Ethics and the legal environment

Case A (ethics and the legal environment)

Background

You are an audit manager at Oscar Edwards Vance (OEV), an accounting firm with offices throughout regional Australia in major centres such as Bathurst, Goulburn, Coffs Harbour and Armidale in NSW, Warwick in Queensland and Bendigo in Victoria. OEV is a medium-sized auditing firm by national standards and most of its clients operate within the manufacturing and service industries.

During early July 2019, you met with the audit senior of OEV, Jack Higgins, to discuss a range of findings related to various clients of OEV.

Framed Ltd

Framed Ltd was a wholesaler of office supplies that sold its products to retailers throughout NSW. Framed had only been breaking even for the last two financial years, with the management of cash flow being a significant issue. Despite the cash flow issues (Framed was often close to the limit on its bank overdraft) revenue had been reasonable. Receivables and payables however, had been creeping up. OEV completed their most recent audit and provided an unmodified opinion.

Within a couple of months of year-end, Framed went into liquidation as it was unable to meet its debts. The liquidator of Framed subsequently discovered a major fraud carried out by two sales representatives of Framed who had been entering falsified sales in order to achieve their sales bonuses. Jack tells you that the audit work on sales and receivables was done by Neville, a junior member of the audit division and that sales and receivables had been materially overstated.

Jack informs you that the liquidator of Framed is pursuing damages from OEV, claiming negligent conduct for not detecting the fraud.

Jack also informs you that VicBank had extended the terms of their overdraft to Framed by relying on the audited financial statements and that they too are pursuing OEV for damages for negligence.

Switch Pty Ltd

Jack then tells you he has been working on the audit of Switch Pty Ltd under the supervision of his audit manager, Bruce. During the audit, Jack discovered a material cut-off error which caused revenue to be materially overstated. Jack reminds you that the policy of OEV is to document any material adjustment in the working papers, with the final determination being made by the senior audit partner. Jack also informs you that from his earlier discussions he knows that the management of Switch does not want to make any adjustments.

Jack says that when they finished off the fieldwork, Bruce told Jack not to mention the adjustment in the working papers. Bruce said that Switch only has a small number of shareholders, that he knows from experience the audit partner won’t want to upset an important client and that they really need to finish things off as soon as possible in order to meet deadlines.

Required

Question 1 (5%)

Based on the information provided by Jack in relation to Framed Ltd, and making reference to specific common law and/or auditing standards, prepare a report which addresses the following:

• An outline of all the elements of the tort of negligence;
• Whether the liquidators of Framed are likely to succeed in their action against OEV;
• Whether OEV can reduce their liability to the liquidators of Framed; and
• Whether VicBank is likely to succeed in their action against OEV.

Solution: