Institute warns auditors on legal threat

The Institute of Chartered Accountants in Ireland (ICAI) has issued guidance designed to protect members against legal challenges from third parties who rely on audit reports.

The guidance has been drawn up in the wake of a Scottish court case dating from last July in which it was found that auditors could owe a duty of care to a third party when drawing up an audit report.

The Royal Bank of Scotland v Bannerman Johnson Maclay and others case highlighted the "potential exposure" of auditors to third parties where they have "failed expressly to disclaim responsibility", according to the ICAI.

As a result of the case, which has since proceeded to trial, auditors in Ireland, England and Wales will be required to insert a paragraph into their audit reports that, the ICAI says, will "clarify" their responsibilities.

"This guidance does not change the purpose or value of an audit," said Mr Brian Walsh, ICAI chief executive, yesterday.

The paragraph, which was initially formulated by the Institute of Chartered Accountants in England and Wales, indicates that the audit report has been made for no other purpose than to inform shareholders.

It continues by noting that the auditors "do not accept or assume responsibility to anyone other than the company and the company's members as a body" for their audit work, report or opinions.

While the paragraph has been designed for immediate inclusion in the audited accounts of Irish public companies, it is as yet unclear how well it will integrate with the requirements of US regulator the Securities & Exchange Commission and, therefore, how it will affect companies that also file in the US. An agreement on the issue is likely to be reached over coming weeks.

In the case, the Scottish Court of Session found that a firm of auditors could legally owe a duty of care to a bank that lent money to a limited company on the basis of an audit report.

The decision was made despite a lack of direct contact between the bank and the auditors, and despite the bank relying on the accounts for a reason other than their statutory purpose.

Separately, the ICAI has also released interim guidance on auditor independence based on recommendations from the European Commission.

The new rules, due to take effect from May, will limit the range of services auditors can supply to their clients. Non-audit services can only be offered where they do not involve a management function or where safeguards have been put in place to ensure objectivity.

The lead auditor on all public company audits will now be required to rotate every five years. Perviously, the rotation had to occur every seven years.

This may create a heavy administrative workload for auditors, as they seek to establish a system of succession within auditing teams.