Question - Legal liability of auditors (7.5% of total subject assessment)
NFD Ltd is a distributor and warehousing facility for chemicals and fertilizer. It 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 Edge Ltd. Two months after the takeover, it is discovered that those inventories NFD 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 Edge against NFD's auditors, the following matters were established in evidence:
The auditors did not attend all stocktakes at year-end. They were present at those for the Sydney based operations of the company only. 50% of the company's inventory is purportedly held at the company's Bathurst facility and it is this inventory that does not exist. The Sydney based inventory is determined to have been overvalued by 35%. Although the auditors correctly verified the quantity of Sydney stock, they accepted managements valuation, which did not take account of considerable obsolescence. It is also raised in evidence that the auditors were subjected to considerable pressure by NFD's management to complete the audit within one month of the balance date. The auditors had held this audit for the past six years and there was no evidence of any previous misstatements of the value of inventory. Edge asserted that they had relied on the audited financial statements, as supplied to them by NFD in making their takeover offer. There is no evidence that the auditors were aware of this intended use of the accounts.
Required:
a) Prepare the case for Edge in their efforts to sue the auditors for negligence. Refer to relevant case law and precedents.
b) Will Edge be successful in their legal action? Justify your position making reference to the relevant cases and precedents.
c) Would your answer to b) change if Edge had written to the auditors telling them that they intended to buy NFD and were relying on the audited financial statements to assist them in making their decision?