Professional Negligence and Liability

Edited by Mark Simpson KC

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Chapter 13 ACCOUNTANTS AND AUDITORS

Authored by JAMES BROCKLEBANK KC AND HARRY WRIGHT

I. INTRODUCTION

13.1 In the modern world, accountants perform a very wide range of functions. While the historical core of those activities is the compilation and review of accounts, the services today provided include a wide range of activities encompassing auditing, financial reporting, taxation and personal finance advice, financial management, and advice as to corporate finance and information technology, as well as acting as liquidators, administrators and receivers. The extent to which accountants, and in particular auditors, are able to offer such a range of services consistently with their duties of independence has been and remains a subject of regulatory and political interest, but is beyond the scope of the present chapter. 13.1.1 The main focus of this chapter is on the rights, duties and regulation of auditors in the context of UK company audits. The law in this area traditionally sought to strike a balance between two competing considerations: on the one hand, the need to impose duties and standards of conduct on auditors that will ensure that the audit remains an effective and valuable defence against the risk of fraudulent or defective financial reporting; and, on the other hand, the need to place sensible limits on auditors’ potential exposure so as to avoid the risk that auditing could become too risky and expensive to be an economically viable activity. The second of these issues features prominently in much of the case law concerning accountants and auditors. However, increasing attention has been paid to the first issue in the wake of high-profile corporate collapses both in the United States and in the UK. Such cases continue to prompt scrutiny of the rules and regulations governing the conduct of audits and, in particular, the extent to which they ensure that auditors carry out an independent and objective check of their clients’ financial statements. Moreover, in parallel with heightened regulatory and political scrutiny of the audit function, recent case law in this jurisdiction suggests declining judicial inclination to use legal principles such as causation and scope of duty to limit auditors’ liability. 13.1.2 Certain reforms of the companies legislation were enacted in the Companies Act 2006, which was intended to codify (and modify) pre-existing legislation. Part 15 of the Act is concerned with accounts and reports and Part 16 contains provisions relating to audit. 13.2 Under the current regulatory regime, reponsibility for regulating the accountancy profession lies primarily with a number of professional bodies which provide training and examinations for their members. There are five principal accountancy bodies in the United Kingdom and the Republic of Ireland, which comprise the Consultative Committee of Accountancy Bodies (or “CCAB”). They are the Institute of Chartered Accountants in England and Wales (“ICAEW”), which was established by Royal Charter in 1880; the Institute of Chartered Accountants of Scotland (“ICAS”), which received its Royal Charter in 1854; Chartered Accountants Ireland, incorporated in 1888; the Association of Chartered Certified Accountants (“ACCA”) founded in 1904; and the Chartered Institute of Public Finance and Accountancy (“CIPFA”), which trains accountants for the public services. 13.2.1 These professional bodies have statutory responsibility for regulating and supervising the conduct of their members. In turn, they are subject to the supervision of the Financial Reporting Council (FRC), an independent body funded jointly by the accountancy profession, businesses and the Government.1 The FRC consists of a management board and certain subsidiary committees, including the Regulatory Standards and Codes Committee and the Conduct Committee. The Regulatory Standards and Codes Committee advises the FRC Board on codes, standard setting, and policy. The Conduct Committee has monitoring, investigative, and disciplinary functions.2

II. THE STATUTORY RIGHTS, DUTIES AND REGULATION OF AUDITORS

13.3 In relation to many areas of their activities, the rights and duties of accountants, together with their appointment, remuneration, resignation and removal, are all closely regulated by statute. Nowhere is this more apparent than in their role as company auditors, in which they are subjected to a number of statutory duties and controls. It is therefore essential to keep in mind any statutory framework within which auditors and accountants work and to remember that their statutory duties will often be the starting point of any claim against them. It is also important for accountants and company directors to be aware of their respective rights and obligations whilst audit work is carried out, in order to prevent mistakes from happening in the first place. This section provides an overview of the relevant statutory framework applicable to auditors in the United Kingdom as at 1 April 2024.3

1. The relevant statutes

13.4 The most comprehensive and wide-ranging statutory provisions relating to accountants are contained in the Companies Act 2006. The 2006 Act was enacted to replace the Companies Acts 1985 and 1989.4 In addition to these Acts, there is also a substantial body of legislation which is relevant to accounts and audits of specific types of institution, predominantly in the financial sector. Although these mirror the Companies Acts to a large extent, there are some significant differences between them and it is important to pay close attention to the applicable legislation in any case when considering claims against accountants or auditors of such institutions. A brief overview of these statutes is given in paragraphs 13.14 to 13.19, below.5

2. The Companies Act 2006

13.5 The Companies Act 2006 sets out company auditors ’ fundamental statutory duties and rights, as well as providing for their appointment, term of offi ce, remuneration, removal, resignation and replacement, including the qualifi cation, appointment and supervision of company auditors.6

(a) The appointment, remuneration and replacement of auditors 7

13.6 In summary, under the Companies Act 2006 all companies (other than those within certain exceptions8) are required to have their annual accounts audited,9 and are required to appoint auditors for that purpose.10 Under the Companies Act 2006, auditors of private companies are automatically deemed reappointed unless the company decides otherwise.11 More generally, sections 485-494 of the Act govern the appointment, remuneration and replacement of auditors.12 The role of the auditors, once appointed, is to report to the company on the annual accounts prepared by the company’s directors, and to state whether those accounts provide a true and fair view of the company’s affairs. This role is discussed in detail in the following paragraphs.13 13.6.1 Eligibility for appointment as a company auditor is governed by Part 42 of the Companies Act 2006.14 A person is eligible for such an appointment only if he is a member of a recognised supervisory body and is eligible for appointment under the rules of that body.15 Recognised supervisory bodies are bodies established in the United Kingdom which maintain and enforce rules as to the eligibility of persons to seek appointment as company auditors and as to the conduct of company audit work, which are binding on persons seeking appointment or acting as company auditors.16 13.6.2 A person will be ineligible for appointment as company auditor if he is (a) an officer17 or employee of the company, or (b) a partner or employee of such a person, or if he is ineligible by virtue of (a) or (b) for appointment as company auditor of any associated undertaking of the company.18 Part 42 of the Companies Act 2006 and associated regulations contain provisions regulating the appropriate qualifications necessary for any person who is to be appointed as a company auditor.19 13.7 The Companies Act 2006 makes provision for the auditors, whilst in office, to be remunerated in such a way as the company in general meeting determines. The amount of the remuneration of a company’s auditors (including sums paid in respect of expenses and benefits in kind) must be stated in a note to the company’s annual accounts. Amounts received for audit work and for other services provided must be separately stated.20 The usual practice is for the directors to be given power to fix the auditors’ remuneration.21 Different disclosure requirements apply to small or medium-sized companies and to other companies.22 In particular, companies which do not fall within the category of small or medium-sized are required to disclose any remuneration receivable in respect of other (non-audit) services by either the auditor or any associate of the company’s auditor.23 13.7.1 The Companies Act also contains provisions allowing the company to remove its auditors at any time by ordinary resolution and specifying procedures which must be followed if auditors are to resign, be removed or replaced. In brief, a company’s auditors can be removed from office at any time by ordinary resolution, and notice of the resolution must be given to the Companies Registrar.24 However, special notice is required for a resolution at a general meeting to remove auditors from office.25 In order to resign, the auditors must leave written notice of their resignation with the company’s registered office26 or, now, send a notice to that effect to the company. Auditors who have ceased to hold office (whether they have resigned, have been removed or have not been replaced after the expiry of their term of office) are required to lodge a statement at the company’s registered office identifying any circumstances connected with their resignation or removal which they consider should be brought to the attention of the company’s members or creditors, or saying that no such circumstances exist.27 If the statement is of circumstances which the auditor considers should be brought to the attention of the members or creditors of the company, the company shall within 14 days of deposit of the statement either send a copy to every person entitled to be sent a copy of the accounts, or apply to the court.28 Failure by the company to do so is an offence.29 13.7.2 The maximum engagement period for auditors engaged for consecutive financial years is governed by section 494ZA of the Companies Act 2006.30

(b) The duty to report on the company’s financial statements

13.8 The most important requirements of the Companies Act in the context of professional negligence claims are the mandatory reporting duties imposed on auditors in relation to a company’s published financial information. The directors of every company (unless exempt) are required to prepare accounts for each financial year.31 The directors must not approve accounts unless they are satisfied that they give a true and fair view of the financial position of the company or group.32 The auditors must have regard to the directors’ duty in this respect in carrying out their own duties under the Act.33 The auditors have a statutory duty to report to the company’s members on whether the information provided by the directors in the financial statements gives a true and fair view of the company’s state of affairs.34 Where the International Financial Reporting Standards (IFRSs) apply (see paras 13.116.1-13.116.2, below), these contain a requirement that the accounts should be “presented fairly”. This requirement appears to be in essence synonymous with the “true and fair” standard stipulated in the Companies Acts and compliance with IFRSs should (save in exceptional cases) produce both a fair presentation and a true and fair view.35 13.9 The Companies Act 2006 imposes a duty on companies to have their accounts audited.36 The required content of the auditors ’ report is governed by section 495 of the Companies Act 2006.37 In particular, the auditor’s report must state whether the accounts give a true and fair view of the state of affairs of the company as at the fi nancial year-end. 13.10 The legislation does not define what is meant by a “true and fair view” of the company’s state of affairs and it is ultimately a question of fact whether the accounts give such a view in any given case.38 Where accounts are properly prepared in accordance with relevant accounting standards, this provides strong evidence that the accounts are true and fair and they will be so regarded save in exceptional circumstances.39 The FRC’s guidance suggests that compliance with accounting standards will be synonymous with presenting a true and fair view in “the vast majority of cases”.40 Compliance with relevant standards will seemingly be regarded as giving a true and fair view even where the accounts (although prepared consistently with accounting standards) are subsequently shown to be inaccurate.41 13.10.1 ISA (UK) 700 contains detailed guidance on the objectives of an auditor in forming an opinion and the required content and form of the opinion. The current version (applicable to statements for periods commencing on or after 15 December 2019) indicates that, in forming an opinion, the auditor must evaluate whether:

(a) the financial statements have been prepared in all material respects in accordance with the applicable financial reporting framework;
(b) sufficient appropriate audit evidence has been obtained;
(c) any uncorrected mistakes in the accounts are material; and
(d) where applicable, the financial statements achieve a fair presentation or give a true and fair view.

13.11 One question which commonly arises in this context is precisely what information must be disclosed in the annual accounts in order to give a “true and fair view” of the company’s or group’s state of affairs. Whilst it will often be sufficient that the accounts comply with generally accepted accounting standards as to disclosure, a greater degree of disclosure may be necessary to prevent the accounts from being misleading in any given case.42 Section 396 of the Companies Act 2006 contains an express stipulation that additional information beyond that required by regulations made under the Act must be included in the accounts or the notes thereto if necessary to give a true and fair view and further permits departure from any such provisions if compliance with them would produce accounts inconsistent with a true and fair view.43 13.12 In reaching a conclusion as to whether the company’s financial statements give a true and fair view of its affairs, auditors are required to form an opinion on certain specific matters set out in the Companies Act. If their view is adverse on any of these principal matters, they should qualify their report, issue an adverse opinion or disclaim an opinion, depending on the nature of the issue.44 The matters on which they are required to form an opinion are:45

(a) whether the information given in the directors’ report and any strategic report for the financial year is consistent with the audited accounts,46 and whether those reports have been prepared in accordance with applicable legal requirements;47
(b) whether the auditors have identified any material misstatements in the directors’ report and strategic report;48
(c) whether the auditable part of the directors’ remuneration report has been properly prepared in accordance with the Companies Act 2006;49
(d) whether adequate accounting records have been kept by the company50 and whether adequate returns have been received from branches not visited by the auditors51;
(e) whether the company’s individual accounts are in agreement with the accounting records and returns52; and
(f) whether the information required to be disclosed in relation to emoluments, loans and other benefits given to the company’s directors and officers has been included in the accounts.53

Further, if the auditors fail to obtain the information and explanations which they believe are necessary for the purposes of their audit, they must say so in their report.54 For accounts relating to financial years beginning on or after 6 April 2008, the auditors’ report must be signed by the senior statutory auditor on behalf of the audit firm55 or, where more than one person is appointed as auditor, by all those appointed.

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