Critically Examine the Liability of Auditors by Referring to the Leading Common Law Cases. Should Liability Reform of Auditors Be Introduced to Hong Kong?

Critically examine the liability of auditors by referring to the leading common law cases. Should liability reform of auditors be introduced to Hong Kong?

Executive Summary

For a long time in accounting industry, the unlimited liability of auditors in many places arouse much debates between parties. It is not only a controversial topic but it is one that causes concern as well. In 2012, the Hong Kong Law Society and LegCo members, the Bill was finally passed as the Legal Practitioners (Amendment) Ordinance (LPAO) which introduces limited liability partnerships (LLPs) for solicitors’ firm (Gary Meggitt, 2012), but there is barely a concise direction when it comes to auditors. In this research paper, the liability of auditors is exemplified mainly through several civil cases, illustrating that auditors can be easily implicated in accounting related disputes. By virtue of bearing unlimited liabilities for any negligence and mistakes, the reform of limited liability partnerships in Hong Kong is recommended by highlighting its imperativeness and support from various parties, as well as its limitations. A possible recommendation is further epitomized.

Liabilities of auditors

Auditors’ liability can be resulted from both criminal and civil offences. Auditors will be liable if breach the law imposed by the government, while auditors will also be liable when there is dispute with individuals or organizations.

For criminal offenses, auditors are generally bound by the laws imposed in the countries they work in. When there are acts like fraud and insider trading, auditors will be prosecuted by the government. Under the Companies Act, if an auditor “knowingly or recklessly causing a report under section 495 to include any matter that is misleading, false or deceptive in a material particular”, the criminal court could prosecute the auditor for his inappropriate audit opinion. It is believed that, with the intention to fraud and trade with confidential information, auditors should be full responsible for their acts that have breached the law.

For civil offenses, there are two civil law that are significant to auditors, contract law and tort law. Under the contract law, if the auditor breach of any contractual obligations fail to comply with terms in the contract, the contractual party can sue the auditor. Under the tort law, auditors will be liable for negligence when they breach a duty of care to the plaintiff who suffers some loss due to the auditors’ breach of duty. There are many common law cases illustrate that auditors’ liability depends on the situation and the relationship between the auditor and the plaintiff.

Re London and General Bank (1895)

In the case, loans as a liability in the book of client was reflected as assets in the Balance Sheet and this was certified by the auditor as a true and fair representation knowing that the amount of loans was not realizable. Shareholders relied on the Auditor’s Report to declare dividend but the amount of dividend was paid out of the company capital and not available profit. Company went into liquidation at last. Later on upon liquidation, the liquidator (P) sued the auditor (D) for negligence and asked for reimburse the company. For the judgment, the court held that an Auditor must be honest and only certify financial statements that he believed is correct and true. The auditor must exercise reasonable level of duty of care in assuring the correctness of the financial statements. Auditors are not responsible to detect every single error and guarantee complete correctness of financial statement but have a duty of exercise care and skills in assuring procedures. Upon court final judgment, the auditor owned a duty of care to the shareholders to identify and report dishonest acts shown on the financial statements.