Smith, PA, is the auditor for Juniper Manufacturing Corporation, a
Smith, PA, is the auditor for Juniper Manufacturing Corporation, a privately owned company that has a June 30 fiscal year.
Juniper arranged for a substantial bank loan, which was dependent on the bank’s receiving, by September 30, audited financial statements showing a current ratio of at least 2 to 1. On September 25, just before the audit report was to be issued, Smith received an anonymous letter on Juniper’s stationery indicating that a five-year lease by Juniper, as lessee, of a factory building that was accounted for in the financial statements as an operating lease was in fact a capital lease. The letter stated that there was a secret written agreement with the lessor modifying the lease and creating a capital lease.
Smith confronted the president of Juniper, who admitted that a secret agreement existed but said it was necessary to treat the lease as an operating lease to meet the current ratio requirement of the pending loan and that nobody would ever discover the secret agreement with the lessor. The president said that, if Smith did not issue his report by September 30, Juniper would sue Smith for substantial damages that would result from not getting the loan. Under this pressure and because the working papers contained a copy of the five-year lease agreement supporting the operating lease treatment, Smith issued his report with an unqualified opinion on September 29. In spite of the fact that the loan was received, Juniper went bankrupt. The bank is suing Smith to recover its losses on the loan and the lessor is suing Smith to recover uncollected rents.
Answer the following, setting forth reasons for any conclusions stated:
a. Is Smith liable to the bank?
b. Is Smith liable to the lessor?
c. Was Smith independent?