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Auditing Theory

Notes reasonable care to ascertain that accounts books show the true position. The auditor is not a
insurer and does not guarantee that the books show the company’s position directly. This point
was further reiterated in Trisure India v. A. F. Fergueson & Co. where it was held that the auditor
must be honest and should have reasonable skill and care in ascertaining the accuracy of the
company’s books of account, balance sheet and profit and loss account. Reasonable care and skill
is not exercised when in spite of the presence of unusual features in the accounts which prima
facie, give reason for believing that the accounts of the company are not in order, the examination
is not detailed.

11.5.8 Standard of Care

Neither legislation nor the normal contract of engagement indicates the standard of care required
of the auditor. However, this issue has been subject to detailed consideration by the Courts. It
has been the law that the auditor must exercise reasonable skill and care in the discharge of his
duties. This has been best described in the following words of Romer J. in City Equitable Fire
Ins. Co., Re : He must be honest, that is, he must not certify what he does not believe to true and
he must take reasonable care and skill before he believes that what he certifies is true. What is
reasonable care in any particular case must depend upon the circumstances of that case. Where
there is nothing to excite suspicion very little inquiry will be reasonably sufficient. Where
suspicion is aroused more care is obviously necessary; but, still an auditor is not bound to
exercise more than reasonable care and skill even in case of suspicion and he is perfectly justified
in acting on the opinion of an expert where special knowledge is required.
The early cases suggested a standard of care based on the concept of the auditor as a watchdog.
In Re Kingston Cotton Mills Case , the Court while holding the auditors liable for not personally
inspecting the securities, it was opined that while it may be easy to charge the auditors with
negligence after the event, the auditor did not have advantage of hindsight. More recent
authorities, however, have higher standard of care based on the auditor’s applying an ‘inquiring
mind’ to his task. In Fomento Sterling Area Limited Selsdson Fountain Pen Co., Lord Denning
observed that “to perform his tasks properly, he (the auditor) must come to it with an inquiring mind —
not suspicious of dishonesty, but suspecting that somebody may have made a mistake somewhere, and a
check must be made to ensure that there has been none”. This point was further reiterated in Re
Thomas Gerrad & Sons Ltd. , where the auditors failed to detect fraudulent accounting principles
although they discovered altered invoices.
They were held liable as “suspicion ought to automatically have been aroused by the discovery”.
Commonwealth cases have also emphasised that the auditor can no longer limit their
investigation to a “watch-dog-role” and a more active inquiring role is required. Thus, it is the
duty of an auditor to bring to bear on the work he has to perform that skill, care and caution
which a reasonable competent, careful and cautious auditor would use. The particular
circumstances of each case determine whether reasonable skill, care, and caution have been
exercised. The trend of the Courts seems to be in the direction of enforcing liability on the
auditors if they fail to take a degree of care which would be required to ensure that there is no
fraud or irregularity. Once the suspicion is raised they must investigate thoroughly and ensure
that any discrepancy in the accounts is brought to light.

11.6 Auditor’s Report

One of the most important duties of the auditor is with regard to the report on the accounts of the
company which the auditor has to submit to the members of the company. “The scheme of the
Act....is that the directors must prepare the accounts; the auditor must make a report to the
members on the accounts; and this report must contain statements on certain specified matters.”

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