Question

5.21    Negligence, duty to detect irregularities

In completing the audit of Jonstone Construction Ltd for 30 June 2015, Ben Snowden signed an unmodified audit report. During the course of the audit, certain anomalies were found in the purchases system. It became apparent that a number of invoices from subcontractors by-passed the normal purchase ledger processes and were authorised directly by the Chief Operations Officer (COO). Ben Snowden did not report these issues to management because no material errors were found.

Subsequently, it was found that the COO was engaged in a significant fraud where some subcontractors were encouraged to submit inflated invoices, the COO would authorise them and the COO and the subcontractor shared in the extra amount paid.

Johnston Construction is now seeking to sue Ben Snowden for negligence for not detecting the fraud. Ben Snowden has indicated that it is not his job as auditor to detect fraud, but merely to express an opinion on the financial report and as no material errors were found during the audit then there is no negligence.

Required

Explain the legal implications of these facts as they relate to the role and liability of Ben Snowden in the audit of Jonstone Construction Ltd.

Answer 1

Ben Snowden is liable to the corporation due to his negligence in performing an audit and thereby failing to uncover fraud committed in Jonstone Construction Ltd.

Auditing Standard (AS) 1001, Responsibilities and Functions of the Independent Auditor, clearly states that “the auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected.”