Reference no: EM133197113
Drussel Importing Ltd. (DIL) is a large importer of food products from Italy. They sell their products in large grocery chains across Canada and have annual sales of $100 million. They have an excellent reputation for the quality of their products. To maintain supply of quality products, in 20_1 they purchased 60% ownership of an exporting business based in Naples, Italy. For Canadian reporting purposes, they consolidated the Italian subsidiary in their financial statements.
DIL is a non-listed public company which is controlled by the extended Drussel family. In addition to family members, some of the shares are awarded to long time employees, including David Peete, the President. There have been no share sales to outsiders and the financial statements are used to set the value of the shares for tax purposes. In January, 20_3, the value of the shares was calculated to be $15 and Mr. Peete was awarded a bonus of 100,000 shares. He was also given a $600,000 loan in order to pay the taxes on the shares.
Big, Boldov, and Best, LLP (B3) has been the auditor of DIL for just the past year ending December 31, 20_2. They took over from a smaller audit firm at the insistence of the Bank of New Brunswick (BNB), which is the primary creditor of DIL. After the acquisition that was funded by $21,000,000 in bank debt, BNB wanted a firm with good international affiliates. Although B3 has never performed work on a company with operations in Italy, they are confident that the Italian firm they are associated with will do good job. Accordingly, they performed minimal quality control on the work done by the Italian firm but had frequent communication with them regarding the scope of work and B3's intent to rely on their work.
Unfortunately, the confirmation sent to the Italian subsidiary's bank was not returned. The Italian auditors did "alternative procedures" to confirm the cash balance as at December 31, 20_2. In fact, there was a massive fraud discovered March 31, 20_3 when DIL tried to pay itself a dividend out of the Italian subsidiary in order to make an interest payment to BNB. The expected funds were not available, DIL missed the payment, and BNB forced DIL into creditor protection on April 13, 20_3. The Drussel family subsequently fired Mr. Peete for his negligence in performing due diligence on the Italian acquisition. When the fraud was discovered, suppliers in Italy stopped dealing with the Italian subsidiary making it worthless.
BNB calculates that it will lose $5,000,000 if DIL comes out of protection, and $12 million if DIL ends up dissolving. It is expected they will sue B3 to recover the loss. Mr. Peete has also given notice he will sue B3 for the loss of his bonus. The Drussel family's lawyer has already advised his client they are not likely to be successful in a lawsuit against B3.
The senior partner, Boris Boldov, has asked you as the audit manager on DIL to make a memo on possible legal liability as well as B3's defence. The last day of field work by the audit team was February 10, 20_3 and a clean audit opinion was issued on February 14.