Question 2 

Part I

What are the legal requirements that a third party has to satisfy to successfully sue an auditor for negligence?

Part II

You are the audit partner of CCC& Co, and you audited ABC Ltd, a custom-made products manufacturing company. ABC Ltd declared bankruptcy within three months of receiving an unqualified auditor’s opinion on its financial statements for the year ended 31 December 20X1. 

The XYZ bank initiated a court challenge against AAA & Co on the grounds that the bank disbursed a $2,000,000 bank loan to ABC Ltd in May 20X1, but ABC went bankrupt shortly afterwards. The plaintiff alleged that your firm’s 20X1 audit of ABC was deficient and argued that the auditors failed to uncover that the value of ABC Ltd’s inventories were substantially lower than reported on the balance sheet. 

CCC& Co audit firm did not issue privity letters to any third party in the past five years.

Required:

Explain whether the XYZ bank is likely to be successful. Use relevant cases established in common law to support your answer.

Part III

The following independent situations raise questions about an auditor’s ethical conduct:

1. An auditor accepts an engagement knowing that she does not have the specialist knowledge required. 

2. An auditor discloses confidential information about a client to a successor auditor.

3. A public accountant agrees to be the committee chairperson for a local fundraising activity.

4. An auditor accepts a commission from an insurance company for recommending it to one of its audit clients.

Required:

a. Discuss what are the fundamental principles of the Code of Ethics for Professional Accountants. 

There is a special need for ethical behaviour by professionals to maintain public confidence in the profession and in the services provided by members of that profession. The ethical requirements for accountants are similar to the requirements of other professions.

b. Indicate in each of the above situation whether the effect on professional ethics is (i) a violation or (ii) not a violation, and explain the reason.