- 5 Marks
AAA – L3 – Q17 – Professional responsibility and liability
Question
You are responsible for providing direction to more junior members of the audit department of your firm on technical matters. Several recent recruits have asked for guidance in the area of auditor’s liability. They are keen to understand how an audit firm can reduce its exposure to claims of negligence. They have also heard that in some countries, it is possible to restrict liability by making a liability limitation agreement with an audit client.
Required:
Explain five methods that may be used by an audit firm to reduce exposure to litigation claims.
Answer
An audit firm’s exposure to litigation claims can be reduced by a number of methods.
(1) Client acceptance procedures
Firms should accept only those clients that carry a low enough risk of litigation for the firm to manage, given its resources. Screening procedures should be used to identify factors that create potential exposure, for instance, a new client with going concern problems is likely to carry more risk than one without such problems.
(2) Performance of audit work
Firms should make sure that all audits are carried out with professional standards and best practice, adhering to the requirements of ISAs. It is crucial in particular that proper documentation is kept, as this will be useful in the event of litigation.
(3) Quality management
Firms should implement a system of quality management in line with guidance contained within ISQM 1 Quality Management for Firms that Perform Audits or Reviews of Financial Statements or Other Assurance or Related Services Engagements and ISA 220 (Revised) Quality Management for an Audit of Financial Statements. This includes both firmwide procedures and those related to individual assignments.
(4) Issue of appropriate disclaimers
There is a risk of a legal duty of care arising to a third party even if the auditor is unaware of this duty. Disclaimers may be used in an attempt to restrict the auditor’s duty of care to shareholders, but there is no guarantee that they will be effective in law.
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