Tutorial topic 2 Flashcards Preview

Auditing > Tutorial topic 2 > Flashcards

Flashcards in Tutorial topic 2 Deck (18)
Loading flashcards...
1

Reasonable care and skill, and negligence

2.10 What is meant by reasonable care and skill and what role do the auditing standards play in establishing reasonable care and skill?

Reasonable care and skill, and negligence

2.10 What is meant by reasonable care and skill and what role do the auditing standards play in establishing reasonable care and skill?

Reasonable care and skill is the standard of skill and care appropriate to the auditor’s professional status, which is considered reasonable in the circumstances as they then exist. Auditing standards provide a guide as to what is meant by reasonable care and skill. However, the courts, in cases such as Pacific Acceptance, have indicated that compliance with professional standards will provide persuasive rather than conclusive evidence of reasonable care and skill. The courts will assess the reasonableness of the standards under specific circumstances, and therefore the courts will determine what is reasonable care and skill. Further, professional standards and practice must reflect changes in the economic and business environment if they are to be used as a guide to what constitutes reasonable care and skill.

2

Reasonable care and skill, and negligence

2.11 Describe the circumstances that are necessary for a negligence claim against auditors to be successful.

Reasonable care and skill, and negligence

2.11 Describe the circumstances that are necessary for a negligence claim against auditors to be successful

The matters that must be proved to the satisfaction of a court before a claim of negligence can succeed are that:

+ a duty of care was owed to the plaintiff (that is, that there was reasonable foreseeability and proximity)

+ the auditor was negligent (that is, that reasonable care and skill were not exercised by the auditor)

+ the plaintiff relied on the auditor

+ the plaintiff suffered a quantifiable loss as a result of the auditor’s negligence

the loss was suffered as a result of relying on the auditor (that is, causation).

3

Liability to clients

2.12 To what extent is an auditor liable to their client for their audit work?

Liability to clients

2.12 To what extent is an auditor liable to their client for their audit work?

Auditors have a duty of care to their clients and therefore are liable to their clients for their audit work, as there is a contract between the client and the auditor that has an implicit term that the auditor will exercise reasonable care and skill in undertaking the audit. In addition, there is a duty of care under the tort of negligence, due to the proximity between the auditor and the client.

4

Liability to clients 2.7

2.13 Under what circumstances can an auditor rely on contributory negligence by the client to reduce the auditor's liability for damages?

Liability to clients

2.13 Under what circumstances can an auditor rely on contributory negligence by the client to reduce the auditor's liability for damages?

The AWA case established for the first time in Australia that contributory negligence by the client is acceptable as a reason for reducing the damages attributable to an auditor. For contributory negligence to apply, there must be a failure by the plaintiff to meet the standard of care required for its own protection, which contributed to bringing about its loss.

5

Liability to third parties 2.8

2.14 What defences are available to auditors against lawsuits brought against them under common law by third parties?

 

Liability to third parties

2.14 What defences are available to auditors against lawsuits brought against them under common law by third parties?

The best defence available to auditors against any suits brought under common law by third parties would be that a duty of care was not owed to the third party. If it were held that a duty of care did apply, then the best defence would be to ensure that the work performed had been completed in a professionally competent manner and in accordance with Australian Auditing Standards. A strong quality control system within the audit firm is also a major defence.

More specifically, the following defences would be available to auditors:

 + a duty of care was not owed to the plaintiff (i.e. there is no reasonable foreseeability and proximity)

 + the auditor was not negligent (i.e. reasonable care and skill was exercised by the auditor)

 + the plaintiff did not rely on the auditor

 + the plaintiff did not suffer a quantifiable loss as a result of the auditor’s negligence

 + the loss was not suffered as a result of relying on the auditor (i.e. causation)

 + the plaintiff (client) failed to meet the standard of care required for its own protection, which contributed to bringing about its loss (contributory negligence).

6

Liability to third parties

2.15 Do auditors have a potential liability to third parties other than under common law?

Liability to third parties

2.15 Do auditors have a potential liability to third parties other than under common law?

Section 18 of the Commonwealth Competition and Consumer Act 2010 and similar provisions in each of the state Fair Trading Acts prohibit misleading and deceptive conduct. Auditors may be sued under these provisions if it is considered that the auditor’s report is misleading or deceptive. An application by the auditors in the Esanda case for the plaintiff’s claim under the South Australian Fair Trading Act 1987 to be dismissed, on the basis that the legislation does not apply to auditor’s reports, was rejected.

Also, s. 50 of the ASIC Act 2001 enables ASIC to take legal action for damages in the public interest. This may include actions against auditors and directors where losses were suffered by investors due to negligent or illegal behaviour.

7

Resonable care and skill, and negligence

2.26 Elegance Pty Ltd (Elegance) , a fashion house, requested Young & Associates to conduct an audit of the company's records. The audit needed to be completed in time to submit an audited financial report to a bank as part of a loan application. Audit partner, Graham Young, immediately accepted the engagement and agreed to provide an auditor's report within three weeks. As they were short of staff, Graham hired two accounting students not to spend time reviewing the controls, but instead to concentrate on proving the mathematical accuracy of the ledger accounts, summarising the data in the accounting records that supported the financial report and obtaining explanations from client's staff for any variances. the students followed Graham's instructions and completed the audit within two weeks and Graham Young issued an unmodified audit report indicating that in his opinion the financial report gave a true and fair view. It was subsequently found that the inventory was significantly overvalued and the auditors had relied on management's representations about the value of the inventory. A large amount of inventory consisted of unsold stock of the past two years that was worthless due to changes in fashion trends. Also, one of the warehouse managers had not written off defective garments worth thousands of dollars. The bank withdrew their loan facility and Elegance was unable to fulfil a large number of orders resulting in a significant loss to the company. As a result, Elegance is suing Young & Associates for negligence.

REQUIRED

Explain whether you consider that Young & Associates was negligent. Justify your answer.

 

 

The following actions by Graham Young are likely to result in the court deciding that he did not exercise reasonable care and skill, as they represent breaches of accepted practice, as indicated in the auditing standards.

 + Hiring two accounting students who have inadequate training and experience and not supervising or directing the work performed is a breach of quality control requirements (ASA220/ISA 220).

 + Failing to gain the required understanding of the accounting system and related internal controls (ASA 315/ISA 315).

 + Failing to ensure that the auditor obtained sufficient appropriate audit evidence—just checking mathematical accuracy and relying on client representations does not meet this requirement (ASA 500/ISA 500).

8

Liability to clients

2.28 Your audit firm, Tran & Associates, has been the auditor of Easyrider Ltd (Easyrider), a large motorcycle manfacturer, for the past five years. Easyrider is Tran & Associates' largest client, and senior partners at Tran & Associates have a good working relationship with the directors and senior management of Easyrider. Easyrider has been a leading motorcycle manufacturer for several years. In the past, audits of Easyrider have run smoothly and its auditor's reports have always been unmodified, stating that in the auditor's opinion the financial report gives a true and fair view. The company has a a 30 June year end. Four moths offer Tran & Associates issued an unmodified opinion on the financial reports of Easyrider for the year ended 30 June 2015, the Chair of Easyrider announced that over the past two years the company had recognised fictitious revenue of $20 million and capitalised development expenditure in excess of $25 million that should have been expensed. These irregularities, which resulted form poor internal controls, resulted in an overal loss for the financial year of 2015 equal to $30 million. Easyrider is suing Tran & Associations for negligence.

REQUIRED

(a) Explain whether Tran & Associates is liable to Easyrider

(b) Discuss whether Tran & Associates can reduce its liability by claiming contributory negligence by Easyrider.

(a) Tran & Associates has a duty of care to its client, Easyrider, under both the law of contract and the tort of negligence. Therefore, Tran & Associates would be liable to Easyrider if the loss was caused by the negligent performance of the audit engagement.

(b) In deciding whether the company was guilty of contributory negligence, the major issue to be determined is whether Easyrider failed to meet the standard of care required for its own protection—in this case, a sound internal control system—which contributed to bringing about its loss. The AWA case established for the first time in Australia that contributory negligence by the client is acceptable as a reason for reducing the damages attributable to an auditor.

9

Liability to third parties

2.30 Quick Money Ltd ( Quick Money) is taking legal action against Crew & Associates (Crew) over the audit of Poultry Pty Ltd (Poultry), which went into liquidation owing almost $10 million to its creditors, including $5 million to Quick Money. Quick Money claimed that the profits recorded were vastly overstated and inventory levels inflated in the financial report of Poultry. Crew has denied that they were negligent and has argued that they relied heavily on information provided by Poultry's management.

REQUIRED

(a)  Do you believe that Crew owes Quick Money a duty of care? Provide reasons for your decision, citing relevant case law where appropriate.

(b) Discuss the validity of Crew's defence

(a) Following the rulings in recent cases, such as AGC, Caparo and Esanda, the test of proximity needs to be satisfied to determine a special relationship.

To satisfy the test of proximity the following must be proved:

 + it was foreseeable by the auditor that the third party would suffer an economic loss as a result of their lack of due care;

 + there was an intention to induce the third party to act in a certain way; and

 + it would be fair, reasonable and just, given all the circumstances, to impose a liability on the auditor for the economic loss.

In this case, there is no indication that Crew induced Quick Money to rely on the audited financial report of Poultry. Therefore it does not appear that Crew owes Quick Money a duty of care

(b) Crew’s defence was that they relied on information from Poultry’s management. Pacific Acceptance (1970) confirmed the standards of reasonable care and skill, which includes that auditors have a duty to check and see for themselves. To rely on client’s personnel and/or management is an aid, but not a substitute for auditor’s procedures. Therefore, if a duty of care did exist, this would not be a valid defence.

10

Accounting bodies' code of ethics 3.2

3.4 What are the fundamental ethical principles for an auditor?

Accounting bodies' code of ethics

3.4 What are the fundamental ethical principles for an auditor?

The five fundamental principles as outlined in sections 110–150 of APES 110 are:

 + Integrity: Auditors should act with consistency, treating like cases in a like manner. Honesty is an integral part of this value. The principle of integrity therefore imposes an obligation on an auditor to be straightforward and honest in all professional and business relationships and requires fair dealing and truthfulness.

 + Objectivity: Auditors must be fair and must not allow bias, conflict of interest or the undue influence of others to override their objectivity.

 + Professional competence and due care: Auditors have a duty to attain and maintain their level of professional competence and should only undertake work that they can expect to complete with professional competence and due care in accordance with applicable technical and professional standards. Auditors have a duty to maintain their level of competence throughout their professional career through continuing professional development.

 + Confidentiality: Auditors hold positions of trust and have access to many valuable and private pieces of information in the course of their work. Therefore, they should respect the confidentiality of information obtained during the course of their work and should not disclose such information to a third party without authority or unless there is a legal or professional duty to do so.

 + Professional behaviour: Auditors should comply with relevant legislation and conduct themselves in a manner consistent with the good reputation of their profession and refrain from any conduct that could bring discredit to it.

11

Auditor independence

3.6 Distinguish between perceived and actual independence, and indicate why both are important to the auditor

Auditor independence

3.6 Distinguish between perceived and actual independence, and indicate why both are important to the auditor

Actual independence is the achievement of freedom from bias and personal interest. This is necessary if the auditor is to provide an independent opinion. Perceived independence is the belief of financial report users that actual independence has been achieved. This is necessary if the auditor’s opinion is to lend any credibility to the financial report.

12

Auditor independence

3.7 List and briefly explain the five categories of threats to independence listed in APES 110

Auditor independence

3.7 List and briefly explain the five categories of threats to independence listed in APES 110

The five categories of threats to independence, according to APES 110.12 and APES 110.200.3, are:

 1. Self-interest threats: may occur as a result of the financial or other interests of a member or of an immediate or close family member

 2. Self-review threats: may occur when a previous judgment needs to be re-evaluated by the member responsible for that judgment

 3. Advocacy threats: may occur when a member promotes a position or opinion to the point that subsequent objectivity may be compromised

 4. Familiarity threats: may occur when, because of a close relationship, a member becomes too sympathetic to the interests of others

 5. Intimidation threats: may occur when a member may be deterred from acting objectively by threats, actual or perceived.

13

Fee determination

3.11 What are the major factors that influence the determination of the audit fee?

 

Fee determination

3.11 What are the major factors that influence the determination of the audit fee?

The fee for an audit engagement should reflect fairly the value of the audit work performed, in accordance with APES 110, s. 240. It is determined by the time necessarily spent by members of the audit team, billed at a standard rate corresponding to the experience, skills and qualifications of the staff involved and the degree of responsibility applicable to the work.

14

Fee determination

3.12 Explain what is meant by contigency fees and how they may impact on the auditor's independence.

Fee determination

3.12 Explain what is meant by contigency fees and how they may impact on the auditor's independence.

Contingency fees are fees that are based on the outcome or result of the work performed. APES 110.290.222 prohibits contingency fees for assurance engagements, as they create a self-interest threat to independence. In some instances they may also lead to an advocacy threat.

15

Professional ethics and ethical theory

3.18 You have been asked to prepare a report that analyses the potential acquistion of Staple Pty Ltd (Staple) by your audit client Hammer Ltd (Hammer). Prior to conducting your analysis, you decide to verify the accuracy and completeness of the cash flow statement provided by Staple for the year ended 30 June 2015. After reviewing a draft of your analysis, Hammer's Chief Financial Officer (CFO) has asked you to focus your attention on the sales and profitablity of Staple and to avoid the distraction of cash flow reporting. He suggests that acquistion or to the likelihood of you being asked to undertake similar engagements in the future.

REQUIRED

Describe two threats to compliance with the fundamental principles that may exist as a result of your discussions with the CFO and explain the fundamental principles of risk.

 

The threats to the fundamental principles are:

 + intimidation threat, based on having to follow the directive of the CFO or risk harming the working relationship and suffering a penalty of lost work

 + self-interest threat, where the potential for future benefits may be reduced (i.e. loss of future work) if the relationship breaks down.

The fundamental principles at risk of being breached are:

 + Integrity: If you are not honest in your analysis — as part of demonstrating integrity, you are required to ensure that reports do not omit or obscure information, where such omissions or obscurity would be misleading

 + Objectivity: If you allow the intimidation or self-interest to influence your report

 + Competence and due care: A proper competent analysis of the takeover requires consideration of its impact on cash flows.

16

Contributory negligence ?

Contributory negligence

The failure of the plaintiff to meet certain required standars of care

17

Independence of Mind:   (Actual Independence)

Independence of Mind:   (Actual Independence)

¨The state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional scepticism.

18

Independence in Appearance:   (Perceived Independence)

Independence in Appearance:   (Perceived Independence)

The avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a Firm’s, or a member of the Assurance Team’s, integrity, objectivity or professional scepticism had been compromised