Question 1 Ethical decision making and the legal liability of auditors at Gaspar Ltd

You are the auditor of Gaspar Ltd (Gaspar). Gaspar is involved in the manufacturing of office furniture. Until recently, Gaspar had been very profitable, but a general economic downturn has reduced demand for its furniture. You have just had a meeting with the CEO of Gaspar, Darren, where you discussed the main audit findings and the adjustments which will need to be made to the financial statements. You tell Darren that one of the lingering concerns about Gaspar relates to whether it satisfies the criteria of a going concern, in particular Gaspar has a major loan contract which requires Gaspar maintain a debt/equity ratio of 50%. This issue has caused you concern, as Gaspar is run by likable people, and the failure of Gaspar would lead to negative consequences for its employees and other creditors. Gaspar is also an important client for your firm.

It is now July, Gaspars year-end was 30 June and your firm carried out most of its work during February. At that time all of the projections looked fine, however recently you found out that one of Gaspars major customers, Newman Ltd has been placed into administration. At year-end Newman owed Gaspar $1.7 million. If this amount were to be written off Gaspar would definitely be breaching its loan contracts. You asked Darren whether any provision had been created in relation to the amount due from Newman or whether any updates to the projections originally audited in February had been made. Darren said that he didnt think that was necessary and justified this by saying that the administrator of Newman believed that it would be able to meet all of its outstanding debts. You said to Darren that that was all good and fine, but you still needed to obtain representations from the administrator yourself. Darren reacted to this badly, and started asking why that would be necessary as he was happy to provide a letter certifying the administrator's statements. You advised Darren that you have to do your job properly, but he shouted this is the first bit of trouble for our business and you are willing to help the bank shut us down. This will be terrible for our customers, suppliers and our workers! At the end of the meeting Darren said that he was simply asking to be given a chance to trade out of the situation and that as far as he was concerned, the accounts would not be altered. Darren also said that if Gaspar were to collapse, he would let all their stakeholders know that the auditors were to blame.

Required:

With reference to the Code of Ethics for Professional Accountants, what should you do in response to the information provided regarding the audit of Gaspar Ltd? Use the following American Accounting Association (AAA) Model template to guide your response.

American Accounting Association Model	Decision-making process
1. Determine the facts	The facts are ...
2. Define the ethical issues
3. Identify the major principles, rules, and values
4. Specify the alternatives
5. Compare values and alternatives
6. Assess the consequences
7. Make your decision

Word guidance: 1000 words

Question 2 Legal liability of Auditors

You are an audit senior at the audit firm Stafford Roach (SR). One of your clients, Raines Ltd is a company involved in the manufacturing of household cleaning products. Raines was carrying a very high level of inventory in its audited balance sheet at the time a successful takeover offer was made by Chaffey Ltd. Two months after the takeover, it was discovered that the inventories held by Raines were considerably over valued as they did not possess the quantity of inventory claimed at the time of the audit. Chaffey is filing court action against SR and claim to have evidence supporting the following:

• SR did not attend all stocktakes at year-end. While SR were present at stocktakes for the Newcastle based operations of the company, the inventory at the Newcastle warehouse was also found to have been overvalued by 27%.
• While SR correctly accounted for the quantity of the Newcastle stock, they accepted managements valuation, which did not take account of significant quantities of chemicals which had degraded in condition and were therefore not of merchantable quality.
• 50% of the Raines' inventory is purportedly held at the companys facility in Muswellbrook and is it this inventory that Chaffey is claiming does not exist.

Chaffey is also claiming that SR were subjected to considerable pressure by Raines' management to complete the audit within 3 weeks of the balance date. SR has undertaken this audit for the past six years and there has been no evidence of any previous misstatements of the value of inventory. Chaffey is also claiming that they had relied on the audited financial statements in making their takeover bid. There is no evidence that anyone at SR was aware that this was the intended purpose of the audited accounts.

Required

Based on the information provided in relation to Raines Ltd, and making reference to specific common law and/or auditing standards, provide the following:

• An outline of all the elements of the tort of negligence;
• The case that Chaffey could prepare in their efforts to sue SR for negligence;
• An assessment as to whether Chaffey will be successful in their legal action; and
• An explanation as to whether this assessment of success (as above) would change if Chaffey had written to SR telling them that they intended to buy Raines and were relying on the audited financial statements to assist them in making their decision

Word guidance: 1000 words