Analysis of Impulse Pty Ltd

Questions: Impulse Pty Ltd (Impulse) is an entertainment system manufacturer that was established in 2005. Your audit firm King Queen have been the auditor of Impulse since its formation. The audit report for the year ended 30 June 2012 was unqualified. Although Impulse had been suffering liquidity problems with a drop in both debtors turnover and inventory turnover, King Queen did not consider that any additional audit work was necessary in regard to the valuation of these assets. In August 2012, Impulse obtained a large loan from a finance company, Easy Finance Limited (EFL), to provide additional working capital. However, Impulse continued to experience severe trading problems and was placed in liquidation in December 2012. King Queen has been notified by EFLs solicitors that they are taking action against your firm based on the audit of the 30 June 2012 financial report. EFL claim that the cause of Impulses failure related to the inadequate provision for doubtful debts and a fall in the value of inventories on hand, and that these problems were evident at 30 June 2012, but had not been adequately dealt with in the financial report due to your negligence. They also claim that they would not have given the loan to Impulse if the 2012 financial report had been qualified. Required a) Would King Queen be liable to EFL? Provide specific case references to support your answer. b) Would your answer change if EFL had written to King Queen advising you that they intended to make a loan to Impulse and were relying on the 2012 audited financial report to assist them in making their decision? Answers: a). In the given case, Impulse Limited was issuing liquidity problems all round. They suffered a drop in the debtors turnover and inventory turnover. The company was facing issues in sustaining in the market as well. In this case, the auditors of the company in spite of knowing these facts didnt prefer highlighting the issue to the users and gave an unqualified report to the users of the company. The audit form in this case didnt prefer carrying out any additional audit work in this regard and thus considered the same as not material from the perspective of the users. The company later on went to Easy finance company and acquired additional loan to meet out the working capital requirement of the company. However, the company continues facing the trading problems and later on went into liquidation. In this case, the auditors possess information about the loopholes in the company but didnt prefer making any additional substantive procedures in this regard. Thus, the loopholes in the company i.e. the drop in the debtors turnover and inventory turnover and the liquidity problems didnt get reflected to the users of the financials in the report. The auditors in this case are expected to carry out necessary substantive audit procedure and bring this issue within the notice of the users. The auditors are under the professional liability to perform utmost care in performing their duties and are likely to bring any unusual items which may not be in the interest of the users should be brought into their notice. Thus in this case, being the auditors hasnt performed their duties, they would be held liable for Easy finance company for the losses they would have borne for the liquidation. In cases Hedley Byrne and Co Ltd v Heller and Partners (1964) AC 465 and Smith v Eric S Bush (1990) 1 AC 831; it was concluded by the Honable Justice, that Auditors are knowledgeable and skilled persons and are responsible for their carelessness due to which the third parties suffered. The auditor will continue to be held liable for the losses borne by EFL Limited irrespective to the fact that EFL would have written to the King and Queen firm asking them to place reliance on the companys audit report. b). In case of Actual independence the auditor are free from any kind of intervention from the management. The auditor in this case is not affected by the thought process of the management. The same is important as this will ensure fairness and truthfulness within the audit profession. On the other hand, under perceived independence, the society has some inbuilt perception about the auditor that their opinion is based on requirements of the Companys management. Perceived independence shows the long term relation between the auditor and his client. Sometimes due to the independence in appearance it can help the management to avoid the difficulties. Audit can be performed easily. References: Tomasic R, Auditors and reporting of illegality and financially fraud, viewed on April 23, ACCA, Professional liability of accountants and auditors, viewed on April 23, 2016. Financial Times, Definition of Auditors independence, viewed on April 23, 2016.