Case Study A - ethical and legal issues

Task - Background

You are a manager in the audit division at Miller Yates Howarth (MYH), an accounting firm with offices throughout the major regional centres of NSW and Queensland. Although a medium sized firm by national standards, MYH is the second largest regional accounting firm in Australia. Most of MYH's audit clients are in the agriculture, mining, manufacturing and property industries. All of those industries are currently under pressure, either from a downturn in commodity prices or fierce competition from overseas competitors.

Ethical issue

Jacqui Leak is one of your audit seniors at MYH and recently came to see you. She is very interested in environmental issues and frequently participates in environmental community work. Morgan Fertilisers Pty Limited is one of MYH's most significant and long standing clients with operations in both Tamworth and Bathurst in NSW and Toowoomba in Queensland. During the annual audit of Morgan Fertilisers for the financial year ended 30 June 2017, Jacqui notices the company had recently changed its contractor for waste management to Dumparound Ltd. Jacqui happens to know, through her community activities, that Dumparound is being investigated by the local council for the level of toxic waste at one of its sites.

The waste management contract between Dumparound and Morgan Fertilisers does not specify damages and has not been signed by Dumparound. The contract is for a substantial amount and is valid for 3 years, and Jacqui is concerned about the implications. The local council carries out strict inspections and imposes heavy fines for toxic dumping.

Jacqui raises the issue with Barry, the MYH partner in charge of the audit. 'This is reality, Jacqui', Barry says. 'As far as I am concerned, we are responsible for the correctness of its financial report, and nothing else. Besides, you do not have the qualification to judge whether a company is a good corporate citizen or not. We are not concerned with the business management.' Jacqui was told to mind her audit without raising any fuss.

Legal liability issue

At the same time Morgan Fertilisers was reported to be carrying a very high level of inventory in its audited balance sheet at the time a successful takeover offer was made by Oasis Ltd. Two months after the takeover, it is discovered that those inventories Morgan Fertilisers does hold were considerably over valued and that they do not in fact possess the quantity of inventory claimed at the time of the audit. In the court action subsequently filed by Oasis against MYH, the following matters were established in evidence:

MYH did not attend all stocktakes at year-end. They were present at those for the Tamworth based operations of the company only. 50% of the company's inventory is apparently held at the company's Bathurst facility and it is this inventory that does not exist. The Tamworth based inventory is determined to have been overvalued by 35%. Although MYH correctly verified the quantity of Tamworth stock, they accepted management's valuation, which did not take account of considerable obsolescence.

It is also raised in evidence that MYH were subjected to considerable pressure by Morgan Fertilisers management to complete the audit within one month of the balance date. MYH have undertaken this audit for many years and there was no evidence of any previous misstatements of the value of inventory. Oasis asserted that they had relied on the audited financial statements, as supplied to them by Morgan Fertilisers in making their takeover offer. There is no evidence that MYH were aware of this intended use of the accounts.

Required - Write a report, including a brief executive summary, to your managing partner that addresses the questions below.

Question 1 - Using the American Accounting Association (AAA) ethical decision model explain the ethical issues involved here and recommend a course of action for Jacqui. You must use the headings of the AAA model in providing your answer.

Question 2 - With reference to relevant case law, prepare a report for the managing partners of MYH on the strength of any negligence case that Oasis might bring against MYH.