Holmes Institute HI6026: Professional Negligence of Audit Firm Report

This report examines the professional negligence of an audit firm, focusing on the Harris Scarfe case and its downfall in 2001. The report delves into the company's financial reporting requirements, auditing standards, and the auditor's professional, legal, and ethical responsibilities. It analyzes the misconduct of management and the external auditor, including issues of internal control, auditor independence, and corporate governance. The report highlights the failure of the auditor to detect financial manipulation and provides recommendations for improvement, such as classification, completeness, cutoff, occurrence, valuation, and rights and obligations testing. Ultimately, the report concludes by summarizing the key factors that led to the company's collapse and the role of the auditors in the scandal.

Report on Professional Negligence of Audit firm
Report on Professional Negligence of Audit firm
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1Report on Professional Negligence of Audit firm
Executive Summary
The report is about an Audit firm which was sued for professional negligence. The company
studied is Harris Scarfe an Australian retail chain located in South Australia. Harris has its head
quarters in Melbourne, Australia. The case study analysises has been done on Harris Scarfe and
it downfall in 2001. What caused the company to remove its stocks from ASX and go in to
bankruptcy. The company faced a debt liability of more than 160 million dollar. The Report
focuses on who all were responsible for the bankruptcy that followed in the company. At the end
the reasons have been stated about why there was misconduct on the part of the auditor and the
management of the company.

2Report on Professional Negligence of Audit firm
Table of Contents
Table of Contents........................................................................................................................................2
Introduction what is Auditing......................................................................................................................3
Financial Reporting Requirements of auditing Standards:..........................................................................4
Auditing Standards......................................................................................................................................5
Auditor’s professional, legal and ethical responsibility...............................................................................7
Professional responsibility.......................................................................................................................7
Legal Liability...........................................................................................................................................7
Ethical responsibility................................................................................................................................7
Case study...................................................................................................................................................8
The misconduct of the responsibilities of the management and external auditor................................10
Internal control......................................................................................................................................10
Independence of the auditors...............................................................................................................10
Audit Committee...................................................................................................................................11
Corporate governance...........................................................................................................................11
The failure of the auditor to detect the manipulation...........................................................................11
Recommendation..................................................................................................................................12
 classification testing...................................................................................................................12
 Completeness testing................................................................................................................12
 Cut off testing............................................................................................................................12
 Occurrence testing-...................................................................................................................12
 Valuation testing........................................................................................................................12
 Rights and obligations testing....................................................................................................12
Conclusion.................................................................................................................................................13
References.................................................................................................................................................14

3Report on Professional Negligence of Audit firm
Introduction what is Auditing
Financial auditing is a process of analyzing the financial records of company to check if
it is lawfully following the rules and regulations according to accounting standards. A listed
company recruits external and internal auditors. To provide independent opinion external
auditors come and analysis the financial records of the company. According to the law every
public company should have an auditing done by external auditors (Jans, and Hosseinpour,
2019).
The audit procedures are divided in to 5 steps. Major auditing firm follows these step to
complete a proper auditing.
Planning: The planning helps the team of auditors to understand the company’s operation,
internal control, its information system these factors help in forming a proper time table and
helps in making auditing strategy (Christopher, Sarens, and Leung, 2009.).
Risk assessment: With the knowledge of the auditor they access to the financial reporting risk.
With a thorough investigation they acknowledge areas that falls under the risky business
circumstances.
Evaluation of internal controls: The auditor’s major duty is to check the internal controls. The
internal control is a key for a robust and more stable organization.
Testing Audit: Tools and technologies like data interrogation tools to check the financial records
from balance sheet transaction receipt (Xu et al., 2011).

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Conclusion and reporting: The raw results, analysis summary and data analysis are put together
to the result. The final conclusion recommendations and finding are put forward to the
organization and the people.
Internal auditors: are employed by the organization who provide objective and independent
financial evaluation. They also examine the operational activities of the business which includes
the functioning of the corporate governance. The major responsibility of the internal auditor is to
identify the problem area and correct them before it is discovered by the external body.
Financial Reporting Requirements of auditing Standards:
According to the type of entity the Australian defines the disclosure regime for financial
reporting (Kilgore, Radich, and Harrison, 2011).
The entities can be classified as:
a. Disclosing entities- consists of listed corporation those have listed shares or have issued
shares in the market due to the prospectus.
b. Unlisted public companies- companies who has gross profit more than $10 million or
more or have gross assets of $5 million or more and 50 or more employees. They are
unlisted or large propriety companies.
c. Small proprietary companies- They are same as any company but it has very less asset
and profit margin.
All the company under the corporation law has to maintain a financial recording system to
record all the financial transactions, for audit of the firm. The annual financial statement is
mandatory for all entities. The small proprietor is not compelled to prepare the annual

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statement. The main statement the balance sheet, PNL statement and cash flow are prepared
by the accounts of the company that is represented to the people after audit is completed. The
statements should be prepared in accordance to the accounting standard of the Australian
Accounting Standards Board (AASB) in consideration to the corporation law. The Annual
financial statements should be circulated to all the members of the entity and should be filled
with the Australian Securities and Investments Commission (ASIC). Also the company has
to prepare a half yearly financial statement in accordance to the annual disclosure
requirements it should be lodged with ASIC but should to be circulate to the members
(Mubako, and O'Donnell, 2018).
The requirement for an annual income statement as per ASIC
a. It should have director’s report about the working entity (De Zwaan, Stewart and
Subramaniam, 2011).
b. It should declare that the account is complying as per the accounting standards and giving
the true and fair financial position of the entity . it the entity is solvent it should also be in
the directors report.
c. Audited by an independent auditor registered with the company.
d. It should have followed the auditing standards for auditing financial statements.
e. The internal auditors should have remarks that statement has been prepared in accordance
to the corporations law and applicable accounting standards. The financial statements are
audited according to the auditing standards as applicable to the entity (Xu Et al, 2013).

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Auditing Standards
The accounting standards used by entities to prepare the reports under the Corporations
Law which are according to the AASB. The Australian Government's Corporate Law Economic
Reform Program (CLERP) conceive the harmonization program for a perfect peaceful solution
(Knechel, and Salterio, 2016).
The Auditing and Assurance Standards Board (AuASB) of AARF has the responsibility
to develop standard and authority on audit and related services. Institute of Chartered
Accountants in Australia (ICAA) and the Australian Society of Certified Practicing Accountants
(ASCPA) develop the guidelines to establish the benchmark for professional conduct.
Standards issued by the AuASB include :
 Standards of Quality Control (SQCs) Applicable to all auditing firm which reviews the
financial statements.
 Standards on Auditing (SAs) The general audit standards are applicable on all the entity
irrespective of its size and worth when an independent Audit is carried out.
The SA is similar to the numbering system followed for International Standards on Auditing
formulated by IAASB. All SA are dependent to one another (Rika, 2009).
 Standards on Review Engagements (SREs) it is about reviewing historical financial
information of the entity.
 Standards on Assurance Engagements (SAEs) the assurance engagements those are
different from the audits and reviews of financial information.

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 Standards on Related Services (SRSs) is about all engagements that is applicable and
agreed to the procedures to information, compilation engagements.
Auditor’s professional, legal and ethical responsibility
Professional responsibility: To provide expression of an opinion of fairness in all material
aspect while auditing the financial statement. To audit the financial statement according to the
accounting standard while following the corporation law. The auditor’s report is considered as
the main resource to look into the company’s financial position and stability. It is their duty to
provide the true and fair expression of their opinion. According to the standards it important that
they mention that his opinion is in conformity with generally accepted accounting principles
(Brasel et al, 2016). It is the responsibility of the auditor to plan and perform the audit and to
obtain reasonable assurance whether all the financial statement are free from the material
misstatement, to see if the misstatement are caused by error or fraud. They have the duty to
assure that if any, then the material misstatement is detected (Manetti and Becatti, 2009.).
Legal Liability: Auditor has a contractual liability, an engagement letter a written contract
between the Certified Public Accountant and the client, which state that both parties’
understanding of the professional relationship between them. The engagement letter needed to be
documented. It consists of the scope , objective, responsibility of both management and the
auditor. No change in the audit engagement should be accepted and followed unless there is any
reasonable justification. The auditor should be independent and competent for being successful
in identifying any fraud in the entity (Pittman, and Zhao, 2018).

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Ethical responsibility- The auditor while performing the duty should be objective in judgment
and pronouncement. They should only put the facts in the assessment in accordance to the
conformity with the criteria and established programs. Opinions based on honest conviction and
adequate knowledge should only be expressed. All evidence and opinion given should have base
and proof. Auditors have access to proprietary info of the organization audited. They have a
moral obligation not to disclose the information to anyone. They should not betray the trust of
the audited entity. They are also not moral correct if they discuss the audit with other auditor sin
their organization. They should never make false, unsupported and misleading statements that
may injure the reputation of the organization. They should not be under any influence whether
monetary while giving opinion and making decision (Gunn,and Michas, 2017).
These are some of the responsibilities that an auditor should be aware of while doing the
auditing of any entity. Many cases are when the auditor has been sued by company for
misconduct that has led the company to go into major losses (van Aalst et al., 2010).
Case study
The case taken to understand the professional duty of an audit firm is Harris Scarfe case
2001. Harris Scarfe Limited experienced huge corporate collapse in Australia with a debt of
$265 million. In that era there were many such scandals that surfaced but this was the one that
was most talked about. It was revealed by the investigators that source of collapse was due to
expectation gap. The term ranges from issues related to corporate governance and independence
auditor. The case talks about the ethics, legal liability and independence related to the Harris
Scarfe. it also discusses about the regulatory bodies including the Australian parliament inquiry,
Ramsey Report, CLERP 9 and the ASX role in prevention of such scams (Clarke, 2003).

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Harris Scarfe was an Australian departmental store established in South Australia, 1849.
The company was into the electronic, kitchen ware and apparels. In 1994, Harris Scarf started
first store in suburban Adelaide in Salisbury it was a success. The company started to expand and
started to look for investors. In 1995, it changed its name to Harris Scarfe Holdings Limited.
From here on it started to focus on expansion of its departmental store and increase its
investment domain. In the year 2001 the company came into news for its stock positions. The
auditors started to investigate its decreasing net asset up to six years. It was found that in the past
six years there have been no evidence of any irregularities. But it was only in 2001 that the
whole fraud came to ground. The board was not aware of the irregularities and mis-conducted
done by the senior management (Svanström, 2016).
It was found that a former Harris Scarfe accountant, Anthony Wight, confirmed
falsification of the accounts that started five years ago Trescowthick became executive chairman.
It was shocking that until 2001 there was no financial problem or any crisis. Ultimately after trial
and case conduct it was found out that Harris Scarfe’s problem behind its collapse was its
fraudulent in the company’s books of account and the representation of fake profit that was
higher than the real value.
There were many plaintiff in this case . the first was the Company itself Harris Scarfe,
and their other holding. Second being the ANZ Banking Group Limited which was the financier
of the company. The defendant are only two the two biggest auditors Ernst & Young and
PricewaterhouseCoopers. They were responsible for the half-yearly reviews audit of Harris till
2001. The first Auditor was Ernst & Young till 1997 and then it was taken over by PWC. The
Plaintiff claimed that the defendants was negligent and they breached the duty of care and

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mislead the conduct of fair trading act 1987. In clear words the assets were over stated and the
liabilities were understated, the profit was also over stated by manipulation. The manipulation
was grave the operating profit was $3.471 million, whereas in reality it was a loss of $4.076
million. The nest asset was also overstated by $32.179 million. The facts were wrongly
represented by the management of the company and the Auditors never did a proper
investigation because of which the company went into a debt of $265 millions (Sarre, 2002).
The misconduct of the responsibilities of the management and external auditor- It was clear
that the main unethical issue was from the management side of the company. The other factors
which are very prominent is the ignorance and misrepresentation from the part of the Auditors
Ernst & Young and PricewaterhouseCoopers. According to the section 296(1) of Corporations
Act 2001 it’s the duty of the directors to prepare yearly financial reports, director’s declaration is
a true and a fair view. After the judgment of Harris Scarfe Alan Hodgson, the Chief Financial
Officer was convicted for a six-year jail. Former Executive Chairman, Adam Trescowthick, was
charged for dishonesty and unethical practice.
Internal control: It is a mechanism that prevents the company from getting into any kind of
fraud. It is the responsibility of the management to provide an effective internal control to0
detect fraud and stop them then and there. Thus the external auditors have to understand how
important is the role of the internal auditors (Du Plessis, 2003).
Independence of the auditors- it’s very important that the auditors follow the Corporations Law
which are according to the AASB and law according to Australian Government's Corporate
Law Economic Reform Program (CLERP). The auditors should make opinions and give

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suggestion from the independent state. They should not be influenced or be under any control
while doing their work.
Audit Committee – The main purpose of the auditor s committee is to assist the assist the Board
of Directors. It will fulfill the oversight responsibilities by keeping them independent and
reviewing the financial information. The committee brings the board and the auditor close for a
periodically meeting with the auditor to discuss audit progress and findings that helps the resolve
any conflicts between the management and the auditor (Adler et al., 2018).
Corporate governance- corporate governance is a system through which the company directs,
manages the code of conduct of board of directors, management and the shareholders. It is the
responsibility of the company to announce that they are producing the financial report in a true
and fair manner but the responsibility of the auditors is to make sure that the4reprot passed it
correctly investigated by their officials and matches with the corporate governance and
company’s management duties. The mistake was from both the sides the management gave
inflated financial records and the auditors missed the proper investigation before issuing the
financial report (Cooper, 2005).
The failure of the auditor to detect the manipulation- it was alleged that the auditors
PricewaterhouseCoopers and Ernst & Young were negligent towards the account of the Harris
and scarfe. 46% of the share was held by the Trescowthick family of Melbourne this means that
too much power in the hands of the members of the boards of same family. It was clear after
studying the case that that it was a wide spread and systematic fraud due to irregular accounting
records that was never detected by the Earnest and young 1988 to1997 and latter by PWC 1997
and on. There was a claim of $220 million by Harris and Scarfe based on the negligence by the

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auditors. Had they conducted audit as per the rules and laws made to be followed the fraud
would have been detected early saving the fall of the enterprise and affecting the shareholder,
stakeholder and the lenders (Mirskehary, 2009).
Recommendation- the auditor has to follow a proper strategy to complete the auditing
procedures. Auditors of Harris Scarfe did not follow the proper procedures and the loophole was
never discovered. There is a proper method by which the mismanagement in the company is
checked and nipped. The auditing procedure deals with
 classification testing - are the transactions are correctly classified under correct heading
and recorded without mis-print.
 Completeness testing-To see if any transaction is missing by means or by mistake.
Example are any bank transaction not recorded or it has been wrongly recorded.
 Cut off testing- The reporting period is correct or not is also comes under testing. This
can be done by following the accounting standards for what transaction to be recorded in
the financial year what can be recorded later.
 Occurrence testing- whether the transaction don actually exist or not. The claims are
true and correct and is present in any record or have proper receipt.
 Valuation testing- The valuation done for the asset and the liabilities are true and have
some evidence recorded in the client books of accounts.
 Rights and obligations testing- The auditors have the duty to check whether the claim
asset is actual in the name of the client or not.

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This is a complete set of audit procedures to be followed by the auditor and should have all the
information before announcing and giving opinion without going through all the records properly
that the company is performing its operation in fair state.
The substantive procedure was not followed by Earnest and young they did not followed
the process step and did not created a conclusive evidence regarding disclosure, rights,
completeness, valuation and existence. The data was all manipulated and a mis representation of
the true state. There were not enough documents that could be competent for any auditor to
conduct true audit after them. That why th epwc also kept giving the same conclusion without
doing proper testing (Allan, 2006).
Conclusion
It was one of the largest retailer a 150-year-old entity in Australia, that collapsed in April
2001 with debts of $160 million. The banker and lender ANZ and Ferrier Hodgson opened the
case, on behalf of Harris Scarfe, in the South Australian Supreme Court. Trescowthick, faced 27
dishonesty charges based on the evidence of its clients. The receiver Ferrier Hodgson, the lender
claimed settlement under litigation against Ernst and Young and PricewaterhouseCoopers
(PwC), for $220 million in damages. The auditor Earnest and young settled the matter by paying
an undisclosed amount to the party and PWC was left with 180 million claim. It can be
concluded that it is very important to follow the proper audit procedures. The auditors charge fee
to do the audit it is expected by them to do their jobs properly. The damage hits not only the
company but also all its stakeholders. In 2002 the company strated to re work on its left
resources and remodeled the remaining store with new stock and layout and also new logo.

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Today it has again flourished as one of the largest retailers in Australia. Today they are enjoying
the r5ecord sales and as a stock flourishing on the AXS.
References
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Brasel, K., Doxey, M.M., Grenier, J.H. and Reffett, A., 2016. Risk disclosure preceding negative
outcomes: The effects of reporting critical audit matters on judgments of auditor liability. The
Accounting Review, 91(5), pp.1345-1362.
Christopher, J., Sarens, G. and Leung, P., 2009. A critical analysis of the independence of the
internal audit function: evidence from Australia. Accounting, Auditing & Accountability
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regulatory and ethical failure. Cambridge University Press.
Cooper, B.J., 2005. . Where were the gatekeepers? Corporate collapses and the role of
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De Zwaan, L., Stewart, J. and Subramaniam, N., 2011. Internal audit involvement in enterprise
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Du Plessis, J.J., 2003. Reverberations after the HIH and other recent Australian corporate
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