Reference no: EM132601056

Far East Factory is a company operating in the manufacturing industry and is led by its managing director, Mr Lee. The company had enjoyed a rapid growth in the previous year due to the following reasons:

1. Mr Lee had been falsifying the sales records of the company by creating several fictitious sales agents who were responsible for 30% of the company's revenue.
2. 25% of the cost of sales was capitalized by falsification of purchase invoices with the corporation of the supplier companies. 
3. The directors of the company were rewarded lucrative bonus plans linked to the reported profits. Hence, the directors did not query the abnormal rapid growth of the company and were unaware of the fraud committed by Mr Lee.

• Mr Lee spent large sum of money in creating false records and bribing accomplices in order to conceal the fraud from the auditors. He insisted that the auditor should sign a 'confidentiality' agreement which effectively precluded the auditors from corroborating sales with independent third parties and from examining the service contracts of the directors. This agreement had the effect of preventing the auditor from discussing the affairs of the company with the sales agents.
• The fraud was discovered when unsatisfied director wrote an anonymous letter to the Stock Exchange concerning the reasons for Far East Factory's growth. The auditors were subsequently sued by a major bank that had granted a loan to Far East Factory on the basis of interim accounts. These accounts had been reviewed by the auditor and review report was issued.

From the above case, answer the following questions:

Question 1: Discuss whether the auditors are guilty of professional negligence in not detecting the fraud.

Question 2: Discuss on how an audit firm can minimize its potential for paying damages in cases involving torts.

Question 3: Explain conditions must be satisfied for an auditor to have to pay damages for a tort