Magazine article The CPA Journal

One Judge's Perception of CPAs

Magazine article The CPA Journal

One Judge's Perception of CPAs

Article excerpt

Why one firm lost a court case

In Brief

But It Was Only a Review!

In a recent court case, a judge found a CPA firm responsible for thefts perpetrated by the client's bookkeeper despite the fact that the firm had only been engaged to review the client's financial statements. The following factors helped influence the judge's decision:

There was no engagement letter.

There was no documentation of any efforts to advise the client of red flags encountered in the course of the engagement.

The workpapers seemed to have been altered after the thefts were discovered.

The judge was adversely influenced by certain actions of the partnerin-charge both before and during the trial.

The testimony of defendant's CPA expert witness was deemed to be biased, whereas plaintiff's expert was considered credible. recent unreported decision by a New York State court-in which a CPA firm was held responsible for thefts perpetrated by its client's bookkeeper-provides a number of valuable lessons for CPAs. The case, Collins v. Esserman & Pelter, Supreme Court Broome County, December 1997, was unusual in that it was tried by a judge and not by a jury. In such cases, the court is not only required to state its finding but also to explain how it assessed the evidence. As a result, the court's decision provides rare and valuable insight into how accountants are perceived in the courtroom.

Background

The case arose out of thefts by the client's bookkeeper of over $280,000. The bookkeeper had the owners of her employer, a construction company, sign checks made payable to two companies she had formed with names similar to the employer's principal subcontractors. She then deposited these checks into bank accounts she had established for these entities. The owners not only signed these checks, but did so without insisting the bookkeeper comply with the company's internal controls that required every check submitted for signature be accompanied by supporting documentation. This was particularly negligent in that 1) the owners had only recently been the victim of thefts by their prior bookkeeper, 2) the bookkeeper was known to have been dismissed for cause (if not theft) by her prior employer, and 3) the owners had discovered the bookkeeper had failed to pay the company's withholding taxes and had falsified the company's books to indicate that the payments had been made.

Who Was at Fault?

The court faulted the defendant accounting firm (and not the company's management) for the losses, concluding that the accountants knew or certainly should have realized something was amiss and took no steps to respond to the many warning signs. Specifically, the court found that the accountants knew the client's bookkeeper had been fired by her prior employer for stealing. They also discovered she had made at least three other false bookkeeping entries. And, lastly, they were aware that she had maintained the client's financial records in a constant state of disarray. The court therefore (but perhaps wrongfully) concluded that the defendant accounting firm had a duty to investigate the situation, although it is not clear what the court would have wished the accounting firm to investigate.

While the court acknowledged that the accounting firm had only undertaken to review the client's financial statements and was not engaged to perform an audit, it nevertheless concluded that the firm's duty to exercise due care required it to take further action. The court presumed (there was no express finding to this effect) that such further action would have led to the discovery of the bookkeeper's thefts. In this regard, the court was clearly influenced by the fact that the successor bookkeeper, who had only had limited accounting experience, was able to uncover her predecessor's thefts within a few weeks of taking the job. The court thus concluded that the successor bookkeeper had uncovered the thefts simply by doing things the defendants had promised to do and had told the client they had done. …

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