Academic journal article Journal of Accountancy

Reckless Conduct Sufficient to Sustain Fraud Claim

Academic journal article Journal of Accountancy

Reckless Conduct Sufficient to Sustain Fraud Claim

Article excerpt

A U.S. district court ruled that an auditor's reckless conduct was sufficient reason to file a claim of securities law violations against the accounting firm. This case began when Coopers & Lybrand performed its 1992 fiscal year audit of Ferrofluidics. Ferro recognized revenue on delivery of its technology systems to its customers and improperly recognized revenue from two sales on or about June 27, 1992. In both cases, items included in the sales recognized by Ferro required substantial design and engineering changes after the sale.

After Ferro had delivered the systems, the firm asked it to obtain statements from the two customers that the sales had been accepted. Only one complied, and even in that case the customer could have returned the item within 30 days after delivery if the unit did not operate per specifications. Although the customer did keep the goods, some design changes were necessary. The firm nevertheless issued an unqualified opinion for fiscal year 1992 that included revenue from these sales, violating several Financial Accounting Standards Board and Accounting Principles Board standards. Subsequently, the financial statements had to be revised to delete these sales; the new statements, minus the two sales, showed a considerably less optimistic picture of the company. This triggered a severe stock market correction. Plaintiff shareholders then brought a class action lawsuit alleging violation of various securities laws.

The plaintiffs said "red flags" on the two sales should have alerted the firm:

1. Revenue from the two deals was recognized three days before the end of the fiscal year. …

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