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Liabilities of an Auditor

Updated on November 7, 2016

The liabilities of an auditor can be classified into two groups; namely, liability under optional audits and liability under statutory audits.

Liability under Optional Audits

The audits which are not legally required are called optional audits. Audit of sole trading concerns, audit of partnership firms, etc. are examples to optional audits. In case of optional audits, auditor comes across two types of liabilities which are as follows;

Liability for Negligence: While conducting the work of audit, auditor should take proper care and should show proper skills. Otherwise it amounts to negligence.

  • For example: Mr. X is a sole trader and Mr. A is his auditor. A has conducted audit work so negligently and therefore he could not find misappropriation of cash, amounting to Rs. 10000/-. Now A is liable to pay such amount to X, it is called liability for negligence.

Contractual Liability: In case of optional audits rights, duties, liabilities etc of auditor will be of contractual nature. So there may be terms between auditor and client according to which auditor has to become liable on certain agreed occasions. Contractual liability is agreed liability.

Liability under Statutory Audits

The audits which are legally required are called statutory audits. Audit of joint stock companies comes into this category. Company auditors liabilities are determined by companies act itself. Liabilities of company auditor are of three types.

  1. Liability for Negligence.
  2. Liability Under Companies Act, 1956.
  3. Liability under Indian Penal Code, 1860.

Liability for Negligence

As in case of optional audits company auditor is liable for his negligence. In case where company wants to proceed legally against its auditor on the ground of negligence, the following conditions are to be fulfilled;

Company must be capable of proving that auditor is negligent.

  1. On account of auditor’s negligence, there should be loss.
  2. The loss arising out of auditor`s negligence should go to share holders.

Case laws:

  • Hudson vs Dehradun Mussori Electric Tramway Co. Ltd: In this case the meaning of negligence is given. Negligence means not taking proper care, and not showing proper skill.
  • Liverpool and Wagon Supply Association Ltd: In this case it is decided that whenever there is loss due to auditors negligence, then only auditor is liable.
  • Amritaze Vs Bruver and Knoff: In this case auditor gets failed in finding misappropriation of cash. Court decides that auditor has to contribute that amount to the company.

Liability Under Companies Act, 1956

Companies act has created civil liability to company auditor at times and at times criminal liability.

Civil Liability: The following sections of companies act read about civil liability of company auditor;

  1. Section 227 of Companies Act, 1956: Company auditor has to specify certain items in audit report. In the absence of such specification civil liabilities arises.
  2. Section 543 of Companies Act, 1956: If auditor mis-uses funds of the company at the time of liquidation, he comes across civil liability.
  3. Section 62 and 63 of Companies Act, 1956: If Company auditor unknowingly certifies false prospectus, civil liability arises.

Case laws:

  • London and General Bank: In this case auditor of the banking company gives clean report though the banking company has not made proper provision for bad and doubtful debts.
  • Union bank of Allahabad: In this case auditor of the banking company gives clean report though financial statements are of fraudulent nature.
  • London oil storage Co. Ltd vs Sean Husluct and Co: Here actual petty-cash differs from recorded balance. But auditor gives clean report.

Criminal Liability: The following sections read about Criminal liability of company audit.

  1. Section 628 of Companies Act, 1956: If company auditor certifies any false statement knowing that it is false. He will be charged with imprisonment up to two years with or without fine.
  2. Section 539 of Companies Act, 1956: If company auditor destructs records of the company at the time of liquidation, he will be charged with imprisonment up to seven years with or without fine.
  3. Section 62 and 63 of Companies Act, 1956: If company auditor certifies fraudulent prospectus knowingly he will be charged with imprisonment up to two years with or without fine.
  4. Section 240 of Companies Act, 1956: If company auditor does not co-operate with government inspectors, he will be charged with imprisonment up to six months with or without fine.

Case law: Official liquidators of Karachi Bank Ltd. vs Directors and Auditors of Karachi Bank Ltd.

Liability under Indian Penal Code, 1860

If company auditor renders any criminal activity he becomes liable under Section 197 of Indian Penal Code. Section 197 of Indian Penal Code deals with Issuing or signing false certificate. The punishment under this act is same as for the giving or fabricating false evidence.

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      rama somani 

      5 years ago

      very useful actually awesome

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      Subbareddy 

      6 years ago

      Nice article

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