Week 3 Ethics and auditors legal liability.pptx

Week 3 Ethics and auditors legal liability

1. Week 3 Ethics and auditors' legal liability

2. Concept of a profession Five attributes of a profession A systematic body of theory Authority Community sanction Ethical codes A culture 2

3. Concept of a profession Professional characteristics: Mastery of a particular skill Adherence to a common code of values and conduct Acceptance of a duty to society 3

4. Concept of a profession Duties of a profession: Competence in the field of expertise and knowledge Integrity in client dealings Objectivity in offering services Confidentiality Discipline 4

5. Duties of a professional accountant Duties to sustain a fiduciary relationship: Behaviour that espouses responsible values. Attention to requirements of clients and stakeholders. Acquire and maintain required skills and knowledge. Maintain credible reputation. Maintain acceptable personal reputation. 5

6. Duties of a professional accountant Values required to carry out duties and maintain rights includes : Honesty Integrity Exercise of due care Objectivity Confidentiality Competence Assumes a commitment to put the public, the client, the profession and employer ahead of any self-interest. 6

7. Professional ethics and the accountant Ethics is concerned with the evaluation of choices where options are not clear, or where there is no absolute right or wrong. Study and practice of ethics are important to enable an accountant to examine critically a situation in which there is a conflict of loyalties and interest. 7

8. An understanding of ethics and ethical issues The word ‘ethics’ is derived from the Greek word ethos, meaning ‘character’. Whereas morality focuses on the ‘good’ and ‘bad’ of human behaviour, ethics focuses on what is ‘right’ and ‘wrong’, and how and why people act in a certain manner. Ethics focuses on a study of choices, standards and behaviour. 8

9. An understanding of ethics and ethical issues The nature of ethics: Teleology Deontology Virtue ethics Ethical relativism 9

10. Professional ethics for accountants Include standards of behaviour for a professional person. Designed for practical and idealistic purposes. Co-regulation of audit independence and standard setting. However, professional ethics has been left in the hands of the profession. 10

11. Code of Ethics for professional accountants Issued in June 2006 by the Accounting Professional and Ethical Standards Board (APESB). Amended in 2011. Part A – Fundamental principles Part B - Members in public practice. Part C – Members in business. 11

12. Code of Ethics for professional accountants Changes from 1 January 2011 Independence requirements extended. Requirements for members joining public interest audit clients. Extending partner rotation. Provisions regarding non-assurance services. Pre or post issuance review. Non-assurance services provided to clients. 12

13. Fundamental principles Public interest is the overriding responsibility Integrity Objectivity Professional competence and due care Confidentiality Professional behaviour For each principal, a conceptual framework is used to identify possible threats and safeguards. 13

14. Types of threats Self-interest threats may occur as a result of financial or other interests of a member, or of an immediate or close family member. Self-review threats may occur when a previous judgement needs to be re- evaluated by the member responsible for that judgement. 14

15. Types of threats Advocacy threats may occur when a member promotes a position of opinion to the point that subsequent objectivity may be compromised. Familiarity threats may occur when, because of a close relationship, a member becomes too sympathetic to the interests of others. 15

16. Types of threats Intimidation threats may occur when a member may be deterred from acting objectively by actual or perceived threats. Public practice behaviour threats may occur as a result of inappropriate marketing of professional services and products. 16

17. Safeguards Safeguards may eliminate or reduce threats to an acceptable level. Two broad categories of safeguards: Safeguards created by the profession, legislation or regulation. Safeguards created in the work environment. 17

18. Safeguards: examples Safeguards created by the profession legislation or regulation: Continuing professional development requirements. Professional standards. Corporate governance regulations. Safeguards created in the work environment: Leadership and transparency. Recruitment procedures for high calibre staff. 18

19. Liability to shareholders and auditees In respect of the provision of auditing services, an auditor is liable to compensate a plaintiff if: a duty of care is owed to the plaintiff and the audit is negligently performed; and the plaintiff has suffered a loss as a result of the auditor’s negligence (where the causal relationship is reasonably foreseeable) and the loss must also be quantifiable.

20. The following issues, therefore, need to be considered and each dealt with separately : Due care; Negligence; Privity of contract; Causal relationship; Contributory negligence; and Damages.

21. The auditor’s duty of care The development of the concept of due care, as applied to the performance of an auditor’s duties, is considered by referring to cases decided in UK and Australian courts. Consideration is also given to the relevance of the profession’s auditing and accounting standards.

22. Implications of the Kingston Cotton Mill and the London and General Bank cases These two cases have formed the basis for most subsequent decisions as to the determination of auditor negligence. The auditor is not necessarily answerable for an error of judgement, provided he or she exercises the skill and care of a reasonably competent and well-informed member of the profession. Nevertheless, a too-literal interpretation of the Kingston Cotton Mill case has been criticised as retarding the development of improved auditing practices.

23. Pacific Acceptance Corporation Ltd v. Forsyth (1970) The narrow interpretation of the Kingston Cotton Mill case concerning some audit practice was finally laid to rest by the Pacific Acceptance case. The Pacific Acceptance case showed the changing expectations in respect of the auditor’s responsibility, with the standard of reasonable care also being raised. ‘Reasonable skill and care’ calls for changed standards to meet changed conditions or changed understanding of dangers, and in this sense standards are more exacting today than in 1896 (Kingston Cotton Mill case).

24. Due care further emphasised in : The Royal Commission into HIH Insurance ‘… auditors have an obligation to ensure that they are, and are seen to be, maintaining high standards of honesty and probity, acting in the interests of the shareholders of the company … and exercising independence of mind …’ Stanilite Pacific Ltd & Anor v. Seaton and Ors (2005) (trading as Price Waterhouse) the judgement referred to ‘… an extension of the duty to exercise reasonable skill and care in giving consent for their report to be included in a prospectus …’

25. Negligence Negligence has been defined as any conduct that is careless or unintentional in nature and entails a breach of any contractual duty or duty of care in tort (that is, to those who the auditor could reasonably foresee would rely on the auditor’s report), owed to another person or persons. The auditor’s duty of care to a client thus arises either in contract or in the tort of negligence.

26. Subsequent to the Pacific Acceptance case, the Australian accounting bodies issued more comprehensive and specific auditing standards and practice statements concerning the conduct of the audit. Disputes may still arise as to whether, in a specific engagement, an auditor has complied with the standards and thus has a good defence against an action for damages on the grounds of negligence.

27. Privity of contract The term privity of contract refers to the contractual relationship that exists between two or more contracting parties. An audit is assumed to be performed in accordance with professional standards unless the contract (engagement letter) contains specific wording to the contrary. Under contract, only the directors (on behalf of the company) or, more commonly, the liquidator or receiver, may sue the auditor in respect of losses incurred by the company arising from the auditor’s negligence. Individual shareholders, creditors, employees etc. have no claim against the auditor under contract.

28. Causal relationship A causal relationship exists between the breach of duty by the defendant and the loss or harm suffered by the plaintiff. 1.This relationship must have been reasonably foreseeable and 2. It must be proven that the loss suffered is attributable to the negligent conduct of the auditor in a negligence case.

29. Privity of contract Segenhoe Ltd v. Akins & Ors (1990) The court held that where an auditor has been negligent and the company has been induced to pay a dividend out of capital — relying on an Incorrectly audited profit and loss account — the auditor is liable for the loss incurred. Galoo Ltd v. Bright Graham Murray (1994) Reaffirmed the causation relationship requirement to establish the liability of the auditor.

30. Contributory negligence Contributory negligence relates to the failure of the plaintiff to meet certain required standards of care. Together with the defendant’s negligence, it contributes to bringing about the loss in question. The judgement in the AWA case is the landmark decision on contributory negligence in an auditor–client relationship.

31. Damages Where auditors fail in their duty to act with reasonable care and skill, whether under contract or in tort, a plaintiff is entitled to recover any economic loss arising out of such a breach of duty. Two issues need to be considered : Firstly, what is the purpose of statements that may give rise to reliance reasonably being placed on them? Secondly, to what extent may responsibility for any loss be assigned on the one hand to the auditor’s negligence and, on the other, to other causes and other parties?

32. Proximity and third party liability As a result of the reluctance of professional indemnity insurers to allow cases to come to court there are very few decided Australian (or overseas) cases of significance involving claims by third parties against auditors. Most of these cases involve action being brought by companies relying on audited accounts in making a takeover bid for another company. Proximity is held to arise through the fact that where a company’s financial condition is such that it is a likely takeover target, auditors should be aware that potential suitors will rely on the accounts and that a duty of care thus arises.

33. The House of Lords in the Caparo case argued that the purpose of the financial statements on which auditors express an opinion is to assist the shareholders in their collective function of scrutinising the company’s affairs. It would be unreasonable, therefore, to hold the auditors responsible for their use, by shareholders or others, for any other purpose. the judgement in the Esanda case was a positive development for auditors because the Court rejected the contention that liability could be based on foreseeability of reliance alone. The Court found that there had to be circumstances establishing a relationship of proximity between the auditor and the third party before a duty of care could be said to exist.

34. Trade Practices Legislation Rights for individual investors. S.52 prohibits misleading and deceptive conduct and has been used as a basis for successful actions by investors.