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