Page 232 - DCOM204_AUDITING_THEORY

Auditing Theory

Notes where it is not he should state in his report that he has accepted a certificate. In the light of Part-
A of ddendum to ISA-8, “Attendance at Physical Inventory Counting” and SAP - 3 “Verification
of Inventories”, the position of auditors as held in Kingston Cotton Mills Co. Ltd. is no longer
valid.

Liability for Misfeasance

The term misfeasance means breach of duty. If auditor does something wrong in the performance
of his duties resulting in a financial loss to the company, he is guilty of misfeasance.

Example: Auditor’s duties are laid down in section 255 of the Companies Ordinance,
1984. If auditor does not perform his duties properly and the company suffers loss he is liable for
misfeasance.
Major Case Laws

London and General Bank Ltd.: In this case auditors were held liable for misfeasance. The
auditors failed to report that Balance Sheet was not properly drawn: - Large sums were advanced
to the customers and interest thereon was accrued, in fact neither advance nor accrued interest
was receivable. No provision for bad debts was made and the company paid dividend. Under
section 260 of the Companies Ordinance, 1984 if the auditors fail to report to the member’s
material misstatement of facts or give untrue picture to the members, and the default is willful,
auditors shall be punishable with fine which may extend to two thousand rupees.

11.7.2 Criminal Liabilities (Section 260)

If auditor fails to comply with the requirements of Sections 157, 255 or 257, he shall be punishable
with fine up to ` 100,000/-. If he knowingly makes a false report for profit to himself or to put
another person to a disadvantage or loss for a material consideration, he shall also be punishable
with imprisonment for a period of one year. If charges of forgery are brought against an auditor,
he may be liable to imprisonment for a term which may be extended to 2 years or fine up to
` 20,000 or both.

Liability to the Company

To hold the Auditors liable for negligence at common law it is necessary for the company to
show that loss has been caused to the company through the failure of the Auditors to perform
their duty with reasonable care and skill. This was held in Leeds Estate Building and Investment
Co. v. Shepherd and London Oil Storage Co. v. Seear Has Luck & Co. amongst other cases. Where an
individual is appointed as an auditor and that individual is a partner in a firm of professional
accountants, that firm may be held liable for his negligence in performing his duties, atleast
where the audit fee is paid directly to the firm. The duty of auditors in case of private companies
was considered in Pendleburys Ltd. v. Ellis Green and Co. The courts held that where interests of the
companies are limited to a very small number of people and there are no outsiders because all
interests are held by the Directors themselves, if the auditor has reported to the directors, then
there is not much else which he can do. This decision underlines the fact that the negligence of
Auditors arises when the issues of public, shareholder interests are paramount. Another factor
which is a crucial element in negligence is that of the standards by which the work of the
auditors are measured. It has been submitted that standards of skill and care change over time.
The standards have become stricter over time and the explanations of directors are no longer

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