Question

Sunshine Shopping Centres has borrowed heavily in recent years. The pressures of rapid expansion have been felt within its finance department, and the chief financial officer (CFO) has begun to make mistakes. The CFO neglected to reclassify some of its debts from non-current liabilities to current liabilities following default on some terms of the contract with an international banking syndicate, and omitted contingent liabilities from the notes to the accounts. The billion dollar mistakes were not detected by either the directors or the auditors, and the financial report and audit report were published. Following discovery of the mistake, the shares in Sunshine Shopping Centres lost value rapidly and the company was placed into liquidation. Required Discuss the auditor’s liability for losses suffered by (i) Sunshine Shopping Centres investors, and (ii) other parties. (i) Sunshine Shopping Centres investors ___________________________________________________________________ ___________________________________________________________________

Answer 1

The misclassification of liabilities as non-current instead of present possibly means that anyone evaluating the financial position of Sunshine Shopping Centres would be misled.

If the liabilities are existing, it is probable that they are due to be paid within 12 months, while they could also be changed and the repayment date prolonged. The reader of the accounts would not be sure if Sunshine had to pay back the debt, and would have uncertainty about the capability of the company to endure in business.

The directors and managers of Sunshine are possible to say that they trusted on evidence provided to them by the finance department. The reports from the finance department almost certainly did not state that the debts were due to be paid off soon. Yet, the directors and managers are under an duty to ask questions about imperative matters such as large debts. They are also indebted to monitor the financial position of their company. They cannot just depend on on others.

The auditors are likely to say that they trusted on information provided by the managers about the due date for the debt repayments. However, the auditors should gather confirmation about the repayment date, not just rely on what the managers tell them.

(a) The investors in Sunshine could bring lawful action against the auditors, in conflict they underwent financial loss as a consequence of the misclassification of the debt.

The auditors reported that the financial accounts were in agreement with the Corporations Act and accounting standards (which they were not, because the debt was misclassified), and that the accounts were true and fair (which they were not because they gave a misleading picture).

It is to be expected that the auditors are accountable to the investors in Sunshine Shopping Centres for their loss and the disappointment of the auditors to ensuing auditing standards, such as those necessitating auditors to gather adequate and suitable evidence about the liabilities and their disclosures.

The auditor could be liable under both contract law (failure to perform the audit they were contracted to do) and tort of negligence.

The investors would need to establish that the auditor owed them a duty of care and the duty of care was breached, and that the investors underwent a loss as a result of that carelessness.

(b) Third parties cannot trust on contract law. Other parties would try to trust on tort law. In addition, to duty of care, breach of the duty and loss, they have to establish that there was rational anticipation..

This means that the other parties would have to establish that the auditor was cognizant, or should have been cognizant, that any carelessness on their part could cause a loss to the third parties.

This is more challenging than establishing probability of the loss underwent by investors. Third parties would have a better case if they obtain a Privity Letter which can be used to prove that a duty of care was owed to them. Otherwise, there would need to be some special circumstances before the auditor was liable to them in this case.