thus extend beyond shareholders and identifiable third parties who
belong to a class likely to rely on financial statements for a purpose which can justifiably be
argued to be a reasonable purpose for a person of that class. All this is within timing constraints.
Conclusively, The ultramares case suggests the need for some limitation of liability but does not
itself provide precise criteria .The concept has been reinforced by Caparo case. Caparo has taken
Ultramares decision one step further by placing strict limits on the perceived purpose of the
auditors report itself, in turn limiting the opportunity for third parties to establish that a duty of
care exists between the auditor and themselves.
In many ways, auditors liability is not materially different concept from manufacturer liability
for products (DonoghueV Stephenson, UK ,1932)

Jebb Fastener’s Vs Mark Bloom
Despite the fact that the auditors were not aware of a bid for the client company at the time they
signed the audit report they would have been liable to the acquirer for the losses suffered had it
not been accepted by the court that the plaintiff would have gone ahead and bought the company
whatever he picture provided by financial statements. Clearly, in the view of the court
prospective purchasers constituted a “reasonably foreseeable group of users and the auditors
would have been well advised to bear them in mind when programming their audit and
considering the overall truth and fairness of accounts.


It is a case where the “reasonable foresight’ test was accepted and auditors, as a result found
themselves liable to third parties who where complete strangers to them at the time the audit took
place.
Whether the defendant auditors knew or reasonably should have foreseen at the time the
accounts for the purpose of deciding whether or not to take over the company, and therefore
could suffer loss if the accounts were inaccurate.

Two-max Ltd and Goode V Dickson, Mc Farlane and Robinson (UK,1982)
This case provided an immediate reinforcement of the judge’s decision in the Jeb Fasteners. The
only deference being that of judge believed that the plaintiff would not have acquired the
company under consideration had the accounts actually shown a true fair view.
The judge in this case commended JEBB Fasteners decision on the grounds that it “combined the
simplicity of the proximity or neighbor principle with a limitation which has regard to the
warning (see Ultra mares V Touche) against exposing the accounts to interminable liability.
Without disagreeing with the basic principle that the auditors had a duty to exercise “reasonable
foresight” in carrying out their work.

Al Saudi Banque (and others) Vs Clarke Pixley (UK, 1989)
In this case it was held that:
The auditors of a company owe no duty of care to a bank who lends money to the company,
regardless of whether the bank is an existing creditor ( at the time of the audit report signed)
making further advances or is only a potential creditor of the company, since either case even if
it is foreseeable that the bank might request a copy of company’s accounts and rely on them
when making an advance to the company there is not a sufficiently close relationship between
the auditors and the bank to give rise to the degree of proximity necessary to establish a duty of
care
Conclusively, when suing an auditor for negligence it is first has to be established that a duty of
care exists. The Jebb Fastener case had appeared to widen the proximity circle by holding
auditors liable to the unknown third parties on the basis of a “ reasonable foresight’. The Al
Saudi Banque , case and the Caparo case rejects this approach as being to open ended .They
proceed to the precedents established in both the Crane Christmas and the Hedley Byrne cases.
That actual knowledge of an intention to rely on the accounts should constitute the primary test
of Proximity.
With regards to the banks who were limited class the judge commended ‘they were limited class
, and their identity and the amount of their exposure was know to defendants when they signed
their reports. But their position is not all comparable with that of the members. They played no
part in appointing the defendants auditors.
The defendants were under no statutory obligation to report to them, nor did they send them to
the company with the intention or in the knowledge that they would be supplied to them.
The judge added that in order to establish sufficiently proximate relationship between parties
• What needs to be shown is not knowledge of an intention that the information will be
provided to them The basic ground rules for establishing a duty of care owed to a third party
are;
• It must be reasonably foreseeable that a statement will be relied upon
• This relevant degree of proximity between parties
• It must be, just and reasonable in all the circumstances to impose a duty of care.



Gross and Ordinary Liability
Liability for negligence may either ordinary or gross. Ordinary negligence refers to lack of
reasonable care, e.g. an auditor who fail together sufficient competent evidence to support the
figure of stock in the balance sheet might be accused of ordinary negligence by an injured party
if all other phase of the audit conformed to generally accepted auditing standards (GAAS). On
the other hand, gross negligence refers to lack of even the slightest care or reckless disregard of
duty (constructive fraud i.e. misrepresentation of facts). For example where the auditor fails
substantially to comply with GAAS, the auditor may be charged by an aggrieved party.
The auditors protects themselves by using (1) Professional standards (2) taking professional
indemnity insurance

Other forms of liability
(i) Civil liability
This is a result of breach of trust (Misfeasance), which is improper execution of some
lawful act. It arises where the auditor fails to do something, which is correct (e.g. failure
by the auditor to discharge his fiduciary duty under contract)
The following conditions must be met for this liability:
1) the auditor must have owed a duty of care to plaintiff
2) The plaintiff must have suffered a loss as a result of auditor’s negligence.
Relevant cases
1) Re-Kingston Cotton Mill Co and Re-London and General Insurance.(auditor as and
officer of the company)
2) Companies Act No. 12 of 2002
3) Westminster Road construction and Engineers Ltd (1932)

(ii) Criminal Liability
In companies Act No.12 of 2002, the auditor may be sued under miscellaneous offences.
if the auditor, in any turn, report or certificate or balance sheet, willfully make a
statement false in any material particular, knowing it to be false, he shall be quilt of an
offence and shall be liable on conviction for not more than three years with or without
hard labour and shall also be liable to fine in lieu of or in addition to such imprisonment
as aforesaid.
Liability under other Acts
(i) Penal code – An auditor may be sued for criminal offences as provide under the
Tanzania penal code
(ii) Theft Act
The auditor can be guilt of a criminal offence under this Act if she aided or
abetted management to publish false statements with intent to defraud
stakeholders
(iii) Prevention of fraud
Any person, by statement, promise or forecast, which he knows to be misleading,
false or deceptive or by dishonesty concealment of material facts, or by reckless
making of any statement, promise or forecast which is misleading, false or
deceptive induces or attempt to induce others for acquiring, disposing, subscribing
for, or underwriting security shall be guilty of an offence and liable to penal
servitude for a term not exceeding seven years.


Liability under professional misconduct
This is stipulated in a code of ethics for Professional Accountant (disciplinary actions) which are
set out by NBAA and TAA as detailed on chapter one.

6.0 Expectation Gap

4.1 The public opinion has become very important in determining what is expected by
auditor’s day-to-day practice. Aggressive litigation is a strong driving force behind
changes in professional recommendation is to what constituter ‘best practice’. The
expectation gap, which is expected to exist, is instrumental in leading to legal actions
against auditors. The gap lies between interpretations of their duty as independent
auditors and client/shareholders interpretation of that duty.

Auditor see their task as Prepares and users of the
assembling sufficient accounts expects auditors (
relevant , reliable audit by virtue of their claimed
evidence to enable them sills and because the high
form an opinion as to the fees they are paid ) to be
truth and fairness of effective in discovering or
financial statements Expectation detracting material cases of
fraud or other irregularity
.Auditors are not always
noted for being effective in
Gap this particular respect
Auditors consider fraud Preparer’s and users argue
detection as a by product of that auditors should design
work they carry out and their tests with the aim of
they do not design their making detection of fraud a
audit test for the specific more central objective- it
purpose of hunting out should not just be an
fraud and error occasional spin-off benefit


The gap can either be liability, performance or standards gap depending on circumstances.

Deep pocket Syndrome
Anti- Auditor litigation is also blamed on the ‘deep pocket syndrome’. This means that in the
wake of a corporate collapse or significant audit failure, creditors or plaintiffs often look to see
which professional advisors involved have the deepest pocket’ in terms of professional
indemnity insurance.
They may then launch an action against those advisors despite an absence of any good evidence
that the advisor was actually negligent.

Auditors duty of confidentiality
Is an implied term of an accountant’s contract with a client, for this reason an accountant should
not, as a general rule, disclose to the other persons, against the clients wishes, information about
the client’s affairs acquired during and as a result of their professional relationship.
An accountant or auditor who becomes aware that a client has committed default or an unlawful
act is normally under no obligation to disclose what she knows to external authorities. But some
circumstance may allow e.g. terrorist actions and money laundering as required by statute.
The auditors have no direct statutory responsibility to detect and reporting fraud, error and other
irregularities but the ISA suggest that “audit procedures should be designed to give an auditor a
reasonable chance of detecting any material misstatement .The standard goes on to suggest how
the auditor should approach the design of the audit work through adequate planning.

Auditors liability- Risk minimization techniques for potential claim/litigation against an
auditor
1) Maintain high quality control audit standards
a. Personnel with necessary qualification, professional as well as academic ability and
willingness to learn
b. Regular performance appraisal
c. Compulsory on job training and a wide range of exposure and circumstances
including attendance to CPD programs.
d. Adequate remuneration to audit personnel
e. Full documentation of audit work for regular reviews by superiors, including review
of audit working papers and programs.
f. Close supervision of delegated work including staff competence in specific
assignment with adequate guidance.

2) Maintaining high quality Audit Controls and procedures
a. Ensure all registered members adhere to the professional standards
b. Obtain public confidence in the profession by demonstration concern for high
standard of work.
c. Demonstrating to the public authorities and other instrument that the profession is
discharging its fiduciary responsibilities
d. Instituting quality controls within firms e.g. peer reviews

3) Encouraging audit firms to become limited liability companies
4) Setting maximum limits of claims against auditors e.g fixed liability as a factor of the audit
fee


5) Setting claims and damages in proportion to respective responsibilities e.g where there is a
contributory negligence on party other than the auditor, such party should be made to bear
part of the claim
6) Use of sound and complete audit standards and guidance appropriate to circumstances of the
specific audit
7) Regular client screening to weed out difficult clients
8) Understanding the client’s business well together associated customers including the integrity
of its shareholders
9) Use of carefully drawn engagement letters and where necessary letters of clarification and
signing contracts which clients specifying the remedies for each party.
10) Exercising extra caution when dealing with clients with financial difficulties e.g. clients with
pending litigation or impending threat of insolvency.
11) Maintain professional independence and integrity all times irrespective of having an
assignment with your client
12) Use of sound and complete audit standards and guidance appropriate to circumstances of
specific audit.


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