Audit Manager Role: Responsible for supervising fieldwork in major audits.
Case at Hand: Material error discovered in client’s financial statements months post-audit.
Background of AFS
Company Profile: American Fuel & Supply Company, Inc. (AFS) based in Wisconsin, a wholesale distributor for automotive and garden supplies.
Major Supplier: Chevron Chemical Company, part of Chevron Corporation, supplied insecticides and weedkillers.
Financial Reporting: AFS had issued comparative financial statements for the fiscal year ending December 31, 1985, with an unqualified opinion from Touche Ross on February 28, 1986.
The Material Error
Nature of Error: AFS had double-billed customers, leading to an overstatement of revenue by nearly $1 million.
Impact: Actual net loss converted to reported net income misled creditors, including Chevron Chemical, who relied on these statements for credit decisions.
Audit Team's Response
Immediate Concern: Audit team, led by audit manager James Wagner, recognized the erroneous financial statements could mislead stakeholders.
Course of Action: Touche Ross decided to withdraw the audit opinion unless AFS notified its stakeholders of the error.
Legal and Ethical Challenges
AFS's Refusal: AFS management did not agree to recall the financial statements, leading to tension between Touche Ross and AFS officials.
Legal Pressure: AFS's legal counsel threatened Touche Ross with legal action over withdrawing the audit opinion, citing breach of confidentiality.
Compromise Reached
Agreement: Touche Ross was allowed to inform the sole secured creditor of the withdrawal of the audit opinion but could not notify unsecured creditors.
Ethical Justification for Touche Ross’s Actions
Transparency: Withdrawing the opinion was a necessary step to maintain transparency and integrity in financial reporting.
Responsibility: The auditors had a moral and professional obligation to ensure that users of the financial statements were aware of any inaccuracies.
Limits of Action: Though the compromise limited the notification to only secured parties, it still ensured some level of communication regarding the error to minimize harm.
Class Discussion Considerations
Evaluate the appropriateness of Touche Ross’s compromise with AFS in terms of professional ethics and legal implications.
Consider the balance between client relationships and the duty to the public and stakeholders relying on financial accuracy.