Knowledge of the rules of conduct, interpretations thereof, and related rulings on independence, integrity, and objectivity will help you respond to the following cases.
Required: For each case, state whether or not the action or situation shows violation of the rules of professional conduct, explain why, and cite the relevant rule or interpretation.
a. Your client, Contrary Corporation, is very upset over the fact that your audit last year failed to detect an $800,000 inventory overstatement caused by employee theft and falsification of the records. The board discussed the matter and authorized its lawyers to explore the possibility of a lawsuit for damages.
b. Contrary Corporation filed a lawsuit alleging negligent audit work, seeking $1 million in damages.
c. In response to the lawsuit by Contrary, you decided to start litigation against certain officers of the company, alleging management fraud and deceit. You are asking for a damage judgment of $500,000.
d. The Allright Insurance company paid Contrary Corporation $700,000 under fidelity bonds covering the employees involved in the inventory theft. Both you and Contrary Corporation have dropped your lawsuits. However, under subrogation rights, Allright has sued your audit firm for damages on the grounds of negligent performance of the audit.
e. Colt & Associates, PAs, audit Gore Company. Ms. Colt and Bill Gore (president) found a limited real estate partnership deal that looked too good to pass up. Colt purchased limited partnership interests amounting to 23% of all such interests, and Gore personally purchased 31%. Unrelated investors held the remaining 46%. Colt and Gore congratulate themselves on the opportunity and agree to be passive investors with respect to the partnership.
f. A group of dissident shareholders filed a class-action lawsuit against both you and your client, Amalgamated Inc., for $30 million. They allege there was a conspiracy to present misleading financial statements in connection with a recent merger.
g. PA Anderson, a partner in the firm of Anderson, Olds & Watershed (a professional accounting corporation), owns 25% of the common shares of Dove Corporation (not a client of AO&W). This year Dove purchased a 32% interest in Tale Company and is accounting for the investment using the equity method of accounting. The investment amount to 11% of Dove’s consolidated net assets. Tale Company has been an audit client of AO&W for 12 years.
h. Durkin & Panzer, PAs, regularly perform the audit of the North Country Bank, and the firm is preparing for the audit of the financial statements for the year ended December 31, 20X4.
i. Two directors of the North Country Bank became partners in D&P, PAs, on July 1, 20X4, resigning their directorship on that date. They will not participate in the audit.
j. During 20X4, the former controller of the North Country Bank, now a partner of D&P, was frequently called on for assistance regarding loan approvals and the bank’s minimum chequing account policy. In addition, he conducted a computer feasibility study for North Country.
k. The Cather Corporation is indebted to a PA for unpaid fees and has offered to give the PA unsecured interest-bearing notes. Alternatively, Cather Corporation offered to give two shares of its common stock, after which 10,002 shares would be outstanding.
l. Johnny Keems is not yet a PA but is doing quite well in this first employment with a large PA firm. He has been on the job two years and has become a “heavy junior.” If he passes the PA exam in September, he will be promoted to senior accountant. This month, during the audit of Row Lumber Company, Johnny told the controller about how he is remodeling an old house. The controller likes Johnny and has a load of needed materials delivered to the house, billing Johnny at a 70% discount—a savings over the normal cash discount of about $300. Johnny paid the bill and was happy to have the materials, which he otherwise would not have been able to afford on his meager salary.
m. PA Lily Rowan inherited $1 million from her grandfather, $100,000 of which was the value of shares in the North Country Bank. Lily practices accounting in Hamilton, and several of her audit clients have loans from the bank.
n. Groaner Corporation is in financial difficulty. You are about to sign the report on the current audit when your firm’s office manager informs you that the audit fee for last year has not yet been paid.
o. Your audit client, Glow Company, is opening a plant in a distant city. Glow’s president asks that your firm’s office in that city recruit and hire a new plant controller and a cost accountant.