Acceptance Of Audit Engagement

ACCEPTANCE OF AUDIT ENGAGEMENT The following are the steps of a prospective auditor should take before deciding whether to accept or not his/her nomination as the auditor: i) Consider qualification for the appointment i.e. validly appointed as an auditor in accordance with the Companies Act e.g. have attained the minimal qualification as identified in the first column of the Accounts Act: • He is not a body corporate, • He is not an officer or servant of the company, not a person who is a partner or in the employment of an officer or servant of the company, • He is not disqualified to be an auditor in a parent, subsidiary etc. Professional ethics do not block him from being an auditor. ii) Meet with the management and know exactly what the assignment involves to ascertain: • The size, location and nature of his potential client and evaluate his ability to serve her/him in terms of resources. • The number, qualification and experience of the personnel to be used in such audit. • To know the timing of the audit i.e. the year end of his potential client and the time the report is required not to delay. AGM. • The current commitment of the firm e.g. the listing of the firm in the stock exchange, mergers, acquisition etc to enable the auditor to assess his liability. iii) Request the client to give permission to communicate with the retiring auditor to find out whether there are reasons professional or otherwise as to why he should not accept the appointment such as: • Reason for his removal • Integrity of the management and their management styles e.g. centralized, decentralized, democratic etc. • Areas of potential risk to put more emphasis while auditing • Nature of the internal control systems to know whether they can be relied upon. NB: Depending on the assessment of the potential client, the auditor can decide to accept or reject the appointment. Once the auditor has accepted the appointment, he should communicate this to the client through a letter of engagement.

Legal liabilities of auditors Auditors are supposed to perform their work in an honest and careful manner since they can be held liable for negligence in the following ways: a) They don’t carry out their work as required by the ISA b) They fail in the duty of protecting the interest of the various users of the financial statements i.e. any person who relies on his work. c) They don’t carry out their work with due care and skill i.e. what an ordinary skilled man or woman would do in that circumstance. N.B. The auditor’s liability falls under three categories: i) To their clients (company itself) ii) To third parties in case of negligence iii) Civil and criminal liabilities CIVIL LIABILITY UNDER THE STATUTE All auditors can be sued in a civil court when they have breached their position of trust e.g. if an auditor uses information acquired during the course of the audit to make financial gain , then in such a case he or she can be sued for breaching his position of trust and confidentiality.

CRIMINAL LIABILITY UNDER THE STATUTE Section 46 of the Companies Act provide that an auditor shall be criminally liable if he willingly makes a material false statement in any report, certification or in the financial statement with the intention to deceive and mislead. Examples of criminal liabilities include: i) The auditor accepts appointment when he is ineligible to do so or continue in office after becoming ineligible. ii) The auditor obtains the advantage of deception. iii) The auditor falsifies accounting records or documents. iv) When the auditor publishes misleading statements intended to deceive members. v) When an auditor misappropriates a clients’ property. vi) When the auditor destroys, defaces or conceals any account record or document made or required for any accounting purpose.

LIABILITY UNDER THE LAW OF CONTRACT There is a contractual relationship between the auditor and his client .Under this contract it is implied that the auditor will carry out the work with a reasonable degree of skill and care. The degree of care and skill required will mainly depend on the nature of work undertaken. Generally if the auditor has complied with ISA it is difficult to prove that he was negligent. In the absence of suspicious circumstances the auditor will not be liable for failing to uncover fraud and error which could not be discovered by exercise of normal skill and care. The auditor can be accused of negligence if: • He fails to detect fraud or error that he could have reasonably detected i.e. material misstatement • He fails to comply with the Generally Accepted Auditing Standards (GAAS) and practices e.g. attending stock take, circularizing debtors, writing to the bank etc. NB: For the client to succeed in a claim for financial loss he must satisfy the court in relation to three matters: i) That there existed a duty of care enforceable by the law ii) That where the duty existed the auditor was negligent in the performance of that duty judged by acceptable professional standards iii) That the client suffered some financial loss as a direct consequence of the auditor’s negligence.

LIABILITITY TO THIRD PARTIES (USERS OF FINANCIAL STATEMENTS) An auditor may be liable for negligence not only under the law of contract but also in the law of tort i.e. if a person to whom he owed a duty of care has suffered financial loss as a result of the auditor’s negligence. For the third party to succeed he must prove the following: • The auditor owed him a duty of care • The auditor was negligent • He has suffered financial loss resulting from the auditor’s negligence.

DUTY OF CARE In Hedley Byrno V. Heller A duty of care exists where there is a special relationship between the parties i.e. where the auditor knows or ought to have known that the audited accounts would be made available to and would be relied on by a particular person. Auditors owe a duty of care if the following conditions are met: • He is fully aware of the nature of transactions which the plaintiff had in contemplation e.g. during the issue of prospectus. • He knew that the advice or information would be communicated to the plaintiff either directly or indirectly • He knew that it was very likely that the plaintiff would rely on that advice or information in deciding whether or not to engage in the transaction in contemplation. The Caparo case: The facts of this case were that Caparo Industry Public Limited Co. purchased shares in Fidelity Public Limited Co. from June 1984 and subsequently made a successful take over bid for Fidelity. Caparo alleged that purchase of most of the shares were made on reliance of fidelity accounts for the year to 31st March 1884 which had been credited by Touché Ross and that those accounts were inaccurate i.e. sold at a profit of 1.3 Million instead of a loss of 0.4 Million. Caparo alleged that if the true facts had been known they would not have made a bid. The decision was that in the circumstances the auditor owed no duty of care to the shareholders either actual or potential in respect to investment decisions. Kingston Cotton Mill Company In this case, auditors accepted the certificate of the manager, a person of acknowledged competence and high reputation to the value of stock in trade. The stock was grossly over estimated for several years in the balance sheet as a result of which dividends were paid out of capital .The auditors did not examine the books, if they had done so and compared the amount of stock at the beginning of the year with the purchase and sales during the year they would have seen that the valuation required explanation. It was held that the auditors were not liable i.e. it is not the auditor’s duty to take stock and he does not guarantee the discovery of all frauds .It was stated that the auditor is a watchdog but not a blood hound.