Background

You are the audit manager of RFC, an accounting firm with offices located throughout regional NSW and Victoria, including towns such as Bendigo, Albury, Wagga, Bathurst and Tamworth. RFC is a middle tier firm which provides audit and accounting services across a range of industries. During May 2020 you met with the audit senior of RFC, Wayne Campbell to discuss several findings related to some of RFCs clients.

Walker Ltd

Next, Wayne tells you about Walker Ltd, a travel company which arranges and promotes Chinese tours of regional/outback Australia and owns a chain of boutique souvenir stores. RFC has been auditing Walker since it was first listed on the ASX in 1993. The financial reports of Walker have never been qualified/modified by RFC but Wayne says that Walker has been returning losses for the last 2 years, which he says are due to short term issues involving the pandemic and a declining perception of Australia as a worthwhile travel destination amongst Chinese travellers. While Walker has no significant long-term debts, it is close to the limit of its bank overdraft.

During the year, Wayne tells you that Walker upgraded its accounting system from a largely manual system to a computerised system. As part of this process, a consultant was hired to assist with the conversion. The system has been in place for 7 months, and the board of directors and senior management have indicated that they are happy with how it is operating. Wayne says, given his lack of experience with accounting systems of this kind, he recently attended a course run by his professional accounting body on how to audit such a system. An external consultant approved the functioning of the system and the internal auditors of Walker also examined the changeover and running of the accounting system and confirmed that everything is operating as it should. Wayne says that he placed reliance on the work of the consultant and the internal auditors as part of his audit.

Wayne goes on to say that the parent company of Walker, Run Ltd, recently completed a takeover of Walker. The takeover was based on the perception that Walkers trading share price of 85c was lower than the net asset backing price of $1.22 per share, as determined from the audited financial reports. Wayne says that after the acquisition process was completed, it was discovered that there were serious errors in the changeover to the new accounting system which meant that the inventory of the souvenir shops was misstated and that the resulting write down of inventory meant the asset backing per share was now 80c per share. Run Ltd is now suing RFC for alleged negligence for the loss of 42c per share.

Question 2 (7 marks)

In relation to Walker, and by referring to case law the auditing standards:

• Outline the major questions which would need to be addressed to determine whether RFC has been negligent in performing its audit of Walker.
• Outline the major issues to be determined in ascertaining whether Walker is guilty of contributory negligence.
• Assuming that Wayne, as auditor, was negligent, determine whether a duty of care is owed to the directors of Run Ltd regarding their actions in taking over Walker.