Professional Ethics & Liabilities of Auditors: formula sheet

Key formulas

Five fundamental principles

Integrity + Objectivity + Professional competence and due care + Confidentiality + Professional behaviour

Write all five in any answer on the Code. Each should be tied to the facts.

Five categories of threats

Self-interest, Self-review, Advocacy, Familiarity, Intimidation

Remember: self-interest, self-review, advocacy, familiarity, intimidation (a mnemonic such as SSAFI). Name the threat before discussing safeguards.

Conceptual framework steps

Identify threats → Evaluate (acceptable level?) → Address (eliminate, safeguard or decline)

Use this as the skeleton of every case answer.

Acceptable level test

Reasonable and informed third party would conclude compliance is not compromised

This is an objective test, not your own comfort.

Self-interest vs self-review

Self-interest = your own gain at stake; Self-review = judging your own earlier work

This pair is the most commonly confused.

Core test for accepting work (Section 320)

Accept only if threats to the fundamental principles are eliminated or reduced to an acceptable level

If safeguards cannot do this, decline the engagement.

Communication with existing accountant (Section 320)

Client permission → write to the existing/previous accountant → consider the reply → decide

For a non-statutory engagement, if the client refuses permission, ordinarily decline unless satisfied by other means. For a statutory audit replacing another auditor, written communication is mandatory under Item 8 of Part I of the First Schedule to the CA Act. The 'other means' route does not apply, so decline if the client will not allow it.

Expert evaluation (SA 620)

Competence + Capabilities + Objectivity → adequacy of the expert's work for your purpose

All three must be assessed before you rely on the work. This comes from SA 620, not Section 320.

Responsibility rule

Responsibility for the opinion = auditor alone

Reliance on an expert does not reduce your responsibility.

Answer format

Provision → Facts → Conclusion

Name the threat, the safeguard and your decision in every case.

Forum rule

First Schedule only → Board of Discipline. Second Schedule or both Schedules → Disciplinary Committee. This applies whether the Director's opinion is guilty or not guilty

The Schedule decides the forum. The Director's opinion decides what the forum does: review and decide whether to agree (not guilty), or inquire (guilty). It is the most tested point.

Process chain

Information/complaint → Disciplinary Directorate (prima facie opinion: guilty or not guilty) → forum by Schedule: Board of Discipline (First Schedule only) or Disciplinary Committee (Second Schedule or both) → if not guilty opinion: forum decides whether to agree with the Director; if guilty opinion: forum inquires → order → appeal to Appellate Authority

Write this chain in order in every descriptive answer.

Punishments available

Reprimand | removal of name from the Register of Members for a period | fine

Both bodies can impose these three. The limits on period and amount are higher for the Disciplinary Committee.

Board of Discipline limit

Removal of name: up to 3 months

If the Board feels more is needed, it refers the case to the Disciplinary Committee. Check the current fine limits in ICAI material, as amendments have revised them.

Disciplinary Committee limit

Removal of name: First Schedule misconduct, up to 5 years. Second Schedule misconduct, up to 5 years or permanently

This is far beyond the Board's 3 months. Fine limits are higher than the Board's. Learn the current figures from ICAI material.

Information vs complaint

Complaint: by an aggrieved person, with the prescribed fee. Information: by government, courts, regulators and others, no fee

The Director can also act on information that comes to ICAI's notice from other sources.

Appeal

Order of Board or Committee → Appellate Authority (within 90 days of the order)

Confirm the time limit in your latest ICAI study material.

Test for civil liability (negligence)

Duty of care + breach of that duty + loss caused by the breach = liability for damages

All three must be present. If the auditor followed SAs and used reasonable care, there is no breach, even if the loss occurred.

Section 147: contravention of auditor provisions

Sections 139, 140, 141, 143, 144 or 145 contravened: fine ₹25,000 to ₹5,00,000. Knowing or wilful contravention with intent to deceive the company, shareholders, creditors or tax authorities: imprisonment up to 1 year and fine ₹1,00,000 to ₹25,00,000

Intent to deceive is what moves the case from the lower fine to imprisonment. If the auditor is convicted under section 147(2) (knowing or wilful contravention with intent to deceive), he must also refund the remuneration received, and is liable to pay damages to the company, statutory bodies or authorities, or any other persons for loss from incorrect or misleading statements in the audit report. These consequences do not follow from the lower-tier fine alone.

Section 143(12): reporting fraud

Fraud of ₹1 crore or more: report to the Central Government. Fraud below ₹1 crore: report to the audit committee or Board, and it is disclosed in the Board's report

Applies when the auditor has reason to believe an offence involving fraud is being or has been committed against the company by its officers or employees. The timelines come from the Companies (Audit and Auditors) Rules, 2014, not from the section itself. The auditor reports to the Board or audit committee within 2 days of knowledge and seeks a reply within 45 days. He then reports to the Central Government within 15 days of receiving the reply, or of the 45 days expiring.

Section 143(15): failure to report fraud

Fine of ₹50,000 to ₹25,00,000

Applies to an auditor who fails to comply with section 143(12). For a firm, the same applies to the auditor concerned.

Section 447: punishment for fraud

Imprisonment 6 months to 10 years and fine of at least the amount involved in the fraud, up to 3 times that amount

Applies to anyone, including an auditor, who is guilty of fraud as defined in the Act. Do not confuse it with the lower penalties of section 147.

Prospectus liability

Section 34: criminal liability for untrue statements. Section 35: civil liability to compensate persons who subscribed

An auditor who consents as an expert to a statement in a prospectus can be liable if the statement is misleading and he cannot prove reasonable belief.

Class action

Section 245: members or depositors may seek damages or other action against the auditor for improper or misleading statements

This gives shareholders a direct route to the Tribunal, in addition to ordinary suits.

Landmark cases and what each decided

Kingston Cotton Mill (1896): reasonable care, watchdog not bloodhound. London and General Bank (1895): auditor must report doubtful matters to shareholders. Re City Equitable Fire Insurance (1925): standard of care depends on the circumstances and he may rely on honest officials unless suspicious. Leeds Estate v Shepherd (1887): liable if dividend is paid out of capital after a negligent audit. Re Thomas Gerrard & Son (1967): must probe suspicious entries and is liable for failing to detect a fraud he should have pursued. Hedley Byrne v Heller (1964): a House of Lords case, not an auditor case; it established liability for negligent misstatement where there is a special relationship and reliance. Caparo v Dickman (1990): narrowed this for auditors; no general duty to individual investors or buyers of shares, and a duty needs the auditor to have known the statements would be used for a specific purpose

Quote the principle with the case name. Do not recite facts at length.

Quick revision

• The five fundamental principles are integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour.
• Threats to compliance are identified, evaluated, then addressed with safeguards or by declining or ending the engagement.
• Objectivity is lost when bias, conflict of interest or undue influence overrides professional judgement.
• Confidentiality has limited exceptions, such as legal duty or authorised disclosure, so check the facts before concluding.
• Professional misconduct is judged against the Schedules to the Chartered Accountants Act, 1949.
• Before accepting an appointment, communicate with the previous auditor as the Code and law require.
• Relying on an expert does not remove your own responsibility for the audit opinion.
• Assess an expert's competence, capability and objectivity before using their work.
• Disciplinary matters are examined by ICAI's disciplinary bodies, and penalties depend on the nature of the misconduct.
• Civil liability usually arises from negligence or breach of duty, while criminal liability arises from fraud or wilful default.
• In every answer, state the provision, apply the facts, then give a clear conclusion.

Common mistakes

• Mixing up self-interest and self-review threats Fix: Ask whose result is being judged. If you are checking your own firm's earlier work, it is self-review. If money or an interest is at stake, it is self-interest.
• Listing the principles without applying them Fix: Link each principle to a fact in the case and state what went wrong.
• Writing to the previous auditor without the client's permission Fix: Always say you need the client's permission first. If it is refused, ordinarily decline. For a statutory audit, do not suggest 'other means' as a substitute for written communication.
• Saying that using an expert shifts responsibility to the expert Fix: State that the auditor's responsibility for the opinion is not reduced.
• Saying the Disciplinary Directorate punishes the member. Fix: The Directorate only screens the complaint and forms a prima facie opinion. Punishment comes from the Board of Discipline or the Disciplinary Committee.
• Mixing up which Schedule goes to which body. Fix: Remember: First Schedule only → Board; Second Schedule or both → Committee. This applies whether the Director's opinion is guilty or not guilty. Write the rule at the start of your answer.
• Treating every audit failure as criminal. Fix: Ask whether the auditor acted knowingly or wilfully with intent to deceive. If not, the case is civil negligence or a fine-only contravention.
• Saying an auditor is always liable to third parties, or never liable. Fix: State both. Hedley Byrne: liability for negligent misstatement needs a special relationship and reliance. Caparo narrowed this for auditors: there is no general duty to unknown investors, but a duty may arise where the auditor knew the statements would be used by that party for a specific purpose and the party relied on them.

Exam tips

• Always name the threat type in words. Marks are often tied to correct classification.
• In case MCQs, look for the one fact that changes the answer, such as the fee, a relative or an earlier service.
• Write answers in provision, facts, conclusion form and keep the conclusion to one clear line.
• Quote section or clause numbers only when you are certain of them, such as Section 144 for prohibited services. Explaining the principle correctly earns the marks.
• Revise the exact wording of the five principles from your edition of the Code before the exam.
• Write the rule first, then the facts, then the conclusion. Examiners reward this order.
• Always mention client permission when the question involves communicating with the previous auditor.
• For expert questions, cite SA 620 and use the triad competence, capabilities and objectivity. Add that responsibility is not reduced.