Ethical issues and consequences
Roy Dussault is a CPA who started a sports equipment importing business. The business became very successful and he sold it to his neighbour. As part of the sale agreement, Roy agreed to perform an audit of the financial statements for the first year at no charge. Roy told the new owner that there would be no problem in issuing an unqualified opinion if the new owner operated the business without increasing the debt levels and kept inventory low. Roy also has been a partner in an audit firm for several years and to avoid any ethical problems, Roy arranged for other staff to do the audit. Roy only reviewed the work of the other auditors and did not do any of the audit planning or testing himself. The audit for the first year was free, and if the new owner wanted an audit for the second year, Roy’s firm would only charge 5 percent of the net income of the company.
Roy’s firm found no material misstatements but the audit report noted a going-concern issue. The new owner took on extra debt from a private source, trying to expand the business too quickly. The excess debt caused the company’s current ratio to fall below 1.8, which violated a covenant of the company’s bank loan agreement. Under the terms of the lending agreement, the bank then called its loan and the new owner went into bankruptcy within 18 months.
The new owner sued Roy’s audit firm for negligence, claiming that Roy had issued an audit report that ruined her business.
Identify and explain at least four ethical issues in the above situation.
Explain whether or not Roy’s audit firm could be found negligent by issuing the audit report that harmed the client’s business.
Source: © CGA-Canada, now CPA Canada. Reproduced with permission.