Question

You are the audit partner of the ABC audit firm, assigned to the audit of XYZ Ltd.

You issued an unmodified auditor's report for the year ended 30 June 2020. In

December 2019, three employees of XYZ Ltd. were charged with systematically and

deliberately entering fictitious transactions and embezzling about $9 million.

ABC audit firm has been notified by the legal representatives of XYZ Ltd. that they

are taking legal action against your firm based on the audit for the year ended 30

June 2020. They claim that you and your audit team were negligent in conducting

the audit, due to your failure to identify the activities of the employees of XYZ Ltd.

Required:

a. Describe the nature of the activity that the three employees had engaged in?

b. What are the legal requirements to successfully sue an auditor for negligence?

.

c. Under what circumstances do you think the ABC audit firm could be found guilty

of negligence in this case?

Answer 1

Fact if the case

ABC the auditor of XYZ LTD. issue a unmodified report on financial statements that are present true and fair on financial statements and are free from material misstatements due to fraud or error however , subsequently discovered some employees involved in fraud i.e embezzlement of 9million.

Afterwards the legal representative sue an auditor that the auditor has not worked properly and misconduct professional behaviour.

The activities that the employees engaged

(a)Defalcation of cash:

Cash may be defalcated in following ways

1. Inflating cash payments by

• Making payments against fictitious vouchers.
• Making payments against vouchers, the amounts whereof have Been inflated.
• Manipulating totals of wage by including names of dummy workers in wage rolls.
• Over casting for petty cash expenditure.

2.Suppressing cash receipts by

• Teeming and Lading
• Adjusting unauthorised rebates, allowances, discounts etc. to customer’ accounts and misappropriating amount paid by them.
• Writing off as debts in respect of balances against which cash has already been received but has been misappropriated.
• Not accounting for cash sales fully.
• Not accounting for miscellaneous receipts e.g. sale of scrap etc.
• Writing down asset values in entirety, selling them subsequently and misappropriating the proceeds.

(b)Legal requirements to sue an auditor

Company can sue an auditor on following ground.

In order for a third party or a client a successfully sue an auditor under negligence, it's not sufficient to just cope up with some evidence and file a court case the plaintiff must prove the following four criteria.

1. Auditor owed a duty of care must fall in the known user or foreseeable user group

2. Auditor breach that duty of care that audit failure

3. The plaintiff suffered a loss and the loss is real loss.

4. There was a casual connection between the auditor negligence and the plaintiff loss

(C) Because of inherent limitations of audit ,there is unavoidable risk that some material misstatements of financial statements may not be detected, even though the audit is properly planned and performed in accordance with SAs.

The subsequent discovery of a material misstatements of financial statements resulting from fraud or error not itself indicates a failure to conduct an audit accordance with applicable SAs

However ,the inherent limitations of an audit are not a justification for the auditor to be satisfied with less than persuasive audit evidence.

Auditor found guilty if he has not performed his work as per the due delegence.

1.He lacking the applying of applicable standard on auditing

2.He lacking his independence during the audit

3.He has not obtained sufficient and appreciate audit evidence

These all results in not detecting a froud or error in financial statements.

Conclusion.

As per the above provision if the ABC the audit firm has not performed their work as per above provision then he will be found guilty of fraud.

However if he performed his work as per the applicable standard on auditing and due delegence then ABC audit firm will not found guilty of fraud