Question

K My Drive - Google Drive X + /drive/my-drive Required ilton (z-lib.org).pdfon, (a): Open with sues that are involved and (b) discuss whether there has or has not been any violationem conuuct. Support your answers by reference to the rules of the AICPA Code of Professional Conduct, available at the AICPA website (www.aicpa.org). AP2.7 (LO 8) Moderate Common law Tyler Corp. is insolvent. It has defaulted on the payment of its debts and does not have assets sufficient to satisfy its unsecured creditors. Slade, a supplier of raw materials, is Tyler's largest unsecured creditor and is suing Tyler's auditors, Field & Co., CPAs. Slade had extended $2 million of credit to Tyler based on the strength of Tyler's audited financial statements. Slade's complaint alleges that the auditors were either (1) negligent in failing to discover and disclose fictitious accounts receivable created by management or (2) committed fraud in connection with Tyler. Field believes that Tyler's financial statements were prepared in accordance with GAAP and, therefore, its opinion was proper. Slade has established that: • The accounts receivable were overstated by $10 million. • Total assets were reported as $24 million, of which accounts receivable were $16 million. • The auditors did not follow their own audit program, which required that confirmation requests be sent to an audit sample representing 80% of the total dollar amount of outstanding receivables. Confirmation requests were sent to only 45% • The responses that were received represented only 20% of the total dollar amount of outstanding receivables. This was the poorest response in the history of the firm, the next lowest being 60%. The manager in charge of the engagement concluded that further inquiry was necessary. This recom- mendation was rejected by the partner in charge. . Field had determined that a $300,000 account receivable from Dion Corp. was nonexistent. Tyler's explanation was that Dion had reneged on a purchase contract before any products had been shipped. At Field's request, Tyler made a reversing entry to eliminate this overstatement. However, Field ac cepted Tyler's explanation as to this and several similar discrepancies without further inquiry Slade asserts that Field is liable as a result of both negligence and fraud in conducting the audit. Required Discuss Slade's assertions and the defenses that might be raised by Field, setting forth reasons for any conclusions stated. AP2.8 (LOS) Challenging Common law Astor Inc. purchased the assets of Bell Corp. A condition of the purchase agreement required Bell to retain a CPA to audit Bell's financial statements. The purpose of the audit was to determine whether the unaudited financial statements furnished to Astor fairly pre- sented Bell's financial position. Bell retained Winston & Co., CPA, to perform the audit. + Page 106 / 733 o

Answer 1

AP 2-7:

The facts reveal negligence on Field's part in that the firm did not follow its own audit program nor did it make a proper investigation into the many irregularities and suspicious circumstances.
Compliance with GAAP is of some evidentiary value to Field if it in fact complied with the principles set forth therein. However, the courts do not invariably accept GAAP as the conclusive test to disprove negligence. Furthermore, even if assuming GAAP were followed literally, GAAS certainly were not under the facts stated.

Field will undoubtedly rely upon the privity defense to avoid liability to Slade, a third party to the Field-Tyler contract. However, most jurisdictions recognize the standing of a third-party beneficiary to sue. Therefore, Slade would assert such status. In a majority of jurisdictions Slade would be regarded as a third-party beneficiary if it is within a known and intended class of beneficiaries. Other jurisdictions have gone even further in recognizing a duty is owed to those whom the CPA should reasonably foresee as recipients of the financial statements for authorized business purposes. There are insufficient facts to determine whether Field knew that Tyler intended to use the audited financial statements to secure credit from Slade. Therefore, it is not possible to determine whether the privity defense will bar recovery.

Fraud does not require that the party suing be in privity of contract with the defendant. However, the most significant problem in proceeding based upon fraud is that fraud requires a knowledge of falsity (scienter) or a recognized substitute therefor. Based upon the facts, Field did not actually know of management's fraud. However, it may be guilty of conduct which may be deemed to be a reckless disregard for the truth. The courts also resort to the constructive fraud theory where the facts are compelling, i.e., a shutting of one's eyes to the obvious. Sometimes, the conduct is labeled gross negligence, and an inference of fraud may be drawn from this by the trier of fact.