Negligence is some act or omission which occurs because the person concerned has failed to exercise the degree of professional care and skill, appropriate to the case, which is expected of accountants or auditors. It would be a defence to an action for negligence to show:
a) that there has been no negligence; or
b) that no duty of care was owed to the plaintiff in the circumstances; or
c) in the case of actions in tort that no financial loss has been suffered by the plaintiff.

For the bank to succeed in any case against the auditors, it must prove the following:

• The auditors owed it a duty of care since there is no contrast between the bank and Auditors, the bank must establish close proximity or sufficient relationship with the Auditors. In this case, the auditors were aware that the bank will rely on the audited financial statements in respect of the loan therefore a duty of care has been established through proximity.
• The bank must prove that the auditor has breached that duty of care by conducting the audit negligently. However, if the auditor can demonstrate to the court that it has followed the applicable auditing standards as evident by its working papers, it may not be found negligent.
• The bank must prove that it suffered financial loss as a result of its reliance on the negligent work of the auditor.        (3 points @ 2 marks each =6 marks)

• There have been several major audit scandals in the past. The fact that audit continues and, indeed, flourishes in the light of these suggests that society has not lost confidence in audit and that it will not do so in the future.
• The major audit scandals appear to be regarded as abnormal occurrences that do not reflect on the work underpinning the vast majority of audits. The cases that have occurred in the past few years represent only a tiny minority of the audits that have been undertaken.
• Each has attracted a great deal of publicity, even notoriety, but there has been nothing to suggest that there is a systematic failure across all audits. Indeed, the publicity generated by each case indicates that these are not routine events.
• Shareholders and other stakeholders almost certainly need the reassurance provided by audit. In the absence of audit they would have little or nothing to support the credibility of the financial statements and this would undermine confidence in investment.
• It would appear that audits are desirable even if they do not offer a guarantee of detecting every single material irregularity in the financial statements. The accountancy profession has done a great deal to enhance the credibility of audit.
• Considerable amounts of time, money and resources have been invested in standard setting, monitoring and regulation of auditors. Major audit scandals are investigated as a matter of routine and any recommendations for the future regulation of audits and auditors are usually implemented as a matter of course.

Responsibility for Prevention of Fraud

Management

• The responsibility for the prevention of fraud, other irregularities and errors rest with management. Management has the fiduciary role of safeguarding assets since the directors of a company are regarded in law as acting in stewardship capacity concerning the property under their control. Management can discharge these responsibilities by adopting methods such as;
• The installation of an effective accounting system
• The institution and the operation of an appropriate system of internal control.
• Ensuring that employees understand and comply with relevant codes of conduct.
• Maintaining a register of relevant legal requirements and ensuring that operating procedures and conditions meet the required standards.
• The establishment of an independent internal audit function and the appointment of audit committees.

Responsibility for Detection
The primary responsibility for the detection of fraud, other irregularities and errors rests with management. This role of detection is an extension of its role in preventing.
Auditor

• The auditor is not responsible for preventing fraud, other irregularities or errors. Audit procedures should be designed to give a reasonable expectation of detecting any material misstatement, whether intentional or unintentional in an entity’s financial statements. The auditor cannot prevent a fraud or other irregularity from occurring, however, the annual recurring audit may act as a deterrent.
• The auditor is to report to management when he identifies significant weaknesses in the structure of accounting and internal control and deficiencies in their operation.
• The auditor’s responsibility regarding the detection of fraud, other irregularities and error is to plan, perform and evaluate his audit work so as to have a reasonable expectation of detecting material misstatement in the financial statement whether they are caused by fraud or other irregularities or errors.
• On the basis of the above it is wrong for the Directors to refuse to pay the audit fees. If it is found that the auditors are negligent in their performance of duty then the directors can bring a charge against them in court or file a complaint with ICAG.                            (1 mark each for any 10 valid points)

An injured party must prove ALL of the following three things in order to succeed in a claim for financial loss against an auditor for negligence:
– That the auditor owes a duty of care;
– That the duty of care has been breached;
– That financial loss has been suffered that was caused by the negligence.          (2 marks)

i) Looking at the strict interpretation of the first requirement, the auditor owes a duty of care only to the shareholders as a body and not to Boafo Bank Limited as an outsider.
The courts, however have accepted that if the Auditor, at the time of signing the report knew that someone, other than the shareholders as a body will rely on the report, then the duty of care extends to the person. The facts of this case show that at the time the auditor signed the Audit Report, he was aware that it was Financial Statements going to form the basis for preparing the projected financial information to be used to seek for the bank facility from Boafo Bank Limited. Paragraph 3 of preamble to question).
This means it is probable that a court will rule that requirement 1 above has been proved.        (2 marks)

ii) A breach of duty of care must be proved for a negligence claim against the audit firm to be successful. Duty of care generally means that the audit firm must perform the audit work to the required standard and that relevant legal and professional requirements and principles have been followed. For an audit firm, it is important to be able to demonstrate that ISAs have been adhered to. This is no evidence in the facts as given to enable us reach the conclusion that the duty of care has been breached or not. Looking at the fact that a loss of GHS4.3M was stated as a profit of GHS20.2M, a difference of GHS24.5M, if this error in the Income statement is confirmed, it is likely to be interpreted by a court to mean that the auditor did not perform the duties expected of him/her with all the skill, care and caution which a reasonably competent, careful and cautious auditor would use. What is reasonable skill, care and caution will depend on the particular circumstances of each case.

In this case, however, an error is material by all standards and will be proof that the auditor has acted negligently unless he can prove that the circumstance that caused this material error was beyond his/her control.
Requirement 2 appears to be likely to be proved.      (2 marks)

iii) Requirement 3 is easy to prove since the loan was given on the basis of the projected financial information based on the audited financial statements, it is likely that a court will not need any serious persuasion to agree with the Bank that its financial loss was caused by the negligence of the auditor. From this discussion, the Auditors must seek an out of court settlement to avoid the bad publicity and likely litigation costs since it is probable that they would be found to be professionally liable to the Bank and the Bank is likely to the Bank for negligence.         (1 mark)

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 control
Firms should implement quality control procedures in line with guidance contained within ISQC1 Quality Controls for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements and ISA 220 Quality Control for an Audit of Financial Statements. This includes both firm-wide 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