Duties of the Auditor in Relation to Errors and Frauds

What exactly is an auditor expected to do about errors and frauds? This question has a long, well-settled answer in auditing theory, rooted in a famous piece of English case law that is still taught wherever auditing is studied.

In Re Kingston Cotton Mill Co. (No. 2) [1896] 2 Ch 279, Lord Justice Lopes laid down what has become the single most quoted principle in the whole subject: "An auditor is a watchdog, but not a bloodhound." This means an auditor is expected to exercise reasonable care, skill, and caution in the ordinary course of an audit — checking, vouching, and verifying diligently — but is not required to approach every account with the suspicion of a detective, treating every transaction as presumptively fraudulent, unless there is reasonable cause for such suspicion. An auditor who has exercised reasonable skill and care, and has no cause for suspicion, is not negligent merely because a well-concealed fraud later comes to light.

At the same time, this is not a licence for a casual or superficial audit. The auditor's duties can be summarised as follows.

1. Primary objective is opinion, not detection. The auditor's principal responsibility is to form and express an opinion on whether the financial statements give a true and fair view — the detection of every error and fraud has never been the primary object of an audit, and no audit (however thorough) can offer an absolute guarantee that none exists.

2. But reasonable care and professional scepticism are mandatory. The auditor must plan and perform the audit in a way that is alert to the possibility that errors or fraud could cause the financial statements to be materially misstated, and must design audit procedures accordingly — this duty has become significantly more explicit and detailed since the Kingston Cotton Mill era, with modern Standards on Auditing (such as SA 240) spelling out exactly what this "reasonable care" requires in practice.

3. Duty to investigate suspicious circumstances. If, in the ordinary course of the audit, something arouses reasonable suspicion — an unusual entry, a document that looks altered, an explanation that doesn't add up — the auditor has a clear duty to probe further, not to accept a convenient explanation at face value and move on.

4. Duty to report. Where a material error or fraud is discovered (or reasonable suspicion cannot be satisfactorily resolved), the auditor must report it — to management, to those charged with governance, and, where the law requires (as under the Companies Act, 2013, for company auditors), in the auditor's report itself.

5. Not an insurer. An auditor does not guarantee, and cannot be held to guarantee, that the accounts are completely free of every error or fraud — liability arises only where the auditor has failed to exercise the reasonable skill and care that a competent auditor, in the same circumstances, would have exercised.