Which categories does auditor’s liability fall under?

1. Civil and criminal liabilities.
An auditor could be sued in a civil court if he breaches his position of trust and confidentiality. E.g.
if he uses information acquired in course of an engagement for his financial gain or for benefit
of another party. Regarding criminal liability, section 136 of the companies Act provides that an
auditor shall be criminally liable if he willfully makes false statement in any report, certificate or
financial statements with an intention to deceive or mislead.

2. Liability to the client company under law of contract.
The audit client company represents all shareholders acting as a body (in this respect, a
company cannot be represented by a single shareholder). The auditor has a duty to report to the
shareholders whether the financial statements show a true and fair view. The auditor therefore
has a contract with the company. Under this contractual relationship, it is implied that the auditor
will carry out his work with a reasonable degree of care and skill. The degree of care and skill
required mainly depends on nature of work undertaken. Generally if the auditor has complied
with the GAAPs and guidance from the ISAs, it would be difficult to prove that the auditor was
negligent.
In the case of Kingston cotton mill, the judge considered the degree of care and skill required
of an auditor and declared that it is the duty of an auditor to bring to bear on the work he has to
perform, that skill, care and caution which a reasonably competent, cautious and careful auditor
would use.
The auditor has no duty to an individual shareholder. A shareholder who makes an investment
decision by relying on the auditor’s report and suffers financial loss cannot claim for damages
under the law of contract. Only if the company i.e. the entire body of shareholders has suffered
a loss can such a case be brought under law of contract .

3. Liability to third parties under tort or negligence.
In this case third parties refer to anyone other than the client company who has used the
auditor’s report and wishes to make a claim for negligence. It therefore includes any individual
shareholders in the company, any potential invertors and other providers of capital such as
lenders and creditors. The difference between these parties and the client company is that such
third parties have no contract with the auditor and therefore no implied duty of care.
For third parties to succeed in claiming for damages under negligence, they must prove that;
• A duty of care existed i.e. the auditor owed the third parties a duty of care.
• The duty of care was breached through auditor’s negligence.
• They suffered a financial loss as a direct consequence of an auditor’s negligence.
In Hedley Byrne and Company Limited versus Heller and Partners (1963), it was held that ‘a duty
of care exists where there is a special relationship between the parties. I.e. where the auditor
knew or ought to have known that the financial statements would be made available and would
be relied upon by a particular person.’ The implication of this statement is that, for there to exist
a duty of care, the third part must have been identified in some way to the auditor. E.g. where
the directors inform the auditor that the financial statements would be used to obtain a loan, the
auditor will have to owe duty of care to the bank in the same way he owes a duty of care to the
client.

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Wilfykil answered the question on April 11, 2019 at 08:59