Auditor’s Professional Liability: A Practical Case Of Accounting Scandal Of Freedom Foods Group, Essay.

“Freedom Foods Group” is an Australia based public limited company that deals in manufacturing, sourcing, marketing as well as distributing a wide range of “food and beverage” products. It is based in “Taren Point”, NSW, Australia. However, its operations are spread over North America, New Zealand, South-East Asia and China apart from the whole country of Australia. It is to be noted that it is an ASX listed company which is traded as “FNP” that employs more than 755 people. The company categorises all its products under three basic categories namely “Dairy and Nutritionals”, “Plant based beverages” and “Specialty seafood.” The major famous brands under the “Dairy and Nutritionals” includes “MILKLAB, Australia’s own, Vitalife (C-store.com.au, 2021, p1). So Natural and many more. The popular brands under the “Plant based beverages” includes “MILKLAB and Australia’s Own Organic.” While the popular brands under the “Specialty seafood” includes “Paramount and Brunswick.” It is thus one of the most popular food and beverages manufacturing, marketing and distribution company in whole Australia and parts of South Asia. The aim of this assignment is to establish the importance of auditor’s professional liability and to portray what negative publicity is created for an auditor or the audit firm in general owing to the negligence or lack of dure care or lack of proper application of professional competence during the audit. Therefore, the objectives of this report are to identify the legal and economic basis of auditing as well as proper application of applicable reporting requirements and auditing standards, followed by analysing and communication of legal and professional judgement of the auditor and his responsibilities to clients and other parties. The report also aims to assess optimum audit strategies and audit approach so that the professional integrity could be maintained and risk of litigation for the auditor could be lessened thereby enhancing the reputation of the auditor and not downgrading it. The aim of this assignment is to be accomplished through deciphering a practical case of accounting scandal concerning “Freedom Foods Group” that was discovered in 2019-2020 where the audit firm, “Deloitte” was sued for professional negligence.

“Freedom Foods Group” deals in manufacturing, sourcing, marketing as well as distributing a wide range of “food and beverage” products such as “Dairy and Nutritionals”, “Plant based beverages” and “Specialty seafood (C-store.com.au, 2021, p1).” The aim of this assignment is to establish the importance of auditor’s professional liability and to portray what negative publicity is created for an auditor or the audit firm in general owing to the negligence or lack of dure care or lack of proper application of professional competence during the audit. The report also aims to assess optimum audit strategies and audit approach so that the professional integrity could be maintained and risk of litigation for the auditor could be lessened thereby enhancing the reputation of the auditor and not downgrading it.

The legal liability case which will be discussed here in this report is concerning the accounting scandal of “Freedom Foods Group” which was discovered in 2019-2020. In this case, both the “Freedom Foods” as well as its auditor, “Deloitte” has been accused. A “class action” has been lodged against Freedom Foods for accounting malpractice and fraud and its auditor, ‘Deloitte” has been accused of negligence of not able to decipher such accounting fraud irrespective of auditing the firm over the last five financial years. The case for which a class action was lodged by the shareholders of Freedom Foods in the “Victorian Supreme Court” is regarding a total of $590 million asset valuation write down as well as restatements in the previous year’s results (Annual Report 2020, 2022, p2(3)). It was material accounting fraud committed by Freedom Foods over the last few years which was discovered in financial year 2019-2020 (Afr.com, 2021, p1(3)). According to the class action, Freedom Foods allegedly contravened its obligations of continuous disclosure as required by the ASX listing rules where it failed to inform the market regarding the “price-sensitive” information concerning FY 2020 as well as historical performances thereby misleading the market altogether. The auditor, “Deloitte” was accused of not able to detect such material accounting fraud for so many years in spite of the fact that it was the same audit firm that audited Freedom Foods over the last five financial years. It is to be noted that Deloitte is also accused of devising out a unique audit strategy which was very useful in treating a considerable amount of expenditures incurred during years as capital assets and hence as a result the profits were inflated by a considerable margin every year in spite of the fact that Freedom Foods were making substantial amount of loss year after year. This made the company to restate several years of accounts again in 2020. The company at last accepted that the accounting figures and data published year after year was very inaccurate and restated several years accounts again in 2020 under the pressure and ongoing investigation being conducted by ASIC. Among the several ground breaking revelations being conduct6ed by Freedom Foods under the ongoing investigations were a reported profit of “$11.6 million” in 2019 when the company actually incurred a net loss of “$145.8 million (Afr.com, 2021, p1(3)).” The company also revealed the fact that the amount of losses were not restricted to the above-mentioned figure of $145.8 million, but was way above the figure for the subsequent year ended, June, 2020 where the loss reached as big as $174.5 million (Afr.com, 2021, p1(3)). So, the audit firm was charged of negligence. It is to be noted that the auditors can be sued of negligence and no proper application of due care being employed by the auditor during audit which cased material loss for the parties relying on such audit report especially the shareholders. It is to finally noted that the total amount of restatements and asset write-downs for Freedom Foods was $590 million out of which the major contributor was asset write downs and faulty capitalisation practices being followed by the company that accounted for $372 million (Afr.com, 2021, p1(3)). This proves that the expenses which Freedom Foods was incurring was completely capitalised in place of putting it on the “Profit and Loss statement” as expenses. Deloitte as an external auditor who was auditing Freedom Foods over the past five financial years failed to detect such smart accounting or earnings management or window dressing conducted by the company executives. So, in this case, the shareholders of Freedom Foods suffered monetary loss due to negligence or non-application of dure care by the auditor, Deloitte, though the charges are yet to be proved. It is to be further noted that there was fraud being committed by the company executives regarding “Stock options” as well worth $5.5 million. Certain share options or extensions that were given were not authorised by the Board and as a result, there was a restatement of $5.5 million concerning share options which were completely unauthorised. Hence, the auditor was sued by the shareholders of Freedom Foods and a “Class action” had been launched against both the Freedom Foods and its auditor, Deloitte.

Objectives of the report

Now, speaking about the parties who were held accountable for the accounting scandal case concerning Freedom Foods firstly includes the top executives of Freedom Foods. It is to be noted that the class action was directed on both the company Freedom Food as well as its auditor, Deloitte. So, the second party who were held responsible here in this case is the audit firm Deloitte. The “Class Action” which was filed by the shareholders of Freedom Foods are currently under the legal jurisdiction of the “Victorian Supreme Court” which is being currently investigated by the ASIC. So, the case is yet to be decided and judgement is yet to passed thereby imposing penalty on the fraudsters by the Court of law. The Court has yet not declared any specific name related to the company to be blamed for this financial accounting fraud at Freedom Foods where the status is till now pending. However, the most probable offenders who are to be blamed here in this case are the top executives of Freedom Foods such namely, “Rory Macleod”, CEO and CFO, “Campbell Nicholas” who resigned just after the accounting fraud was discovered. The audit partner of Deloitte responsible for the audit of Freedom Foods for the past five years may be considered equally liable for the financial accounting fraud through they might not have a direct association with the financial fraud. They can only be charged with negligence and non-application of due care and professional competence and behaviour during the past audits which is stressed by APES 110 (APES 110, 2010, p11-22(1)). Finally, commenting on the appropriateness of the case or penalties imposed, it can be said that the suing both the company and its auditor is justified by the shareholder as they have lost a considerable portion of money or investment out of such fraud. If the shareholders have incurred loss out of negligence on the part of the auditor, they are legally capable of suing the auditor, which they did.

The relevant issues on both accounting and auditing as per the financial accounting fraud case concerning Freedom Foods firstly includes “faulty capitalisation practices” followed by “faulty and ambiguous accounting policies.” Proper authorisation and improper accounting treatment of “Share options” was yet another accounting issue that was highlighted here in this financial accounting fraud case concerning Freedom Foods. The eminent auditing issues here in this case includes “negligence” on the part of auditor followed by non-application of “professional competence, due care and professional behaviour’ by the auditor, Deloitte who has been auditing Freedom Foods for the past five years. So, the first accounting issue was “faulty capitalisation practices.” As the independent investigation being conducted by the ASIC, it could be seen that Freedom Foods were treating a considerable amount of expenses especially the ones incurred on machinery, maintenance of new product lines or even on buildings were treated as capital expenditure in place of posting such expenses on the “profit and loss account.” This faulty or purposeful act decreased the expenses by a considerable level every single year thereby inflation the profit for every single year. This is why a reported profit of “$11.6 million” in 2019 turned into a net loss of “$145.8 million” upon investigation and the company had to restate its accounts for several years including the one of FY 2019 (Afr.com, 2021, p1(2)). The second accounting issue is the “faulty and ambiguous accounting policies.” There was no proper oversight concerning the implementation of the accounting policies which resulted in excess asset write down every single year. Depreciations were charged ambiguously that resulted to a total faulty write down of assets amounting to be $372.8 million (Abc.net.au, 2021, p1(2)). It is not all, Freedom Foods even wrote down its possessed brands and goodwill worth $75.9 million. The impartial investigations being run by the ASIC also revealed that the company had to legally write down another $60.1 million worth inventory which was included into inventory on account of the inventory being either obsolete or unsaleable or out of date. Lastly, there was issues regarding the appropriate accounting or treatment for “Share Options” as well. The impartial investigations being conducted by the ASIC revealed that granting or extension of “Share Options” to the eligible employees were unauthorised by the Board and proper accounting treatment was also not followed. This resulted into a restatement of $5.5 million concerning the Share Options by Freedom Foods. Now, speaking about the auditing issues that were highlighted by the accounting fraud scandal concerning Freedom Foods firstly includes “negligence” on the part of the auditor, Deloitte. The auditor also did not employ proper due diligence, due care, professional competence and professional behaviour during the audit of Freedom foods during the last five financial years. These facts can be proved by the revelations made by the ASIC investigations reports which states that the current year 2020 when the fraud was discovered, the audit report was 11 pages long and all previous audit reports provided by the same auditor, Deloitte was merely half-a-page long (Afr.com, 2021, p1(2)). The auditor in the current year, 2019-20, when the fraud was discovered also identified the control deficiencies within the internal operations as per ASA 240 stating the management’s role to override the internal controls (Afr.com, 2021, p1(3)). If this professional behaviour, due care and diligence and enthusiasm could have been shown by the auditor earlier, then such heinous accounting crime would not have occurred at such a large scale or would not have occurred at all at the first place.

Legal liability case of Freedom Foods Group

Now speaking about the root cause of the issue was fraud and market pressure. The first root cause of the issue was fraud. The fraud was committed by the top executives working at Freedom Food namely the CEO, “Rory Macleod”, and CFO, “Campbell Nicholas.” There was restatements and asset write-downs for Freedom Foods worth $590 million out of which the major contributor was asset write downs and faulty capitalisation practices being followed by the company that accounted for $372 million (Afr.com, 2021, p1(3)). The company did not charge many expenses such as the ones incurred on buildings and other items instead was capitalised by the executives. This was a major fraud which was conducted by the top executives over the duration of the last five years. The result of the fraud was portrayed through “$11.6 million” profit as of 2019 which turned into a net loss of “$145.8 million” in the same year (ANNUAL REPORT 2019, 2022, p6). As a result, the company has to restate all of its accounts over again in 2020. This whole incident of fraud committed by the executives of Freedom Food can also be considered as a market pressure which included the top executives to commit such fraud in order to portray better financial performance of the firm over the years. This portrayal of profit in place of loss is done out of self-interest by the executives as the executive compensation is completely linked to the performance of the firm. There is one more issue which is to be mentioned over here which is a kind of fraud being committed by the granting or extension of “Share Options” to the employees especially to the executives or other top-level employees worth $5.5 million without the proper authorization or recommendation of the Board. So, the root cause of the identified issues is fraud being committed by the top-level employees or executives who have been employed at Freedom Foods.

The audit strategy which will be most suitable here would be “substantive procedures approach.” The audit strategy is appropriate here in this case as there is serios doubt regarding various accounts that is to be thoroughly investigated (Almasria et al., 2021, p7(1)). The accounts of machinery and building is to be thoroughly investigated as the maintenance of new product lines or even on buildings were treated as capital expenditure in place of posting such expenses on the “profit and loss account.” This faulty or purposeful act decreased the expenses by a considerable level every single year thereby inflation the profit for every single year. This is why a reported profit of “$11.6 million” in 2019 turned into a net loss of “$145.8 million” upon investigation and the company had to restate its accounts for several years including the one of FY 2019 (Afr.com, 2021, p1(2)). The occurrence, classification, completeness and accuracy are to be thoroughly tested by the auditor for these accounts in order to provide an impartial view on the prepared financial statements (Maldonado, Pinho and Lobo 2019, p2(18)). The accounts of share options should also be properly verified. The occurrence and completeness of the revenues and expenses are also to be tested on a thorough basis.

Accusations against Freedom Foods and Deloitte

The other effective measures which would prevent the filing of similar kind of litigations against the auditors includes maintenance of due diligence, due care and professional behaviour by the auditors during the audit where they should word work with utmost objectivity and integrity (APES 110, 2010, p12-22(1)). The auditors should apply due care and be vigilant at all times during the audit of any client so that they would be able to detect any material misstatement or fraud existing within the prepared financial statements of the client. This portrayal of due care and diligence would avoid any cases of negligence to be filed on the auditors.

As a result of the frauds committed in the company, there were certain regulatory and corporate governance changes introduced. These changes were important to ensure prevention of such frauds in the future and efficient management of resources. Crucial appointments of key personnel were made as a part of board renewal process with a motive to incorporate the benefits of skills and experience of a diverse group of individuals. Appointments of Stuart Black AM as the new Independent Non-Executive director and Chair of the Finance and Audit Committee was made along with the appointment of Genevieve Gregor to the post of independent Chair of the board (2021 CORPORATE GOVERNANCE STATEMENT, 2022, p1(8)). An experienced corporate governance lawyer was also appointed as the General Counsel and Company Secretary (2021 CORPORATE GOVERNANCE STATEMENT, 2022, p2(6)). With these appointments the board now is made up of the majority of independent non-executive directors and is expected to discharge its duties with integrity and proficiency. The board policies, charters and processes were also updated which reflected the inclusion of all the imperative strategies and procedures. The framework supporting the risk management practices and processes also witnessed certain essential changes which held great importance in tackling the issues prevalent in the organization (2021 CORPORATE GOVERNANCE STATEMENT, 2022, p2(5)).  The changes also included putting in place an internal audit function and appointment of an internal auditor having great experience, to the post of head of Internal Audit (2021 CORPORATE GOVERNANCE STATEMENT, 2022, p2(4)). With the motive of promoting behaviours which are supremely important for organizational efficiency and to incentivise those achieving the desired goals and objectives which enhance the shareholder value, a comprehensive framework of executive remuneration was developed keeping in mind both the short term and long-term implications (Noumi.com.au, 2021, p1). A Risk Appetite Statement was also developed which would enable the company to assess its tolerance and capacity to take risk and accordingly get involve into activities with appropriate levels of business risk.

Conclusion

The aim of this assignment is to access the event of fraud being conducted in Freedom Foods during the last five years that went undetected by the auditor of Freedom Foods. Freedom Foods is one of the largest manufacturers, distributions and marketers of food and beverage products in Australia. As portrayed in the aim above, the fraud was carried out by the executives of the company and such fraud remained undetected by the auditors for the last five audits and this is why a case of negligence was lodged against the auditors in the Victorian Supreme Court. The root cause of the issue was fraud being committed by the executives of Freedom Foods and negligence on the part of the auditor. The audit strategy that is to be adopted for such kind of an audit is “substantive procedures approach.” Finally, it can be said that the auditors should follow the fundamental principles for professional accountants namely the due care and competence, objectivity, integrity and professional behaviour during the future audits so that the similar kind of litigations could be avoided in future.

Reference and bibliography 

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Afr.com (2021), Freedom Foods' accounting scandal is a shocker. [online] Australian Financial Review. Available at: <https://www.afr.com/chanticleer/freedom-foods-accounting-scandal-is-a-shocker-20201130-p56j48> [Accessed 14 December 2021].

Almasria, N., Airout, R.M., Samara, A.I., Saadat, M. and Jrairah, T.S., 2021. The role of accounting information systems in enhancing the quality of external audit procedures. Journal of management Information and Decision Sciences, 24(7), pp.1-23. https://www.researchgate.net/profile/Nashat-Almasria/publication/353702982_The_Role_Of_Accounting_Information_Systems_In_Enhancing_The_Quality_Of_External_Audit_Procedures/Links/610b99611ca20f6f8600210c/The-Role-Of-Accounting-Information-Systems-In-Enhancing-The-Quality-Of-External-Audit-Procedures.pdf

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C-store.com.au (2021), Full scale of Freedom Foods accounting scandal revealed - Convenience & Impulse Retailing. [online] Convenience & Impulse Retailing. Available at: <https://www.c-store.com.au/full-scale-of-freedom-foods-accounting-scandal-revealed/> [Accessed 14 December 2021].

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