Part Three
Audit
Responsibilities
Structure of Seminar
• 1.Auditing Standards
• 2.Professional auditing standards system
• 3.Fundamental principles of professional
ethics
• 4.Audit Quality
• 5.Audit liability
1.Auditing Standards
• From 2004, Auditing & Assurance Standards Board
(AUASB) constituted under the government’s
Financial Reporting Council (FRC); issues Australian
Auditing Standards (ASAs)
• From 1 July 2006, Australia fully adopted
international auditing standards (ISAs)
• Standards a minimum level of care
2.Professional auditing
standards system
1.Auditing standards
-National auditing standards
-Independent Auditing Standards
-Internal auditing standards
-International Standards on Auditing
3.Fundamental principles of
professional ethics
The CPA’s Code of ethics and conduct sets out five
fundamental principles of professional ethics and
provides a conceptual framework for applying those
principles. Members must apply this conceptual
framework to identify threats to compliance with the
principles, evaluate their significance and apply
appropriate safeguards to eliminate or reduce them so
that compliance is not compromised.
• The fundamental principles
• Members of the CPA must comply with the
fundamental principles set out in the Code of ethics
and conduct (integrity, objectivity, professional
competence and due care, confidentiality and
professional behaviour)
• Confidentiality
•
Confidentiality requires members to refrain from
disclosing information acquired in the course of
professional work except where:
- -Consent has been obtained from the client, employer
or other proper source, or
--There is a public duty to disclose, or
--There is a legal or professional right or duty to
disclose
• A member acquiring information in the course of
professional work should neither use nor appear to
use that information for his personal advantage or for
the advantage of a third party.
• In general, where there is a right (as opposed to a
duty) to disclose information, a member should only
make disclosure in pursuit of a public duty or
professional obligation.
•
A member must make clear to a client that he may
only act for him if the client agrees to disclose in
full to the member all information relevant to the
engagement.
• Where a member agrees to serve a client in a
professional capacity both the member and the client
should be aware that it is an implied term of that
agreement that the member will not disclose the
client's affairs to any other person save with the
client's consent or within the terms of certain
recognised exceptions, which fall under obligatory
and voluntary disclosures.
• If a member knows or suspects his client to have
committed money-laundering, treason, drugtrafficking or terrorist offences, he is obliged to
disclose all the information at his disposal to a
competent authority. Auditing standards require
auditors to consider whether non-compliance with
laws and regulations affects the accounts.
• Integrity, objectivity and independence
The fundamental principles require that members
behave with integrity in all professional and business
relationships and they strive for objectivity in all their
professional and business judgements. Objectivity is a
state of mind but in certain roles the preservation of
objectivity has to be shown by the maintenance of
independence from those influences which could
impair objectivity.
It is very important that the auditor is impartial,
and independent of management, so that he can give
an objective view on the financial statements of an
entity. The onus is always on the auditor not only to
be ethical but also to be seen to be ethical.
Independence and objectivity matter because of:
(a) The expectations of those directly affected,
particularly the members of the company. The audit
should be able to provide objective assurance on the
truth and fairness of the financial statements that the
directors can never provide.
(b) The public interest. Companies are public
entities, governed by rules requiring the disclosure of
information
• What can the auditor do to preserve objectivity? The
simple answer is to withdraw from any engagement
where there is the slightest threat to objectivity.
However there are disadvantages in this strict
approach.
--Clients may lose an auditor who knows their business.
-- It denies clients the freedom to be advised by the
accountant of their choice.
• A better approach would be to consider whether the
auditors' own objectivity and the general safeguards
operating in the professional environment are
sufficient to offset the threat and to consider whether
safeguards over and above the general safeguards are
required, for example specified partners or staff not
working on an assignment.
• However the ultimate option must always be
withdrawing from an engagement or refusing to act.
• Threats to independence and objectivity Compliance
with the fundamental principles of professional ethics
may potentially be threatened by a wide range of
different circumstances. These generally fall into five
categories:
•
Self-interest
•
Self-review
•
Advocacy
•
Familiarity
•
Intimidation
4.Audit Quality
• DeAngelo [1981] – “the ability to detect
misstatements plus to report the misstatements”
• In other words: Quality = Competence +
Independence
• Both are essential!
5.Audit liability
• 1) The Legal Environment
• Auditors, as professionals, have a fiduciary duty to
act in the best interests of shareholders
• Auditors are accountable in law for their professional
conduct
• Alleged audit failures can result in litigation against
audit firms
• Requirement to hold a practising certificate imposes
obligation to have professional indemnity (PI)
insurance for possible liability
Audit liability
• A “hard” insurance market
• This source of “compensation” (insurance) creates a
perception of auditors having “deep pockets”, thus
claims against auditors
• This is consistent with the insurance hypothesis of the
demand for auditing!
The “Litigation Crisis”
The Litigation Crisis
Settled Cases
Out of Court Settlements
• Protection of auditors’ reputation
BUT
• Confidence problems not addressed
• Auditing standards may not be adjusted
• Audit expectations gap may not be addressed
• Lack of impetus for regulatory change
• Issues related to audit quality & independence are not
publicly analysed
Audit liability
• 2) Bases of Liability
• Contract law
• Engagement letter is contract between auditor &
directors
• Common law (tort of negligence) (next slide)
• Trade Practices law
• S.52 prohibits deceptive & misleading conduct
• Issuing a ‘clean’ opinion when a qualified opinion is
warranted?
Audit liability
3.)Professional Negligence
• Action for damages may also be brought against an
auditor under tort of negligence
– Conduct that is careless or unintentional & breaches
duty of care
– Extension of Donoghue & Stevenson (1932) to
financial injury
• Negligent misstatement
• What are the essential elements?
• What constitutes due care?
• To whom does the auditor owe a duty of care?
What is Due Care?
• Kingston Cotton Mill Co. (1896)
• London & General Bank (1895)
• The auditor is not necessarily answerable for an error
of judgment, provided he/she exercises the skill and
care of a reasonably competent and well-informed
member of the profession
• A “watchdog” not a “bloodhound”
• Pacific Acceptance Case (1970)
• “Reasonable skill and care” calls for changed
standards to meet changed conditions or changed
What is Due Care?
understanding of dangers, and in this sense standards
are more exacting today than in 1896
• Standards are thus a minimum standard of care
• HIH Royal Commission emphasised the fiduciary
duty of auditors, as users rely on their integrity
Duty to Third Parties
Duty to Third Parties
• Esanda – good news for auditors, but is it socially
desirable?
• Liability of experts for consequences of negligent
advice
• Common law remains complex and uncertain due to
differences in judicial opinions & interpretation
• Courts must balance rights & responsibilities of
auditors, investors & wider society
Audit liability
• 4)Reform of Legal Liability
• Professional Standards Legislation (PSL) 2004
• Co-ordinates state & territory level legislation to be
nationally consistent
• Limits civil liability for misleading & deceptive
conduct
• Occupational schemes registered under PSL
• Must have minimum PI cover of $500,000
• A statutory cap on liability relative to fees charged
• Proportionate liability replaces joint & several
liability
• Contributory negligence (AWA Case) now irrelevant
Reform of Legal Liability
•
•
•
•
•
•
CLERP 9 Act (2004)
Companies can be registered as an auditor
Authorised Audit Company
Each director must be a registered auditor
AAC must have adequate PI cover
Suggested cover to be 10 times the maximum
engagement fee
• Reforms designed to address possible dysfunctional
consequences of litigation and insurance crises.
Audit liability
•
•
–
–
•
–
•
•
5)Avoidance of Litigation
Engagement letters
Audit & non-audit services
Clearly define scope & responsibility
Investigate prospective clients thoroughly
The first line of defence!
Comply fully with professional standards
Recognise their limitations – a minimum standard
only
•
–
–
•
–
•
•
Engagement letters
Audit & non-audit services
Clearly define scope & responsibility
Investigate prospective clients thoroughly
The first line of defence!
Comply fully with professional standards
Recognise their limitations – a minimum standard
only
Audit liability
• 6) Conclusions
• Business failure ≠ audit failure!
• Litigation is a significant & costly issue for the
profession
• Auditors must take great care to protect themselves
from litigation by complying with professional
pronouncements, using sound judgment and
maintaining quality & independence