Audit Legal Implications

The legal responsibilities of auditors

Understanding Audit Legal Implications

Inaccurate or erroneous financial information cause audit legal implications. Auditors are responsible for making sure that all line items on financial statements are presented fairly. The audit reports ultimately affect the business decisions of banks, government, investors, and other business-related entities. Auditors, in a sense, are required by law to report fairly their opinion on client companies. Otherwise, they can be subjected to lawsuits and other audit legal implications.


Audit Legal Implications


One of the most important professional standards that an auditor must follow is the notion of due professional care. The concept of due professional care is stated in general auditing standards and is also required by most codes of professional conduct issued by an accounting body. Due care is a technical legal term and in the context of an auditor, it means that the auditor must be diligent in applying technical standards and must document each stage of the audit process thoroughly. Due professional care implies that:

  • The auditor must possess the required skills.
  • There is a duty to approach the task with care and diligence.
  • Good faith and integrity, however not infallible.
  • Liable for negligence or dishonesty but not for pure errors for judgment.


Sources of Legal Liability

Let’s take a closer look at all the involved parties here. Let’s again consider our triangular relationship between the users, client, and auditor. Auditors can be sued not only by client companies but also by other parties.


Legal Implications in Audit


Who Might Sue?Why Sue?
Client Breach of contract
Users Failure to identify a misstatement
GovernmentFraud (Issuing an incorrect audit report intentionally)


In summary, clients can sue auditors if there is a breach of contract between the two entities. Users may sue auditors if the latter fails to identify a material error that ultimately ends up influencing the users’ investment decisions. Finally, the government also plays a large role in accounting scandals that deal with fraud.


Unjustified Lawsuits

Despite the potential for lawsuits against auditors, many lawsuits by third parties are unjustified. For example, if a third party (i.e. user) sues the auditor because the client (i.e. the company being audited) is no longer a viable company, it is not justified because the auditor is not responsible for making sure that the company can continue operating in the long term. The auditor is solely responsible for ensuring that financial statements are presented fairly against the appropriate evaluation criteria.

In addition, unjustified lawsuits may also involve the phenomenon of audit risk. Audit risk is the risk that an auditor will express an inappropriate audit opinion on the financial statements. Essentially, these situations deal with errors in the financial statements even after following the relevant auditing rules. These are simply unfortunate situations when an auditor, for example, decides to pick a sample to audit that is not representative of the entire population. If, however, an auditor were not to comply with general auditing standards outlined by the governing accounting body, it is called audit failure and is a valid reason for a lawsuit.


Successful Lawsuits Against Auditors

In order for a third party or a client to successfully sue an auditor, it is not sufficient to just come up with some evidence and file a court case. The plaintiff must prove the following four criteria:

  1. Auditor owed a duty of care to the plaintiff – Few possible users that an auditor owes a duty of care to is a known or foreseeable user of the financial statements
  2. Auditor breached that duty of care – For example, a situation of audit failure as described above, where the auditor fails to comply with the auditing rules specified by the accounting body
  3. Plaintiff suffered a loss – The plaintiff must prove that there was an actual loss. An opportunity cost such as missing out on shares increasing in price is not enough
  4. Connection between Auditor’s negligence and Plaintiff’s loss – The plaintiff needs to prove that the plaintiff actually relied on the entire set of the financial statements


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