As the audit senior for the First Hardware Ltd.'s (First Hardware) audit, you are happy with the smoothness of the audit undertaken for the year ended 30 June 2015. Today, your audit partner tells you that First Hardware has gone into liquidation. The financial controller was diverting company funds into a Swiss bank account and has left the country to live in Majorca. The lawyers for First Hardware are taking action against the audit partner for not performing an appropriate audit. They believe that a properly conducted audit should have detected such a fraud.
The fraud was substantial; however it was not material from the company's point of view. You explain to the partner that the audit was performed in accordance with all auditing standards and nothing was found to arouse suspicion during the audit. The audit took the same amount of time as last year's, and all appropriate work steps were performed. Your work was reviewed by a manager and the entire file was reviewed by the audit partner.
The audit partner is still concerned. He brings an audit partner is an associated office of your accounting firm and asks her to review the audit file. She agrees and spends a day reviewing the file. After completing her review, she is satisfied that the audit was performed properly.
Required:
Explain the following:
1. Whether your accounting firm has acted with reasonable care and skill.
2. How the lawyers for First Hardware might present the case against the auditor.
3. How the auditor partner might defend the claim.
4. What you think the court's decision will be if the case goes to trial.
5. Why the audit partner may offer First Hardware a substantial settlement amount, even if the partner is convinced he acted with reasonable care and skill.