5-19 (OBJECTIVES 5-2, 5-3) The following are five independent situations.
1. Joanie Brogan is a partner in an audit firm that operates as a limited liability partnership (LLP). The firm has been sued for an alleged audit failure related to an audit engagement handled by a different partner in the firm. While Brogan had no involvement in the engagement, she is concerned that the plaintiff may successfully sue her
seeking restitution from her personal assets.
2. A lawsuit has been filed against Carter Hockaday, CPA, charging him with constructive fraud in the audit of Broughton Company’s financial statements. Hockaday has examined all the audit documentation in his files and reviewed all relevant auditing standards. He is convinced that his audit fully complies with standards of the profession but is uncertain what he should use as his primary defense tactic.
3. West Camera Co. filed for bankruptcy in January 2018. A recent blog suggested that West’s external auditors should be sued for failing to include a going concern explanatory paragraph in the firm’s opinion on the financial statements issued before the bankruptcy, even though the fair presentation of the financial statements is not being disputed.
4. The audit firm Weaver and Jones, LLP, received a subpoena for its documentation related to the audit of Westbrook Corporation’s financial statements. The firm has refused to respond, alleging that the documentation is considered privileged communication between the firm and its client.
5. Spencer Cullen, CPA, is a defendant in a lawsuit alleging that Cullen should be held
legally liable for gross negligence for a fraud involving the valuation of securities included in the financial statements of one of his clients. Cullen was uncertain how to
establish a correct valuation for the securities and decided to rely on the price estimation supplied by management.
Analyze each situation and provide your assessment of the potential resolution of each
scenario, including potential liability for the auditor or audit firm involved.
5-20 (OBJECTIVES 5-4, 5-5) Lauren Yost & Co., a medium-sized CPA firm, was engaged to
audit Stuart Supply Company. Several staff were involved in the audit, all of whom had
attended the firm’s in-house training program on effective auditing methods. Throughout
the audit, Yost spent most of her time in the field planning the audit, supervising the staff,
and reviewing their work.
A significant part of the audit entailed verifying the physical count, cost, and summarization of inventory. Inventory was highly significant to the financial statements, and
Yost knew the inventory was pledged as collateral for a large loan to First City National
Bank. In reviewing Stuart’s inventory count procedures, Yost told the president she be-
lieved the method of counting inventory at various locations on different days was highly
Required
Required
LEGAL LIABILITY
undesirable. The president stated that it was impractical to count all inventory on the same
day because of personnel shortages and customer preference. After considerable discussion,
Yost agreed to permit the practice if the president signed a statement that no other method was practical. The CPA firm had at least one person at each site to audit the inventory count procedures and actual count. There were more than 40 locations.
Eighteen months later, Yost found out that the worst had happened. Management below the president’s level had conspired to materially overstate inventory as a means of covering up obsolete inventory and inventory losses resulting from mismanagement. The misstatement occurred by physically transporting inventory at night to other locations after it had been counted in a given location. The accounting records were inadequate to uncover these illegal transfers.
Both Stuart Supply Company and First City National Bank sued Lauren Yost & Co.
Answer the following questions, setting forth reasons for any conclusions stated:
a. What defense should Lauren Yost & Co. use in the suit by Stuart?
b. What defense should Lauren Yost & Co. use in the suit by First City National Bank?
c. Is Yost likely to be successful in her defenses?
d. Would the issues or outcome be significantly different if the suit was brought under
the Securities Exchange Act of 1934
