(c) South Africa Institute of Chartered Accountants. Contact SAICA for permission to reproduce this article., Audit and Assurance

REASONABLE CARE AND SKILL — THE MODERN SCOPE OF THE AUDITOR’S DUTY

Benjamin Kujinga, LLB LLM, full time PHD candidate at the University of Cape Town. Advanced Programme in Taxation candidate at UNISA.

It is trite law in South Africa that auditors, as skilled persons, must in the performance of their duties exercise a certain level of skill and care – Tonkwane Sawmill Co (Pty) Ltd v Filmalter 1975 (2) SA 453 (W). The test for the reasonable person or the so called bonus paterfamilias, involves an inquiry into whether a reasonable person in the shoes of the defendant would have acted differently or similarly to the way the defendant acted – Kruger v Coetzee 1966 (2) SA 428 (A). A person is said to have acted negligently if his actions do not suit the standards of the reasonable person. Conversely, a person is described as competent and careful if he acted according to the standards of the reasonable person. The reasonable person is a fictional creature of the law created with a view to obtaining a workable objective norm for conduct in society. He is therefore a person who is neither exceptionally gifted nor hopelessly dull. His qualities are to be found between these two extremes.

When dealing with skilled persons like auditors the reasonable man test is modified to become the reasonably careful and skilled auditor test. Any person who is attempting to establish negligence on the part of an auditor must therefore prove that the auditor’s actions in performing his work were not compliant with the standards of the reasonably careful and competent auditor. As with the ordinary reasonable man, a reasonably careful and competent auditor is not required by South African law to be exceptionally gifted. In English law the position is the same and the so called ‘Bolam’ test established in Bolam v Friern Hospital Management Committee [1957] 1 WLR 582 is used. McNair J stated in this case that:

Where you get a situation which involves the use of some special skill or competence, then the test as to whether there has been negligence or not is not the test of the man on the top of a Clapham omnibus because he has not got this special skill. The test is the standard of the ordinary skilled man exercising or profession to have that special skill.

The U.K. case of Lanphier v Phipos 1838 8 C and P describes the position further by stating that:

Any person who enters into a learned profession undertakes to bring to the existence of it a reasonable degree of care and skill. He does not undertake, if he is an attorney, that at all events you shall gain in your case, nor does a surgeon undertake that he will perform a cure, nor does he undertake to is the highest possible degree of care and skill.

This case and the SA case of Herschel v Mrupe 1954 (3) SA 464 (A) is authority for the proposition that the highest level of skill and care is not expected even from skilled persons.

It is easy to get carried away by the fact that auditors perform very important functions and expect them to go beyond what the law requires them. Auditors have been described as ‘shareholders’ safeguards’- Lipschitz v Wolpert and Abrahams 1977 (2) SA 732 (A) and in Haig v Bamford 72 DLR (3d) 68 (1976) an opinion was expressed that:

With the added prestige and value of his (auditor’s) services has come a concomitant and commensurately increased responsibility to the public.

It is against this background that it is important to decipher from case and statutory law the true meaning of the term ‘reasonable care and skill vis a vis auditors. This is done with auditor liability in mind, where the failure to conform to expectations of reasonable care and skill is one of the elements required to be proved before clients or third parties can successfully claim damages in delict against auditors as stated in International shipping Co (Pty) Ltd v Bentley 1990 (1) SA 680 (A).

 

ELEMENTS OF THE DUTY

A detailed overview of what constitutes reasonable care and skill is provided in the case Pacific Acceptance Corporation v Forsyth (1970) 92 WN (NSW) 92. These elements entail inter alia:

In suspicious circumstances an auditor must act accordingly and probe such matters to the bottom – Dairy Containers Ltd v NZI Bank [1995] NZLR 30. An example of such circumstance is found in the case Nelson Guarantee Ltd v Hodgson [1958] NZLR 609 where the auditor was found negligent for trusting a client’s bookkeeper who had once been dismissed by another accounting firm for borrowing money from the firm’s clients. Conversely the case In Re London General Bank: Ex Parte Theobald (No 2) [1895} Ch 2 673 is authority for the proposition that where nothing excites suspicion extra inquiries are not required. In Thoroughbred Breeders Association v Pricewaterhouse 1999 (4) SA 968 (W) it was stated that an Auditor must exercise professional judgment in deciding which matters justify further in depth investigation.
1. An auditor must act with reasonable suspicion aka professional skepticism. In the case In Re Kingston Cotton Mill (No 2) [1896] 2 Ch 279 it was famously pointed out that, “an auditor is a watchdog not a bloodhound and should not approach his work with suspicion or a foregone conclusion that there is something wrong.” This should not suggest a lax approach to auditing because the courts have generally favoured a stricter approach where auditors are generally suspicious but not overzealous. Linked to this is the standard set in Pacific Acceptance requiring auditors to first scrutinise the efficiency of the client’s system of internal control before placing any reliance thereon.
2. The auditor must be sure of all relevant facts through proper and established auditing checks and ignore rumours and reputations. In verifying any information an auditor should conduct a personal and direct examination of the subject matter of the audit. In the Pacific Acceptance case an auditor was referred to as a ‘skilled inquirer’ who prefers to know by direct investigation rather than by hearsay evidence.
3. Where expert advice is required an auditor must obtain it in order to properly verify transactions –Ex Parte Theobald and Pacific Acceptance cases. In the case Bevan v Webb 4 [1909] 2 Ch 59 the court stated generally that “permission to a man to do an act, which he cannot do effectually without the help of an agent, carries with it the right to employ an agent.” This rule establishes a responsibility on auditors to obtain expert assistance where it is clear that such assistance will enhance the quality of the audit.
4. An auditor who employs inexperienced clerks must appreciate their inexperience and plan his supervision and review accordingly – Pacific Acceptance. To support this principle and commenting on the use of trainees, Lord Denning in Jones v Manchester Corp [1952] 2 QB 852 stated that “it would be in the highest degree unjust that the hospital, by getting inexperienced doctors to perform their duties for them, without adequate supervision, should be able to throw all responsibility on those doctors as if they were fully experienced practitioners.”
5. An auditor must comply with auditing standards and statutory provisions. Auditing standards have legal backing in terms of the Auditing Profession Act 26 of 2005 section 44 (3) (a). In the Pacific Acceptance case Moffit J stated that the test for reasonable skill has to be had with regard to prevailing standards, conduct and procedures. He however stated that the determination of reasonable care and skill in a particular case is not the exclusive province of the auditing profession because the court retains the final and overall prerogative to rule on the legal and binding standards.

 

CONCLUSION

It is important to note that that reasonable care and skill is a relative concept with much depending on the circumstances of each case. The elements of the duty outlined here are not conclusive. As stated in the In Re Kingston Cotton Mill case:

It is the duty of an auditor to bring to bear on the work he has to perform that skill, care, and caution which a reasonably competent, careful and cautious auditor would use. What in any particular case is a reasonable amount of care and skill depends on the circumstances of that case.

It is unacceptable to judge the quality of an audit with the benefit of hindsight. Auditors who have a good idea of what is reasonably expected from them have a more than fair chance of successfully resisting a claim for damages where fraud and other material misstatements are subsequently discovered in audited financial statements.