Page 18 - DCOM204_AUDITING_THEORY

Auditing Theory

Notes Alleged Misrepresentations by Accountants

The alleged facts of the case, if true, would be particularly egregious. The following
reports are provided according to the court’s pre-trial decision. Whether the allegations
will be proven remains to be seen. In June 2000, E&Y recommended to a client, a medical
and nutritional company, to retain CGEY as the vendor to implement a commercial off-
the-shelf software package that the client had selected, based on E&Y’s recommendation,
for its short and long-term business needs. E&Y made a number of representations to the
client to induce the client to hire CGEY, and the court concluded that, without those
representations, the client would probably have selected another IT service provider. E&Y
reportedly represented that (1) CGEY was competent, experienced and qualified to
implement the system selected by E&Y, and (2) CGEY’s performance of services had
already been “coordinated” with E&Y.
Existence of Fiduciary Duty
A fiduciary relationship existed between the accounting firm and its client for several
reasons. First, the client had developed a relationship of trusting the accounting firm’s
judgment based on prior professional services. Second, the accounting firm offered to
provide additional consulting services. Third, the medical and nutritional company was
less sophisticated than the accounting firm in the “specialty” for which the accounting
firm and the services firm were hired.
Potential Breach of Accountant’s Fiduciary Duty
Thus, “when a fiduciary fails to disclose personal interests preliminary to contract, and/or
represents the existence of a questionable competence and experience critical to the contract
and procures a benefit such as that alleged to E&Y and the newly formed CGEY, the risk of
liability for the negligent misrepresentations and a question of fraud is properly alleged.”
Atkins Nutritionals, Inc. v. Ernst & Young, LLP, NYLJ, Jan. 10, 2002. Accordingly, a fiduciary
relationship arose and could have been breached if proven at trial.

Questions:
1. What you have observed about code of auditing standard followed in Cap Gemini
and Ernst & Young deal?

2. What misrepresentations by accountants had been discovered?
3. Analyze the case in your own words necessitating the need of auditing?
Source: Outsourcing-law.com

1.9 Summary

The word ’Audit’ is originated from the Latin word ‘audire’ which means ‘to hear’. In the
earlier days, whenever there is suspected fraud in a business organization, the owner of
the business would appoint a person to check the accounts and hear the explanations given
by the person responsible for keeping the account and funds.
Audit may be defined as an official inspection of an individual’s or organization’s accounts,
typically by an independent body.
The role of accountancy is to record the transaction in the book of accounts, extraction of
trial balance, preparation of trading and Profit and Loss Account and balance sheet etc.

On the other hand, auditing is the examination of books of account and checking the
financial statement for the purpose of finding out the true and fair position and results of
operation of a concern.

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