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Learning objectives
2.1 Identify the attributes of professional status and describe to what extent they exist in public
accounting.
2.2 Describe the regulation of auditing and its subject matter.
2.3 Explain the impact of internationalisation on auditing.
2.4 Outline the characteristics of the professional bodies and accounting firms engaged in the
auditing profession and describe the internal structure of an audit firm.
2.5 Identify the elements of quality control within audit firms and explain practice-monitoring
programs.
2.6 Explain the concepts of reasonable care and skill, and negligence.
2.7 Explain the auditor’s legal liability to clients.
2.8 Explain the auditor’s liability to third parties
2.9 Describe alternative methods used to limit the auditor’s liability.
Major chapter sections
Professional status of the auditor
Regulation of auditing and of the subject matter of audits
Internationalisation of auditing
Profile of the auditing profession and of audit firms
Quality control
Reasonable care and skill, and negligence
Liability to clients
Liability to third parties
Limitation of liability
Lecture plan
Since many students are interested in a career in public accounting, we normally spend some time
covering the items in this section. In particular, we like to go over the status of auditing as a
profession and the role of government and professional associations in the auditing and assurance
services environment.
Instructor Resource Manual t/a Auditing and Assurance Services in Australia 6e by Gay & Simnett
You should outline the learning objectives for this chapter, and also walk them through how this
chapter fits into the flowchart of the overall auditing and assurance framework.
[Use slides 2-1 to 2-3]
LO 2.1: Professional status of the auditor
It is important that students realise that auditing is a profession and, therefore, like all professions,
must exhibit the attributes of systematic theory, professional authority, community sanction,
regulative codes and culture.
[Use slides 2-4 and 2-5]
LO 2.2: Regulation of auditing and of the subject matter of audits
It should be pointed out to students that the audit and assurance function is carried out in a complex
environment, composed of interrelationships between government and professional organisations and
individual auditors and audit firms. Students should be made aware of the main government and
independent agencies that regulate auditing and the subject matter of audits, and the role played by
the accounting bodies.
[Use slides 2-6 to 2-13]
LO 2.3: Internationalisation of auditing
Business is now conducted globally and this has contributed to the development of international
auditing practices. Introducing students to the importance of the global environment at this early
stage prepares them for considering this aspect in relation to client business risk later on.
[Use slides 2-14 to 2-16]
LO 2.4: Profile of the auditing profession and of audit firms
We review the three key professional accounting bodies that dominate the auditing profession in
Australia. We then briefly review the structure of firms (e.g. sole trader, partnership or authorised
audit company), the categorisation of firms (e.g. Big 4, national firms, regional firms and local firms)
and the types of services (e.g. audit, tax, management consulting, internal audit, and accounting and
insolvency services) that are offered by public accounting firms. We also give an example of the
internal structure of an audit firm.
[Use slides 2-17 to 2-24]
LO 2.5: Quality control
Students should be made aware at this stage that quality control procedures are essential to ensure
auditors meet their responsibilities. We discuss the overall requirements of ASA 220 (ISA 220),
Instructor Resource Manual t/a Auditing and Assurance Services in Australia 6e by Gay & Simnett
ASQC 1 (ISQC1) and APES 320 and the key quality control procedures used by the professional
accounting bodies, including practice reviews and professional development.
[Use slides 2-25 and 2-29]
LO 2.6: Reasonable care and skill, and negligence
We usually start our discussion of this topic by referring to the agency or stewardship notions
covered in Chapter 1. It is then easy to show the students how parties to the contract (principals and
agents) should have recourse against the auditor if an inappropriate auditor’s report is issued.
Students should realise that an auditor does not guarantee their work product. However, the auditor is
required to perform professional services with due care. When the auditor fails to carry out
contractual arrangements with the client, they can be held liable for breach of contract and/or
negligence.
When discussing the concept of reasonable care and skill we use the quote from Lord Bridge in the
Caparo case. When discussing the auditor’s liability under common law for negligence, we discuss
the elements for establishing auditor liability for negligence:
1 the duty to conform to a required standard of care
2 failure to act in accordance with that duty
3 actual loss or damage to client
4 a causal connection between the auditor’s negligence and the client’s damage.
[Use slide 2-30 to 2-32]
LO 2.7: Liability to clients
We point out that the auditor’s liability for breach of contract arises from the obligations included in
the engagement letter.
It is important that students realise that an auditor’s liability to clients can arise both in contract and
in the tort of negligence. We discuss the main cases that have led to the development of the auditor’s
liability to clients. Particular emphasis is placed on the Pacific Acceptance case, as this was the first
time the court gave a decided indication of what was expected under reasonable care and skill.
We also discuss the development of the concept of contributory negligence here, emphasising the
AWA case (1995), which establishes the principles of contributory negligence.
[Use slides 2-33 to 2-36]
Instructor Resource Manual t/a Auditing and Assurance Services in Australia 6e by Gay & Simnett
LO 2.8: Liability to third parties
It is important for students to know that auditors’ liability to third parties for negligence is very
complex and that court rulings are not always consistent.
It is important for students to be aware of the history of the development of the current position
regarding auditors’ liability to third parties. Therefore, we go through some of the major cases,
beginning with Donoghue and Stevenson and going through to Esanda, and discuss the concepts of
special relationship, reasonable foreseeability and proximity. The amount of time spent here will
depend on how much of this material students have already covered in business law subjects.
[Use slides 2-37 to 2-41]
We also point out to students that legal decisions have resulted in third-party requests for privity
letters.
[Use slide 2-42]
Students should also be made aware that although the auditor’s liability to third parties under the tort
of negligence now seems very narrow and is limited to situations where the auditor induced the third
party to rely on the auditor’s report, the auditor may also have a potential liability under the
Commonwealth Competition and Consumer Act 2010 or the relevant state Fair Trading Acts and
under the ASIC Act.
[Use slides 2-43 to 2-44]
Students should also be made aware of the fact that auditors may be subject to criminal prosecution,
although this is rare.
[Use slide 2-45]
LO 2.9: Limitation of liability
We find that a useful way of introducing this topic is to refer to the substantial litigation against
auditors over the past twenty years or so and refer to the claims made in cases in Australia, such as
Tricontinental, the State Bank of South Australia, Westpoint, MFS and Centro. We also discuss the
problems of operating as a partnership and of obtaining satisfactory professional indemnity
insurance.
We then discuss the arguments for and against limiting the auditor’s liability and the different
schemes introduced through
