Titanic Sdn Bhd (20 marks)

Jenny & Co. is the auditor for Titanic Sdn Bhd (Titanic), a company that trades in
cosmetic and health care products. Titanic has been Jenny & Co’s audit and tax
client for five years and as such, the auditor is familiar with Titanic’s business
operations. The auditor’s previous encounter with Titanic has been problem free and
Titanic’s management was found to be of good integrity during previous audit
sessions.

For the present year audit, the auditor has set Titanic’s inherent risk at a low level.
Since control was found to be adequate and reliable, control risk has also been set
at a low level, enabling the auditor to set detection risk at a higher level so that less
detection works is necessary.

To test the inventory amount at year-end, the auditor performed an observation of

physical inventory. Titanic uses count sheets as part of its controls during physical
stock-take. As the company has increased in size, the physical stock-take lasted for
a few hours and ended late in the evening. Although exhausted, the auditor and the
count team were happy when the counting process was finally completed and
everything was found to be in order. While preparing to leave Titanic’s premises, the
management of Titanic passed two additional count sheets to the auditor, explaining
that they have overlooked those items in the separate section. The additional count
sheets added another RM150,000 to the recorded inventory. Consequently, the
auditor traced the items on those two additional count sheets to original purchase
orders, supplier invoices, shipping documents and receiving reports. Having verified
all items to the respective documents, the auditor was convinced that they represent
overlooked legitimate inventory and approved their addition to the recorded
inventory.

Upon completion of the audit, Jenny & Co supplied Titanic with eight copies of the
audited financial statements since Titanic needed some extra copies to submit to
banks and other potential lenders for financing purposes.

Later, it was found that the management of Titanic had falsified the books to avoid
bankruptcy. The financial statements were misstated by approximately RM500,000.
Instead of having a net worth of RM400,000, the company was actually insolvent.
The assets had been overstated by RM350,000 of fictitious investments and
RM150,000 of non-existing inventory.

Hiroshi, one of the suppliers, was one of the recipients of the audited accounts. He
extended a loan of RM200,000 to Titanic. Since the loan has become uncollectible,
he seeks to recover the loss from Jenny & Co via a negligence legal suit.

Required:

Will Hiroshi be successful in the legal suit against Jenny & Co? How would Jenny &
Co defend itself? Discuss.

Support your answer with the relevant court cases.

[ 20 marks ]
MKT Sdn Bhd (33 marks)

A. “Negligence on the part of the auditor could be so willful so as to constitute a

conspiracy with management to defraud the company or other parties. The
auditors could be brought to court on criminal fraud charges” (Gill, G.S. &
Cosserat, G.W., 2000).

Required:

a. Explain the two classes of law in which auditors can be held liable.
[ 4 marks ]

b. Explain the term “deep pocket syndrome” in the context of auditor’s liability.

[ 2 marks ]

c. State the FIVE (5) elements a plaintiff must prove to be successful in an

action against an auditor for fraud.
[ 5 marks ]

d. Identify FOUR (4) measures that can be taken at the audit firm level to
minimize the legal liability against auditors.
[ 4 marks ]

B. You are auditing MKT Bhd (MKT), a trading company for the year ended 31
December 2018. You are currently testing the company’s accounts receivable.

One of the procedures you relied upon to test the accounts receivable was
accounts receivable confirmation. Your statistical MUS sampling leads to selecting
86 (with a total combined value of RM15,560,968) out of 1,000 accounts
receivable listed in the accounts receivable listing (total accounts receivable
population was RM40,326,465). Out of the 86 accounts receivable sampled:
a. 6 of them had value of more than RM1,000,000 each.
b. 4 of them (1 of which had value more than RM2,500,000) did not respond
to the confirmation request even after the 3rd attempt.

You decided to abandon confirmation procedure on the 4 debtors that did not
reply after the third attempt. Subsequent inspection of documentation revealed
that there were sales contracts, invoices and purchase orders from all the 4 non-
respond debtors. A post balance sheet check also revealed that there were
payments that came in from all the 4 debtors involved during January 2019. As
such, you opined that they represent valid debtors and conclude that the accounts
receivable was fairly stated.

Upon completion of the audit, you found that MKT’s other accounts were also
fairly stated and issued 3 copies of the audited financial statements to the
company.
 Later in 2019, the financial statements were found to be misstated by
approximately RM5,000,000. Instead of having a net worth of RM3,200,000, the
company was actually insolvent. The management of MKT had falsified the books
to avoid bankruptcy. Out of the RM5,000,000 misstatement, RM4,720,000 was
due to non-existing trade debtors. The management of MKT had created fictitious
sales contracts with the 4 fictitious debtors. They had even requested their
subsidiary companies to make some payments in January 2019 to make it look as
if the payments were from the 4 fictitious debtors. Your audit failed to detect the
fraud committed by the management of MKT.

Relying on the audited financial statements, Beevi Resources (Beevi), one of the
longstanding suppliers, had extended a loan of RM2,000,000 to MKT. Since the
loan has become uncollectible, Beevi seeks to recover the loss from you via a
negligence legal suit.

Required:
Discuss the legal implications and your liabilities as a result of the above scenario.
Who should win the case, the auditor or Beevi? Explain your answer.
[ 18 marks ]

Butler Manufacturing Corporation Sdn Bhd (25 marks)

Butler Manufacturing Corporation Sdn Bhd planned to raise capital for plant
expansion by borrowing from banks and making several equity offerings. Butler
engaged Meng, CA, to audit its financial statements. Butler told Meng that the
financial statements would be given to certain named banks and included in the
prospectuses for the equity offerings.

In performing the audit, Meng did not confirm accounts receivable and, as a result,
failed to discover a material overstatement of accounts receivable. Also, Meng was
aware of a pending class action product liability lawsuit that was not disclosed in
Butler’s financial statements. Despite being advised by Butler’s legal counsel that
Butler’s potential liability under the lawsuit could result in material losses, Meng
issued an unqualified opinion on Butler’s financial statements.

CIMB Bank, one of the named banks and Butler’s long-standing, existing banker,
relied on the financial statements and Meng’s opinion in giving Butler a RM500,000
loan. A couple of months after obtaining the bank loan, Butler also raised
RM16,450,000 through equity offerings.

Shortly after obtaining the CIMB Bank loan, Butler began experiencing financial
problems but was able to stay in business because of the money raised by the
offerings. Then Butler was found liable in the product liability suit. This resulted in a
judgement Butler could not pay. Butler subsequently defaulted on CIMB Bank loan
and was involuntarily petitioned into bankruptcy. This caused CIMB Bank to sustain
a loss. As a result, CIMB Bank sued Meng for negligence and common-law fraud.
These transactions took place in a jurisdiction providing for accountant’s liability for
negligence to known and intended users of financial statements.

Required:

a. Discuss the legal implications and liabilities of Meng as a result of the above
scenario. Who should win the case, CIMB Bank or Meng?

Support your answer with the relevant court cases.

[ 15 marks ]

b. Explain whether CIMB Bank will be successful in suing Meng for common-law
fraud.
[ 10 marks ]