Tute Solution - Week 4_2-2015

Tute Solution - Week 4_2-2015 - ACCT30004 Auditing and...

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Unformatted text preview: ACCT30004 Auditing and Assurance Services Suggested Solutions and Advice Week 4 Advice Students should continue to develop good answering techniques, this time in relation to Legal Liability questions. In these types of questions it is essential that the answer identify the legal position and then apply them to the facts of the specific situation. For example, if the question were to ask whether negligence existed in a particular situation, the answer would need to: 1. Determine whether a duty of care exists 2. Determine whether there has been a breach of the duty of care 3. Determine whether loss or damage has occurred and that there is a causal connection between the breach and the loss Under each of the three requirements above, a good answer would need to: a. Identify the legal principle(s) (legal case and decision) b. Apply the principle(s) from the case to the specific situation in the question Sometimes a diagram assists with understanding the situation (example below). Suggested Solutions 5.24 Negligence, liability to third parties Required (a) What are the liabilities, if any, of the auditor? To whom is the auditor liable? (b) If the auditor did uncover the embezzlement, and noted it in the notes to the financial statement, is he still liable and to whom? (c) What factors should appropriately be considered before the auditor’s liability is confirmed? Tute Solution -­‐ Week 4_2-­‐2015.Docx Updated – 26 August 2015 1 (a) The auditor is only liable when there is a duty of care proven towards the injured party. In this case, the auditor has knowledge that the financial statements will be used for the purpose of loan negotiation with the Bank of Australia. It is important to examine the terms of the engagement and whether the Bank of Australia was named as the only bank in the negotiations. For the other financial institution which subsequently lent money to Sonny to establish a cause of action for negligence against the auditors, it must prove that: § The auditors owed a legal duty of care to the Financial Institution § The auditors breached the legal duty by failing to perform the audit with the due care and competence expected of members. § The auditor’s failure to detect the embezzlement is directly caused by a failure of due care proximately caused the damages suffered by the Financial Institution; § The Financial Institution suffered actual losses or damages. The facts of this case do not establish that the auditors were negligent by not detecting the embezzlement, because of its nature. However it can also be argued that the auditors will not be liable to the Financial Institution for negligence because they owed no duty to them. This is the case because the auditor was not in privity of contract with them, and the financial statements were neither audited for the primary benefit of the Financial Institution, nor was it within a known and intended class of third parties who were to receive the audited financial statements. Although in the Columbia Coffee & Tea Case (1992), the New South Wales Supreme Court held that it was not necessary to prove that the audited financial statements were prepared for the purpose of the plaintiff or the class of persons intended to rely upon the audit, the Lowe Lippman Figdor & Frank v. AGC (1992), and Esanda Finance Corp Ltd v. Peat Marwick Hungerfords (1994) endorsed the decision in the Caparo case that the defendant did not owe the plaintiff a duty of care. (b) If a duty of care was owed to Financial Institution, it may however be stated that the auditor is likely to be liable to the Financial Institution if it is proven that the audit has been done negligently, or that proper auditing standards have not been followed. The auditors would have lacked reasonable ground for the belief that the financial report was fairly presented if they recklessly departed from standards of due care in that it failed to investigate embezzlements, having the knowledge. The mere noting in the financial statements does not necessarily mean the proper discharge of due care. The auditors intended that others rely on the audited financial report. The Financial Institution justifiably relied on the audited financial report in deciding to loan Sonny and, if damages resulted from a negligently prepared financial report, the auditors will be liable. (c) Factors to be considered before the auditor’s liability is confirmed: § Establishment of due care to exist between the lender and the auditor, proximity § The audit has been negligently performed § The causal relationship between the auditor’s negligence and the financial injury Tute Solution -­‐ Week 4_2-­‐2015.Docx Updated – 26 August 2015 2 5.29 Negligence, contributory negligence Required (a) Decide what major questions must be answered to determine whether you have been negligent. You should support your answer by reference to case law and the auditing standards. (b) Outline the major issues to be determined to decide whether the company is guilty of contributory negligence. (c) Assuming you were negligent, explain whether you owe a duty of care to the New Zealand parent company. (a) The key issue in determining whether an auditor has acted with ‘due care’ or not is by looking at decided cases and the relevant professional standards. Cases such as Kingston Cotton Mill and London and General Bank have suggested that the auditor will have exercised due care if he or she exercises the skill and care of a reasonably competent member of the profession. The case of Pacific Acceptance did say that the courts would consider whether the auditor had followed the appropriate professional standards in determining whether he or she had acted with due care. Not complying with the professional standards would probably mean that the auditor had not acted with due care. Complying with the standards may or may not mean that the auditor had acted with due care. The professional standards to consider in this case are as follows: ASA 570 Going Concern states that the auditor should obtain sufficient appropriate audit evidence that it is appropriate, based on all reasonably foreseeable circumstances for the financial report to be prepared on a going concern basis. In this case the onus will be on you to prove that you had reasonable grounds to believe that the company would continue as a going concern. Based on the facts that the company had been making losses for the last three years, had short term cash flow difficulties, and the bank overdraft was nearing its limit it looks as though some reference to going concern problems should have been disclosed. ASA 315 and ASA 330 require an auditor to obtain an understanding of the control procedures sufficient to assess its effectiveness. This includes the use of information technology. Although you went to a training course, it does not appear that you had a particularly good knowledge of the controls over the new computer system. ASA 620 Using the Work of an Expert states that the auditor should assess the appropriateness of the expert’s work as audit evidence. It does not appear that you have done anything to assess the work performed by the expert. It appears that there may be a reasonable case of negligence against you for your work on this audit client. (b) The principle of contributory negligence was introduced to the Australian legal environment by the AWA case (1992). Contributory negligence relates to the failure of the plaintiff to meet certain required standards of care that contribute to bring about the loss in question. In the AWA case the court accepted that the directors have a duty to establish a sound system of internal control to safeguard the company’s assets. Their failure to do so was held to be contributory negligence. In this case the failure of the Kiwi Tours to implement proper controls over the changeover Tute Solution -­‐ Week 4_2-­‐2015.Docx Updated – 26 August 2015 3 to its new computer system would be grounds for a claim of contributory negligence. (c) The key case that is most relevant to the facts of this case is the Caparo case (1990). On appeal to the House of Lords it was found that a duty of care was owed only to third parties that were existing shareholders to whom the auditor knew their report would be sent and relied upon. This approach was recently endorsed by the High Court of Australia in 1997 in the Esanda case. To owe a duty of care the following would have to be established according to Brennan, CJ, in Esanda Finance (on the appeal to the High Court in 1997): • The report was prepared on the basis that it would be conveyed to a third party. • The report would be conveyed for a purpose that was likely to be relied upon by that third party. • The third party would be likely to act in reliance on that report, thus running the risk of suffering the loss if the statement was negligently prepared. Tute Solution -­‐ Week 4_2-­‐2015.Docx Updated – 26 August 2015 4 ...
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