Johnson & Company, CPAs, audited Guaranteed Savings & Loan Company. M. Johnson had the assignment of evaluating the collectability of real estate loans. Johnson was working on two particular loans:
(1) A $ 4 million loan secured by Smith Street Apartments and
(2) A $ 5.5 million construction loan on Baker Street Apartments now being built. The appraisals performed by Guaranteed Appraisal Partners Inc., showed values in excess of the loan amounts. On inquiry, Bumpus, the S& L vice president for loan acquisition, stated, “I know the Smith Street loan is good because I myself own 40 percent of the partnership that owns the property and is obligated on the loan.” Johnson then wrote in the audit documentation:
(1) The Smith Street loan appears collectible as; Bumpus personally attested to knowledge of the collectability as a major owner in the partner-ship obligated on the loan;
(2) The Baker Street loan is assumed to be collectible because it is new and construction is still in progress; and
(3) The appraised values all exceed the loan amounts.
a. Do you perceive any problems with related- party involvement in the evidence used by Johnson? Explain.
b. Do you perceive any problems with Johnson’s reasoning or the appropriateness of evidence used in that reasoning?