Question

Purple Distributors Ltd is a broad-based chemical warehousing and wholesaling company. It is reported to be carrying a very high level of inventory in its audited balance sheet at the time a successful takeover offer is made by Popper Holdings Ltd. Two months after the takeover, it is discovered that those inventories Purple does hold are considerably overvalued, and that Purple doesn’t in fact possess the quantity of inventory claimed at the time of the audit. In the court action subsequently filed by Popper against Purple’s auditors, the following matters are established in evidence. The auditors didn’t attend all stocktakes at year-end. They were present at those for the Sydney-based operations of the company only. However, 50% of the company’s inventory is purportedly held at its new Orange facility, and it is this inventory that doesn’t in fact exist. The Sydney-based inventory is determined to have been overvalued by approximately 35%. Although the auditors correctly verified the quantity of Sydney stock, they accepted management’s valuation, which didn’t take account of considerable obsolescence. It is also raised in evidence that the auditors were subjected to considerable pressure by Purple’s management to complete the audit within one month of the balance date. The auditors had held this audit for the past six years and there was no evidence of any previous misstatements of the value of inventory. Popper asserted that they had relied on the audited financial statements, as supplied to them by Purple, in making their takeover offer. There is no evidence that the auditors were aware of this intended use of the accounts.

Required: (a) What is the probable extent of the auditors’ liability in this case?

Answer 1

In the case, the auditors have not verify the stock/inventory valuation at the Purple’s new Orange facility didn’t exist by 50% and the Sydney based inventory also overvalued by 35%. It is the Purple’s management who confirmed the valuation of the inventory to the auditors. Being, the auditors not a technical person, so they have to accept the quantity and valuation as provided and confirmed by the company’s management. The management has also forced the auditors to complete the audit work within a month’s time. So due to difficulty in verifying each and every item and stock physically due to lack of technical knowledge along with limited time, the auditors could not able to verify and confirm the inventory based on management’s certification. Thus there is no liabilities exist to the Auditors and Popper could not succeed in the case against the auditors, but can claim the loss to Purple for mis-statement of the inventory in the balance sheet.