Audit 3

According to the last digit of my Roll Number (H-5279752), I am required to select the topic “Legal liability of Auditors”. For this purposes I have prepared this Field Study Report in the light of the subject “Auditing (MBA-580)”. In the first part of this Report I have reviewed theoretical part of my topic and in the second part the practical aspects. For the purposes of field study I have selected M. Yousaf Adil Saleem & Co., Chartered Accountants, Cavish Court, A-35, Blocks 7 & 8, KCESU, Shahrah-e-Faisal, Karachi, which are providing the auditing services to the companies.

LIABILITY OF AN AUDITOR APPOINTED BY A PRIVATE CONCERN The auditor must obtain instructions in writing from his client in the case of a private concern relating to the scope of his duties so that he may not be held responsible for work, which he never undertook to perform. If the auditor does not faithfully comply with the instructions and performs his work in a manner so as to result in negligence and consequential loss to the client, he may be held responsible for it. If he fails to perform his duties as laid down in the agreement which was entered into between him and his client, he may be sued under the Contract Act, 1872.

LIABILITY OF AN AUDITOR APPOINTED BY A LIMITED COMPANY A chartered accountant is qualified to become the auditor of a public company or a private company which is a subsidiary of a public company or having paid up capital more than Rs. 3,000,000/-. A firm whose partners are practising in Pakistan as Chartered Accountants can be appointed by its firm name as auditors of a company and can act in its firm name. DUTIES The auditors are required to make a report to the members of the company on the accounts and books of accounts of the company and on every balance sheet and profit and loss accounts or income and expenditure statement. Their report covers all other document forming part of the balance sheet and profit and loss accounts or

income and expenditure account, including notes, statements or schedules annexed with the financial statements and which are laid before the members of company in general meeting during their tenure of office. The report covers the following matters:

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Obtaining of all information and explanations necessary for the purposes of the audit.

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Proper books of accounts required by Companies Ordinance, 1984 have been kept by the company.

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Preparation of the balance sheet and profit and loss account or in the income and expenditure account in conformity with the Companies Ordinance, 1984 and in agreement with the books of accounts;

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Opinion regarding true and fair view of the (1) balance sheet as at the end of its financial year (2) the profit and loss accounts or the income and expenditure account and profit, loss, surplus or deficit for its financial year and (3) the statement of changes in financial position or sources and application of funds of a listed company, of the changes in the financial position or the sources and application or funds for its financial year.

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Opinion regarding (1) incurring of expenditure during the year for the purposes of the company’s business and (2) conducting the business, making investments and incurring of expenditure during the year in accordance with the objects of the company; and

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Deduction of zakat deductible at source under the Zakat and Usher Ordinance.

AUDITORS' LABILITY FOR NEGLIGENCES An auditor to a limited company is an agent of the shareholders. He is required to exercise reasonable care and, skill in the performance of the work entitled to him, and if he fails to do, then the question of his liability with reference to the negligence arises. This matter is discussed in the light of legal provisions as under: (1) Where an auditor is proved to be negligent but no loss is sustained by his client arising out of his negligence, he is not liable.

(2) An auditor cannot restrict his liability by entering into an agreement as his duties are defined and laid down in the Companies Ordinance, 1984, and therefore any such agreement (if executed) would be against the law and will be void. He will be liable for damages in spite of such an agreement. (3)An indemnity clause inserted in the articles of a company, by which the directors, managing agents, auditor and other officers of the company are relieved from liability has been declared void by Section 194. However, the court may relieve an auditor of liability for negligence, or misfeasance if it is proved that he acted honestly and reasonably. (4) If the auditor fails to perform his job with reasonable care and skill and consequently his client suffers a loss due to his negligence, he is liable to make good the loss on an action being taken against him by the company. (5) Action against the auditor for negligence can be taken any time during the life-time of the company. AUDITORS' LIABILITY FOR MISFEASANCE After a company has gone into liquidation, misfeasance proceedings can be instituted against the auditor by: (1) The liquidator, or (2) The creditor, or (3) A contributory of the company. The term 'misfeasance' means breach of duty involving the company in a loss. Under Section 412 when a company in liquidation, its past and present directors, promoters, managing agents and auditors are liable to make good all losses sustained by the company on account of negligence of duty or breach of trust if misfeasance proceedings are initiated against him within the prescribed time.

CRIMINAL LIABILITIES AND AUDITOR

An auditor may be guilty of a criminal offence under the following sections: Section 270 260

417

418 492

Extent of Liability As the result of a public prosecution initiated, an auditor may be held criminally liable. An auditor may be liable to a fine up to Rupees 2,000 if his report does not comply with the requirements of Sections 157, 255 and 257. If the auditor's report is made with the intent to profit such auditor or any other person or to put another person to a disadvantage or loss or for a material consideration, the auditor shall, in addition to the penalty provided be punishable with imprisonment for a. term which may extend to six months and with fine which may extend to Rs. 2,000. If a charge of falsification of accounts or forgery is brought against an auditor, he may be liable to imprisonment for a term, which may extend to two years or also to a fine, which may extend to Rs. 20,000, or with both. An auditor may be prosecuted if it is proved that he has been guilty of any criminal offence in relation to the company. If an auditor makes a false statement in any report, certificate, balance sheet etc., knowing it to be false he is liable to imprisonment for a term, which may extend to three years and also to a fine not exceeding Rs. 20,000.

AUDITORS LIABILITY IN DUAL APPOINTMENTS When two auditors are appointed to audit the accounts of a concern and to submit a report on the accounts, each in jointly and severally liable, unless the contrary is clear from the terms of the appointment. LIABILLITY OF AN HONOURARY AUDITOR An honorary auditor cannot relieve himself of liability on the plea that the agreement between him and his client was not supported by consideration and hence it was void. It is generally believed in the profession that if he wishes to relieve himself of the liability, he should not commence the work.

AUDITOR A WATCHDOG AND NOT A BLOODHOUND The auditor; like the watchdog, is employed to protect the interests of those who appointed him. While he would be entitled to assume that trusted servants of the company were honest, he could only rely upon their statement provided he took reasonable care and used his normal skill. In adopting the attitude of watchdog, he would not be exonerated from his responsibilities if he took everything for granted. He must perform his duties with the normal degree of skill and care. In case of suspicions he must thoroughly investigate into the matter and assume the role of a detective, also he is not expected to have a suspicious mind unless the circumstances of the case aroused his suspicions. However, the law is restricted from imposing upon auditor responsibilities, which the circumstances of his office would not warrant. He is not likely to be held reliable resulting from a fraud, which could not be uncovered by the application of normal skill and reasonable examination of the books of accounts produced to him. However, an auditor must not be a sleeping watchdog.

M. Yousaf Adil Saleem & Co. is a partnership firm of Chartered Accountants. Its main office is situated at 138140, Regency Arcade, The Mall, Faisalabad. It has other offices at Karachi, Islamabad and Lahore. The firm is exclusively involved in the auditing services to companies and private concerns. Its one of the clients is M/s. Sitara Energy Limited. The main object of the company is to carry on the business of Electric Power Supply and to fulfil this object, the company do such acts which are incidental to the main business and conducive to attaining the main object. The said company appointed M. YOUSAF ADIL SALEEM & CO., as auditors for the years 1998 and 1999. They audited the accounts for the said periods and submitted the same to the shareholders as well as regulatory bodies according to the statutory provisions. The Securities and Exchange Commission of Pakistan, a regulatory body of the corporate sector in Pakistan, while examining the accounts revealed that the company paid donations amounting to Rs. 6,609,169/- in year 1998 and Rs. 38,487,202/- in the year 1999 out of which Rs. 6,209,543 and Rs. 37,023,000/- for the years 1998 and 1999 respectively were paid to Aziz Fatima Trust.

Since quantum of donation paid was very high i.e., in the year 1999 it calculates to above Rs. 2/- per share, the Commission inquired the position from the auditors and the management. In response both auditors and management quoted the following explanations:  The company owns the biggest power plant in the private sector and is making good profits and paying handsome cash dividends to the shareholders (1999 – 60%) (1998-35%) (1997-25%).  It is purely charitable donation and we are supplementing the government welfare activities.

 Aziz Fatimah Trust is a charitable institution duly approved by the CBR and the Hospital is providing adequate medical care to the poor, needy and suffering humanity.  Donation was given with the approval of the Board of Directors. The Commission after hearing both auditors and management concluded that:  The company’s Memorandum and Articles of Association revealed that it does not contain any clause authorizing it to pay donations.  Majority of the directors of the company have interest as trustees in the Trust.  The resolution of the Board of Directors totally disregarded the company’s main object and also jeopardized the interests of shareholders.  The assets of a company cannot, as a rule, be employed for any purposes other than those pertaining to the objects specified in the Memorandum and Articles of Association. Many judgements are available:  Halsbury’s Laws of England Vol. 6 (Page 170, para 357)  Ashbury Ry. Carriage company Vs. Riche, (1875) LR 7 HL 653  Dr. Lakshmanaswami Mudaliar Vs. LIC (1963) :AIR 1963 SC 1185  Chitralipi Films 1974 Tax LR 2180 at 2185 (Cal.).  Directors are not authorized to contribute to donations and charities to unlimited extent as has been resolved.  Whatever the justification of payment for donation may be, fact remains that it has been paid out of assets belonging to the members of a company.  The auditors failed to qualify the expense in the audit of accounts and they are found guilty of professional misconduct. As the spirit of law has been defeated in this case, therefore, in terms of the provisions of section 472 of the Companies Ordinance, 1984 the company’s directors are issued orders on April 5, 2000 to deposit the total sums of Rs. 57,619,979/- in company’s account within 30 days.

 In the above stated case it is true that the interest of shareholders especially small shares has been jeopardized as the management has paid a huge amount of donation (Rs. 2/- against per share).