Liabilities of Auditors – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.
Liabilities of Auditors – CA Final Audit Question Bank
Professional Negligence
Question 1.
Write a short note on: Professional Negligence.
Answer:
Professional Negligence:
It connotes any failure to perform a duty according to accepted professional standards, which has resulted in some loss, damage or detriment to the party who had engaged a professional.
It is an act or omission which gives rise to a civil liability to compensate.
Elements of Professional Negligence
(a) Existence of duty or responsibility: One party is owed to another party to perform some act with due care, skill and competency.
(b) Occurrence of Breach: A breach occurs while performing the duty.
(c) Loss or damages: Loss or detriment being served by the party to whom the duty was owed as a result of breach. To establish a liability in respect of a third party, it is necessary that such third party should have suffered a loss or damage on account of the professional negligence.
Coverage: Professional negligence is necessarily restricted to the duties in a professional capacity.
Civil and Criminal Liabilities under Companies Act, 2013
Question 2.
Explain the liability of the auditor under the Companies Act, 2013, for making an untrue statement in the report (as an expert forming a part of the prospectus). [May 10 (5 Marks)]
Or
Indicate the precise nature of auditor’s liability for a misstatement that had occurred in the prospectus issued by the company. [MTP-Oct. 18]
Answer:
Liability of auditor for making untrue statements:
Criminal liability for misstatement in prospectus: Sec. 34 of Companies Act, 2013 provides that where any prospectus is issued or circulated or distributed, which includes any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead, then every person who authorises the issue of such prospectus shall be liable u/s 447 (fraud).
Civil liability for misstatement in prospectus: Sec. 35 of Companies Act, 2013 provides that where a person has subscribed for securities of a company acting on any statement included, or the inclusion or omission of any matter, in the prospectus which is misleading and has sustained any loss or damage as a consequence thereof, the company and every person who is a director of the company at the time of the issue of the prospectus; has authorised himself to be named and is named in the prospectus as a director of the company, or has agreed to become such director, either immediately or after an interval of time; is a promoter of the company; has authorised the issue of the prospectus; and is an expert, shall, be liable to pay compensation to every person who has sustained such loss or damage.
Punishment for Fraud: Sec. 447 of Companies Act 2013, provides that, any person who is found to be guilty of fraud, involving an amount of at least ₹ 10 lakh or 1% of the turnover of the company, whichever is lower shall be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to 3 times the amount involved in the fraud.
Where the fraud involves an amount less than ₹ 10 lakh or 1% of the turnover of the company, whichever is lower, and does not involve public interest, any person guilty of such fraud shall be punishable with imprisonment for a term which may extend to 5 years or with fine which may extend to ₹ 50 lakh or with both”.
It is also provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than 3 years.
Question 3.
Mr. X, a young chartered accountant, wants to start practice and he required your advice, among other things, on criminal liabilities of an auditor under the Companies Act, 2013. Kindly guide him. [Nov. 13 (4 marks)]
Or
Mr. Arjun, a newly qualified Chartered Accountant started his practice wants to specialize in Audits of corporate and required your advice on criminal liabilities of an auditor under the Companies Act, 2013. Kindly guide him. [May 16 (4 Marks)]
Answer:
Criminal Liabilities under Companies Act, 2013:
Criminal liability for misstatement in prospectus:Sec. 34 of Companies Act, 2013 provides that where any prospectus is issued or circulated or distributed, which includes any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead, then every person who authorises the issue of such prospectus shall be liable u/s 447 (fraud).
Punishment for false statement: Sec. 448 of Companies Act, 2013 provides that if in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of any of the provisions of this Act or the rules made thereunder, any person makes a statement,(a) which is false in any material particulars, knowing it to be false; or (b) which omits any material fact, knowing it to be material, he shall be liable under section 447.
Punishment for fraud: Sec. 447 of Companies Act, 2013 provides that, any person who is found to be guilty of fraud, involving an amount of at least ₹ 10 lakh or 1% of the turnover of the company, whichever is lower shall be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to 3 times the amount involved in the fraud.
Where the fraud involves an amount less than ₹ 10 lakh or 1% of the turnover of the company, whichever is lower, and does not involve public interest, any person guilty of such fraud shall be punishable with imprisonment for a term which may extend to 5 years or with fine which may extend to ₹ 50 lakh or with both”.
It is also provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than 3 years.
ICAI Examiner Comments
Candidates lacked knowledge of the sections 447 and 448 of the Companies Act, 2013 and mainly discussed about quantum of punishment and the amount of fine rather than the provisions leading to arising of criminal liability.
Question 4.
A Chartered Accountant in practice has been appointed as ail auditor of a company which raised finance from the capital market on the basis of a prospectus issued a few years back. The main ) object for raising the finance was specified to be setting up a project on information technology. The company advanced the sum so raised to various firms and private companies in which the I directors of the company were a partner or a director respectively.
These parties had no standing whatsoever with information technology. the Balance Sheet, these advances appeared as a current asset under the head “Short-term Loans and Advances – unsecured, considered good”. There was no mention to the notes to accounts about nature and purpose of such advances; and the auditor has issued routine audit report without any qualifications. On the very next day to the issuance of audit report, the directors and their related parties gone disappeared. The company, in which the auditor was conducting audit, has just vanished. You are required to state whether the auditor will be held guilty for professional misconduct? Is there any liability subsists under any law?
Answer:
Auditor’s negligence in performance of duties:
Clause 7 of Part I of Second Schedule to the CA Act, 1949 provides that a CA in practice will be deemed to be guilty of professional misconduct if he does not exercise due diligence in performance of his duties or is grossly negligent while performing his duties.
Schedule III to the Companies Act, 2013 requires specific disclosure of loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other person or amounts due by firms or private companies respectively in which any director is a partner or a director or a member.
As per Section 188 of the Companies Act, 2013, no company shall enter into any contract or arrangement with a related party with respeet to sale, purchase or supply of any goods or materials, except with the consent of the Board of Directors given by a resolution at a Board Meeting. Section 184 requires disclosure of interest by director and also lays down the procedure to be followed in this regard. Section 189 of the Companies Act, 2013 requires that every company shall keep one or more registers in which particulars of all contracts or arrangements, to which Section 184 or Section 188 applies, shall be entered separately.
In the given case, the company has advanced the sum to the parties that are related to the Directors of the company and showed the same under the head “Short-term Loans and Advances – unsecured, considered good” rather than specific disclosure under the notes to accounts. The auditor of the company also issued clean audit report without any qualifications. It appears that the auditor did not perform his duties properly.
Conclusion: Auditor is guilty of professional misconduct under Clause 7 of part I of Second Schedule to CA Act, 1949 and is also liable to be’ punished u/s 147 of Companies Act, 2013, due to nonobservance of compliance of Schedule III and Sections 184,188 and 189 of Companies Act, 2013.
Question 5.
Indicate the precise nature of auditor’s liability in the following situation: Certain weaknesses in the internal control procedure in the payment of wages in a large construction company were noticed by the statutory auditor who in turn brought the same to the knowledge of the Managing Director of the company. In the subsequent year huge defalcation came to the notice of the management. The origin of the same was traced to the earlier year. The management wants to sue the auditor for negligence and also plans to file a complaint with the Institute.
Answer:
Liabilities of auditor:
SA 265 on “Communicating Deficiencies in Internal Control to TCWG and Management” requires the auditor to determine whether, on the basis of the audit work performed, he has identified one or more deficiencies in internal control. If one or more deficiencies in internal control has been identified, he shall determine whether, such deficiencies individually or in combination constitute significant deficiencies. Significant deficiencies are required to be communicated in writing to TCWG and management on a timely basis.
In the given case, certain weaknesses in the internal control procedure in the payment of wages in a large construction company were noticed by the statutory auditor and brought the same to the knowledge of the Managing Director of the company. In the subsequent year, a huge defalcation took place, the ramification of which stretched to the earlier year. The management of the company desires to sue the statutory auditor for negligence.
The precise nature of auditor’s liability in the case can be ascertained on the basis of the following considerations:
(a) Whether the defalcation emanated from the weaknesses noticed by the statutory auditor, the information regarding which was passed on to the management; and
(b) Whether the statutory auditor properly and adequately extended the audit programme of the previous year having regard to the weaknesses noticed.
If circumstances indicate the possible existence of fraud or error, the auditor should consider the potential effect of the suspected fraud or error on the financial information. If the auditor believes the suspected fraud or error could have a material effect on the financial information, he should perform such modified or additional procedures as he determines to be appropriate. Thus, normally speaking, as long as the auditor took due care in performing the audit work, he cannot be held liable.
The fact that the matter was brought to the notice of the managing director may be a good defence for the auditor as well. In Kingston Cotton Mills Ltd., it was held that it is the duty of the auditor to probe into the depth only when his suspicion is aroused. The statutory auditor, by bringing the weakness to the notice of the managing director had alerted the management which is judicially held to be primarily responsible for protection of the assets of the company and can put forth this as defence against any claim arising subsequent to, passing of the information to the management.
Question 6.
Indicate the precise nature of auditor’s duties in the following situation: Based upon the legal opinion of a leading advocate, X Ltd. made a provision of ₹ 5 crores towards Income Tax liability. The assessing authority has worked out the liability at ₹ 15 crores. It is observed that the opinion of the advocate was inconsistent with legal position with regard to certain revenue items.
Answer:
Auditor’s liabilities in case of short provisions:
SA 500 on “Audit Evidence” requires that auditor to perform appropriate procedures while using the work of management expert as audit evidence. Before relying on expert’s opinion, the auditor should have seen that opinion given by the expert is prima facie appropriate and acceptable.
In the present case, opinion of the management expert was inconsistent with legal position with regard to certain items. It is, perhaps, quite possible that auditor did not seek reasonable assurance as to the appropriateness of the source data, assumptions and methods used by the expert properly.
SA 500 requires that auditor to resolve the inconsistency by discussion with the management and the expert. In case, the experts’ work does not support the related representation in the financial information, the inconsistency in legal opinions could have been detected by the auditor if he had gone through the same. This seems apparent having regard to wide difference in the liability worked out by the assessing authority.
Conclusion: Auditor should reject the opinion and insisted upon making proper provision.
Question 7.
State the nature of liability as provided in the Companies Act, 2013 of an auditor for not appropriately dealing with a misstatement appearing in audited Financial statements or a false statement in Audit Report. [Nov. 18-Old Syllabus (4 Marks)]
Answer:
Auditor’s Liability for not appropriately dealing with a misstatement appearing in audited financial statements or a false statement in Audit Report:
Sec. 448 of Companies Act, 2013 provides that if in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of any of the provisions of this Act or the rules made thereunder, any person makes a statement,—
(a) which is false in any material particulars, knowing it to be false; or
(b) which omits any material fact, knowing it to be material, he shall be liable under section 447.
Punishment for fraud: Sec. 447 of Companies Act, 2013 provides that, any person who is found to be guilty of fraud, involving an amount of at least ₹ 10 lakh or 1% of the turnover of the company, whichever is lower shall be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to 3 times the amount involved in the fraud.
Where the fraud involves an amount less than ₹ 10 lakh or 1% of the turnover of the company, whichever is lower, and does not involve public interest, any person guilty of such fraud shall be punishable with imprisonment for a term which may extend to 5 years or with fine which may extend to ₹ 50 lakh or with both.”.
Liabilities under Income-tax Act, 1961
Question 8.
In assessment procedure of M/s Cloud Ltd., Income Tax Officer observed some irregularities. Therefore, he started investigation of Books of Account audited and signed by Mr. Old, a practicing Chartered Accountant. While going through books he found that M/s Cloud Ltd. used to maintain two sets of Books of Account, one is the official set and other is covering all the transactions. Income Tax Department filed a complaint with the Institute of Chartered Accountants of India saying Mr. Old had negligently performed his duties. Comment. [May 14 (4 Marks)]
Answer:
Liabilities of Auditor:
It is the auditor’s responsibility to audit the statement of accounts and prepare tax returns on the basis of books of account produced before him. After being satisfied with the books and documents produced to him, he can give his opinion on the basis of those documents only by exercising requisite skill and care.
In the present case, Income tax Officer observed some irregularities during the assessment proceeding of M/s Cloud Ltd. Therefore, he started investigation of books of account audited and signed by Mr. Old, a practicing Chartered Accountant. While going through the books, he found that M/s Cloud Ltd. Used to maintain two sets of Books of Account, one is the official set and other is covering all the transactions. Income Tax Department filed a complaint with the ICAI saying Mr. Old had negligently performed his duties.
Mr. Old, the auditor was not under a duty to prepare books of account of assessee and he should, of course, neither suggest nor assist in the preparations of false accounts. He is responsible for the books produced before him for audit. He completed his audit work with official set of books only.
Conclusion: As Mr. Old, performed the auditing with due skill and diligence; and, therefore, no question of negligence arises. It is the duty of the Department to himself investigate the truth and correctness of the accounts of the assessee.
Question 9.
Write a short note on – Auditor’s liability in case of unlawful acts or defaults by clients.
Answer:
Auditor’s liability in case of unlawful acts of the client:
The Institute has recommended following course of action for a member when he is not directly involved in tax frauds committed by his clients, but he discovers such fraud in the course of his professional work:
(a) Member is under no obligation to inform income tax authorities about taxation frauds.
(b) If the fraud relates to accounts or tax matters of the client for past years for which the client was not represented by the member, client should be advised to-disclose. The member may however continue to act for the client in respect of current matters, but at the same time he is also required to ensure that the past fraud does not in any way affect the current tax matters.
(c) If the fraud relates to past years accounts examined and reported by the member himself, on the basis of which the tax assessment in the past has been made, he should advise the client for a disclosure. In case the client refuses, he should disassociate himself from the case and make a report to authorities that the accounts examined by him previously are unreliable on account of some information obtained later. (Details of information should not be communicated)
(d) In case of suppression of current accounts, the client should be advised to make a full disclosure. If he refuses, the accountant should make a complete reservation is his report and disassociate himself with return.
(e) If the services are dispensed with before completion of the assignment, there is no further duty to disclose.
Question 10.
Mr. Ram, a Chartered Accountant has appeared before the Income Tax Authorities as the authorized representative of his client and delivers to the income tax authorities a false declaration. What are the liabilities of Mr. Ram under Income-tax Act, 1961? [May 17 (4 Marks), MTP-Aug. 18)
Answer:
Liabilities under Income-tax Act, 1961:
Section 278 of Income-tax Act, 1961 (Liability for submission of false information): Any person who acts or induces, in any manner another person to make and deliver to the Income Tax Authorities a false account, statement, or declaration relating to any income chargeable to tax which he knows to be false or does not believe to be true is punishable
(i) in a case where the amount of tax, penalty or interest which would have been evaded, if the declaration, account or statement had been accepted as true, or which is wilfully attempted to be evaded, exceeds ₹ 25 Lacs, with rigorous imprisonment for a term which shall not be less than 6 months but which may extend to 7 years and with fine;
(ii) in any other case, with rigorous imprisonment for a term which shall not be less than 3 months but which may extend to 2 years and with fine.
ICAI Examiner Comments
Candidates showed lack of knowledge on liability of Chartered Accountants acting as authorised representative and delivering false information u/s 278 of the Income-tax Act, 1961 and most of them mistakenly related with professional misconduct under the Chartered , Accountants Act, 1949
Question 11.
What are the liabilities of a Chartered Accountant under Income-tax Act, 1961 for furnishing an incorrect statement in any report or certificate required to be submitted by him under the Act? [Nov. 18-New Syllabus (4 Marks)]
Answer:
Liabilities of a Chartered Accountant under Income-tax Act, 1961 for furnishing an incorrect statement in any report or certificate:
Liabilities u/s 271]: Sec. 271J of the Income-tax Act, 1961 provides that where the Assessing Officer op the Commissioner (Appeals), in the course of any proceedings under this Act, finds that an accountant or a merchant banker or a registered valuer has furnished incorrect information in any report or certificate furnished under any provision of this Act or the rules made thereunder, the Assessing Officer or the Commissioner (Appeals) may direct that person to pay a penalty of ₹ 10,000 for each such report or certificate.
Liabilities u/s 278;
Section 278 of Income-tax Act, 1961 (Liability for submission of false information): Any person who acts or induces, in any manner another person to make and deliver to the Income Tax Authorities a false account, statement, or declaration relating to any income chargeable to tax which he knows to be false or does not believe to be true is punishable
(i) in a case where the amount of tax, penalty or interest which would have been evaded, if the declaration, account or statement had been accepted as true, or which is wilfully attempted to be evaded, exceeds ₹ 25 Lacs, with rigorous imprisonment for a term which shall not be less than 6 months but which may extend to 7 years and with fine;
(ii) in any other case, with rigorous imprisonment for a term which shall not be less than 3 months but which may extend to 2 years and with fine.