BAC 3624

Advanced Auditing

Tutorial 6 Q & A

Your public accounting firm is the auditor for Mecinta Berhad. This company has been
your biggest client since 2005. The company manufactures expensive garments for
export. The company does most of its trade with overseas suppliers and customers.
Your firm in 2010 advised your client to set up a treasury management department to
minimise the risk of adverse currency movements. Mecinta Bhd. duly appointed a new
treasury manager, Rusita in January 2011.
In March 2012, when you were carrying out the audit of Mecinta Berhad for the year
ended 31 December 2011, you found out that Rusita had entered into foreign exchange
transactions without ensuring that the risk of adverse currency movement was fully
hedged.
You also found that there were no supporting documents for these foreign currency
transactions. When asked about the supporting documents, Rusita explained that she had
full authority to enter into these foreign currency transactions and that she was taking
advantage of favourable trading conditions to produce an estimated profit for the
company of RM 5 million.
You raised these matters with the company finance director, Johari who assured you that
Rusitas activities were being properly monitored. Johari admitted that he did not check
these transactions back to documentation. The finance director agreed to investigate the
matter of the missing documentation and to include a note to the accounts regarding the
companys commitments on foreign exchange transactions.
During the next audit early in 2013 you noted that the systems within the treasury
management department had not improved since the previous year. Again documents
could not be found and Rusita became increasingly worried when you questioned her. On
the second day of the audit, Rusita disappeared and could not be contacted on her mobile
phone or at home.
A subsequent investigation of the treasury management department indicated that
Mecinta Bhd had lost RM 20 million as a result of Rusitas speculation on foreign
exchange markets.
Mecinta Bhd has instructed its lawyers to start proceedings against you to recover the
losses. The claim alleges that you negligently performed your contractual duties firstly by
recommending that a treasury management department be established and secondly in
failing to discover the improper transactions.
Required:
(a) What arguments would you expect to face from Mecinta Bhd.s lawyers?
(b) What points could you raise to defend yourself against the arguments
identified in part (a) above?
(c) What are the responsibilities of the auditors with respect to detection of
fraud?

BAC 3624

Advanced Auditing

Tutorial 6 Q & A

ANSWER
a. The plaintiff may claim there was a duty of care:
1. arising from the statutory audit
2. arising from the extra statutory recommendation
The plaintiff may claim that the auditors did not exercise reasonable skill and care in the
following areas:

reference to auditing standards and other indications of practices acceptable to the

profession
questions over independence (size of fee)
circumstances regarding the treasury management dept. should have warranted
particular care
poor segregation of duties
inadequate accounting system
missing documents
adequacy of management explanations
materiality of the transactions
adequacy of note to the accounts

b.

Courts will apply two tests

(i) Did the auditors exercise reasonable skill and care?

(ii) Did their negligence cause the loss?
Regarding the extra statutory claim, it is not part of an auditors duty to give advice. It
was only a recommendation and a sensible one. It was the Companys poor
implementation that led to the loss

The auditors were not negligent but exercised reasonable skill and care (Kingston
Cotton Mill)
Errors of judgment in themselves are not proof of negligence
No suspicious circumstances
Causation allowing the company to carry on trading is not the same thing as
causing a loss
Contributory negligence
Independence no evidence to prove that the auditors were not independent
(c) ISA 240 requires that an audit be designed to provide reasonable assurance that of
detecting both material errors and fraud in the financial statements. To accomplish this
audit must be planned and performed with an attitude of professional scepticism in all

BAC 3624

Advanced Auditing

Tutorial 6 Q & A

aspects of the engagement. The auditors should not audit with the belief that the
management is dishonest but should not rule out possibility of dishonesty.
Question 2
You are the auditor of Le Mann Tours Bhd., a company which promotes tours from
France to Malaysia and owns a chain of duty free shops. You have been auditing the
company since it was listed on the Bursa Malaysia ten years ago. Although the accounts
have never been qualified before, you are aware that the company has been making losses
for the past three years as a result of short term cash flow difficulties. The company has
no long term loans and the bank overdraft is near its limit at the end of the financial year.
During the last financial year, the company upgraded its accounting system to Statistical
Analysis Programme (SAP) system. A consultant was hired to aid in the correct
changeover of files for this system. At year end, this new system had been in place for six
months, and the directors report they are happy with the way in which it is operating.
You do not have the expertise to review and evaluate the SAP system, so you ask an
independent SAP consultant to undertake this role. This consultant concludes that the
system appears to be functioning properly and that the changeover was correctly carried
out. You have never audited this type of system before and therefore you attended some
courses to familiarise yourself with its features and functionalities. Your firm has standard
work programme that you use to test the controls operating within the system.
In your review of the minutes of board of directors meetings, you become aware that the
French company (which owns 40% of the shares of the company) is considering making
an offer for the remaining shares. This is because the companys share price is trading
well below its net asset backing.
After your audited 30 June 2012 financial statements are published, the take over offer
from the French company proceeds on the basis of an offer price equivalent to the net
asset backing of RM1.10 per share (as determined in the financial statements). The
takeover results in acceptances of 100% of the issued capital.
Later, it was discovered that there were errors in the changeover of the accounting
system, which resulted in inventory at the duty free stores being materially misstated.
After the subsequent write-down of inventory, a new asset backing of 70 sen per share is
established. The French company is suing you for alleged negligence for its loss of 40 sen
per share.
Required:
i.
What major questions must be answered to determine whether you have been
negligent? Bonus marks will be given to students using relevant cases to support your
answers.
ii. Outline the major issues to be determined whether the company is guilty of negligence
or not.

BAC 3624

Advanced Auditing

Tutorial 6 Q & A

iii. Assuming that you were negligent, explain, whether you owe a duty of care to the
French company.
Answer
(a) (i)The key issue in determining whether an auditor has acted with due care or not is
by looking at decided cases and the relevant professional standards. Cases such as
Kingston Cotton Mill and London and General Bank have suggested that the auditor will
have exercised due care if he or she exercises the skill and care of a reasonably competent
member of the profession. The case of Pacific Acceptance did say that the courts would
consider whether the auditor had followed the appropriate professional standards in
determining whether he or she had acted with due care. Not complying with the
professional standards would probably mean that the auditor had not acted with due care.
Complying with the standards may or may not mean that the auditor had acted with due
care.
The professional standards to consider in this case are as follows:
Going Concern: states that the auditor should obtain sufficient appropriate audit evidence
based on all reasonably foreseeable circumstances for the financial report to be prepared
on a going concern basis.
In this case the onus will be on you to prove that you had reasonable grounds to believe
that the company would continue as a going concern. Based on the facts that the company
had been making losses for the last three years, had short term cash flow difficulties, and
the bank overdraft was nearing its limit it looks as though some reference to going
concern problems should have been disclosed.
An auditor is required to obtain an understanding of the control procedures sufficient to
assess its effectiveness. This includes the use of information technology.
Although you went to a training course, it does not appear that you had a particularly
good knowledge of the controls over the new computer system.
Using the Work of an Expert states that the auditor should assess the appropriateness of
the experts work as audit evidence.
It does not appear that you have done anything to assess the work performed by the
expert.
It appears that there may be a reasonable case of negligence against you for your work on
this audit client.
(ii) The principle of negligence that had to be considered include whether there was a
causation relationship, whether the accounts were negligently audited. One must also take
into account whether the third party was likely to be relying on the audit report to make
decision. In this case the failure of the Le Mann Tours to implement proper controls over
the changeover to its new computer system would be grounds for a claim of negligence.
(iii) The key case that is most relevant to the facts of this case is the Caparo case (1990).
On appeal to the House of Lords it was found that a duty of care was owed only to the
existing shareholders to whom the auditor knew their report would be sent and relied
upon. There was thus a duty of care owed to the French company.