FAU Balancing Auditor Liability and Client Confidentiality Case Study Paper For this case I was assign to answer the questions 6 and 7 that are posted at t

FAU Balancing Auditor Liability and Client Confidentiality Case Study Paper For this case I was assign to answer the questions 6 and 7 that are posted at the end of this case. I am attaching some documents that I was provided with in class. ISSUES IN ACCOUNTING EDUCATION
Vol. 32, No. 1
February 2017
pp. 17–32
American Accounting Association
DOI: 10.2308/iace-51318
Cook and Thomas, LLC: Balancing Auditor Liability, Client
Confidentiality, and the Public Interest
Kelsey R. Brasel
Ball State University
Brian E. Daugherty
University of Wisconsin–Milwaukee
ABSTRACT: In this case students are asked to assume the role of Alex Trifold, CPA, an audit partner for the public
accounting firm, Cook and Thomas, LLC, who holds going concern information about an audit client that may impact
other entities audited by Cook and Thomas. The case study illustrates how adherence to auditing standards may
place auditors in a difficult situation when balancing the auditor’s risk of litigation, the clients’ rights to confidentiality,
and the auditor’s duty to the public. Additionally, the case provides exposure to prior litigation cases against auditors
with unfavorable outcomes when auditors chose to protect their client’s confidentiality, and, conversely, in cases
where auditors chose to protect the greater public interest. The case requires students to engage in critical thinking
by providing their viewpoints as to the optimal balance of limiting auditor liability, adhering to client confidentiality
requirements, and simultaneously serving the public interest. The case study is appropriate for both undergraduate
and graduate auditing courses.
Keywords: auditor liability; client con?dentiality; auditors’ duty to the public; Public Company Accounting
Oversight Board; AICPA code of conduct; Regulation Fair Disclosure.
INTRODUCTION
I
n this case you will assume the role of Alex Trifold, CPA, an audit partner for the public accounting firm, Cook and
Thomas, LLC. As you will learn in the case, Alex Trifold holds potential going concern information about a client that
may impact other entities audited by Cook and Thomas. This case is concerned with client confidentiality within a firm in
terms of whether information pertaining to one audit client can be shared with the engagement teams of other clients of the firm.
The requirements of client confidentiality between the audit client and an external party are clearly set forth by regulations (e.g.,
AICPA 1992, 1988). However, the way in which an audit partner considers client confidentiality in practice may not always be
clear and straightforward, particularly when the external parties are other engagement teams, in differing locations, of the
auditor’s firm. Therefore, this case focuses on the way in which an audit partner considers client confidentiality in practice
within a firm that has common inter-dependent clients.
According to regulations, a CPA is not permitted to disclose confidential client information to others in the firm who are
not connected to the audit engagement. However, with respect to auditor liability, historical legal opinions have been mixed on
matters pertaining to auditor clients’ confidentiality rights and the auditor’s duty to the public. Auditors have previously
suffered negative litigation consequences when adhering to client confidentiality rules and when acting in a manner that
demonstrates a concern for the broader public interest. As you will discover as you work through the case, the potential
conflicts remain an unresolved issue nearly 50 years after the rendering of certain legal opinions involving confidentiality
litigation against auditors.
We thank Lori Holder-Webb (editor), an anonymous associate editor, and two anonymous reviewers for their constructive comments and feedback on
earlier versions of the manuscript. We are grateful to Kyle Peel for administrating the case and appreciate the undergraduate and graduate students
participating in the case for their feedback used for case validation purposes.
Editor’s note: Accepted by Lori Holder-Webb.
Submitted: January 2013
Accepted: October 2015
Published Online: October 2015
17
Brasel and Daugherty
18
The remainder of the case presents information on a hypothetical audit client of Cook and Thomas, LLC. The case
provides general background information on auditors’ duties to the public, auditors’ client confidentiality requirements, and
auditors’ litigation risk (Cashell and Fuerman 1995). At the end of the case you will find case questions to complete.
COOK AND THOMAS, LLC
As a partner for the international public accounting firm Cook and Thomas, LLC, you are comfortable with complex
problems and situations, but the current engagement of Fine Furniture Manufacturing is particularly challenging. Since joining
Cook and Thomas, LLC out of college you have been located in the Chicago, Illinois office. For the past two years, you have
been assigned as engagement partner on the annual financial statement audit of Fine Furniture Manufacturing. Fine Furniture
has been a client of the firm for 12 years out of the Chicago office and has traditionally been an uneventful audit. You and your
audit engagement team are currently completing the year-end audit of Fine Furniture Manufacturing for the year ended
December 31, 2014.
Fine Furniture Manufacturing is a medium-sized publicly held corporation established in 1982. The company specializes in
manufacturing wood furniture including park benches, patio furniture, and rocking chairs. Nearly all of the furniture produced
by Fine Furniture Manufacturing is constructed using a revolutionary and proprietary product called ‘‘paple’’ that is supplied by
Paple Lumber Supply in Atlanta, Georgia. Since its founding in 1991, Paple Lumber Supply has revolutionized the lumber
industry by creating a hybrid wood product that is a cross between pine and maple (hence, paple). Paple has the economic
benefits of pine lumber with the sturdiness and longevity of maple wood. Paple Lumber Supply is the only company of its kind
to manufacture paple lumber. Paple Lumber Supply’s largest customer is Fine Furniture Manufacturing. Paple Lumber Supply
is also a publicly held corporation and is audited by the Atlanta office of your firm, Cook and Thomas, LLC.
As a manufacturer of wood furniture, Fine Furniture Manufacturing sells its products wholesale to retail stores. Fine
Furniture Manufacturing’s largest customer is Front Porch Furniture in St. Louis, Missouri. Front Porch Furniture is audited by
the St. Louis office of your firm, Cook and Thomas, LLC. Front Porch Furniture is a publicly held corporation established in
1985 specializing in high-quality outdoor furniture. Front Porch Furniture’s largest supplier of inventory is Fine Furniture
Manufacturing and a majority of its sales are derived from Fine Furniture Manufacturing’s products. Front Porch Furniture has
multiple store locations throughout the Midwest and advertises that it specializes in ‘‘bringing you the best of southern living.’’
Over the past five years, Front Porch Furniture has experienced continued growth in sales of furniture manufactured by
Fine Furniture Manufacturing. Due to the increased sales, Front Porch Furniture plans to expand its store locations into the
Colorado region by opening eight new store locations in the next year. Front Porch Furniture is currently in the process of
securing a ten-year, 6 percent note payable in the amount of $30 million from Mutual Trust Bank for the expansion. One large
factor in the bank’s consideration of the note is an analysis of Front Porch Furniture’s 2014 financial statements. Mutual Trust
Bank will provide final approval on the note after it reviews the audited 2014 financial statements.
The Chicago office of Cook and Thomas, LLC has an uneventful history with Fine Furniture Manufacturing and has issued
unmodified (clean) audit opinions every year since it began auditing the company. Fine Furniture has been historically
profitable and its financial performance has generally been in line with that of its competitors. The client is not followed by a
large number of analysts given its niche as a mid-market, publicly held company and thus does not face the scrutiny or pressure
of larger public companies that have a large analyst following and consensus analyst forecasts. The financial performance
during the first three quarters of the current year has been relatively consistent with prior year’s results and those of its peers.
However, during the fourth quarter of the current fiscal year under audit, Fine Furniture Manufacturing experienced
drastically increased costs of production relating to two unforeseen factors that occurred during the last two months of the year.
Specifically, the company experienced material and uninsured damages to the company’s custom manufacturing equipment.
Additionally, the company was unable to favorably negotiate its union contract and has experienced increased pension
expenses that are material to the company. Therefore, the Fine Furniture Manufacturing engagement team believes these factors
raise substantial doubt about the ability of Fine Furniture to continue as a going concern. Under current standards, the going
concern decision requires the auditor to consider whether there is substantial doubt about the ability of the client to remain a
going concern through the next fiscal year-end.1
1
In August 2014, the Financial Accounting Standards Board (FASB) issued an updated standard, Accounting Standards Update No. 2014-15, that will
explicitly require management to assess an entity’s ability to continue as a going concern, and to provide footnote disclosures in certain circumstances.
The updated standard is effective for entities with fiscal years ending after December 15, 2016. The standard continues to use a ‘‘substantial doubt’’
framework, but extends the forward-looking period to within one year after the audit report issuance date. See the FASB website for additional detail.
In September 2014 the Public Company Accounting Oversight Board (PCAOB) issued a practice alert reminding auditors of their responsibilities in a
going concern context, and indicated that a new auditing standard may be proposed to align with the FASB’s updated standard. See the PCAOB
website for additional information.
Issues in Accounting Education
Volume 32, Number 1, 2017
Cook and Thomas, LLC: Balancing Auditor Liability, Client Confidentiality, and the Public Interest
19
During the audit, you have discussed Fine Furniture Manufacturing’s ability to continue as a going concern with its
management. Despite the conversations, the client will not agree to provide consent to disclose (prior to the release of the audit
opinion) the audit firm’s substantial doubt about its ability to continue as a going concern to either its primary supplier (Paple
Lumber Supply) or its primary customer (Front Porch Furniture). The client refuses to provide consent because both
management and the audit committee believe Fine Furniture Manufacturing can navigate the issues giving rise to the going
concern opinion, and further believes the company will remain a viable concern for years to come. As noted by management,
auditors in general have a relatively poor track record for issuing going concern opinions in the year prior to a client filing for
bankruptcy. Fine Furniture has appropriately disclosed its plans to address the relevant factors causing Cook and Thomas’
substantial doubt about its ability to continue as a going concern in the footnotes to the financial statements to be filed soon with
the Securities and Exchange Commission (SEC). Regardless of the client’s beliefs and footnote disclosure, you and your audit
team believe there is substantial doubt the company can continue as a going concern and have determined the audit report must
include a going concern paragraph. Fine Furniture Manufacturing, Paple Lumber Supply, and Front Porch Furniture all have
December 31 fiscal year-ends and similar expected audit opinion dates on or about February 25, 2015.2 All three companies are
audited by different offices, engagement partners, and audit engagement teams of Cook and Thomas, LLC.
As partner of the audit engagement, you are concerned about Fine Furniture’s ability to continue as a going concern and
the implications regarding the audits of Paple Lumber Supply and Front Porch Furniture. You are especially concerned with the
audit report to be issued for Front Porch Furniture since the audit report will be relied upon by Mutual Trust Bank before
approving a note payable. As the auditor of the Fine Furniture Manufacturing, do you have a duty to inform the engagement
teams of Paple Lumber Supply and Front Porch Furniture that your client has a going concern issue? Or do you have a duty to
uphold your client’s right to confidentiality and withhold the information from the other engagement teams until Fine
Furniture’s audited financial statements are filed with the SEC?
Suppose both engagement teams for Paple Lumber Supply and Front Porch Furniture issue unmodified opinions for their
respective clients. If Fine Furniture Manufacturing were to become insolvent, and Paple Lumber Company and/or Front Porch
Furniture were unable to locate alternative customers or wholesale product sources, respectively, then Cook and Thomas would
likely face litigation if Paple Lumber Company and/or Front Porch Furniture were to file for bankruptcy shortly after receiving
clean unmodified audit opinions. Alternatively, the firm may face litigation, under client confidentiality rules, from Fine
Furniture Manufacturing if the pending going concern opinion is disclosed to the Paple Lumber Company and/or Front Porch
Furniture engagement team(s) prior to public release of the opinion.
The Cook and Thomas’ policy regarding potential going concern issues requires you to consult with the national office of
the firm. The national office has expertise regarding technical and subjective issues including going concern situations, and is
able to assist engagement partners in making more difficult decisions. Your consultation with the national office is just a few
days away. In preparation for your meeting with the national office, you decide to refresh your understanding of the issues by
researching an auditor’s duty to the public, client confidentiality, and legal liability.
Auditor’s Duty to the Public
You decide to begin your reading with the American Institute of Certified Public Accountants’ (AICPA) Code of
Professional Conduct. The AICPA emphasizes the auditor’s duty to the public in its Code of Professional Conduct by stating,
‘‘Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and
demonstrate commitment to the profession’’ (AICPA 1988, § 53).
The Code of Professional Conduct acknowledges potential conflicting pressures from various stakeholder groups and
states, ‘‘In resolving those conflicts, members should act with integrity, guided by the precept that when members fulfill their
responsibility to the public, clients’ and employers’ interests are best served’’ (AICPA 1988, § 53.02). Additionally, the Code of
Professional Conduct states, ‘‘Those who rely on certified public accountants expect them to discharge their responsibilities
with integrity, objectivity, due professional care, and a genuine interest in serving the public. They are expected to provide
quality services, enter into fee arrangements, and offer a range of services—all in a manner that demonstrates a level of
professionalism consistent with these Principles of the Code of Professional Conduct’’ (AICPA 1988, § 53.03).
A fundamental understanding of the term ‘‘public interest’’ is essential to following the AICPA’s Code of Professional
Conduct. The International Federation of Accountants (IFAC 2012) defines the ‘‘public interest’’ in a recent policy position.
The IFAC defines the public interest as ‘‘the net benefits derived for, and procedural rigor employed on behalf of, all society in
relation to any action, decision, and policy.’’ The broadness of the definition comes from the IFAC’s very broad definition of
the ‘‘public.’’ According to the IFAC, the public includes all individuals and groups because accountants directly and indirectly
2
The Sarbanes-Oxley Act of 2002 now requires most public companies to file audited financial statements with the Securities and Exchange
Commission within 60 days of their fiscal year-end.
Issues in Accounting Education
Volume 32, Number 1, 2017
Brasel and Daugherty
20
affect all levels of society. Therefore, the public includes investors, shareholders, and business owners; consumers and
suppliers; and taxpayers, electorates, and citizens (IFAC 2012).
During your reading, you come across four publications that discuss the auditor’s duty to the public. In the first article, the
authors adopt a ‘‘common good’’ definition of the public interest by focusing on the advancement of the good of institutions,
communities, and individuals. This definition identifies both mutual interests of society and private interests of individuals
(Shapiro and Naughton 2013). In the second article, the author argues the AICPA’s Code of Professional Conduct should
explicitly state that the interest of the public outweighs client confidentiality when there is a conflict of interest between the two
(Bowie 1986). However, the author also observes when the conflict is not obvious, the Certified Public Accountant (CPA) may
not even know the public good is threatened (Bowie 1986). A third article suggests the public interest is clearly dominant, in
contrast to the interests of both auditors and clients (Waples and Shaub 1991). In the fourth article, the authors view the
AICPA’s Code of Professional Conduct as a transitional document, suggesting that ‘‘the profession should always be searching
for the changes that will improve the level of professional service to the public we are commissioned to serve’’ (Collins and
Schultz 1995, 40).
These observations regarding public interest are notable in that they are silent with respect to the degree that negative impacts
on the accounting firm may indirectly have on the greater public good. Consider for example the impact that negative litigation
outcomes against auditors on matters regarding client confidentiality and the public interest may have. The annual audit client
acceptance and retention requirements of the profession, by definition, involve risk and reward judgments by auditors. To the
extent litigation risks are perceived to be increased, whether by virtue of client characteristics or by auditing and accounting
standards, fees can be expected to rise to counter this risk. You note that this may or may not serve the greater public interest.
While the AICPA’s Code of Professional Conduct and the views of others who have published on the matter of the
auditor’s duty to the greater public interest seem to suggest this outweighs client confidentiality matters, you feel that, in order
to cover all the bases, you would be well suited to review the authoritative requirements insofar as they relate to confidentiality.
Auditor’s Client Confidentiality Responsibilities
In addition to your duty to the public as an auditor, you also hold client confidentiality responsibilities. Rule 301 of the
AICPA’s Code of Professional Conduct addresses client confidentiality by stating ‘‘a member in public practice shall not
disclose any confidential client information without the specific consent of the client’’ (AICPA 1992). Therefore, Rule 301
suggests that client confidentiality is necessary regardless of the auditor’s motivation to protect the public good.
You value the service that you as an audit partner provide to the profession, its clients, and the capital markets. You also
know that you cannot provide these services if you are not a CPA and are becoming increas…
Purchase answer to see full
attachment