The Gazette 1992

GAZETTE

MARCH 1992

"An auditor is not bound to be a

detective, or . . . to approach his

work . . . with a foregone

conclusion that there is some-

thing wrong. He is a watch-dog

not a bloodhound".

This was also the approach adopted

Re London and General Bank

(No. 2)

where it was stated that an

auditor could not be equated with

an insurer.

Thus he will not be held

liable for failing to uncover frauds or

defalcations which the company's

accounting records do not make

apparent, or which are not

discoverable by the exercise of

reasonable care and skill. This was

the position in

Re City Equitable

Fire Insurance Co Ltd.

where an

auditor was held not to be liable for

failing to notice from the company's

accounting records that it had

regularly bought investments shortly

before successive annual audits and

had disposed of them shortly

afterwards and for failing to enquire

what had been done with the money

representing the investments during

the greater part of the year. These

enquiries would have shown that the

managing director has used the

funds received from these annual

sales for his own purposes.

However an auditor must consider

the possibility that errors have been

made somewhere.

If the contents of

the accounts are such that the

suspicions of a competent

accountant would be raised, then he

must increase his investigation of the

affairs of the company so that these

suspicions are put to rest.

Debtors, investments and the auditor

Where a company is listed on the

stock exchange, its accounts will be

used for the valuation of the

company. Therefore, it is of

particular importance that an

accurate representation of its assets

be shown in its accounts.

If investments have been made by a

company (public or private) the

auditors should seek certificates in

relation to them or confirmation

from the holder that such certificates

have been lodged with a bank or

stockbroker." Where money has been

advanced by the company the

auditor must consider whether they

are realisable, whether the security

for them is adequate and what the

cost of realisation is. The question

of the value of debtors is a matter

of considerable subjectivity, as is the

decision as to the method of

depreciation of company assets.

Auditors liability in relation to stock

valuation

Thomas Gerrard& Sons Ltd.,

the auditors were held liable where a

managing director had falsified the

accounts by altering invoices and the

auditors, having come across the

altered invoices, failed to make

sufficiently exhaustive inquiries. They

had accepted the assurances of the

managing director that the dates on

the invoices for stock purchased by

the company during the financial

year in question had been altered by

him to dates in the following year

because the stock had not been

delivered. In fact delivery had taken

place and the managing director's

alterations were part of a system to

hide the fact that the company had

been suffering losses by showing

current assets at the end of the

financial year at an inflated figure

and a reduced figure for its current

indebtedness.

In the Irish case of

Kelly

-v-

Haughey Boland & Co'

the

plaintiffs were the directors of a

company making crystal glass and

they entered into an agreement in

1977 to purchase a company making

bone china, Royal Tara China Ltd.

Prior to concluding the agreement

they were furnished with audited

accounts of Royal Tara for 1973 to

1976, which had been prepared by a

member of the defendant firm of

accountants, acting as auditor for

Royal Tara China. The plaintiffs held

a number of meetings with the

defendants prior to the sale during

which the figures as to the stock

were explained. Having taken over

Royal Tara China, the plaintiffs

became aware of production

difficulties in the company and

wrote to the vendors claiming that

the figures for stock in 1973 and

1974 had been understated, and that

these had been brought forward to

1976 to produce an exaggerated view

of Royal Tara's trading position at

the date of purchase. The plaintiffs

subsequently commenced proceedings

against the defendant auditors,

claiming damages for breach of the

duty of care owed to them.

Lardner J held in the High Court

that the defendants did owe a duty

of care to the plaintiffs in respect of

those accounts prepared at the time

when they knew or ought reasonably

to have known that they would be

used by a third party who they knew

would rely on the accounts in taking

a decision as to whether to invest in

Royal Tara. This would include the

accounts prepared for 1975, when

there was a reasonable possibility of

a sale, and 1976, in respect of which

accounts were prepared from the

plaintiffs. However it would not

include the accounts for earlier

years.

The court held that members of the

defendant firm which had prepared

the Royal Tara accounts had been

negligent in relation to the stock-

taking in failing to attend physically

any stock-taking made by Royal

Tara, since although the relevant

accounting standards did not specify

attendance as necessary, it was

regarded as good practice and a

reasonable method of ascertaining a

true and fair view of accounts as an

auditor; and while failure to attend

physically at some stock-taking

might not have amounted to a lack

of care, the evidence was that for 20

years there had never been any

attendance. However, since the

plaintiffs had not made out the

allegation that the defendants had

failed to verify the information on

which the accounts for 1975 and

1976 were based and since it was

not established that the stock

figures for 1973 and 1974 were

understated or had been brought

forward to 1975 and 1976, the

plaintiffs had not established that

the figures for these years were false

or misleading. The claim was

therefore dismissed.

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