The aim of the audit of financial statements is to enable the auditor to give his opinion on whether or not the financial statements of the company under audit accurately reflect—in all significant respects—the financial position of the company and its income results and cash flows.
Importantly, the auditor plays a significant role in the development of a certain business and is responsible for the analysis of the financial statements of a certain business (Craswell, Francis & Taylor 1995). Noted below are various factors influencing the auditor’s responsibility:
Figure (2): Factors influencing the auditor’s responsibility
An external auditor may be exposed to civil legal responsibility towards a client (business firm which audited its accounts) or the third party of user financial statements if it is confirmed that he failed in doing his professional duties according to the required care and professional skill. This means that, in the case of auditor negligence or if he committed a fraud by giving an inappropriate opinion about financial statements, the auditor becomes responsible for compensating for incurred injuries.
Rulings passed by courts in different countries with established judiciary practices, such as the USA and the UK, and which deal with legal problems raised by accounts audits, state that external auditors exert due professional care. The problematic pivot became an explanation for the meaning of due professional care.
Auditor's responsibility
Auditing standards
Professional code of conduct
Ongoing Professional Development
Professional bodies Accounting
standards
Legal Responsibility
Clients &
Third party Control
Of Audit quality
3.2.1 Due Professional Care
Due professional care, as one of the general principles governing the auditing process, indicates the care level, diligence, personal judgment, skills and professional competencies familiar to other auditors working in the same conditions in which the auditor works or in similar conditions. This means that the auditing process and the compiling of reports is carried out with the same degree of care, competence, learning and experience available to other members in the auditing and accounting profession, as required by professional standards (Guy, Alderman & Winters 1999).
As auditors are required to exercise personal judgment, care, regular skills and expected skills from other auditors, this means that evaluating auditors when investigating negligence cases requires comparisons to be drawn between the auditing procedures carried out by auditors with the care criterion; this includes procedures that other auditors would follow in the same conditions, i.e. if it is confirmed that an auditor was remiss in carrying out these procedures, thus he became negligent (Kadous 2000).
Thus, in practice, due professional care is determined, or the performance level is compared with auditor performance (defendant) in order to explore the extent of negligence when carrying out professional duties, which is carried out by the experts appointed by the courts before which the case against this auditor is raised. This means establishing the level of due professional care for a particular situation completed after the auditor has completed the auditing process. As a result of this, researchers agree that the due care criterion is vague as the auditor does not know in advance before beginning auditing. Furthermore, experts appointed by the court may have more information than what the auditor had relied upon when giving his opinion; this may lead to a hindsight of due care, or well-known hindsight, resulting from late awareness (Anderson et al., 1997; Kadous 2000).
In the same context, the study of Kadous (2000) indicates that determining the due care criterion after completing the auditing process may lead to auditing failure consequences on the care level of the required auditing. This study concludes that there is a forward relationship between the intensity of results based on auditing failure on the one hand and the due care level of the auditor on the other hand—an increased intensity of results or losses (e.g. workers lose their jobs, expose to several parties to
loss, firm failure), increase of due care level determined by the court. Some authors (Bonner et al., 1998) suggest that the nature of the fraud committed in financial statements has an influence on the understanding of the jury and judges of the auditor’s responsibility.
Some authors (Schwartz 1997; Radahakrishnan 1999) argue that the inability of auditors to predicate the due care criterion shall be used in evaluating their performance, which may be an incentive for them to increase their auditing effort or present more conservative opinions in terms of auditing reports so as to reduce the possibility of their exposure to litigation risk or to negligence (Kinney & Nelson 1996).
3.2.2 The Third Party
Generally, we can define the third party, i.e. those with the right to litigate the auditor legally (Boynton & Kell 1999) as:
Primary beneficiary: indicates a known person, his name given in advance to the auditor, as he will be the main user or primary beneficiary of the auditing results and auditing reports. For example, a client informs an auditor before beginning the auditing. Then this auditing report will be used in obtaining a loan from a particular bank. In this case, the bank is considered as the primary beneficiary of the auditing.
Other beneficiaries: a category of users, their names are not given in advance to the auditor, but they depend on his opinion when making their decisions related to audited firms. Examples of this category are stockholders, prospective investors, creditors and others who use financial statements.
From the above-mentioned, it is clear that the third party who has the right to litigate auditors, due to injuries incurred resulting from his depending on misleading financial statements accredited by the auditor, belongs to different categories with branched and conflicting interests. Nobody calls an auditor to reconcile between the interests of these categories or to care for their interests to the same degree. Moreover, opening the door to legal responsibility for the third party to litigate the auditor ultimately exposes the auditor to arbitrary requirements, causing the greatest injury to the auditing profession.