Aqua Inc. was a privately owned company that operated a marina business from two lakefront properties in northern Ontario. The company was started by two brothers. The company provided boat docking, sold gasoline and boating supplies, and was very successful.
Aqua’s accountant, John Purd, is a PA who operated an accounting proprietorship in a nearby town. John offered only accounting, bookkeeping, and some investment coun selling services. John’s business has been successful, and he approached Aqua with a desire to purchase part of the Aqua business. John suggested that he would buy a one-third interest in the business by buying shares from the two brothers. The company could then issue a new class of non-voting shares, and they would all become very wealthy, almost immediately, just from the sale of the shares. John explained that this plan would make the existing shareholders wealthy without giving up control of the business.
John explained that Aqua would have to have audited financial statements to encourage potential investors and that he could save the company money by conducting the audit himself. John had to thoroughly analyze Aqua’s books anyway as part of his due diligence in buying the shares for himself, so he would charge Aqua only a small fee for his audit services.
The brothers agreed with John’s suggestion, and John bought a third of the company. John conducted the audit by himself over the next two months. As John had promised, he gave an unqualified audit opinion on the financial state¬ments. As soon as the audit was completed, John found one of his own clients, New Investments Ltd., to buy the shares. After expenses, John and each of the two brothers received approxi¬mately $800,000. Unfortunately, Aqua’s business failed in the following year, when it was discovered that Aqua did not own the lakefront properties, but had only leased them. When the leases expired, the landlord refused to enter a new lease and Aqua filed for bankruptcy. As the auditor, John was sued by Aqua’s bank and by New Investments, both of whom claimed they had relied on the audited financial statements in their dealings with Aqua. John claimed that the two brothers had lied to him that the business owned the lakefront properties, so he was not responsible.
REQUIRED
a. As the auditor, identify to which parties John owed a duty of care. Explain your answer by stating why John would owe a duty of care to each party you mention.
b. Identify ethical violations by John.