4. AUDITOR LIABILITY

Aud Eaton & Partners (AEP) is an audit firm based in Christchurch.It audits the financial statements of Shifty Finances Ltd (SFL), a small finance company that has its head office in Christchurch.SFL has branches across the main centres of the South Island.In their

31 March 2019 audited annual report, SFL reported a net profit before tax of $1,000,000.On 15 April 2019, Lottacash Ltd (LL) unexpectedly acquired all the shares in SFL.However, soon after this takeover it was discovered that the allowance for impaired loans and advances was significantly understated.As a consequence, the total of 'Loans and Advances (net)' in SFL's balance sheet for the period ended 31 March 2019 was overstated by $150,000 (representing 0.1% of SFL's total assets), while loans and advances impairment expense was understated by the same amount .

Ak Rewel, auditor-in-charge of the audit of SFL's financial statements, had 18 months' practical auditing experience.In auditing the allowance for doubtful debts, Ak had relied on a schedule of slow paying borrowers provided to him by SFL's chief accountant.Unknown to Ak, however, this schedule was not complete.LL have decided to take AEP to court for negligence, claiming that they would not have paid anywhere near the full asking price for the acquisition of SFL had they known about the overstatement of 'Loans and Advances'.

REQUIRED

Answer all of the following questions.Where applicable, support your discussion with reference to relevant case law.

a) Discuss whether you believe AEP was in any way negligentin its audit of SFL's

31 March 2019 financial statements.

b) Discuss whether you believe that AEP owed LL a duty of care.

c) Discuss whether you believe LL will be successful in their case against the audit firm.Justify your answer.

d) AEP is a partnership.If the legal action were to be successful, discuss the extent to which the AEP partners' personal assets could be at risk.