Case 7 Tan and Cañada, a firm of CPAs, audited the accounts of Sterling Skins, Inc.
, a corporation
that imports and deals in fine furs. Upon completion of the examination, the auditors supplied
Sterling Skins with twenty copies of the certified statement of financial statement. The firm knew in
a general way that Sterling wanted that number of copies of the auditor's report to furnish to banks
and other potential lenders. The statement of financial position in question was in error by
approximately P800,000. Instead of having a P600,000 net worth, the corporation was insolvent.
The management of Sterling Skins had doctored the books to avoid bankruptcy. The assets had been
overstated by P500,000 of fictitious and non-existing accounts receivable and P300,000 of non-
existing skins listed as inventory when in fact Sterling Skins had only empty boxes. The audit failed
to detect these fraudulent entries. JC, relying on the certified statement of financial position, loaned
Sterking Skins P200,000. They seek to recover their loss from Tan and Cañada.
Required:
State whether each of the following is true or false and give your reasons:
a. If JC alleges and proves negligence on the part of Tan and Cañada he will be able to
recover his loss.
Answer: FALSE, Because the firm (Tan and Cañada) do not have contact with JC and
didn’t mean to cause harm due to failed of detecting the fraudulent entries that’s why it’s
generally not enough for recovery.
b. If JC alleges and proves constructive fraud (that is, gross negligence on the part of Tan
and Cañada) he will be able to recover his loss.
Answer: TRUE, if it is proven that it made intentionally by the firm, therefore they are liable
to recover the losses of JC.
c. JC does not have a contract with Tan and Cañada
Answer: TRUE, if they do not have contract, firm will not be liable for recovery.
d. Unless actual fraud on the part of Tan and Cañada could be shown, JC could not recover.
Answer: FALSE, JC could recover his loss because it is an actual fraud or it is made
intentionally by the CPA, since JC relied upon those flase statement that’s why it is
sufficient for a recovery.
e. JC is third-party beneficiary of the contract Tan and Cañada made with Sterling Skins.
Answer: FALSE, JC is not beneficiary of the contract because he is unknown party and
will not be able to recover his losses unless it is actual fraud.
(Assuming a liberal interpretation that there was legal relationship between auditors and third
parties this code is covered)
280 Objectivity – All services The objectivity principle is aimed at making financial statements
more relevant and reliable. Professional accountant should provide any professional service
whether there are threats to compliance with fundamental principle of objectivity resulting from
having relationship with a client, directors and officers. A professional accountant in public
practice who provides an assurance service is required to be independent of the assurance client.
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Section 291 Assurance Engagement It’s significance are designed to enhance intended users’
degree of confidence about the outcome of the evaluation or measurement of a subject matter
against criteria
Case 8. The CPA firm of Angeles, Belen, and Cruz was expanding very rapidly. Consequently, it
hired several junior accountants, including a man named Dantes. The partners of the firm
eventually became dissatisfied with Dantes' production and warned him that they would be
forced to discharged him unless his output increased significantly. At that time, Dantes was
engaged in audits of several clients. He decided that to avoid being fired, he would reduce or
omit entirely some of the standard auditing procedures listed in audit programs prepared by the
partners. One of the CPA firm's clients, Best Corporation, was in serious financial difficulty and
had adjusted several of the acounts being examined by Dantes to appear fiancialy sound. Dantes
prepared fictitious working papers in his home at night to support purpoted completion of
auditing procedures assigned to him, although he in fact did not examine the adjusting entries.
The CPA firm rendered an unqualified opinion on Best's financial statements, which were grossly
misstated. Several creditors, relying on audited financial statements, subsequently extended large
sums of money to Best Corporation.
Required:
Would the CPA firm be liable to the creditors who extended the money because of their reliance
on the erroneous financial statements if Best Corporation should fail to pay them? Explain.
Answer: Yes, the firm will be liable to the creditors because of the unreliable information. When
the information is not reliable, the user of the financial statement will be the one who suffer
irreversible consequences because they depend on unreliable information given by the firm. In
this case, Dantes neglect the auditing procedure that may result to a big impact and loss to the
firm although it is not an actual fraud but still Dantes made a not acceptable work that’s why the
CPA Firm is liable to the creditors.
Section 150 Professional Behavior - It’s principle is to impose an obligation on professional
accountants to comply with relevant laws and regulation and avoid any action that the
professional accountant knows or should know may discredit the profession
Section 130 Professional Competence and Due care – It’s significance is for the professional
accountant to maintain their professional knowledge and skill at the level required to ensure that
clients or employers receive competent professional service and to act diligently in accordance
with applicable technical and professional standard when providing professional services.
Which is not present towards Dantes because he set aside the auditing standard procedures that
indicate to such gross negligence.
Case 9. Carlos, CPA, is the auditor for Jupiter Mfg. Corp., a privately owned company that has a
June 30 fiscal year. Jupiter arranged for a substantial bank loan that was dependent on the bank
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receiving, by September 30, audited financial statements which showed a current ratio of at least
2 to 1. On September 25, just before the audit report was to be issued, Carlos received an
anonymous letter on Jupiter's stationery indicating a five-year lease by Jupiter, as lessee, of a
factory building 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. Carlos confronted the president of Jupiter, 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 Carlos did not issue his report by
September 30, Jupiter would sue Carlos for substantial damages that would result from not
getting the loan. Under this pressure and because the working papers contained a copy of the 5-
year lease agreement that supported the operating lease agreement, Carlos issued his report with
an unqualified opinion on September 29.
Answer the following questions, setting forth reasons for any conclusions stated:
a. Is Carlos liable to the bank?
Answer: Yes, because Carlos is the one who issued erroneous statement and there has
purpose of deceiving in addition he is aware that it may cause harm to the bank so
there was an act of fraud in effect if the false statement that have been issued by the
CPA resulted damages to the bank therefore Carlos will be liable to recover bank
losses.
b. Is Carlos liable to the lessor?
Answer: No, because the lessor also committed an intentional fraud that lead to his
own loss because he agreed of such “secret agreement” with the president that’s why
lessor will not be able recover any loss from Carlos.
c. Is there potential for criminal action against Carlos
Answer: Yes, because due to lack of Professional Behavior Carlos issued unqualified
opinion without following the financial reporting standard and it was non-compliance
with the ethical requirements that’s why criminal fraud was already present and also as
CPA he is lack of integrity by aiming to mislead the users of financial statement.
General application of the Code- It’s significance is to increases users confidence and
perception about the financial reporting. To be competent and perform services to
exercise due professional care and recognize their responsibility for the users of financial
statement to ensure that the information is fair to all parties and not biased.
Section 110 Integrity- It’s imposes an obligation on all professional accountants to be
straightforward and honest in professional and in business relationship. Integrity also
implies fair dealing and truthfulness
It is so important that financial statements are true and accurate that public companies use
outside certified public accountants to audit their books to ensure the financial reports
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follow the generally accepted accounting principles and that the figures reported are
accurate.
Case 10. Rain Tan recently joined the CPA firm of Base, Umapas & Cañada. She quickly
established a reputation for thoroughness and a steadfast dedication to following prescribed
auditing procedures to the letter. On her third audit for the firm, Tan examined the underlying
documentation of 200 disbursements as a test of purchasing, receiving, vouchers payable, and
cash disbursement procedures. In the process, she found 12 disbursements for the purchase of
materials that had no receiving reports documentation. She noted the exceptions in her working
papers and called them to the attention of the in-charge accountant. Relying on prior experience
with the client, the in-charge accountant diregarded Tan's comments, nothing further was done
about the exceptions. Subsequently, it was learned that one of the client's purchasing agents and a
member of its accounting dep't were engaged in a fraudulent scheme to divert the receipt of
materials to a public warehouse while sending the invoices to the client. When the client
discovered the fraud, the conspirators had diverted approximately P70,000 in materials, P50,000
of it after the completion of the audit.
Required:
a. Discuss the legal implications and liabilities to Base, Umapas & Cañada as a result of these
facts.
Answer: Because of the actual fraud made by the agent and their in-charge accountant. CPA
firm has a big chance that they would be held liable to the client since it was within the covered
the employment.
As an in-charge accountant there was lacking of fundamental principles and that is to maintain
the integrity also the professional competence and due care, it appears when in charge accountant
failed to fulfill his legal duties by engaging into fraudulent scheme. In addition the intent of
deceiving, recovery for dereliction of duty will be available to the client.
b. Discuss the legal implications and liabilities to Base, Umapas & Cañada if the CPA firm is a
limited liability partnership.
Answer: Liability would be limited to those damages that would be avoided when professional
competence and due care had been occurred. Liability partners and staff
responsible for the engagement and the firm would be liable. However, other partners who are
not engaged on fraudulent scheme would not be liable
340 Financial Interest, Compensation and Incentives Linked to Financial Reporting and
Decision Making
Professional accountants in business may have financial interest or may know of financial
interest of immediate or close family members in certain circumstances, give rise to threats to
compliance with the fundamental principles.
in this case the in-charge accountant was lacking of fundamental principles and that is to
maintain the integrity also the professional competence and due care and they are potentially
liable to its client because of the negligence made by in charge accountant.
Its importance is to be alert to the principle of integrity, which imposes an obligation on all
professional accountants to be straight forward and honest in all business relationship
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Professional accountant in business shall not manipulate information or use confidential
information for personal gain or for the financial gain of others. The more senior the position that
the professional accountant in business holds, the greater the ability and opportunity to influence
financial reporting and decision making and the greater the pressure there might be from
superiors and peers to manipulate information.
In evaluating the significance of any threat, and, when necessary, determining the appropriate
safeguard to be applied, professional accountant in all business shall evaluate the nature of the
interest.
Case 11. Gonzales & Esteban, CPAs, audited Nicole, Inc. The audit was deficient in several
respects:
i. Gonzales & Esteban failed to verify properly certain receivables and later proved to be
fictitious.
ii. With respect to other receivables, although they made a cursory check, they failed to detect
many accounts that were long overdue and obviously uncollectible.
iii. No physical inventory was taken of the securities claimed to be in Nicole
's possession, which in fact had been sold. Both the securities and cash received from the sales
were listed on the statement of financial position as assets.
There is no indication that Gonzales & Esteban actually believed that the FS were false.
Subsequent creditors, not known to Gonzales & Esteban, are now suing based on the deficiencies
in the audit as described above. Gonzales & Esteban moved to dismiss the lawsuit against it on
the basis that the firm did not have actual knowledge of falsity and therefore did not commit
fraud.
Required:
May the creditors recover, without demonstrating that Gonzales & Esteban had actual
knowledge of falsity? Why or why not?
Answer: Creditors may not recover, they can only be recover if there is an actual fraud however
in this case ordinary negligence may be present. On the other hand the audit was deficient in
several respect like they failed to check the receivables and collectivity of receivable and might
be enough to be liable for any loss by not taking notice of possible material misstatement. It
shows that the auditor executed an inadequate way that is mandatory to utilize to guarantee the
assurance of financial statement is free from material misstatement besides there is an omission
in reckless disregard of legal duty so that evidential matter is insufficient to form a reliable
opinion.
Section 330 Acting With Sufficient Expertise – It’s significance as a professional accountant in
business should not intentionally mislead an employer as to level of expertise or experience
possessed, nor should a professional accountant in business fail to seek appropriate expert advice
and assistance when required.
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330.2 Although there’s some circumstances that threaten the ability of a professional accountant
like insufficient time for properly performing or completing the relevant duties, Incomplete,
restricted or otherwise inadequate information for performing the duties properly.
Like what happened in case 11 The audit appears to have been exercise in inadequate way
because the auditor has been grossly negligent in the performance of duties since they disregard
the auditing standard
The significance of the threats should be evaluated and if they are other than clearly
insignificant, safeguard should be considered and applied as necessary to eliminate them or
reduce them to an acceptable level.
Safeguard that may be considered include:
Obtaining additional advice or training
Ensuring that there is adequate time available for performing the relevant duties
Case 12. Carlo Vasquez, the founding and senior partner of a successful and respected public
accounting firm, was a highly competent practitioner who always emphasized high professional
standards. One of the policies of the firm was that all reports by members or staff be submitted to
Vasquez for review. Recently, Alex Corpuz, a junior partner in the firm, received a phone call
from Harry Flores, a close personal friend. Flores informed Corpuz that he, his family, and some
friends were planning to create a corporation to engage in various land development ventures;
that various members of the family are presently in a partnership (Flores Ventures), which holds
some land and other assets; and that the partnership would contribute all its assets to the new
corporation and would assume the liabilities of the partnership.
Flores asked Corpuz to prepare a statement of financial position of the partnership that he
could show to members of his family, who were in the partnership, and to friends, to determine
whether they might have the interest in joining in the formation and financing of the new corp.,
Flores said he had the partnership general ledger in front of him and proceeded to read to Corpuz
the names of the accts. and their balances at the end of latest month. Corpuz took the notes he
made during the telephone conversation with Flores, classified and organized the data into a
conventional statement of financial position, and had his secretary type the statement of financial
position and an accompanying letter on firm stationery. He did not consult Vasquez on this
matter or submit this work to him for review.
The transmittal letter stated: "We gave reviewed the books and records of Flores
Ventures, a partnership, and have prepared the attached statement of financial position at March
31, 2013. We did not perform an audit in conformity with PSAs, and therefore do not express an
opinion on the accompanying statement of financial position." The statement of financial
position was prominently marked "unaudited." Corpuz signed the letter and instructed his
secretary to send it to Flores.
What legal problem are suggested by these facts? Explain
Answer: The legal problem in this case is when Corpuz failed to comply with one of the policies
of the firm and that was all reports by members or staff be submitted to Vasquez for review.
Corpuz made it intentionally that’s why it is considered as an actual fraud because he stated in
the letter that the Firm has reviewed the books and records of Flores Ventures well in fact there is
no such review happened. This action may affect the users of financial statement because of
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unreliable financial statement and if it’s proven that Flores financial statement was deceiving,
CPA Firm will be held liable for its damage and losses to those who relied over the financial
statement.
Section 320 Preparation and Reporting of Information – Professional accountants in business
are often involved in the preparation and reporting of information that may be either public or
used by others inside or outside the employing organization.
A Professional accountant who has responsibility for preparation or approval of the general
purpose of financial statements of an employing organization and its purpose is to satisfied that
those financial statement are presented in accordance with the applicable financial reporting
standard
-in case 12 financial statements consists of limited investigatory procedures designed to provide
statement users with a limited degree of assurance that the financial
statements are in conformity with financial reporting standards.
Threats to compliance with the fundamental principles for example, self interest or intimidation
threats to integrity, objectivity or professional competence and due care are created because
professional accountant in business is pressured to prepare or report information in misleading
way through the actions of others.
The significance of any threat shall be evaluated and safeguards applied when necessary to
eliminate the threat such safeguard include consultation with the superior within the employing
organization.
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