The role of a company auditor is a crucial element of corporate governance, providing an independent check on the financial statements prepared by a company’s management. The primary legal responsibilities an auditor holds are both statutory and based in common law, and are owed to the members of the company as a collective body. The law does not impose a duty on auditors to be perfect, but it does mandate a specific standard of professional care and skill in the performance of their duties. This essay will explain the auditor’s main legal responsibilities and the standard of care they are expected to meet.
Statutory and Contractual Responsibilities
The principal responsibility of an auditor is statutory, originating from the Companies Act 2006. The core duty is found in section 495 of the Act, which requires the auditor to make a report to the company’s members on the annual accounts. This report must state, among other things, whether in the auditor’s opinion the accounts give a “true and fair view” of the company’s financial position. This is the central pillar of an auditor’s function. The Companies Act 2006 also imposes further duties, such as the duty to state whether the directors’ report is consistent with the accounts (Companies Act 2006, s 496). An auditor’s responsibilities are also founded in contract, through the engagement letter with the company. However, these contractual terms cannot limit the auditor’s statutory duties. Failure to fulfil these responsibilities can lead to liability.
The Common Law Standard of Care
Beyond the statutory framework, the courts have developed a standard of care that an auditor must exercise. The classic articulation of this standard is the “watchdog, not a bloodhound” principle derived from the case of *Re Kingston Cotton Mill Co (No 2)* [1896] 2 Ch 279. In that judgment, Lopes LJ stated that it is not an auditor’s job to approach their work with the assumption that the company’s officers are dishonest. An auditor is justified in trusting the company’s servants, provided they take reasonable care. However, if circumstances arise that ought to create suspicion, the auditor must then investigate the matter thoroughly. This principle confirms that an auditor is not an insurer who guarantees the correctness of the company’s books.
The law requires auditors to possess and use the reasonable care and skill of a competent professional in their field. This was established in *Re London and General Bank (No 2)* [1895] 2 Ch 673, where it was held an auditor must be honest and exercise a reasonable degree of care and skill. What constitutes ‘reasonable care’ is not a fixed standard, but evolves over time with changes in professional practice and technology. A modern auditor is expected to maintain professional scepticism and be alert to the risks of misstatement, whether due to error or fraud. The standard today is therefore more demanding than it was in the nineteenth century. For instance, in *Barings plc v Coopers & Lybrand* [2003] EWHC 1319 (Ch), the court placed emphasis on the need for auditors to understand the company’s business and the control environment, suggesting a more proactive approach is required of a modern ‘watchdog’ than was previously the case.
In conclusion, an auditor’s legal responsibilities are primarily to report to the company’s members on whether the financial statements present a true and fair view. This is a duty set out in the Companies Act 2006. In performing this function, the auditor is held to a standard of reasonable care and skill, as expected of a competent member of the profession. While the historic principle that an auditor is a watchdog and not a bloodhound remains relevant, the expectations of what a reasonable watchdog should detect have undoubtedly increased over the last century, in line with developments in the accounting profession itself.
References
- Barings plc (in liquidation) v Coopers & Lybrand (No 2) [2003] EWHC 1319 (Ch)
- Companies Act 2006
- Re Kingston Cotton Mill Co (No 2) [1896] 2 Ch 279
- Re London and General Bank (No 2) [1895] 2 Ch 673
