Joker & Wild LLC has just been sued by its audit client,Canasta, Inc., claiming the audit failed to be conducted inaccordance with generally accepted auditing standards, lacked therequisite care expected in an audit, and failed to point out thatinternal controls were not working as intended. The facts of thecase are that the auditors failed to find the accounting manager’smisappropriation of assets when he stole inventory and thenimproperly, knowingly, wrote down inventory for marketdeclines.
Current market values of inventory were not provided to theauditors despite numerous requests for this information. Theauditors relied on management’s representations about these values,which understated inventory by 10 percent. The plaintiff clientbrought the suit against the CPA firm claiming negligence,asserting the firm’s failure to find the vice president’smisappropriations of inventory and false valuations damaged thecompany by prematurely recognizing losses and then causing largereversals in the subsequent fiscal year when the inventory was soldfor 15 percent above the original cost. The defendant CPA firmsought to blame the client, claiming Canasta did not cooperate onthe audit and the vice president overrode internal controls.
1)Are the auditors guilty of malpractice? Explain.
2)What defenses are available to Joker & Wild in this case?Explain what they must prove to successfully assert thesedefenses.
3)Assume you are not aware of state laws on auditor legalliability. What legal concepts might a court of law use to resolvethe lawsuit?
4)Do you believe the auditors should be held legally liable? Whyor why not?
