bea2004 background reading unit 2 audit liability law and …
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Auditor Liability: Law and Myth D.R. Gwilliam Introduction Representatives of the accounting profession and the large auditing firms are currently lobbying for restriction of their liability in respect to negligent audit work. They argue that the overwhelming scale of claims to which they are exposed is such that unless measures are taken to allow audit firms to restrict their liability exposure there are likely to be significantly adverse consequences for the market for audit services. These may include the collapse of one or more of the large firms and consequent further restriction on competition within the market, or voluntary withdrawal by major firms from a market perceived as too risky for the level of reward offered. This is not a new debate – audit firms have been pressing for further legal protection for at least thirty years and the majority of the arguments have been 1extensively rehearsed over the years. However, the post Enron collapse of Arthur Andersen has both acted as a spur to the efforts of the profession and the firms to secure changes in the law and also provided, on the face of it at least, evidence to support their contentions as to the possibility and actuality of the demise of a major firm. This paper seeks to provide a background to this debate by means of setting out the legal environment within which auditors work and the various protection mechanisms currently available to auditors and then proceeds to consider ...
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| Publié par | Ustlo |
| Nombre de lectures | 49 |
| Langue | English |
Extrait
1
Auditor Liability: Law and Myth
D.R. Gwilliam
Introduction
Representatives of the accounting profession and the large auditing firms are currently
lobbying for restriction of their liability in respect to negligent audit work. They argue that
the overwhelming scale of claims to which they are exposed is such that unless
measures are taken to allow audit firms to restrict their liability exposure there are likely
to be significantly adverse consequences for the market for audit services. These may
include the collapse of one or more of the large firms and consequent further restriction
on competition within the market, or voluntary withdrawal by major firms from a market
perceived as too risky for the level of reward offered.
This is not a new debate – audit firms have been pressing for further legal
protection for at least thirty years and the majority of the arguments have been
extensively rehearsed over the years.
1
However, the post Enron collapse of Arthur
Andersen has both acted as a spur to the efforts of the profession and the firms to
secure changes in the law and also provided, on the face of it at least, evidence to
support their contentions as to the possibility and actuality of the demise of a major firm.
This paper seeks to provide a background to this debate by means of setting out the
legal environment within which auditors work and the various protection mechanisms
currently available to auditors and then proceeds to consider the specific issue of
whether the scale of the liability crisis currently confronting professional firms in the UK
is of the order of magnitude which those firms would have us believe and which might
suggest government intervention.
The Legal Environment
Auditors have contractual responsibilities to their client, normally the company as an
artificial person, and may owe duties in tort to any other parties, e.g. shareholders,
creditors, potential shareholders and creditors, who can demonstrate that they are owed
a duty of care by the auditor, although a duty to third parties will be owed in only very
restrictive circumstances. The courts have been anxious to limit the range of third parties
which can successfully argue that they are owed a duty of care, in part to avoid the
spectre raised by Cardozo J of liability in an indeterminate amount for an indeterminate
time to an indeterminate class.
2
In particular in
Caparo
3
the House of Lords determined
1
See, e.g., Gwilliam, D., ‘Auditors' Liability:
Should the Government Intervene?’ pp 22,
The Seventh Tom Robertson Memorial Lecture, University of Edinburgh, 1989; Gwilliam,
D., ‘The Auditor and the Law: Some Economic and Moral Issues’, in M. Bromwich and A.
Hopwood (eds)
Accounting and the Law
, Prentice-Hall, 1992, 191-204; Gwilliam, D.,
‘Auditors' Liability: the Public Policy Arguments’ (1992) 8 PN 147-151.
2
In
Ultramares Corporation v Touche
(1931) 255 NY 170.
3
Caparo Industries plc v Dickman
[1990] 2 AC 605.
2
that audited financial reports are not published for the purpose, in legal terms at least, of
providing information for the making of investment decisions and therefore shareholders
and creditors seeking to rely on them for this purpose would normally have no legal
redress against a negligent auditor.
Further, for any claim to succeed it must be shown
that the auditor was negligent in that they failed to carry out their duties with the requisite
level of skill and care and also that the party making the claim suffered loss consequent
on reliance upon the auditor’s work. Detailed discussion of what constitutes negligence
and of the circumstances in which third parties are able to demonstrate that they are
owed a duty of care is beyond the scope of this paper
4
but in general terms the conduct
of an audit in accordance with professional standards is likely to be sufficient to defeat a
claim of negligence.
More specific aspects of the current legal environment
which are relevant to the
present debate include those relating to:
•
The organisational structure of audit firms
•
Restrictions
on the ability of the auditor to negotiate a contractual limit on liability
•
The use of a disclaimer in the audit report
•
Contributory negligence as a defence
•
The operation of section 727 of the Companies Act 1985
I will consider each of these in turn.
Organisational structure
Historically audit firms had to be constituted as partnerships with unlimited liability
attaching to the firm and individual partners, but this is no longer the case. First audit
firms pressed for, and obtained in the 1989 Companies Act, the right to incorporate.
However a combination of perceived adverse taxation consequences and a
disinclination to disclose the detailed information as required in company annual reports
meant that very few firms did in fact incorporate. Only one of the then major international
firms, KPMG, chose to incorporate part of its audit activities. Instead the major firms
lobbied for the introduction into UK law of a form of limited liability partnership modelled
on an organisational form pioneered in North America.
5
As documented in Sikka
4
See Gwilliam, D., ‘Changes in the Legal Environment’ in M. Sherer and S. Turley (eds)
Current Issues in Auditing
(3rd ed.) Paul Chapman Publishing 1997, 103-128 for an
overview.
5
See Freedman, J. and Finch, V., ‘Limited Liability Partnerships: Have Accountants Sewn
Up the ‘Deep Pockets’ Debate’ [1997] JBL
387-423 and Finch, V. and Freedman J., ‘The
Limited Liability Partnership: Pick and Mix or Mix-up?’ [2002] JBL
475-512
for extensive
discussion of the limited liability partnership organisational form.
Deleted:
page 000??
Deleted:
Limitation
3
(2004)
,
6
two of the large firms spent approximately £1m to sponsor the introduction of
such legislation in Jersey and threatened to move their headquarter operations to that
country. Instead the UK government promised to introduce equivalent legislation and
following the passing of the Limited Liability Partnership Act 2000 the four largest UK
auditing firms all now operate as limited liability partnerships.
Contractual limitation of liability
Section 310 of the 1985 Companies Act acts to prevent an officer of the company
(including an auditor) limiting contractually their liability to the company for negligence in
the performance of their duties. Introduced in the 1929 Companies Act following the
City
Equitable
7
case of 1925 (where the auditor was relieved of liability for negligence
because of a clause in the articles of association of the company which stated that
liability would only follow consequent to ‘wilful negligence’) it has been re-enacted in all
subsequent Companies Acts (although it was amended in the 1989 Act so as to allow
the company to purchase indemnity insurance on behalf of their auditors should they so
wish to do so – to date few, if any companies have availed themselves of this
opportunity).
8
Although a Law Commission study
9
formed the ‘tentative view’ that reform
of this section was justified and there was scope for a review of the extent to which
auditors were prevented from limiting their liability contractually this has not resulted in
any subsequent change of the law. A call for change to this section to allow an agreed
limitation of liability between the auditor and the client is fundamental to the current
campaign of the large firms.
Disclaimers
Following the
Bannerman
10
case, in which a lower court judge found there to be a duty
of care owed by an audit firm to a bank which had lent money to the auditor’s client, the
large firms acted to limit their liability to third parties by including a disclaimer of liability
in their audit report. Following this unilateral action ICAEW, which previously had not
encouraged the use of disclaimers in statutory audit reports, issued guidance as to the
nature and likely efficacy of such a disclaimer and recommended their use.
11
As yet the
6
Sikka P. ‘Globalisation and Its Discontents: Accounting Firms Buy Limited Liability
Partnership Legislation in Jersey’, paper presented at the EAA Conference, Prague,
2004.
7
[1925] Ch 407.
8
See Gwilliam, D., ‘Exclusion Clauses, Indemnities and Disclaimers’
(1988) 4 PN 8-11;
Arnull, C., ‘Professional Advisers and Limitations on Liability’ (2003) 19 PN 493-564 for
further discussion of the operation of this section.
9
Law Commission, Common Law Team; Department of Trade and Industry,
Feasibility
Investigation of Joint and Several Liability
, 1996, HMSO.
10
Royal Bank of Scotland v Bannerman Johnstone Maclay
[2003] PNLR 77.
11
ICAEW Technical Release Audit 1-03,
The Audit Report and Auditors’ Duty of Care to
Third Parties – Bannerman
2003. Interestingly this recommendation was not endorsed by
ACCA.
4
standing of such a disclaimer has not been tested in the courts and it is an open
question as to whether such a disclaimer adds significantly to the protection already
provided.
12
However in that judges in both
ADT Ltd v BDO Binder Hamlyn
13
and
Bannerman
referred to the possibility of disclaiming responsibility and implicitly at least
suggested that failure to make such a disclaimer amounted to a voluntary assumption of
responsibility it may be that there are situations in which the courts will disallow a third
party action which might otherwise succeed because of the presence of this disclaimer
14
.
Here a separate wider international issue is the disapproval of the SEC of the use of
such disclaimers, which may have ramifications for those UK firms which also file their
accounts with the SEC.
Contributory Negligence
For many years auditors have claimed that they are unfairly held to account for the
failures of others, in particular client management. They argue that they should only be
responsible for ‘their share’ of the relevant damages, the majority of which damages
would normally lie at the feet of company management. Whereas auditors have the right
to make contribution claims (under the Civil Liability (Contribution) Act 1978) against any
party who they consider to have been responsible wholly or in part for any loss for which
auditors have been held accountable this right may be of little value where such parties,
typically directors, have limited assets. If, however, damages be apportioned in
accordance with the precepts of contributory negligence the auditor would benefit
directly from such a reduction with the risk of other parties financial fragility being passed
on to the aggrieved plaintiff. In the past auditors have rarely been successful in raising a
defence of contributory negligence. One legal issue was whether such a defence, which
was originally envisaged for use in actions in tort, was valid in the case of contractual
actions brought by a company against an auditor.
15
More tellingly has been the view of
the courts that whereas the failings of management may be relevant to the question of
whether or not the auditor has conducted his or her duties with appropriate reasonable
skill and care, they cannot in themselves be a defence to an action brought by the
company. As stated by Moffitt P in the Australian case
Simonius Vischer
: ‘If, as where
the audit is of a public company, the audit contract or the undertaking of the audit is
found to impose a duty to be exercised so as to safeguard the interests of the
shareholders, it is difficult to see how the conduct of any servant or director could
constitute the relevant negligence, so as to defeat the claim against the auditor, whose
duty is to check the conduct of such persons and, where appropriate, report it to the
shareholders.’
16
12
See
Jackson & Powell on Professional Negligence
, 5
th
ed., 2002, para 15-101; Dugdale
and Stanton,
Professional Negligence
, 3
rd
ed., 1998, paras 26.13
et seq
.
13
[1996] BCC 808.
14
See Arnull C., ‘Auditors’ Reports, Misconceptions and Third Party Disclaimers’ (2002) 18
PN 146-155 for a wider discussion of the use of disclaimers in the audit context.
15
This was resolved in
Forsikringsaktieselskapet Vesta v Butcher
[1989] AC 852 (CA).
Contributory negligence can be invoked where the defendant’s negligent breach of
contract would have given rise to liability in the tort of negligence independently of the
existence of the contract, but not where liability does not depend on negligence but arises
from breach of a strict contractual duty.
5
However, more recently the courts have shown a greater willingness to allow the
defence and to apportion any damages accordingly, for example in the Australian case
AWA Ltd v Daniels
17
and more recently in the UK in
Barings Futures
18
in which the
failure to provide adequate supervision of Leeson and his trading was grounds for
reduction of damages ranging from 50 to 95 percent over four different time periods.
19
Discretionary Relief
Section 727 of the Companies Act 1985 provides that in circumstances where an officer
of a company (including an auditor) has been negligent
but ‘he has acted honestly and
reasonably, and that having regard to all the circumstances of the case (including those
connected with his appointment) he ought fairly to be excused for the negligence, … that
the court may relieve him, either wholly or partly, from his liability on such terms as it
thinks fit.’ The section was first introduced into company legislation in 1908 but was not
extended to cover auditors until 1929. Although over the years the courts have been
asked to grant such relief in a number of cases involving auditors these applications
were invariably unsuccessful, the principal obstacle being that it is difficult to see how it
can be reasonable to be negligent – particularly when the underlying test for the non-
negligent performance of an auditor’s duties is that they are carried out with the exercise
of reasonable care and skill, an issue raised by North P. in
Dimond
20
: ‘To begin with it is
difficult to understand how a negligent officer or auditor could nevertheless be held to
have acted “reasonably” but there it is, for the section undoubtedly recognises that in
some circumstances an auditor or other officer of the company, though guilty of
negligence, may be held nevertheless to have acted reasonably.’
21
However, again recently there has been evidence of a willingness of the courts to
apply this section in the favour of the auditors.
22
In
Barings Futures
, following decisions
in Australian cases, the judge (Evans-Lombe J) concluded that Deloitte & Touche ‘may
have acted reasonably for the purposes of the section even though I have found them to
have acted negligently, if they acted in good faith and their negligence was technical or
16
Simonius Vischer & Co. v Holt and Thompson
[1979] 2 NSWLR 322.
See Gwilliam, D.,
‘Apportionment in Actions Against Auditors’ (1988) 24
Abacus
37-53 for a review of the
application of the defence of contributory negligence in actions against auditors.
17
(1995) 16 ACSR 607.
18
Barings plc (In Liquidation) v Coopers & Lybrand (No. 7)
[2003] EWHC 1319; [2003]
PNLR 34.
19
See Dugdale, A., ‘Auditor’s Liability to the Client: Ups and Downs Professional’ (2003) 19
PN 536-541.
20
Dimond Manufacturing Co. Ltd v Hamilton
[1969] NZLR 609.
21
See Gwilliam, D., ‘The Court’s Power of Discretionary Relief in Actions Against Auditors’
(1988) 19 (No. 73)
Accounting and Business Research
43-46 for further discussion of the
operation of this section.
22
See Dugdale, A., ‘Auditor’s Liability to the Client: Ups and Downs’ (2003) 19 PN 536-541.
Deleted:
Professional
6
minor in character, and not “
pervasive and compelling
”.’
23
On this basis he found that
Deloitte & Touche had indeed acted reasonably for the purposes of this section.
Specifically the audits had been carried out with great thoroughness for very low fees
and the identified negligence was limited in extent, technical in nature and not pervasive
or compelling. In consequence the damages awarded against Deloitte & Touche were
reduced accordingly.
The DTI Consultation Exercise
Whereas the UK government has been prepared, after some persuasion, to grant the
structural changes in the form of incorporation and limited liability partnerships, it has
been less happy to see the more sweeping changes in liability law now being advocated
by the audit firms. However a consultation document issued by the Department of Trade
and Industry in December 2003 signalled a more flexible approach. It stated:
‘Nevertheless, provided satisfactory evidence is forthcoming, the Government is in
principle prepared to consider whether some of the rules that govern auditors’ liability
when conducting the statutory audit of the company should be reformed’. Included
among the evidence sought by the DTI before it was prepared to endorse change was
the answer to the specific question:
Given that no audit firm has yet collapsed as a result of a claim successfully
made against it in the UK, how real is the threat to the largest firms?
As limited liability partnerships audit firms are required to produce annual reports subject
to accounting and disclosure requirements almost identical to those for limited
companies. Given that we now have audited accounts for three of the largest four UK
firms, KPMG, PricewaterhouseCoopers (PWC) and Ernst & Young (EY) (Deloitte have
yet to file their first set of accounts) might these form a starting point for the identification
of such evidence?
Within each of these annual reports there is discussion of liability issues in the
Chairman’s statement or its equivalent. There is also separately provided information as
to risk management procedures, and, within the audited financial statements
themselves, information as to the accounting policies followed in relation to claims and
related insurance recoveries, identification of current provisioning against claims and
further disclosures as to contingent liabilities. Reviewing these throws up a number of
interesting accounting and auditing issues and also sheds some light on the question
posed by the DTI as to the perceived likelihood of a major firm collapse.
The Chairman’s statement
In all three reports a line strongly supportive of liability reform is taken. Each chairman
identifies the extent of liability exposure, the potential for a major firm collapse and calls
for modification of section 310 to allow contractual limitation of liability. To quote from
each statement in turn.
23
Barings plc (In Liquidation) v Coopers & Lybrand (No. 7)
[2003] EWHC 1319; [2003]
PNLR 34 at [1133].
Deleted:
Deleted:
¶
¶
7
‘KPMG seeks further progressive change on issues affecting the profession,
notably the reform of auditor liability…The continuing increase in claims and
settlements and limited insurance cover create a situation where there is real risk
of further contraction in the number of major audit firms.’ (Mike Rake, KPMG)
‘We absolutely accept that we should be held accountable for our failure, but the
scale of activities of the larger corporates and trends in litigation have combined
to create liability exposures which are both unsustainable and uninsurable. This
needs to be fixed before the Big Four is reduced to the Big Three or less.’ (Kieran
Poynter, PWC)
‘One major issue facing all the large accountancy firms today is auditor liability. It
is becoming common for firms to face claims that can run into hundreds of
millions, or even billions, of pounds and that are significantly in excess of the
available insurance cover…[repeal of section 310 would remove] the risk of
another major audit firm collapsing. That possibility would leave companies with
an unacceptably restricted choice of auditors.’ (Nick Land, EY)
However, in each report the further information provided as to risk management
procedures, the specific information as to the level of provisioning against claims and the
disclosures as to contingent liabilities provides little, if any, support for the picture
painted by the leaders of these firms.
Risk Management Disclosures
The rise of the risk management culture has been a key development in corporate
governance in recent years and it has been accompanied by an increasing level of
disclosure in annual reports as to the nature of risk management activities within
companies and commercial entities. The large audit firms have a high level of expertise
in risk management, as for example in the development of ‘business risk’ audit
approaches which have been seen as positioning external audit and linked advisory
services within the overall risk management profile of their clients. Not surprisingly all
three firms provide extensive disclosure as to their own quality control and engagement
management procedures including information as to training, procedural manuals,
engagement team structure and review procedures, internal quality review,
independence compliance procedures etc. There is also an emphasis on the rigour of
client acceptance procedures and monitoring of client integrity.
For example, the PWC
report states:
‘The firm has specific procedures to assess the risks associated with new clients,
including whether they meet expected standards of integrity. We undertake
annual risk reviews of all audit clients, which include confirming that they
continue to meet these standards. We decline to accept clients where our
assessment indicates that these standards are not met.’
Overall the impression given is a reassuring one and is not suggestive of a liability crisis
or an inability to manage professional risk. Indeed, the only slightly negative note is to be
found in the EY Business and financial review which comments that: ‘the risks
associated with our services are increasing as litigation becomes more frequent, driven
by a “blame culture” and the pursuit of so-called “deep pockets”.’
8
Financial Statement Disclosures
Although the risk management disclosures are indicative of internal quality controls and
checks which should suffice to protect auditors against findings of negligence, this is of
course ‘soft’ information. The audited financial statements should provide an insight into
how successful these preventative activities have been in keeping the level of claims
and payouts to manageable proportions. First it is necessary to ascertain how the firms
account for claims, claims which may or may not reach the courts and may or may not
be covered wholly or partially by insurance whether internal or external.
Accounting policies
The accounting policies followed by the firms are set out below. They are couched in
general terms and say little more than appropriate provision is made for likely
settlements. There would appear to be a difference between KPMG’s policy of showing
separately gross estimated settlements and related insurance recoveries whereas PWC
and EY net off the two – a point which is discussed further below. No reference is made
to profit and loss disclosure of insurance expense and little is disclosed about how much
insurance cover the firms hold or how much it costs them, although two of the firms (one
here and one under contingent liabilities) refer to substantial cover through captive
insurers – but with significant sums written or reinsured in the commercial market.
The respective accounting policy notes are:
‘Substantial insurance cover in respect of professional negligence claims is
carried. Cover is principally written through a number of mutual insurance
companies, but also through the commercial market.’
‘Where appropriate, provision is made against the eventuality of settlement of
claims with any related insurance recoveries included in “Debtors”.’ (KPMG)
‘In common with comparable practices, the Group is involved in a number of
disputes in the ordinary course of business which may give rise to claims.
Provision is made in the financial statements on a prudent basis for all claims
where costs are likely to be incurred and represents the costs of defending and
concluding claims. The Group carries professional indemnity insurance and no
separate disclosure is made of the cost of claims covered by insurance as to do
so could seriously prejudice the position of the Group.’ (PWC)
‘Provision is made on a case-by-case basis in respect of the cost of defending
claims and, where appropriate, the estimated cost to Ernst & Young LLP of
settling claims. Separate disclosure is not made of any expected insurance
recoveries in respect of claims on the grounds that disclosure might seriously
prejudice the position of the firm.’ (EY)
Provisions and contingent liabilities
9
Inspection of the respective balance sheets reveals that the actual scale of provision is
in fact quite modest. KPMG appear to make no provision at all – which given their
accounting policy implies that they have no expectation of making any payments in
relation to current liability claims whether covered by insurance or not. PWC have the
largest year end provision, £66m, reduced by £1m from the opening provision of £67m.
EY have a year end provision £20.3m, reduced from £22.5m at the start of the year.
Nor does reference to contingent liability disclosures give any indication of a high
level of potential charges associated with settlements or court judgments. All three firms
make reference to the potential for claims but none provide any quantification thereof –
which would be the normal treatment under
Financial Reporting Statement (
FRS
)
12
Provisions, contingent liabilities and contingent assets
– and indeed the disclosures are
relatively bland and reassuring:
‘The businesses consolidated in the financial statements of the group may, in the
normal course of conducting their businesses, receive claims for alleged
negligence. They contest such claims vigorously and maintain substantial
professional indemnity cover.’ (KPMG)
‘The Group’s policy with regard to claims which may arise in connection with
disputes in the ordinary course of business is described in note 1 on Provisions.’
(PWC)
‘In the normal course of business, Ernst & Young LLP may receive claims for
alleged negligence. Substantial insurance cover is carried in respect of
professional negligence. Cover is principally written through captive insurance
companies involving other Ernst & Young firms and a significant amount of the
total cover is reinsured through the commercial market. Where appropriate
provision is made for the costs of such claims.’ (EY)
Accounting and auditing issues
The treatment of liability issues within these financial statements raises a number of
accounting and auditing issues. Clearly there is scope for greater disclosure as to the
cost and extent of insurance cover and of the scale of actual and potential claims. There
is also the question of why the firms differ in their treatment of gross and net claims. FRS
12
states – and gives insurance as an example – that recoveries related to provisions
should be shown separately as an asset, i.e. settlements and recoveries should not be
netted off. The standard does however allow that
in extremely rare cases
required
disclosure need not be provided in situations where the disclosure could be
expected to
prejudice seriously the position of the entity in dispute with other parties
. In such
circumstances the entity
should disclose the general nature of the dispute, together with
the fact that, and reason why, the information has not been disclosed
. KPMG have
reported for a number of years on the basis of an accounting policy in line with the
mainstream provisions of FRS 12, and the other two firms, setting their public accounting
policies for the first time this year, will have deliberated as to whether their situation does
fall into the
extremely rare
category (as of course will have their auditors).
24
They will
24
The Statement of Recommended Practice
Accounting by Limited Liability Partnerships
provides no additional guidance – in fact it avoids the issue. It states, in a footnote,
10
also have considered whether the disclosures provided do in fact comply with the more
limited disclosure requirements then specified. (It is true that Ernst & Young’s UK
GAAP
25
questions whether the requirement to gross up is an improvement on the
previous rules under
Statement of Standard Accounting Practice
18 where net
disclosure was allowed – but it is nevertheless in the standard).
With respect to contingent liabilities FRS 12 requires quantification of the
financial effect
unless the possibility of any transfer of economic benefits is remote
. UK
GAAP suggests that a probability of transfer of less than 5% may be considered
sufficiently remote for non-disclosure as a contingent liability. Here for two of the firms
non-disclosure other than in general terms may be consequent to the view taken that
disclosure would seriously prejudice the business – although the case for this would
seem to be weaker than that for actual provisions. However, for KPMG this would imply
that not only have they not needed to make any provision for expected settlements
irrespective of insurance recoveries (and reviewing the financial statements for 2001 and
2002 no provisions were necessary in those years either) but that they expect the
chance of a material transfer of economic benefit arising from a contingent liability to be
less than one in twenty. One might conjecture from this that whichever major audit firm
Mike Rake considers is at
real risk
of going out of business it is not KPMG!
A third issue is a more specific auditing one. Auditing standards require auditors
to consider the implications of other information contained in the annual review in
respect to its consistency with the financial statements. Consideration of the comments
made by the respective chairmen will have heightened auditor awareness of the need to
investigate closely the appropriate level of provisioning and may also have prompted
them to consider, at least in passing, issues as to the possibility of a going concern
qualification in the audit report. Logically one might think that if three out of four firms
believe that there is a very real risk of one of the four collapsing within a reasonably
short time frame then the inclusion in the audit report of an explanatory paragraph along
the lines suggested in
the auditing standard SAS 600
would be informative to users of
accounts (and also perhaps provide a further degree of legal protection for the auditor in
the event of such a collapse occurring). The fact that all three reports are unqualified and
include no such paragraph may suggest that the auditors are more sanguine as to the
prospects of their clients than the clients themselves.
Conclusion
These accounting and audit issues may well be of interest to those dealing on a
commercial basis with audit firms, and of course to partners past, present and future in
the firms given that reported accounting profits normally directly impact upon partner
remuneration - but in conclusion it is necessary to return to the question posed by the
DTI: how real is the threat posed to the largest firms? This involves consideration of the
threat posed by existing claims and also that posed by claims that might arise in the
‘Professional services firms will apply FRS 12 in relation to claims against them and
associated insurance reimbursements. Such matters are not specific to LLPs and so are
not addressed in this SORP.’
25
Wilson, A.,Davies, M., Curtis, M. and G. Wilkinson-Riddle,
UK & International GAAP,
7
th
edn
(2001) at p.1971
Deleted:
[PLEASE SPELL
OUT]
Deleted:
SSAP
Deleted:
[PLEASE SPELL
OUT]
Deleted:
SAS 600
[PLEASE
SPELL OUT]
11
future. On the basis of the audited financial statements it is clear that to date the firms
have managed their liability risk far more successfully than might have been thought –
as encapsulated in the following table:
KPMG
PWC
EY
Profit for the year £m
263
579
193
Net assets £m
272
372
270
Outstanding provisions for
claims £m
Nil
66
20.3
Quantified
contingent
liability disclosure
Nil
Nil
Nil
(figures for the most recent reporting period)
The question of whether future as yet unknown claims might result in the closure
of a firm in the short to medium term is of course impossible to answer definitively. It is
also true that even if that is a significant possibility there are wide economic and legal
policy issues involved in deciding how important is the preservation of the present
auditing status quo. However, and given that the audit firms have highlighted the
existence of a liability ‘crisis’ for at least twenty years, extrapolating evidence from the
past forward would suggest that the risk is in fact significantly less than that which the
leaders of the firms would have us, and the DTI, believe. Taken together with the
generally protective stance taken by the courts, as evidenced by their increasing
willingness to allow apportionment of damages on the grounds of contributory
negligence and also the possibility of discretionary relief under section 727 of the
Companies Act 1985, it may be argued that the case for further limitation of liability is not
well founded.
D.R. Gwilliam
*
*
University of Wales, Aberystwyth.
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