Question:

Ray, the owner of a small company, asked Holmes, CPA, to conduct an audit of the company's financial statements. Ray told Holmes that the audit must be completed in time to submit audited financial statements to a bank as part of a loan application. Holmes immediately accepted the engagement and agreed to provide an auditor's report within three weeks. Ray agreed to pay Holmes a fixed fee plus a bonus if the loan was granted. Holmes hired two accounting students to conduct the audit and spent several hours telling them exactly what to do. Holmes told the students not to spend time reviewing the controls but to concentrate on proving the mathematical accuracy of the ledger accounts and to summarize the data in the accounting records that support Ray's financial statements. The students followed Holmes' instructions and after two weeks gave Holmes the financial statements, which did not include footnotes because the company did not have any unusual transactions. Holmes reviewed the statements and prepared an unqualified auditor's report. The WORKING PAPER, however, did not refer to GAAP or to the year-to-year application of such principles.

Ray received the loan from the bank.Unfortunately,6 months later Ray was forced into liquidation due to financial difficulties.As a result, the bank was unable to recover the amount of loan.The bank is now attempting to recover its money from Holmes on the grounds that Holmes audit report was negligently prepared.

Required:

1) Do you believe Holmes has used reasonable skill and care in conducting the audit?

2) Do you believe Holmes owes the bank a duty of care?