Cable Corp. orally engaged Drake & Co., CPAs, to audit its financial statements. Cable’s management informed Drake that it suspected the accounts receivable were materially overstated. Though the financial statements Drake audited included a materially overstated accounts receivable balance, Drake issued an unqualified opinion. Cable used the financial statements to obtain a loan to expand its operations. Cable defaulted on the loan and incurred a substantial loss.

If Cable sues Drake for negligence in failing to discover the overstatement, Drake’s best defense would be that Drake did not

  1. Have privity of contract with Cable.
  2. Sign an engagement letter.
  3. Perform the audit recklessly or with an intent to deceive.
  4. Violate generally accepted auditing standards in performing the audit.