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