(GROUP 6)

Halimah Binti Sulaiman

Siti Rasyiqah Binti Sadali
Nur Amalina Binti Mustaf-Jab
Nurul Amirah Binti Mohd Rodhi
Fatin Aqila Binti Mohd Ibrahim

Question 16 (April 2010, Q1C)

(i) Explain whether the auditor has exercised
due care in the audit Prospek Teguh
Sdn Bhd
(ii)Discuss the possible liability of the auditor
if a lawsuit is initiated by Oct Bank against
Nadyah & Sarinah. Quote relevant legal
cases to support answer.

Answer (i)
In the case of Prospek Teguh, the auditor had encountered a major
internal control deficiency. But, the matter was not highlighted to the
top management. In addition, there was no evidence that the auditor
had carried out additional audit procedures in order to determine the
impact of internal control weakness on the truth and fairness of
Prospek Teguh Sdn. Bhd's financial statement. As such, there is a
strong possibility that the auditor has not exercised due care in the
performance of the audit.
Example of Case = Ultramares v Touche Et. Al (1931)
The auditor did not owe duty of care to the plaintiff based on the
doctrine of privity of contract. The court quote that, ' If a liabilty for
negligence exist in this case, an accountant may be exposed to a
liability in an indeterminate amount for an indeterminate time to an
indeterminate class i.e, the liability of the auditors is no limit'.

Answer (ii)
Based on privity of contract, Oct Bank is a third party that should not
have relied on the auditor's report because the audit report was
issued to the shareholders in accordance with the statutory
requirements. It may also be argued that the auditor is not
responsible for internal control weakness and detection of fraud.
If legal action is initiated by Oct Bank, the following conditions might
need to be tested before auditor's liability is determined.
1) Whether the auditor owe duty of care
- Yes. The auditor failed to put a disclaimer in the audited
report as it was only prepared for the client.

Continued
2) Whether the auditor breach the duty of care
- Yes. The auditor failed to inform the management pertaining
to the major internal control weaknesses that they have
found.
3) Whether the client and 3rd party (plaintiff) suffered loss
- Yes. The loss suffered by the third party due to client
defaulted in their subsequent payments.
4) Any causal relationship between the breach of duty of care with
the plaintiff damages.
- Yes. Since the auditor did not perform their duty accordingly,
it leads to the damages of the 3rd party.

Conclusion

Hence, since all the elements have been fulfilled, then there is a
high possibility that Oct Bank will win the case.

Principle established from other cases suggested that an auditor might also
be held responsible to third parties.
Ultramares Corporation vs. Touche Niven & Co (1931) - if an auditor was
negligent, they were liable to the third party, if the third party was deemed to
be primary beneficiary (is one about whom the auditor was informed before
conducting the audit)
Candler vs. Crane, Christmas & Co (1951) - Accountants owe a duty to their
employer or client and also to any third person to whom they themselves
show the accounts, or to whom they know their employer is going to show
the accounts so as to induce him to invest money. The court held that in
absence of a contractual relationship between the parties, the auditor did
not owe a duty of care to the plaintiff.
Hedley Byrne & Co vs. Heller & Partners (1963) - It was established that
auditor's liability to third party is similar to their liability to clients. The
absence of a contract did not constitute a valid defence.
JEB Fasteners Ltd vs. Marks, Bloom & Co (1981) - The court held that when
there is sufficient degree of proximity or neighbourhood, a duty of care is
owed to the third party. Auditor to any foreseeable party that might suffer
losses arising from reliance on the audited accounts.

Question 20 (June 2012, Q4B)

(i) Explain four methods that may be used
by an audit firm to reduce its exposure to
lawsuits.
(ii) Explain the necessary conditions or tests
that must be met in order to establish
whether a duty a care can be imposed on
the auditor.

Answer (i)
Use engagement letters for all professional services. The written terms of the
engagement should help the auditor minimize any potential risk of exposure which
might arise as a result of any misunderstanding as to the auditor's responsibilities.
Investigate prospective clients thoroughly. Litigation can be limited by avoiding clients
that are in poor financial health or managed by directors whose business ethic or
competence are suspect as a result of past association with failed corporations.
Establish and maintain high standards of quality control. The dominant objective of
quality control is the assurance that all the firm's work complies with required
professional standards.
Maintain adequate professional indemnity cover. Responsible public accountants
need to carry such insurance for the protection of their clients.
Be prepared to issue a privity letter, on request. The purpose of the letter is to
establish a relationship with required foresee ability and proximity, and thus a duty of
care by the auditor to the third party.

Answer (ii)
Whether the damage or loss is foreseeable
Whether there existed a relationship of proximity
between the parties
Whether it is fair, just and reasonable that the
law should be impose the duty of care on the
party for the benefit of the other.