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3. Standards of reporting
1. The report shall state whether the financial statements are presented in accordance
with generally accepted accounting principles.
2. The report shall identify those circumstances in which such principles have not been
consistently observed in the current period in relation to the preceding period.
3. Informative disclosures in the financial statements are to be regarded as reasonably
adequate unless otherwise stated in the report.
4. The report shall either contain an expression of opinions regarding the financial
statements taken as a whole, or an assertion to the effect that an opinion cannot be
expressed. When an overall opinion cannot be expressed, the reason therefore should
be stated.
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3. Due professional care- This standard requires the auditors to plan and carry out every
step of the audit engagement in an alert and diligent manner. Full compliance with these
standards would avoid or minimize any negligent acts or material omissions by the
auditors.
4. Adequate planning and supervision-is essential to a satisfactory audit. The appropriate
number of audit staff of various levels of skill and the time required for each need to be
determined in advance of the field work. Staff members with limited experience and new
staff members if any should be closely supervised while they are on work.
5. Sufficient understanding of internal control- effective internal control provides
assurance that the client’s records are dependable and that its assets are protected. When
the auditors find this type of internal control, the quantity of other evidence required is
much less than if control is weak. Thus, the auditor’s assessment of internal control has
great impact on the length and nature of the audit process.
6. Sufficient competent evidential matter-this standard of field work requires that the
auditors gather sufficient competent evidence to have bases for expressing an opinion on
the financial statements. The term competent refers to the quality of the evidence. Some
evidential matters are stronger and more convincing than others.
7. The reports must specifically state whether the financial statements are inconformity with
GAAP.
8. Consistency in the application GAAP
9. Adequate informative disclosure in the financial statements is to be assumed unless the
audit report states otherwise.
10. The report must contain an opinion on the financial statements as a whole, or must
disclaim an opinion.
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2.2 The need for professional ethics
All recognized professions have recognized the importance of ethical behavior and have
developed codes of professional ethics. The fundamental purpose of such codes is to provide
members with guidelines for maintaining a profession attitude and conduct them in a
manner that will enhance the professional stature of their discipline.
Characteristics of a profession
All of the generally recognized professions such as auditing, medicine, engineering, theology,
architecture and the like are characterized by the following elements/ features/.
I) Specialized body of knowledge- A highly developed profession has a very highly
specialized written body of knowledge. The more the profession is highly developed, the
more specialized the body of knowledge and voluminous requiring, longer period of time
to absorb. The body of knowledge is dynamic and in continuous development and growth
and not static. The body of knowledge here goes far beyond general education
knowledge. Always, there is need for technical competence and familiarity with
current/contemporary/ standards of practice that might be embodied in the code of
professional conducts.
II) Standards of qualification for admission- A profession to be a profession must have
well recognized and accepted predetermined criterion of qualification for admission into
the profession. The standards include educational requirements as well as other moral and
legal criteria fulfillment. The educational requirement is composed of theoretical
knowledge and practical experience. Thus, attaining a license to practice as a certified
public accountant requires an individuals or group members, to meet minimum standards
of education and experience.
III) Standards of conduct of behavior- A profession has a standard of conduct of behavior
to be observed by the professionals through prescribed code of ethics that attempt to
enforce general rules of conducts, and maximum and minimum rules on competence and
responsibility to client and colleagues.
IV) Level of status recognition- The quality and level of professional services demanded by
society determines the level of status and recognition to the profession. The level of
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status and recognitions earned in a society is a function of the quality of professional
services rendered which in turn is a function of the standards of profession qualification
and the degree of the social, moral, and legal responsibility assumed. (They have direct
relationship). Thus, careless work or lack of integrity on part of any auditor(s) may lead
the public to negative view towards the entire profession. Accordingly, reasonable level
of competence to practice their service as required by standards and to give clients and
the public an assurance that the profession intends to maintain high standards and enforce
compliance by individual members’ broads the reputation of the profession.
V) Acceptance of social responsibility/ Responsibility to serve the public/ – A professional
to be a profession must accept responsibility for the consequence of its action. Not only
legal responsibilities which arises out of contractual obligation, but also moral
responsibility to the profession itself and to the society at large. Accordingly, auditors are
representatives of the public-creditors, stockholders, consumers, employees, and others-in
the financial reporting process. The role of the independent auditors is to ensure that
financial statements are fair to all parties and not biased to benefit one group at the at the
expense of another. This responsibility to serve the public interest must be a basic
motivation for the professional.
We live in an era of litigation in which persons with real or fancied grievances are likely to take
their complaints to court. In this environment, investors and creditors who suffer financial
damages or reversals find CPAs, as well as attorneys and corporate directors, tempting targets for
lawsuits alleging malpractice.
Thus, CPAs must approach every engagement with the prospect that they may be required to
defend their work in court. Even if the court finds in favor of the CPAs, the costs of defending a
legal action can be very high. Moreover, lawsuits can be extremely damaging to a professional’s
reputation. In extreme cases, the CPA may even be held criminal for professional malpractice.
Thus, every member considering a career in public accounting should be aware of the legal
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liability inherent in the practice of this profession and should conduct the audit with reasonable
skill and care. Though audit report is not a guarantee that the figures are free from error, the
auditor must conduct the audit that it stands a reasonable chance of discovering a material error
in the figure. It is difficult to determine what is meant by reasonable skill and care. The
auditors’ principal duties center around the report on the truth and fairness of the financial
statements. The auditors are not required to make any positive statement if they are satisfied
with the audit matters. They must, however state any reservations in the audit report. There is
always a possibility that someone will disagree with some of the assumptions upon which the
figures have been based. The auditors are also required to form an opinion on several matters ant
properly report them in their report.
Gross Negligence- is the lack of even slight care, indicative of reckless disregards for one’s
professional responsibilities. Substantial failures on the part of an auditor to comply with GAAS
might be interpreted as gross negligence.
Constructive fraud- differs from fraud as defined above in that constructive fraud does not
involve a misrepresentation with intent to deceive. Gross negligence on the part of an auditor as
been interpreted by the courts is constructive fraud.
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Breach of contract- is failure of one or both parties to a contract to perform in accordance with
the contacts provisions. E.g. Failure by auditors(s) to perform in accordance with contractual
specifications indicated in the engagement letter.
An auditor holds position of great responsibility and has to perform a given duties, statutory or
otherwise, allotted to him. In performance of his duties, he has to exercise reasonable care and
skill. His client expects him to follow generally accepted auditing standards and he/she may be
held liable in case he does not act with reasonable care and skill required from him in the
particular circumstances.
In other words, if his client suffers any loss due to his negligence or breach of trust or
duty and, the errors or frauds remain undetected, he would be held liable for the same and
may be called upon to pay the damages suffered by the client on account of his
negligence or breach of duty. The auditor may be penalized for failing to apply
reasonable care and skill. This could take the form of a disciplinary action by the
professional body or civil or criminal proceedings.
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The auditor can be held liable if the following conditions are satisfied.
i. There should be sufficient ground for holding him liable for negligence. A general charge
will not be enough and the specific matter in respect of which he failed must be indicated
ii. It must be proved that the client has suffered a loss on account of this negligence
The auditor cannot be held liable if there is loss to the client without his negligence or there has been
negligence of the auditor but it has not resulted into the loss to the client. At the same time, it must be
proved that the auditor has acted negligently, i.e. he did not exercise the reasonable care and skill in
the performance of his duties. What is reasonable care and skill should be determined on the basis of
the particular circumstances of the each case. It should be largely determined by a comparison with
the standard, which the members in this profession generally observe. It may be noted that the auditor
does not act as an insurer and does not guarantee the accuracy of the books of account
3. Auditor’s contractual liability: The contractual liability arises out of the contract entered
between the auditor and the client. This arises when there is no statute governing the rights or
duties of an auditor. Since there are no statutory provisions, the question of liability has to be
settled in accordance with the terms and conditions settled by the auditor with his client in
the agreement. Hence the agreement with the auditor has to be in written clearly specifying
the terms of duties, responsibilities and scope of the audit. The auditor will be liable if he
does not observe high standards of his profession and work honestly. Sometimes, the auditor
will be in a delicate situation because of the frauds or irregularities carried on by the client’s
parents or close relatives. In such cases, he must not give way to emotions. He must honestly
and truthfully report the matter to his client in clear words without any hesitation, laying
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aside all other considerations. If he does not do so, he fails in the performance of his duties
and may be held liable for the same.
a) Duty- that the auditor(s) or audit firm accepted a duty of care to exercise skill,
prudence, and diligence.
b) Breach of duty- that the auditor(s) or audit firm breached his/her/its duty of care
through negligent performance.
c) Loss-that the client suffered a loss.
d) Proximate-cause- that the loss is resulted from the auditor(s) negligent act or
performance
4. Auditor’s third party liability- In addition to being sued by clients under common law,
auditors may be liable to third parties under common law. This is due the fact that the audited
financial statements are used by many people other than the client. These users of financial
statements may completely rely upon the audited statements and enter into transactions with
the company without any further enquiry. This are known as third parities which includes
individual and group society members such as potential stockholders/investors/, venders,
bankers, and other creditors, employers, employees, and customers, tax authorities and
others.
An audit firm may be liable to such third parities if a loss was incurred by the claimant due
to reliance on misleading financial statements. A typical suit might occur when a bank is
unable to collect a major loan from an insolvent customer. The bank may claim that the
misleading audited financial statements were relied on in making the loan and that the audit
firm should be held responsible because it failed to perform the audit with due care. Some
real world cases on liability of auditors to third parties are given below.