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The auditing profession is facing growing litigation. Some reasons are stated below:
Auditor Litigation
Audit failure is when the auditor issues an innapropriate opinion because of failing to comply with the
requirements of GAAS. These parties that suffered losses are allowed to recover some or all of the
losses. It is difficult to determine if due care hasn’t been performed. Also legal precedent makes it
difficult to determine who has the right to expect of an audit and recover losses. Connection between
audit failure and liability is not straightforward.
Bussiness failure is when a business is unable to repay its lenderos or meet expections of investors. So
financial statements may be materially misstated despite an audit done in accordance with GAAS. This is
called audit risk which is when financially statements are fairly stated when in fact they were materially
misstated. It is avoidable as well concealed frauds are hard to detct.
The underlying cause of conflit between statement users and auditors is called the expectations gap.
There is a difference in expectations between auditors role and responsibilities.
They have legal liability to their clients for negligence or breach of contract should they fail to provide
the services or should they fail to exercise due care. They will be held under common law tort of
negligence or provincial securities.
The issue here is standard of care. Failure to meet GAAS is evidence of negligence. Under tort law if
auditor is negligent they will be sued. Four things need to be satisfied.
Liability to clients
The most common source of lawsuits is clients. Duty of care isn’t an issue here. More so over not
completing contractual obligations.
Liability to third parties under common law.
Certain cases you may be liable to third parties including actual and potential shareholders, vendors,
bankers, and other creditors etc. since there is no contract they rely on tort law. They have to first argue
a duty of care.
Auditors are not liable for ordinary negligence to those that they don’t have a contractual relationship.
Hedley byrne
Forseeable third parties, says that auditors are liable if they know beforehand that the third parties
would be relying on their audit report.
Gordon t haig
Hercules
Duty of care is present when the auditor had knowledge of the specific third party or a narrow class of
third parties and the specific third party or limited class relied upon the financial statements for the
purpose of the transaction it was prepared for.
Securities legislation gives investors the right to sue auditors for misrepresentation in their audit report.
Duty of care of Hercules doesn’t apply here.
Criminal liability
Can face criminal liability, but these are rare. They can face criminal and quasi criminal liability for
breaches of securities legislation, in which the regulator makes allegations.
Auditors defense
PA typically rely on five defenses when clients or third parties make claims of negligence.