You are a manager in Groom & Co, a firm of Chartered Certified Accountants. You have just attended a monthly meeting of audit partners and managers at which client-related matters were discussed. Information in relation to a client, which was discussed at the meeting, is given below:

Spaniel Co

The audit report on the financial statements of Spaniel Co, a long-standing audit client, for the year ended  31 December 2012 was issued in April 2013, and was unmodified. In May 2013, Spaniel Co’s audit committee contacted the audit engagement partner to discuss a fraud that had been discovered. The company’s internal auditors estimate that $4•5 million has been stolen in a payroll fraud, which has been operating since May 2012.

The audit engagement partner commented that neither tests of controls nor substantive audit procedures were conducted on payroll in the audit of the latest financial statements as in previous years’ audits there were no deficiencies found in controls over payroll.

The total assets recognised in Spaniel Co’s financial statements at  31 December 2012 were $80 million. Spaniel Co is considering suing Groom & Co for the total amount of cash stolen from the company, claiming that the audit firm was negligent in conducting the audit.

Required:

Explain the matters that should be considered in determining whether Groom & Co is liable to Spaniel Co in respect of the fraud. (12 marks)