The Prairieland Bank was a mediumsized midwestern financial institution. The management had a good reputation for backing successful deals, but the CEO (and significant shareholder) had recently moved to San Francisco to be “close to the big-bank center of activity.” He commuted into the Prairieland head office for two or three days each week to oversee major deals. Lately, the bank’s profitability had decreased, and the management had begun to renegotiate many loans on which payments had fallen behind. By doing so, the bank was able to disclose them as current rather than nonperforming, as the unpaid interest was simply added to the principal to arrive at the new principal amount. Discussions were also under way on changing some accounting policies to make them less conservative. Ben Hunt, the audit partner on the Prairieland Bank account, was becoming concerned about the risk associated with giving an opinion on the fairness of the financial statements. During the early days of the audit, it became evident that the provision for doubtful loans was far too low, and he made an appointment to discuss the problem with the CEO and his vice president of finance. At the interview, Ben was told that the executives knew the provision was too low, but they did not want to increase it because that would decrease their reported profits. Instead, they had approached a company that provided insurance to protect leased equipment, such as earthmovers, against damage during the lease and arranged for insurance against nonpayment on the maturity of their loans.As a result, they said, any defaults on their loans would be made up from the insurance company, so they did not see any point to increasing the provision for loan losses or disclosing the insurance arrangement. When he heard of this, Ben expressed concern to the Prairieland management, but they were adamant. Because Prairieland was such a large account, he sought the counsel of James London, the senior partner in his firm who was in charge of assessing such accounting treatments and the related risk to the auditing firm. James flew out to confer with Ben, and they decided that the best course of action was to visit the client and indicate their intent to resign, which they did. After dinner, James was waiting at the airport for his plane home. By coincidence, he met Jack Lane, who held responsibilities similar to his own at one of the competing firms. Jack was returning home as well and was in good spirits. On the flight, Jack let it slip that he had just picked up an old client of James’s firm, Prairieland Bank.

Questions

1. Which decision was right: to resign or to serve?

2. What should James do?