Background
At
one time the audit was conducted primarily to inform management of
irregularities and inefficiencies in the business. Due to which the world’s
conception for the auditor was developed as bloodhound who is responsible to
detect and prevent fraud and irregularities. Later on the concept was gradually
changed as the auditor’s role as a watchdog more than the bloodhound due to
inherent limitations of audit. The audit was intended only for a limited number
of business which gradually was broadened to a wide range of business. The need
for independent audits was generated by public ownership of business
enterprises and by the requirements of the investors, investment specialists,
stockholders and lenders demanded more reliable information. It is now well
recognized that the audited financial statements are even intended for the use
of third parties who have no contractual relationship with the auditor. The auditor's function has expanded from that of a
watchdog for management to an independent evaluator of the adequacy of
disclosures and fairness of results depicted by the financial statements issued
by management to stockholders, creditors and others.
It
is the responsibility of auditor to provide independent opinion on the truthfulness
and fairness of the financial statements during the course of audit, the
auditor may also provide the details (error and irregularities either
intentional or unintentional). In case of any abnormal situation, the remedial
action has to come from the owner of the entity. He has to discharge his
responsibility by informing about the irregularity found in the normal course
of audit.
Markets
are only viewed as a safe and stable if investors can trust the activities of the
auditors. Duty of the auditor is not to harm other person. As a professional
accountant, the auditors must be sincere, systematic, honest, truthful, and
tactful. An auditor has a professional knowledge and expertise in his field.
The auditor owes the highest degree of care possible to his client and must
deal with his client in the utmost good faith.
As
part of private profession with a public mandate, the auditors face unique
pressures and challenges that demand their careful attention and impeccable
judgment. Audit profession is such type of profession that demands auditor to
protect the public interest and trust, even under the weight of management’s
pressure. The “public watchdog”
function demands that the accountant maintain total independence from the
client at all times and requires complete fidelity to the public trust.”
Expectation
Gap: Watchdog or Bloodhound
The
extent to which an external auditor is responsible for a failure to detect
fraud is probably the classical example of the gap between what an auditor sees
as the auditor's responsibility and what company directors, shareholders and even
the public expect of an auditor.
As
per Nepal Standard on Auditing (NSA)-200 Objectives and General Principles Governing
an Audit of Financial Statements “the objective of an audit of financial
statements is to enable the auditor to express an opinion whether the financial
statements are prepared, in all material respects, in accordance with
applicable financial reporting framework.”
As
such, NSA addresses material misstatements of the accounts resulting from
fraud, rather than the fraud itself. The implication, therefore, of NSA, is
although the auditor should plan the audit with a reasonable expectation of
detecting if fraud does not result a material misstatement, then the auditor
will not necessarily have a duty to uncover it.
The
role of auditor is sublimely unique. Audit
is only the profession which actually intends to detect the material
misstatement and convey with the management to adjust the financial statements
and in other case issues a qualified opinion in contrast to the modern concept
which states that the “customer is always right.” And then should emphasis
other profession does not boost public confidence.
However,
the public has big expectation with the auditor. Public assume that, the
auditor shall know all about fraud and there shall not be any stone unturned
regarding fraud.
Legal
Precedent
The
principle “Auditor is watchdog” is widely accepted in the world. This principle
is originated form the court decision. Hence, it is very strong and legally
backed principle.
More
than 100 years have elapsed since the Court of Appeal in England delivered a
landmark judgment in the Kingston Cotton Mills case. The facts were reasonably
simple and not contended by the parties. The company’s managing director, who
subsequently confessed the frauds he committed, had falsified its accounts. In
particular, the quantities and value of the company’s stock had been falsified
for many years but there were nothing on the face of the accounts to excite
suspicion. It was suggested to the court that the auditor should not have
relied solely on the representation of the managing director and should have
further investigated the matter. In a unanimous judgment, the three Lord
Justices reversed the decision of the lower court and found in favor of the
auditor:
“It
is the duty of an auditor to bring to bear on the work he has to perform that
skill, care, and caution which a reasonably competent, careful, and cautious
auditor would use. An auditor is not bound to be a detective, or, as was said,
to approach his work with suspicion, or with a foregone conclusion that there
is something wrong. He is a watchdog, but not a bloodhound. Auditors must not
be made liable for not tracking out ingenious and carefully laid schemes of
fraud, when there is nothing to arouse their suspicion ...So to hold would make
the position of an auditor intolerable.”—Lord
Justice Lopes Regarding Kingston Cotton Mills (1896)
Problems
In
this famous judgment, Lord Justice Lopes, perhaps unintentionally, shaped the
very ethos of the audit profession for the next century. In the watchdog
mindset, the profession adopted a passive approach to an audit, together with
an implicit presumption that the representations made by management could be,
and indeed should be, relied upon. Yet, whatever the merits of this philosophy
100 years ago, the audit profession is increasingly seen as having failed to
meet the public interest, particularly over the last few years. The flood of
recent corporate failures and punishment to auditors irrefutably challenges to
the flaws of the watchdog-driven audit philosophy. The auditor shall be honest
and works as an active watchdog rather than sleepy dog. Unfortunately, for the
profession, some blue –blooded auditors kept watching while the burglars ran away with shareholders money in some
high profile corporate scandals. Currently, many auditors play as a sleeping
dog rather than active watchdog, based on this principle.
Conclusion
The
need of the hour is, for the audit profession to rediscover its ethics and
reinvent itself to capitalize on the emerging new frontiers. The theme of this
judgment is to make auditor more ethical and loyal to the organization.
Auditors
owe to their clients the highest duty of care possible – fiduciary duty. When
the auditor breaches that duty, liability can result in financial reimbursement
to the client for the losses sustained.
An
auditor is not expected to be a bloodhound and detect every fraud and flaw in
the company's books. Nor is an auditor exposed to indeterminate liability. To
the contrary, the courts recognize the need to control the expansion of
liability for negligent misstatement and economic losses. The development of
proximity of relationship as a limitation on duty of care is to be welcomed by
auditors.
Like a watch dog, auditor should protect the
interest of those who appointed. Auditors are not servants, they are
independent third parties with no financial interest. So, the auditor should
not be in favor or interest of who appointed him but should be loyal to his
profession and point out what is wrong and what is right. If auditor starts to
become loyal to the person who appointed him, then it can be great chaos. In
that case it refers that if auditor is concealing the tax liability of the
company to preserve the interest of the shareholder it is alright but that is
not ethically and professionally correct. But he will assume the servants of
the company honest and he will rely on their statements. Further he can take a
reasonable care. He should perform his duties with competence and due care. The
attitude of watch dog will not reduce his responsibilities.