Business Law Study Set 1

Business

Quiz 47 :

Accountants Liability and Malpractice

Quiz 47 :

Accountants Liability and Malpractice

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Parente, Randolph, Orlando Associates (Parente) is an accounting firm that had done auditing work for Sparkomatic for nearly 20 years. On June 14, 1993, Sparkomatic entered into a Memorandum of Intent with Williams Controls to sell Williams assets from Sparkomatic's Kenco division. The sale price was to be the "audited book value" of the assets, and the book value would be based on the June 30, 1993, balance sheet (which Parente did not prepare). Sparkomatic then engaged Parente to audit the financial statements for December 31, 1990, 1991, and 1992 and to prepare an interim balance sheet for 1993. On August 1, 1993, Sparkomatic and Williams Controls entered into an asset purchase agreement, which required that Williams be furnished financials through June 1993 as prepared by "Sparkomatic's independent public accountant." Parente was not identified by name in the agreement. Parente did review the asset purchase agreement with Williams prior to commencing its work and knew that Williams would be using the information Parente prepared. Following the closing, additional information came to light indicating that Williams had overpaid for the assets of Kenco, and Williams filed suit against Parente for negligence, negligent misrepresentation, and breach of contract. Parente moved for summary judgment. What should the decision be and why Discuss several possible theories. [Williams Controls v Parente, Randolph, Orlando, Associates, 39 F Supp 2d 517 (MD Pa)]
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Refer to the case Williams Controls v Parente, Randolph, Orlando, Associates to answer question as below:
Facts to this case
• An accounting firm made misstatements in their client's financial statement.
• W relied on these reports to make purchase from the client.
• The accounting firm knew W would be using those reports.
• W found they overpaid for the purchases.
Case Issue
The issue is whether the accounting firm is liable to W.
Relevant Terms, Laws, and Cases
Malpractice - is when a professional, such as doctor, lawyer, or accountants, work which results in an injury to another.
Analysis and Conclusion
The court cited that prior cases required privity of contract to sue for negligence. In this case, W was not the firm that hired the accountant, thus, W had no privity of contract to sue for negligence.
However, the court cited that the accounting firm can be liable for negligent misrepresentation; privity is not required for negligent misrepresentation. They were aware that W would be using the reports and their misstatements caused injuries to W.
The court also held that summary judgment can't be granted to the accounting firm for breach of contract. As there was a question whether W was an intended beneficiary for the auditing contract between the accountant and their client. The reason in W's favor was that W relied on the contract to purchase assets from the client, and W may have been intended to benefit from the audit because they need it to make purchase from the client. If W was an intended beneficiary they have a claim for breach of contract.
Thus, the accountant is not liable for negligence only.

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In a common law action against an accountant, lack of privity is a viable defense if the plaintiff:
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A) Lack of privity means that the creditor had no contract or was not intended beneficiary of the service contract between the accountant and the debtor client. Negligence suit requires privity in contract. Thus, lack of privity would be a defense.
This is the answer.
b) Lack of privity would not be defense for gross negligence of the accountant such as intended fraud by the accountant. This is a serious offense.
This is not the answer.
c) The client has privity to the accountant because he hired the accountant. It would be a ridiculous defense to claim your own client has no privity to their own contract.
This is not the answer.
d) Lack of privity would not be defense for fraud by the accountant. This is a serious offense.
This is not the answer.

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AUSA Life Insurance Company and others were institutional investors in the securities of JWP, Inc., a company that went belly up, resulting in nearly a 100 percent loss of their investments. Ernst Young served as auditor for JWP from 1985 to 1992. During most of that period, JWP was in a period of rapid expansion that was financed by private placements of debt securities, and it became increasingly leveraged. By 1991, it was losing an average of $10 million per month. Ernst Young knew of "accounting irregularities" from at least 1988 through 1991 but did not insist on their correction. Ernst Young issued unqualified financial opinions for all of those years. One of the irregularities was recording anticipated future tax benefits of net operating loss in violation of GAAP. AUSA and its fellow investors sued Ernst Young for their losses. The federal district court dismissed the case and AUSA appealed. Should AUSA be able to recover Explain your answer. [ AUSA Life Insurance Co. v. Ernst Young, 206 F.3d 202 (2d Cir. 2000), 119 F. Supp. 2d 394 (S.D.N.Y. 2000), aff'd in unpublished opinion]
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Equisure, Inc., was required to file audited financial statements when it applied for a listing on the American Stock Exchange (AMEX). Stirtz, Equisure's auditor, issued a favorable audit opinion used for the AMEX application. Stirtz also issued "clean" opinions on Equisure's required SEC filings, such as its 10k. Noram, a securities broker, loaned $900,000 in margin credit to purchasers of Equisure's stock based on the firm's audited financials. AMEX stopped trading on Equisure's stock because of allegations of insider trading and stock manipulation, and Noram was left without collateral for $2.5 million in loans. Stirtz resigned as Equisure's auditor, and Noram filed suit against Stirtz. The trial court granted Stirtz summary judgment. Noram appealed. Who is liable here Was the court's decision correct [Noram Investment Services, Inc. v Stirtz Bernards Boyden, 611 NW2d 372 (Minn App)]
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Cable Corp. orally engaged Drake Co., CPAs, to audit its financial statements. Cable's management informed Drake that it suspected the accounts receivable were materially overstated. Though the financial statements Drake audited included a materially overstated accounts receivable balance, Drake issued an unqualified opinion. Cable used the financial statements to obtain a loan to expand its operations. Cable defaulted on the loan and incurred a substantial loss. If Cable sues Drake for negligence in failing to discover the overstatement, Drake's best defense would be that Drake did not
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For almost 13 years, Touche Ross had prepared the annual audit of Buttes Gas and Oil Co. Buttes wanted to obtain a loan from Dimensional Credit Corp. (DCC) and showed DCC its most recent annual audit. DCC made the loan on the basis of what it learned from the audit. The loan was not repaid, and DCC then realized that it had been misled by negligent statements about Buttes's financial condition that appeared in the annual statement prepared by Touche Ross. Would DCC be able to recover against Touche Ross for its negligence in preparing this report
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Audit firm Grant Thornton had prepared financial reports for use by the board of directors of First National Bank of Keystone (Keystone) in response to an investigation by the Office of the Comptroller of the Currency (OCC) that raised questions about the value of Keystone's loan portfolio. Stan Quay, a partner at Grant Thornton, was in charge of the 1998 audit. On March 24, 1999, Quay presented several members and prospective members of Keystone's board and Keystone's shareholders with draft copies of Keystone's 1998 financial statements and told them that Keystone was going to get an unqualified or "clean" audit opinion on its 1998 financial statements. In April 1999, and despite the fact that Keystone was in fact insolvent at the end of 1998, Grant Thornton issued a clean audit report for Keystone. The audit report contained the following statement: "This report is intended for the information and use of the Board of Directors and Management of The First National Bank of Keystone and its regulatory agencies and should not be used by third parties for any other purpose." Gary Ellis, a president of another bank, was being recruited in early 1999 by the Keystone board to take the president's position at Keystone. Following the Keystone board meeting on March 24, 1999, Ellis met Quay and two other outside directors at a bar at the Fincastle Country Club. Quay spoke with Ellis and the two outside directors because Keystone did not have a chief financial officer, thus making Quay the only person capable of going over the financial statements with the others. At the country club, Quay told Ellis and the two outside directors that Keystone was going to receive a "clean [audit]." Ellis also attended the March 25, 1999, shareholders' meeting at which Quay informed the group that Grant Thornton was going to give Keystone a clean audit opinion for 1998. On March 30, 1999, Ellis visited Keystone. During this visit, Quay told Ellis once again that Keystone would receive a clean audit opinion for 1998. Ellis signed a two-year contract at a base salary of $375,000 plus benefits, including the use of a corporate vehicle and a country club membership. He also purchased $49,500 in Keystone stock. By September 1999, Keystone Bank was closed. Ellis filed suit against Grant Thornton. The district court ruled in favor of Ellis on his negligent misrepresentation claim and found that he was entitled to $2,419,233 in damages. Grant Thornton appealed. Is this verdict correct Explain why or why not Grant Thornton is liable for the loss of the job. [ Ellis v. Grant Thornton LLP, 530 F.3d 280 (4th Cir. 2008)]
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In general, the third-party (primary) beneficiary rule as applied to a CPA's legal liability in conducting an audit is relevant to which of the following causes of action against a CPA img
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David S. Talesnick served as the accountant for Kenneth Ronson and his wife as well as for Ronson's company, performing accounting and tax services for all. From 1980 to 1983, Ronson, his wife, and his company invested in the White Rim Oil Gas, Pine Coal, and Winchester Coal limited partnerships. During those years, the Ronsons and his company were able to report losses on their income tax returns because of these investments. However, the IRS determined that the limited partnerships were not qualified investments under the tax code and disallowed the loss deductions. The Ronsons and his company all owed back taxes, interest, and penalties as a result. The Ronsons disputed the finding and asked Talesnick how they might appeal the ruling and not have the interest clock ticking on what they owed. Talesnick wrote a letter and advised them to post a bond of $91,300, the amount then due. Talesnick was incorrect in his advice on payment and accrual of interest, and by the time the final determination was made against the Ronsons and Ronson's company, they owed $235,063 with interest. The Ronsons sued Talesnick for malpractice. Could they recover How much [Ronson v Talesnick, 33 F Supp 2d 347 (DNJ)]
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What is the difference between the standards for auditor liability in a civil action by investors against the auditor vs. auditor liability for violation of securities laws
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Hicks, the president and manager of Intermountain Merchandising, wanted to sell the business to Montana Merchandising, Inc. To provide a basis for the transaction, he retained Bloomgren, an accountant, to make an audit of Intermountain. Bloomgren knew that Montana would use the audit report in making the purchase of the business from Intermountain. Bloomgren's audit report showed the Intermountain business as profitable. Thayer, Montana's president, relied on this report in agreeing to purchase the business of Intermountain and in agreeing to the terms of the purchase. Sometime later, it was discovered that the accountant had made a number of mistakes and that the business that was sold was actually insolvent. Thayer and Montana Merchandising sued Hicks and Bloomgren for damages. The suit claimed that the accountant had negligently misrepresented the facts. The accountant defended on the basis that Thayer was not in privity of contract with him and therefore could not sue him. Was he right [Thayer v Hicks, 793 P2d 784 (Mont)]
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Which of the following services is a CPA generally required to perform when conducting a personal financial planning engagement a. Assisting the client to identify tasks that are essential in order to take action on planning decisions b. Assisting the client to take action on planning decisions c. Monitoring progress in achieving goals d. Updating recommendations and revising planning decisions
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The auditing firm of Timm, Schmidt Co. prepared annual financial statements for Clintonville Fire Apparatus, Inc. (CFA). CFA showed these statements to Citizens State Bank and asked for loans. On the basis of the financial statements, Citizens loaned CFA approximately $380,000. Timm later discovered that the financial statements overvalued CFA by more than $400,000. Citizens demanded repayment of the loans. CFA could not pay the balance, and Citizens sued Timm and its malpractice liability insurer. They raised the defense that the suit was barred by lack of privity and the fact that no one in the Timm firm knew that CFA intended to use the financial statements to obtain loans from anyone. Is the lack of privity a defense [Citizens State Bank v Timm, Schmidt Co., 335 NW2d 361 (Wis)]
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The certified public accounting partnership of James, Guinn, and Head prepared a certified audit report of four corporations, known as the Paschal Enterprises, with knowledge that their report would be used to induce Shatterproof Glass Corp. to lend money to those corporations. The report showed the corporations to be solvent when in fact they were insolvent. Shatterproof relied on the audit report, loaned approximately $500,000 to the four corporations, and lost almost all of it because the liabilities of the companies were in excess of their assets. Shatterproof claimed that James and other accountants had been negligent in preparing the report and sued them to recover the loss on the loan. The accountants raised the defense that they had been retained not by Shatterproof but by Paschal. Was this defense valid [Shatterproof Glass Corp. v James, 466 SW2d 873 (Tex App)]
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Beckler Associates, CPAs, audited and gave an unqualified opinion on the financial statements of Queen Co. The financial statements contained misstatements that resulted in a material overstatement of Queen's net worth. Queen provided the audited financial statements to Mac Bank in connection with a loan made by Mac to Queen. Beckler knew that the financial statements would be provided to Mac. Queen defaulted on the loan. Mac sued Beckler to recover for its losses associated with Queen's default. Which of the following must Mac prove in order to recover I. Beckler was negligent in conducting the audit. II. Mac relied on the financial statements. a. I only b. II only c. Both I and II d. Neither I nor II
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Which of the following statements is (are) correct regarding the common law elements that must be proven to support a finding of constructive fraud against a CPA misrepresentation I. The plaintiff has justifiably relied on the CPA's misrepresentation. II. The CPA has acted in a grossly negligent manner. a. I only b. II only c. Both I and II d. Neither I nor II
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Henry Hatfield, CPA, was hired to prepare audited financial statements for Happy Campers, a nonprofit organization providing summer camp scholarships for inner-city, low-income children. The executive director of Happy Campers was embezzling but falsified records that Hatfield used in his audit. First Bank gave Happy Campers a $100,000 loan based on Hatfield's certified financials. The embezzlement was discovered, and Happy Campers defaulted on the loan. Can First Bank recover its loss from Hatfield
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