Gaelic Inns was a company that ran a pub. Between 2001 to 2004, its finance manager devised and carried out a scheme and misappropriated company funds by delaying the banking of cash received on the day of sales and used the cash for her personal benefit. The cash used would be replaced subsequently by cash received from subsequent sales.
As part of its audit, the audit firm had obtained the bank reconciliation statement and noted a substantial amount of more than $600,000 that had not been banked into Gaelic Inns’ bank account. The auditor had asked but did not receive satisfactory information from the finance manager.
When the misappropriation was discovered, the finance manager was charged and convicted and Gaelic Inns sued the auditors for negligence in failing to spot the misappropriations and to warn management that the high levels of unlodged cash deposits indicated a risk of fraud.
In 2007, the trial judge had awarded judgement to Gaelic Inns as damages for negligence in respect of audits performed by the auditors. The auditors appealed the decision and the Court of Appeal, relying on the concept of contributory negligence, reduced the quantum of damages by 50% for which the auditors were liable.
Breach of laws, rules and regulations, e.g.,. criminal breach of trust for misappropriating company funds.
Internal controls, e.g., weak internal controls and a failure of checks and balances within the company. The Court of Appeal had determined that Gaelic Inns should have been able to catch the fraud but failed to do so due to negligence on their part.
Considerations by Auditors:
~ Reliance on management representation? For example, could the auditors have paid more attention to the bank reconciliation statement and performed additional audit procedures?
~ Professional Competence and Due Care? For example, could the auditors have performed more work, e.g., adopt an attitude of professional scepticism and be more alive to the possibility of fraud?