1. Are the auditors guilty of malpractice? Explain.

2. What defenses are available to Joker & Wild in this case? Explain what they must prove to successfully assert these defenses.

3. Assume you are not aware of state laws on auditor legal liability. What legal concepts might a court of law use to resolve the lawsuit?

4. Do you believe the auditors should be held legally liable? Why or why not?

Joker & Wild LLC has just been sued by its audit client, Canasta, Inc., claiming the audit failed to be conducted in accordance with generally accepted auditing standards, lacked the requisite care expected in an audit, and failed to point out that internal controls were not working as intended. The facts of the case are that the auditors failed to find the accounting manager’s misappropriation of assets when he stole inventory and then improperly, knowingly, wrote down inventory for market declines.

Current market values of inventory were not provided to the auditors despite numerous requests for this information. The auditors relied on management’s representations about these values, which understated inventory by 10 percent. The plaintiff client brought the suit against the CPA firm claiming negligence, asserting the firm’s failure to find the vice president’s misappropriations of inventory and false valuations damaged the company by prematurely recognizing losses and then causing large reversals in the subsequent fiscal year when the inventory was sold for 15 percent above the original cost. The defendant CPA firm sought to blame the client, claiming Canasta did not cooperate on the audit and the vice president overrode internal controls.