Case : Liability to the shareholders and the company

Maxref ltd is a new dot.com company specialising in online trading in multimedia items such as DVDs. Music, online reports, and celebrity commodities. It has been listed on the Australian Securities Exchange since last year. As auditor of Maxref' s first year's financial statements for the year ended 30 June 2009, you note that the accounts show a turnover of about $10 million, shareholder's funds of $2 million, and a profit before tax of $250,000. During the course of your audit you discover that the balance of the sales ledger control account is $500,000 and that about 80% of the accounts receivable are from new customers who bought items online without full details of the banking particulars. You further discover that all online transactions were reported and executed without proper security checks. Moreover, half of the items listed as stock for sale cannot be located. The share price of the company stands at $1.50. You raise the issue with the director of Maxref and he tells you that this is no uncommon with this type of e-business and that he is concerned only that the Australian Securities Exchange allows it to go on trading. He assures you that nothing major will happen; an unqualified auditor's report its all that is necessary. However, you are worried about your own ability.

Required: 

Discuss the potential liability of the auditor to:

- the shareholders

- the company

Answer:

An auditor is potentially liable to the shareholders of the company whose books of accounts the auditor has examined and audited. This is because shareholders base their decisions to further invest in a company or to hold their investments or to sell their shareholdings on the basis of the financial information that has been verified and certified by the auditor. As such we can say that auditor is liable to the shareholders with regards to the truthfulness of the financial position and health of the company which they have certified in the company's audited financial statements. Auditors are liable to shareholders under the provisions of contract law and law of tort. Under the contract law shareholders can seek remedy from an auditor if they fail to comply with the terms of an engagement letter. Under the provisions of law of tort auditors can be sued for negligence if they breach a duty of care towards the shareholders and consequently the shareholders suffer from a loss.

An auditor is potentially liable to the company for breach of duty. An auditor has a duty of properly examining the books of accounts of a company and examines its corporate governance and internal control framework so as to ensure that the company keeps on functioning is a going concern. When auditor does not do its duty properly and is negligent then the company can face repercussions with regards to its business and operations and may go into liquidation as well. In such a case the company can claim against the auditor breach of contract and can claim damages for negligence. Auditor's failure to deliver a competent report makes them liable to the company.

In this case if the auditor gives an unqualified audit report then it will be falsifying the financial position of Maxref Ltd. and hence it will be liable both to the shareholders of the company as well as the company. 

Reference:

https://www.accaglobal.com/an/en/student/exam-support-resources/professional-exams-study-resources/p7/technical-articles/auditor-liability.html