Smothers & Nelson, CPAs, have previously been engaged by Garrison Corporation to perform compilations and tax returns. Henry Garrison, the company’s president, indicated to the accountants that he needed “something more” than they previously provided. Mr. Garrison told Jose Vegas, the partner in-charge of the engagement, that the resulting financial statements from this proposed engagement would be used primarily for management’s purposes internally, as well as short-term bank loans. Vegas recommended that a review of the financial statements be performed, and work commenced without an engagement letter. As Vegas proceeded with the work, he indicated uneasiness about certain figures and conclusions but said he would take the client’s word about the validity of some entries, since the review was primarily for internal use and was not an audit. If Vegas had not relied on the representations of management, he would have detected a material act of fraud committed by management.

(a) Explain the role that an engagement letter could have played in this scenario and indicate what should have been covered in the letter.
(b) What was Vegas’ duty in this review? What is the potential liability faced by Smothers & Nelson, CPAs? Who may assert claims against the firm?

  • CreatedJanuary 21, 2015
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