During the audit of Clements Manufacturing Company, Bill Gahagan, CPA, noticed that scrap steel from the manufacturing process was piled in an unfenced vacant lot next to the plant. No records were kept of the amount of scrap generated in the manufacturing process or the amount on hand at any time. Scrap sales were recorded when made by the maintenance foreman.

Gahagan included these weaknesses in his report of reportable conditions to management, together with his recommendations for strengthening controls by fencing the area and weighing and recording the daily scrap production; however, the management of Clements took no action on the recommendations included in the report.

Six months later, it was discovered that the maintenance supervisor reported only a small portion of the actual scrap that was sold and had kept most of the proceeds from the scrap sales for himself. The president of Clements then called Gahagan and asked him why he had not caught the maintenance supervisor in his audit and suggested that he might hold Gahagan liable for the loss.

Discuss how Gahagan should handle this situation and how he would reply to the president. What liability do you think Gahagan would have in this situation? Would your answer be different if the letter was sent to the audit committee?