Contributory Negligence

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I.CASE 4.28: Contributory Negligence

Facts:
Pride Accountants has been the auditor of Skyhign Ltd for the last five years. •The audited was made for the year ended 30 June 2009, where Pride Accountants issued an unqualified opinion of the financial reports. •Skyhigh is a largest client of Pride Accountants.

They have a good working relationship.
In the past, audits of Skyhigh have run smoothly and its financial reports have always been unqualified. •The audited was made for the year ended 30 June 2009, where Pride Accountants issued an unqualified opinion of the financial reports. •Four months after, the chair of Skyhigh Ltd announced that over the past two years the company have recognized fictitious revenues of $40 million and capitalized development expenditure in excess of $50 million which should have been expensed. •These irregularities resulted in an overall loss for the financial year of 2009 equal to $60 million.

a.Outline relevant issues in deciding whether your firm, PA, has been negligent in the performance of its duties as the auditor of Skyhigh Ltd.

The position of auditors, with regard to negligent misstatements, was made clear in the Pacific Acceptance case; it was established that any plaintiff, bringing an action negligent misstatement against an auditor had to establish four elements. They were:

There must be a duty of care owed to the plaintiff by the auditor; •The behaviour complained about must fail to achieve the required standard of care; •The auditor's negligence must have caused the plaintiffs loss; and •The plaintiff’s loss must have been a reasonably foreseeable consequence of the auditor's breach of a duty of care.

In deciding whether the company was guilty of contributory negligence, the major issue to be determined is whether PA failed to meet the standard of care required —in this case, fictitious and irregulars figures in the financial report—which contributed to bringing about its loss.

A duty is imposed on auditors to exercise reasonable skill and care in auditing a company’s financial statement. This duty was established in Pacific Acceptance Corporation Limited v Forsyth where the defendant auditors were held to be negligent in falling to inform the plaintiff of the existence of fraud and irregularities to certain loans. Therefore, in order for a plaintiff to make a successful claim in negligence it must be proven that an auditor has acted carelessly in falling to meet the sufficient standard of care.

b.Develop a defence for PA against any action that Skyhigh might take. Refer to relevant case law in your answer.

The defence of contributory negligence is available to auditors under the common law. The relevant authority is AWA Ltd v Daniels T/A Deloitte Haskins & Sells & Ors, in which the Supreme Court of New South Wales held that the plaintiff company failed to meet the standard of care required for its own protection and was thus proportionally liable along with the auditor auditors. This judgment overruled the decision in Pacific Acceptance Corporation Limited v Forsyth where Moffitt J stated that the client’s directors or employees were also negligent. Overall, the defence of contributory negligence attempts to apportion blame fairly amongst those parties responsible, particularly where financial losses are attributable to a third party’s own commercial misjudgment. In addition, since the auditor's opinion on the financial statements or internal control over financial reporting is based on the concept of obtaining reasonable assurance, the auditor is not an insurer and his or her report does not constitute a guarantee. Therefore, the subsequent discovery that either a material misstatement, whether from error or fraud, exists in the financial statements or a material weakness in internal control over financial reporting exists does not, in and of itself, evidence (a) failure to obtain reasonable assurance, (b) inadequate planning,...
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