ACCT 444 ACCT444 ACCT/444 Week 2 Homework

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ACCT 444 ACCT444 ACCT/444 Week 2 Homework

Maritza Lopez January 12, 2016

ACCT 444 Professor Hayes 5-23 (Objectives 5-4, 5-5, 5-7)

Chen, CPA, is the auditor for Greenleaf Manufacturing Corporation, a privately owned company that has a June 30 fiscal year.

Greenleaf arranged for a substantial bank loan that was dependent on the bank’s receiving, by September 30, audited financial statements that showed a current ratio of at least 2 to 1.

On September 25, just before the audit report was to be issued, Chen received an anonymous letter on Greenleaf’s stationery indicating that a 5-year lease by Greenleaf, 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.

Chen confronted the president of Greenleaf, 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 Chen did not issue his report by September 30, Greenleaf would sue Chen for substantial damages that would result from not getting the loan.

Under this pressure andbecause the audit files contained a copy of the 5-year lease agreement that supported the operating lease treatment, Chen issued his report with an unqualified opinion on September 29.

Despite the fact that the loan was received, Greenleaf went bankrupt within 2 years.

The bank is suing Chen to recover its losses on the loan, and the lessor is suing Chen to recover uncollected rents.

Required

Answer the following questions, setting forth reasons for any conclusions stated::::

a. Is Chen liable to the bank?

Mr. Chen is liable to the bank in my opinion. The reason is because since Chen was a party to theissuance of false financial statements.

So, the elements necessary to establish an action for common law fraud are present. There was a material misstatement of fact, knowledge of falsity, intent that the plaintiff bank relies on the false statement, actual reliance, and damage to the bank as a result thereof.

If the action is based upon fraud, there is no requirement that the bank establish privacy of contract with the CPA.

b. Is Chen liable to the lessor?Well no because because since the lessor was a party to the secret agreement. So, the lessor cannot claim reliance on the financial statements and cannot recover uncollected rents.

Even if the lessor was damaged indirectly his or her own fraudulent actions led to the loss and the equitable principle of unclean hands precludes the lessor from obtaining relief.

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