The role of an auditor

The legal duties of an auditor are governed in statute by the

Companies Act 2006 and supported by case law; most
notably Caparo v Dickman, which established the modern requirement
for imposing tortious liability in circumstances where there is no
contractual relationship. Company directors have a duty to manage a
company and produce financial statements. The purpose of an audit is
to provide independent opinion for the company’s shareholders that
those financial statements present a view which is true and fair. An
auditor therefore has a contractual relationship with the company, with
an implied contractual term that he carries out his functions with
reasonable skill and care.

Auditing Standards requires that auditors should plan and perform an

audit with 'professional scepticism'. This need for a critical assessment
of audit evidence must be balanced with a company's commercial
interests; it would be impracticable to incur unnecessary costs by
challenging absolutely everything in an apparently well-run company.

The traditional view (expressed by Lord Lopes in Kingston Cotton

Mill (1896)) was that “an auditor is not bound to be a detective… he is
a watch dog, but not a bloodhound". This view was restated in broader
terms by Lord Denning in Fomento (Sterling Area) v Selsdon Fountain
Pen Co (1958). Denning held that to perform his task properly, an
auditor should come to the audit with an enquiring mind, not
suspicious of dishonesty but suspecting that someone may have
made a mistake somewhere, and making checks to ensure that there
had been none.  

Former Chancellor Lord Lawson of Blaby has been one of the most
vocal critics of audit firms and last year accused them of being "the
dogs that didn’t bark" during the financial crisis. He has also argued
that auditors should have some responsibility concerning the public
interest.
The position remains that auditors do not generally owe a legal duty to
any other person or body for any purpose outside the remit of the
audit. Liability other than that owed to the company would be reliant
on the existence of a sufficient degree of proximity with a claimant as
a member of an identifiable class in circumstances where it is likely
the claimant would rely on the audit for the purpose of deciding
whether or not to enter into a particular transaction. 

Reform of the audit market

The House of Lords Economic Affairs Committee addressed the
question of what auditors could and should have done to mitigate the
financial crisis as part of its inquiry into the concentration of firms in
the audit market. Later this year, a report will publish its findings,
which are likely to make suggestions for reform. The European
Commission has already set out its proposals for reform, following a
consultation to address failings in the European audit market.
Suggestions mooted include the mandatory rotation of auditors and a
cap on advisory fees.

Much has been made of the fact that the Big Four accountancy firms
(PwC, Deloitte, KPMG and Ernst & Young) collectively scrutinise all
but one of the FTSE 100 companies' accounts.  Although there is
nothing to say that these firms are collectively abusing their dominant
market position, regulators have been keen to tackle their dominance.

One practical problem that has arisen from the dominance of the Big
Four is the difficulty of finding expert witnesses for accountancy
related investigations and litigation. It is sometimes the case that only
witnesses from the Big Four have the requisite practical experience in
a specialised field. Alternative options can be limited where conflicts
arise.

Auditors like to say their role is that of a watchdog (who barks when

they see something suspicious) rather than a bloodhound (who
actually searches for something suspicious). So beware next time you
pick up a set of financial statements with a spotless audit opinion. It
does not guarantee a clean bill of health.

An auditor is appointed by the shareholders in case of a limited company. He is expected to

play the role of a watchdog on their behalf and should look after their interests.

Unlike a bloodhound the duty of the auditor is verification and not detection. If he discovers
something suspicious, during the course of audit, he should probe the matter thoroughly
and appraise the shareholders about it. In the absence of such suspicious circumstance, he
is fully justified in believing and relying on representations made by the ‘tried servants’ of
the company. In short, in case of frauds and errors, the auditor has a duty of ‘reasonable
care only.