Deloitte Audit Case Study PDF

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9/11/2020

Auditors and Legal Liability Deloitte and Touche vs Livent Inc. (Receiver of)

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Case Study

EXECUTIVE SUMMARY

This case study is about two of the leading companies of their respective industries, one is Deloitte and Touche, a leading name in the audit firms, and second one is the Livent Inc. a leading name in the power sector. The case is about the professional negligence and duty of care against the Deloitte and Touche by the Livent Inc. as they are doing audit in the client. This case has certain dynamics and turning points in its story which lead the case towards opposite directions. The case was sued in the Supreme Court of Canada and also heard there. The case decision was in favor of the Deloitte and Touche Company and they are not set responsible for the losses incurred in the Livent Company during 1992 till 1998. It was all the mistake and frauds of the Livent Inc. directors who have done irregularities and misstatements in their financial statements and also there is one point in the case which was raised by the Supreme Court that the audit reports generated by the Deloitte was not useful shareholders to be relied upon or to evaluate the performance of the management as these statements are wholly prepared for the solicitor’s investments in the Livent Inc. So, they are not in used by the shareholders. We will now look further into the case dynamics and its factors in depth and try to research out more points in details to conclude a fruitful result and lesson from them as well as to study more about audit strategies and approaches used by the audit firms and auditors and how they can upgrade them to avoid these types of cases in the courts as these cases will damage the repo of both the firm and the client side badly and both parties have to incur the loss of legal fees and goodwill losses. So some recommendations for this are also provided in the end of the report.

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Table of Contents INTRODUCTION:................................................................................3 Audit of a Company...............................................................................4 Professional Negligence and the Auditor’s Liability............................4 MAIN SCANDAL:.................................................................................5 Effects of Professional Negligence on Livent Company:.....................6 Audit Documentation:...........................................................................7 Audit Strategies:.....................................................................................7 DELOITTE’S AUDIT APPROACH AND THEIR SCANDAL:.......10 CONCLUSION....................................................................................11 RECOMMENDATIONS.....................................................................12

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INTRODUCTION: This case study is about two leading and emerging names of their respective industries, one from power sector and another from audit industry, and both are competitive in their markets. This case study is taken from the leading case of professional negligence between Deloitte & Touche (DTTL) and Livent Inc. in the courts of Canada. Deloitte & Touche is facing professional negligence and duty of care claim in the Supreme Court of Canada from Livent which was their client. It is not a new case but millions of dollars have been fined in the courts on auditing firms for such type of hearings. In 2001, Livent sued Deloitte and Touche for doing professional negligence in the audit from 1992 till 1998 which destroyed the cash position of the company badly. It’s trending nowadays that auditors are failing to fulfill their firm’s promise of fair and correct representation of financial statements during the audit. We will now discuss further in depth about dynamics and aspects of the case in detail, analyses audit approaches and strategies acquired by the firm, as well as

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weaknesses in them and will recommend some suggestions to improve the procedures and avoid such cases in future. Audit of a Company Audit is referred to as the process of the financial inspection of the accounts and transactions of the company or the organization by any independent auditor or the firm. Two main types of Audit includes internal audit and the external audit. While doing an audit of a company or an organization is a liability of professionalism and duty of care. It is not an easy task to check and verify the transactions in the financial statements of the organization. Firstly Auditors do planning for the audit of any company. This includes planning for audit strategies, procedures, timings, engagement and approaches required for it. Professional Negligence and the Auditor’s Liability Professional negligence is considered as the breach of the duty of care between the two parties, preferably, the professionals and the clients in this case. It is also defined as the failure of a professional in any field to act with the reasonable duty of care with skills required in the contract with the client. The auditors in the audit firms have own the liability to their clients as they are directly answerable to the client and they receive fee for this in return. It is the legal liability of the auditor to do its client’s work with professionalism and care. If any person or client faces any damage or loss due to the auditors mistake, the client has right to claim its damages in court and sue the auditor or the firm. These are called as liabilities of the auditor due to the professional negligence or misstatements. This case between Livent Inc. and the Deloitte and Touche Company is also a professional negligence case in the Supreme Court of Canada. And this case goes in favor of Deloitte

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as they didn’t incur any professional negligence within the contract. It was the result of illegal acts and cover-ups of the directors of the Livent company during the six year period which resulted in loss for the company after the receivership. MAIN SCANDAL: In 2001, Livent Inc. sued Deloitte & Touche in the claim of professional negligence and for not showing duty of care during the audit from 1992 to 1998 in the Supreme Court of Canada. It was not the first time that any company sued its auditing firm for unfair representation of their financial statements in the audit reports. But this case has certain turning points in its story. During the audit from 1992 till 1998, Deloitte found out many unfair transactions and irregularities in their accounting records. They reported these all to the management of the company on immediate basis. The management of the Livent Inc. offered two ways for the Deloitte; whether to continue audit with these irregularities and cover them in the reports or resign from their services. The big mistake made by Deloitte at that time was that they were chosen to continue by covering all unfair data in the reports. Later, the new management in November 1998 discovered all that commitments and misstatements in the records. Between these all, Livent Inc. went into receivership in September 1999 and the receiver sued the Deloitte for their professional negligence and illegal act. This was again a turning point in the case as the management committed the illegal cover-up of the irregularities in the financial statements first, then the management was changed and the new management sued the audit firm which was against the illegal commitment. This case is unique as the both parties was responsible for doing wrong intentionally. This case became complex and complicated more and more and goes against the Deloitte firm in the end.

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(https://www.mondaq.com/canada/audit/666958/deloitte-v-liventthe-scope-of-auditor-negligence) Effects of Professional Negligence on Livent Company: Because of this case, the goodwill and reputation of both the client, Livent and the audit firm, Deloitte got affected and Livent Inc. had to incorporate more loss than the firm. However, in the end the Supreme Court didn’t find Deloitte liable in this case as it is not written anywhere the level of reliance on the audit reports. Client and its shareholders didn’t required to reliant completely on the reports and took their organizational decisions based on them. It is necessary that the company’s internal control system is strong enough to be reliant on the audit reports. Because it is very difficult to find out irregularities and misstatements in the financial statements of the organization if they are done wholly by the illegal commitments of the directors itself internally and this is beyond the scope of the external auditor. In Livent Inc. directors itself are involved in misstatements intentionally to show “all good” on the financial statements and the audit reports in order to keep them eligible for promotion and appraisal. And this is the worst side of the industry that even the directors of the companies are not sincere with the objectives of the companies, instead they just want to increase their own bank balance only. With this thinking ideology, they are just making losses for their companies and one of the practical example of that scenario is the Livent Inc. One of the reason of the irregularities and misstatements in the financial statements of the Livent Inc. were their own directors who do fraud to hide the losses of the company from 1992 till 1998 in the financial statements. They do this as they breaking the concept of Goal congruence and Corporate Governance in the organization. May their pay and remuneration was not enough or

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market competitive or maybe they were corrupt. These all are the dimensions to be kept in mind while doing research on this case. While talking about the audit experience from any audit firm, they are just responsible for doing external audit and it works best when the internal control system of the company is strong enough to run audit on their system. Otherwise it is the primary requirement for audit to do vouching firstly in order to authorize the transactions whether they are in accordance with the accounting standards and regulatory bodies or not. We will now discuss further about audit strategies, approaches and their results and amendments also. (https://www.lexology.com/library/detail.aspx?g=835e9498-65014d56-9d66-471269ea41bf) Audit Documentation: While talking about the audit procedures, it requires certain strategies to be applied as well as certain documentations too. These documentations are known as audit documentation. That Audit documentation referred to as the records or documentation of procedures that auditors performed, the audit evidence that they obtained and the conclusion that makes by them based on the evidence obtained. Audit documentation is sometimes called audit working paper or working paper.

Internal control documents that auditor prepare in Ms Word, Ms Excel or other application is the example of audit documentation. Audit Strategies: Audit strategies are the first step before starting audit officially in any organization. So it is necessary to carefully handle this step as

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it is the first step. Audit strategies are the combinations of many factors to be considered. These include    

Best audit approaches needed to be used management and allocation of resources appropriately best suitable timings for the audit and appropriate ways for the management of the audit engagement

These factors are worth valuable and necessary before audit and they must be decided depending upon the nature and environment of the client. Audit approaches are the major requirements for the audit. Approach chosen should be effective and efficient according the requirement. Factors Interfering in the Selection of Audit Approaches: Selection of the audit approach depends upon many factors. These factor includes: o Their relationship with the client, cooperation and understanding level. o The nature and environment of the business in its respective industry and market. o Satisfaction level of the client’s internal control system o and in last the scope of the engagement of the client In general, four types of audit approaches exist there. Substantive Procedures Audit Approach When internal control systems over the financial reporting procedures in the organization are not strong enough to be relied upon by the auditors, then they go for substantive testing or vouching for large amount of transactions. In vouching1 process, 1 Vouching is the process of checking material transactions and their respective entries with the accounting standards whether they follow them or not.

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auditors can go for checking huge amount of material transactions to verify them whether they are following accounting standards or other accounting regulatory bodies. This approach demands you a lot of time, labour and cost as there is requirement of huge amount of material transactions data handling. Balance Sheet Audit Approach When the business is new or is an emerging one, then auditors can go for balance sheet approach. This is because when the business is in beginning, they have huge amount of assets and investments in their statements of financial position, but they don’t have much operational transactions as they don’t have no material sales yet. So that’s why auditors believe that the major risk area is balance sheet as compared to the income statement and that if balance sheet amount is accurate then there will be no material error in the income statement also that’s why this is assumed as less risky area during the audit. Many new emerging organizations go for this approach as it is beneficial for them and it saves time of the auditors as well as cost of the client too. System Based Audit Approach When the internal control system over the financial reporting systems in the organization are strong enough to do audit, then auditors choose system based approach. In this approach, first auditors verify this, that organization’s internal control system is strong and validated enough or not, if validated then for their own verification they do vouching also but on a small basis. Then they will verify the financial statements of the organization. It is an easy way and approach but not applicable to all organizations that’s why it is not much in used by the audit firms. Risk Based Audit Approach

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While talking about this approach, this is the most commonly used audit approach by the audit firms. In this approach, auditors directly go for the audit of the most risky areas of the financial reporting system of the company. Auditors will identify areas with possible risks and material misstatements and saves time by spending it on less risky areas. This is most commonly used approach by the auditors and the audit firms. Firstly, auditors will identify risky areas and then design and formulate strategies to detect them and aware the management of the organization about them. But before applying this approach, it is necessary to identify the nature and environment of the client organization first in order to formulate its possible risk mark areas. (https://www.wikiaccounting.com/what-is-auditstrategy/#:~:text=Audit%20strategy%20generally%20means %20the,approach%20to%20conduct%20audit%20assignment) DELOITTE’S AUDIT APPROACH AND THEIR SCANDAL: Deloitte’s Audit approach is a risk-based approach which is also a most common audit approach in the industry and used by the most firms. According to their audit approach statement: “Our methodology, known as Deloitte Audit, is an innovative, technology-driven, business-focused and year-round audit approach that requires a comprehensive understanding of our clients’ operations. We offer high quality and risk-mitigating audit services as a part of the financial statement audit process.”

“Overview of our Audit Approach:

 Planning and coordination with no last minute surprises,

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 Leveraging industry focused and advanced technologies,  Providing ongoing communication to discuss audit and accounting issues.” (https://www2.deloitte.com/tr/en/pages/audit/solutions/our-auditapproach.html#:~:text=Our%20methodology%2C%20known %20as%20Deloitte,the%20financial%20statement%20audit %20process) This statement indicates their methodology and innovation in the audit procedures which they continuously opting in order bring their name on the top of the market. But such type of cases, say this case of Livent Inc. which we are discussing are the ways of damaging reputation and their quality services in the competitive market. To avoid such type of cases in the court and their legal fees, board of directors should develop some procedures and strategies in the presence of auditors of the firm and ask them to develop some ways to detect misstatements done by the directors of the client side. So, this will be helpful in saving their face from illegal activities of the client. Actually when the situation is double-sided, it is very difficult to say responsible to any single person or firm for the wrong act. In this case, directors of the Livent Inc. was itself involved in the misstatements and cover-up of the irregularities in the financial statements of the company. After the change of the management and receivership, the new management has decided to verify and do the audit of the financial statements from 1992 till 1998. The court decided that Deloitte was not responsible for the damages of the Livent Inc. as said that Deloitte reports were not prepared for the use of shareholders. They should be used for solicitor’s investment purpose for which they were prepared. For the other use of reports, Deloitte was not responsible for that. This decision creates a turning point in the history of the industry and thus gave a lesson for other clients too.

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CONCLUSION In a the end we can conclude from this whole case study that this case study is between two big names in their respective industries and also this case gives a strong moral for industry personnel that not every time there is a same mistake by a same person or the firm. This time there was a mistake of Livent Inc. directors and they did the fraud with their own company. Court declared that reports prepared by the Deloitte Company were not for the use of the shareholders as they were prepared only for the solicitor’s investments purpose. But this case damaged the reputation of both the companies badly. Some precautionary measures should be taken in advance by the firms and the clients both in order to avoid such cases, loss of goodwill and huge legal fees in courts. Nowadays such cases are more reporting in courts as it is trending. RECOMMENDATIONS There are some recommendations for the audit firms for their upcoming contracts that will help to reduce such type of cases in future. Firstly, they should do substantive testing before going into the contract because severe frauds in their own companies in past causes bad impacts on audit firm’s credibility. They should do research before contracting whether the company chosen for audit has any past data for fraud in their internal control system. Because after contract, these all fraud material will go on the head of the audit firm. So that’s why it is a necessary step. These will surely help in reducing such type of cases in the courts and thus better the audit procedures more convenient.

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