Case $8-6$ Kay & Lee, LLP

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Kay & Lee LLP was retained as the auditor for Holligan Industries to audit the financial statements required by prospective banks as a prerequisite to extending a loan to the client. The auditor knows whichever bank lends money to the client is likely to rely on the audited statements.

After the audit report is issued, the bank that ultimately made the loan discovers that the audit client$$s inventory and accounts receivable were overstated. The client subsequently went bankrupt and defaulted on the loan. The bank alleged that the auditor failed to communicate about the inadequacy of the client$$s internal recordkeeping and inventory control. Moreover, the bank claims that the auditors were grossly negligent in not discovering the overvaluation of inventory and accounts receivable.

The auditors asserted that there was no way for them to know that the client included in the inventory account $$1$ million of merchandise in transit to a customer on December $31,2021.$ The shipping terms were unclear, so the auditors accepted management$$s representations in that regard. As for the receivables, the auditors claimed the client falsified confirmations by sending them to a post office address, retrieving them, and then confirming the stated balances.

$8-6$: Qu $04$ To succeed in obtaining a judgment,...

To succeed in obtaining a judgment, the bank would have to prove these three things as part of a five$-$step process.

Multiple Choice

False representation by the accountant; belief by the accountant the representation was accurate; the accountant intended to induce the third party to rely on accurate representation

Knowledge or belief by the accountant the representation was false; that the accountant intended to induce the third party to rely on false information; that the third party relied on false information

Accountant intended the third party to rely on accurate representation; that the third party relied on the accurate representation which was later proved false; that the third party suffered damages

That the third party suffered damages; an accurate representation by the accountant; knowledge or belief by the accountant that the representation was accurate