You are the external auditor of Kiwi Tours, a company which promotes New Zealand tours to the UK and owns a chain of duty-free shops. You have been auditing the company since it was listed on the London Stock Exchange in 1990. Although the accounts have never been qualified, you are aware that the company has been making losses for the last three years, due to 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 financial year, the company upgraded its accounting system to a computer database. A consultant was hired to aid in the correct changeover of files for this Electronic Data Processing (EDP) system. At year-end, this new system had been in place for six months, and the directors report they are happy with the way it is operating. As you do not have the expertise to review and evaluate the database management system, you ask an independent expert to undertake this. This person concludes that the system appears reliable and that the changeover was correctly carried out. As you have never before audited this type of system, you attend some courses to familiarise yourself with its features. Your firm has a standard work program that you use to test the controls operating within the system.

In your review of the minutes of the board of directors’ meetings, you become aware that the New Zealand parent company, which owns 40 per cent of the shares of the company, is considering making an offer for the remaining shares. This is because the company’s share price is trading well below its net asset backing.

After your audited 30 June 20X0 financial statements were published, the takeover offer from the New Zealand parent company proceeded on the basis of an offer price equivalent to the net asset backing of £1.10 per share (as determined from the financial statements).

The takeover resulted in acceptances of 96 per cent of the issued capital, and compulsory acquisition proceedings have been instituted for the other four per cent. While these compulsory acquisition proceedings were being instituted, it was discovered that there were errors in the changeover of the EDP system, which resulted in stock at the duty-free stores being materially misstated. After the subsequent write-down of stock, a new asset backing of £0.70 per share was established. The New Zealand parent company is suing you for alleged negligence for its loss of £0.40 per share.

Required

(a) What major questions must be addressed to determine whether you have been negligent?
You should support your answer by reference to case law and Auditing Standards.

(b) Outline the major issues to be determined to decide whether the company was guilty of contributory negligence.

(c) Assuming you were negligent. Do you owe a duty of care to the New Zealand parent company?