Johnson & Company, PAs, audited the Guaranteed Trust 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 the Smith Street Apartments and
(2) A $5.5 million construction loan on the Baker Street Apartments now being built. The appraisals performed by the Guaranteed Appraisal
Partners Inc., showed values in excess of the loan amounts. Upon enquiry, Mr. Bumpus, the trust company vice-president for loan acquisition, stated, “I know the Smith Street loan is good because I myself own 40% of the partnership that owns the property and is obligated on the loan.”
Johnson then wrote in the working papers:
(1) The Smith Street loan appears collectible; Mr. Bumpus personally attested to knowledge of the collectability as a major owner in the partnership 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 M. Johnson? Explain.
b. Do you perceive any problems with M. Johnson’s reasoning or the appropriateness of evidence used in that reasoning?