Question 5 You are a partner in the Edmonton, Alberta office of the audit firm, Rowlands, Marcellin & Khan, LLP. You have been hired by the legal firm of Mason and Darrow to help them with two cases charging other audit firms with negligence. Both the plaintiff and the defendants have made their preliminary statements and you have the files to look at. The plaintiff in each case is Martha MacKinnon. She is a graphic artist with little accounting knowledge. Since 2015, she has managed the investment portfolio for her ninety-year-old father who suffers from dementia. The portfolio pays for Mr. MacKinnons nursing home. Martha has stated that she looks at four things. Are sales increasing or decreasing? Are total assets increasing or decreasing? Are profits increasing or decreasing? And most important, is there a clean audit opinion? Tempus Corporation owns several office buildings across Canada. One building is in Toronto. Due to the rapidly changing value of Toronto real estate, the building has been regularly reappraised and the value has increased. This increased total assets and net income due to the gain, even as revenues fell. In 2019 a major tenant in the Toronto building moved out. Short on cash, Tempus had to sell the Toronto property at a distressed price. Tempus suspended dividends and the stock price fell by 50%. The auditors, DWH and Associates, LLP stated: We obtained a copy of the appraisers report from Tempus and it supported the new valuation. The reappraisal was fully discussed in the notes. If Ms. MacKinnon had looked at the cash flow statement, she would have seen that the company was running out of cash.

The other defendant, M3 Holdings is a diversified company with investments in companies that manufacture parts for the auto sector. Three Melanson brothers held 60% of the Class A voting shares, and 20% of the Class B common shares, and 100% of long term debt. In 2018, M3 consolidated all of the intellectual property in patents and trademarks in a separate company run by their children. The intellectual property was transferred at book value. The IP company was consolidated in the statements of M3 Holdings and everything was fully disclosed in the notes. Shortly after, in 2019, the IP company was sold to the Melanson children for book value. Next, a separate company was set up in Mexico and all manufacturing was transferred there. M3 Holdings then went into voluntary liquidation in Canada. Common shareholders received 20 cents on the dollar.

The auditors, Castle and Brock, LLP stated The Controller of M3, Kevin Melanson, stated that the transfer was for tax purposes. We had no reason to doubt him. Transferring assets at the adjusted cost base is permitted by the Canada Revenue Agency. This was fully disclosed and the financial statements were fairly stated.

Required

a) (10 marks) Evaluate the case against DWH.

b) (10 marks) Evaluate the case against Castle and Brock.