[JLloyd829]

American Corp. retained Baker, CPA, to conduct an audit of its financial statements to obtain a bank line of credit. American signed an engagement letter drafted by Baker that included a disclaimer provision. As a result of Baker’s failure to detect a material misstatement in American’s financial statements, the audit report contained an unmodified opinion. Based on American’s audited financial statements, National extended credit to American. American filed a petition in bankruptcy shortly thereafter. National sued Baker for damages based on common-law fraud. What would be Baker’s best defense?

A. Baker acted with due diligence in conducting the audit.
B. Baker included a disclaimer provision in the engagement letter with American.
C. National was not in privity with Baker.
D. Baker lacked the intent to deceive

Ninja is saying that the correct answer is D. Lacked the intent to deceive a.k.a lacked Scienter which I thought was a proper defense in the case of gross negligence… I think that the answer should be A. Baker acted with due diligence in conducting the audit, since it was only regular negligence.

[teejaypark]

I would argue a lack of intent is different from lack of scienter, which directly translates to knowledge. One could not intend to deceive, but still deceive because he did not know of the error. Baker's failure to detect material misstatements is still okay if he followed GAAS procedures and reasonably concluded an unmodified opinion. If he did not intend to deceive (or have malicious intent to deceive), then he did his job as a CPA. The CPA must always act with due diligence, so it's not a good argument.

[pharaoh]

I think because the question is saying that Baker is suing “based on common law fraud”, so the defense should be trying to prove that no fraud or intention for fraud was committed.

FAR 8/2016
AUD 1/2017
REG TBD
BEC TBD

[JLloyd829]

Thank you both for your insight… really appreciate it!!

[Author]

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