In order to expand its operations, Barton Corp. raised $5million in a public offering of common stock, and also negotiated a $2 million loanfrom First National Bank. In connection with this financing, Barton engaged Hanover &Co., CPAs, to audit Barton’s financial statements. Hanover knew that the sole purpose ofthe audit was so that Barton would have audited financial statements to provide to FirstNational Bank and the purchasers of the common stock. Although Hanover conductedthe audit in conformity with its audit program, Hanover failed to detect material actsof embezzlement committed by Barton Corp.’s president. Hanover did not detect theembezzlement because of its inadvertent failure to exercise due care in designing theaudit program for this engagement.After completing the engagement, Hanover issued an unqualified opinion on Barton’sfinancial statements. The financial statements were relied upon by the purchasers ofthe common stock in deciding to purchase the shares. In addition, First National Bankapproved the loan to Barton based on the audited financial statements. Within sixty daysafter the sale of the common stock and the issuance of the loan, Barton was involuntarilypetitioned into bankruptcy. Because of the president’s embezzlement, Barton becameinsolvent and defaulted on the loan from the bank. Its common stock became virtuallyworthless. Actions have been brought against Hanover by:• The purchasers of the common stock who have asserted that Hanover is liable fordamages under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934.• First National Bank, based upon Hanover’s negligence.• Trade creditors who extended credit to Barton, based upon Hanover’s negligence.a. Discuss whether you believe Hanover will be found liable to the purchasers of commonstock.b. Indicate whether you believe First National Bank will be successful in its claimagainst Hanover.c. Indicate whether you believe the trade creditors will be successful in their claimagainst Hanover.
In order to expand its operations, Barton Corp. raised $5
million in a public offering of common stock, and also negotiated a $2 million loan
from First National Bank. In connection with this financing, Barton engaged Hanover &
Co., CPAs, to audit Barton’s financial statements. Hanover knew that the sole purpose of
the audit was so that Barton would have audited financial statements to provide to First
National Bank and the purchasers of the common stock. Although Hanover conducted
the audit in conformity with its audit program, Hanover failed to detect material acts
of embezzlement committed by Barton Corp.’s president. Hanover did not detect the
embezzlement because of its inadvertent failure to exercise due care in designing the
audit program for this engagement.
After completing the engagement, Hanover issued an unqualified opinion on Barton’s
financial statements. The financial statements were relied upon by the purchasers of
the common stock in deciding to purchase the shares. In addition, First National Bank
approved the loan to Barton based on the audited financial statements. Within sixty days
after the sale of the common stock and the issuance of the loan, Barton was involuntarily
petitioned into bankruptcy. Because of the president’s embezzlement, Barton became
insolvent and defaulted on the loan from the bank. Its common stock became virtually
worthless. Actions have been brought against Hanover by:
• The purchasers of the common stock who have asserted that Hanover is liable for
damages under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934.
• First National Bank, based upon Hanover’s negligence.
• Trade creditors who extended credit to Barton, based upon Hanover’s negligence.
a. Discuss whether you believe Hanover will be found liable to the purchasers of common
stock.
b. Indicate whether you believe First National Bank will be successful in its claim
against Hanover.
c. Indicate whether you believe the trade creditors will be successful in their claim
against Hanover.
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