Common Law Liability Exposure. Smith, CPA, is the auditor for Juniper ManufacturingCorporation, a nonpublic entity that has a June 30 fiscal year. Juniper arranged for a substantial bank loan, which depended on the bank receiving audited financial statements showing adebt-to-equity ratio of no more than 2 to 1. The bank’s deadline for receiving these financialstatements was September 30. On September 25, just before the auditors’ opinion was to beissued, Smith received an anonymous letter on Juniper’s letterhead indicating that Juniper’sfive-year lease of a factory building that was classified in the financial statements as anoperating lease was in fact a capital lease. The letter stated that Juniper had a secret writtenagreement with the lessor modifying the lease and creating a capital lease.Smith confronted the president of Juniper, who admitted that a secret agreement existedbut said it was necessary to treat the lease as an operating lease to meet the debt-to-equityratio requirement of the pending loan and that nobody would ever discover the secret agreement with the lessor. The president said that if Smith did not issue a report by September 30,Juniper would sue Smith for substantial damages that would result from not getting the loan.Under this pressure and because the audit documentation contained a copy of the five-yearlease agreement supporting the operating lease treatment, Smith issued the report with anunmodified opinion on September 29. In spite of the fact that it received the loan, Juniperwent bankrupt. The bank is suing Smith to recover its losses on the loan, and the lessor issuing Smith to recover uncollected rents.Required:Answer the following, setting forth reasons for any conclusions stated.a. Is Smith liable to the bank?b. Is Smith liable to the lessor?c. Was Smith independent?
Common Law Liability Exposure. Smith, CPA, is the auditor for Juniper Manufacturing
Corporation, a nonpublic entity that has a June 30 fiscal year. Juniper arranged for a substantial bank loan, which depended on the bank receiving audited financial statements showing a
debt-to-equity ratio of no more than 2 to 1. The bank’s deadline for receiving these financial
statements was September 30. On September 25, just before the auditors’ opinion was to be
issued, Smith received an anonymous letter on Juniper’s letterhead indicating that Juniper’s
five-year lease of a factory building that was classified in the financial statements as an
operating lease was in fact a capital lease. The letter stated that Juniper had a secret written
agreement with the lessor modifying the lease and creating a capital lease.
Smith confronted the president of Juniper, who admitted that a secret agreement existed
but said it was necessary to treat the lease as an operating lease to meet the debt-to-equity
ratio requirement of the pending loan and that nobody would ever discover the secret agreement with the lessor. The president said that if Smith did not issue a report by September 30,
Juniper would sue Smith for substantial damages that would result from not getting the loan.
Under this pressure and because the audit documentation contained a copy of the five-year
lease agreement supporting the operating lease treatment, Smith issued the report with an
unmodified opinion on September 29. In spite of the fact that it received the loan, Juniper
went bankrupt. The bank is suing Smith to recover its losses on the loan, and the lessor is
suing Smith to recover uncollected rents.
Required:
Answer the following, setting forth reasons for any conclusions stated.
a. Is Smith liable to the bank?
b. Is Smith liable to the lessor?
c. Was Smith independent?
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 4 images
