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BOOSTER BANK
Monday, May 13, 2019, 11:07 a.m.:
“Congratulations are in order! You remember that I told you last year that we would be submitting your
opinion about Circuit Board Framework (CBF)’s financial statements to a bank to get some financing for
our planned addition of a production facility. Don’t you? Well, Booster Bank just notified me that the loan
committee approved our three million dollars loan after analyzing this year’s audited financial statements.
The committee was really impressed that while everyone else in our industry operated at a loss or just
broke even, we showed a substantial profit this period,” crowed Ryan Walker, CFO of CBF, in a
telephone call to Logan Wright, an auditing manager at Dash Spencer, LLP. Logan headed the audit
team that issued an unqualified opinion on CBF’s financial statements for each of the last four years.
“That’s great!” Logan responded. “The loan means that you’ll be able to complete that new circuit board
production facility that you told me about, doesn’t it? That circuit board is the product your budget shows
is going to increase sales revenue and cash flow next year. It’s a good thing you were able to generate a
profit and get the loan. Without the new product, things looked pretty bleak.”
CBF designs and manufactures circuit boards for low-tech applications, such as those used in major
household appliances. Sales in the appliance circuit board industry had declined or been flat in the past
18 months because of people’s reluctance to buy new appliances in a poor economy. CBF’s new circuit
board was for washers and dryers that compete with Maytag’s Neptune series. CBF’s customer (a major
competitor of Maytag) was launching a new washer/dryer with characteristics similar to the Neptune
series, but they expected the price to be about 25% below that charged by Maytag. CBF had developed a
circuit board to meet the engineering specifications of the new product but could only land the business if
they had new production facilities.
Jasmine Young, an auditing staff member assigned to one of Logan’s jobs, overheard the conversation
between Logan and Ryan on the speakerphone while sitting in Logan’s office.
“Logan, I didn’t know that the company operated at a profit this year!” exclaimed Jasmine. “During my
fieldwork, I analyzed the monthly income statements through November, and they showed that the
company operated at a loss almost every month! How did they report a substantial profit at year-end?”
Logan replied, “Several years ago they made an investment in the stock of a closely held company that
they thought might be a good strategic alliance. Unfortunately, that opportunity didn’t work out. Until
December 2018, CBF had been holding the investment and hadn’t been receiving any dividends. The
CFO of CBF actively searched for a company to buy the stock, and in December 2018, located a strategic
buyer who took it off their hands at a substantial gain!” Logan continued. “Since CBF frequently buys and
sells stock investments, the gain is a part of their income from continuing operations.”
“Oh, that’s clever!” Jasmine responded. “But if it were such a large transaction, why didn’t they just use
the cash flow from the stock sale to finance the new manufacturing facility?”
“Well,” Logan explained, “the company that CBF sold the stock to, Easy Exchange, is having their own
cash flow problems right now. They couldn’t afford to give CBF cash, so CBF accepted a non-interestbearing note due in 5 years. Although CBF won’t see the cash for five years, since the title to the stock
has passed to the new owners, it can record the gain on the sale.”
Jasmine pondered this information for a few minutes, and then queried, “Why a non-interest-bearing
note? Most companies with a credit rating like Easy Exchange are paying about 15% on loans for
transactions like this one.”
1
“CBF didn’t have any loans against the investment, so they aren’t incurring any interest cost on the stock
or the new note. They figured that there isn’t any need to hurt Easy Exchange’s cash flow when CBF
doesn’t have any interest cost on the investment,” Logan responded.
“Logan, you sure know a lot about this transaction,” teased Jasmine. “You’d think that you had found the
buyer and negotiated the deal.”
“Well, I am pretty excited,” Logan responded. “I worked with the CFO on the transaction, reviewing the
entry in the general journal and its reporting in CBF’s income statement. I may not have arranged the
deal, but I was instrumental in getting out the audited statements just in time. As you know, CBF really
needed some serious cash infusion as soon as possible from some lender to complete a production
facility for that new circuit board.”
“Since I missed all the excitement while I was working on a different client, why don’t you share
the details of the transaction?” demanded Jasmine.
“Well, CBF was carrying the investment at $6,600,000 and sold it to Easy Exchange for $10,000,000. So,
they booked a $3,400,000 gain on the transaction,” Logan confidentially replied.
Jasmine looked troubled and finally confided to Logan, “I’m enrolled in a CPA review course, and last
week we studied long-term receivables and payables. I learned that generally accepted accounting
principles (GAAP) require notes receivable due in more than one year to be carried at their present value.
Wouldn’t that affect the profit you reported?” Logan looked at Jasmine like she was trying to put him on
the spot and icily replied, “I explained that CBF didn’t incur any interest on this investment before the sale,
so present value calculations aren’t necessary! And, yes, the income statement we audited is consistent
with GAAP.”
Circuit Board Framework (CBF)
Income Statements
For the four years ended December 31, 2018
2018
2017
2016
2015
Net Revenues and Gains Expenses and Losses
$30,250,000
$28,930,000
$27,610,000
$22,990,000
Cost of Sales
16,416,000
13,122,000
10,632,600
9,936,000
Gross Profit
13,834,000
15,808,000
16,977,400
13,054,000
Operating Expenses
3,476,000
3,382,500
3,179,000
2,530,000
Other Expenses
5,027,000
4,362,600
3,460,600
2,435,400
Net Income Before Taxes
5,331,000
8,062,900
10,337,800
8,088,600
Taxes
1,119,510
1,693,209
2,170,938
1,698,606
Net Income After Taxes
$4,211,490
$6,369,691
$8,166,862
$6,389,994
Common Shares Outstanding
3,000,000
3,000,000
3,000,000
3,000,000
2
Memo
To:
Nora Lopez, Loan Delinquency Department, Booster Bank.
From:
Juan Parker, Senior Lending Officer, Booster Bank
Date:
January 17, 2022
Re:
Default on CBF’s loan
______________________________________________
__________________________
As I mentioned to you earlier today, I am forwarding to you the CBF’s file. It is now in default on
the three million dollar loan we extended on May 10, 2019. The total amount currently outstanding is
$2,390,000. We were just informed yesterday that CBF has commenced bankruptcy protection under
Chapter 7 of the Bankruptcy Code. As such, the prospects of a full recovery are minimal.
In addition to the loan documents, I am attaching copies of all the financial statements that we
obtained from CBF as part of the loan application, including the one for the year 2018, which we received
from CBF’s CFO on March 2, 2019.
In looking back at the financial statements that we had in our file, I was stunned by CBF’s
dramatic and sudden collapse. When we approved the loan, the loan committee gave a lot of weight not
only to the financial statements from 2018 but also to the ones from the prior three years; we were keenly
impressed by the firm’s pattern of income stability during those four calendar years.
I am also attaching a copy of an article I had placed in my file a number of years back. Ever since
reading the article, I have had a lingering suspicion that the story in the article is about CBF.
GREEN TIMES
December 13, 2019
boards, had substantially overstated income
and assets in contravention with General
Accepted Accounting Principles. It is really
too bad. I am really looking forward to
joining this new firm. I believe it has a lot of
potential,” said one of the twelve departing
accountants who wished to remain
Glen Oak, Green. In a surprise move
yesterday, twelve staff accountants at Dash
Spencer, LLP left the firm and joined a
competitor, Pillsbury & Skadden. In an
interview with one of the twelve former
auditors, it was learned that the departure
followed alleged auditing irregularities
practiced by senior partners at Dash
Spencer, LLP. “I have been really
disillusioned with the level of scrutiny the
senior managers and partners have been
employing with regard to a number of audit
engagements. In one case that I have
worked on while I was an intern, my former
manager signed off on an unqualified audit
opinion where the client, a designer and
manufacturer of home appliance circuit
3
Required:
Assume that you are Ms. Lopez, an associate in the Loan Delinquency Department at the Booster Bank.
Your supervisor would like to find out from you whether Booster Bank has a claim of negligence against
the accounting firm of Dash Spencer, LLP.
You have gathered additional information from the bankruptcy courts and know about the 2018 sale of
stock to Easy Exchange and its accounting treatment in the income statement. Read the legal cases
collected by the legal assistant and attached in the Library. Assume that the applicable precedent is from
the fictional jurisdiction of the state of Green provided to you in the attached library. Assume that the
financial statements audited by Dash Spencer for the calendar years of 2017, 2016, and 2015 were
accurate.
Prepare a report (see guidelines on the class website) for your supervisor.
You may want to review section 53.01 of the AICPA Code of Professional Ethics (you can review the
section in the case library.) In preparing your answers, you may also wish to review the following Lower
Division Core concepts, described in the Lower Division Core section of the BUS 302L website: financial
accounting concepts 4, 7, and 9, and business law concept 2.
4
BOOSTER BANK LIBRARY
1.
APB Opinion 21
2.
AICPA Code of Professional Conduct, Section 53 – Article II: The Public Interest
3.
Bily v. Peat Young & Company
4.
Manhattan Federal v. Coopers Gibson
5
APB Opinion 21, (portions bolded to direct reader)
12. Note exchanged for property, goods, or service. When a note is exchanged for property, goods, or
service in a bargained transaction entered into at arm’s length, there should be a general presumption that
the rate of interest stipulated by the parties to the transaction represents fair and adequate compensation
to the supplier for the use of the related funds. That presumption, however, must not permit the form of the
transaction to prevail over its economic substance and thus would not apply if (1) interest is not stated, or
(2) the stated interest rate is unreasonable (paragraphs 13 and 14) or (3) the stated face amount of the
note is materially different from the current cash sales price for the same or similar items or from the market
value of the note at the date of the transaction. In these circumstances, the note, the sales price, and the
cost of the property, goods, or service exchanged for the note should be recorded at the fair value of the
property, goods, or services or at an amount that reasonably approximates the market value of the note,
whichever is the more clearly determinable. That amount may or may not be the same as its face amount,
and any resulting discount or premium should be accounted for as an element of interest over the life of the
note (paragraph 15). In the absence of established exchange prices for the related property, goods,
or service or evidence of the market value of the note (paragraph 9), the present value of a note that
stipulates either no interest or a rate of interest that is clearly unreasonable should be determined
by discounting all future payments on the notes using an imputed rate of interest as described in
paragraphs 13 and 14. This determination should be made at the time the note is issued, assumed, or
acquired; any subsequent changes in prevailing interest rates should be ignored.
13. Determining an appropriate interest rate. The variety of transactions encountered precludes any
specific interest rate from being applicable in all circumstances. However, some general guides may be
stated. The choice of a rate may be affected by the credit standing of the issuer, restrictive covenants, the
collateral, payment and other terms pertaining to the debt, and, if appropriate, the tax consequences to the
buyer and seller. The prevailing rates for similar instruments of issuers with similar credit ratings
will normally help determine the appropriate interest rate for determining the present value of a
specific note at its date of issuance. In any event, the rate used for valuation purposes will normally be
at least equal to the rate at which the debtor can obtain financing of a similar nature from other sources at
the date of the transaction. The objective is to approximate the rate which would have resulted if an
independent borrower and an independent lender had negotiated a similar transaction under comparable
terms and conditions with the option to pay the cash price upon purchase or to give a note for the amount
of the purchase which bears the prevailing rate of interest to maturity.
14. The selection of a rate may be affected by many considerations. For instance, where applicable, the
choice of a rate may be influenced by (a) an approximation of the prevailing market rates for the source of
credit that would provide a market for sale or assignment of the note; (b) the prime or higher rate for notes
which are discounted with banks, giving due weight to the credit standing of the maker; (c) published market
rates for similar quality bonds; (d) current rates for debentures with substantially identical terms and risks
that are traded in open markets; and (e) the current rate charged by investors for first or second mortgage
loans on similar property. i7
APB21, Footnote 7–A theory has been advanced which states that no imputation of interest is necessary if the stated interest
rate on a note receivable exceeds the interest cost on the borrowed funds used to finance such notes. The Board
considers this theory unacceptable for reasons discussed in this Opinion.
1
Copyright 2000 Financial Accounting Standards Board (source of GAAP)
6
AICPA Code of Professional Conduct
Section 53 – Article II: The Public Interest
Members should accept the obligation to act in a way that will serve the public interest, honor the public
trust, and demonstrate commitment to professionalism.
.01 A distinguishing mark of a profession is acceptance of its responsibility to the public. The accounting
profession’s public consists of clients, credit grantors, governments, employers, investors, the business
and financial community, and others who rely on the objectivity and integrity of certified public
accountants to maintain the orderly functioning of commerce. This reliance imposes a public interest
responsibility on certified public accountants. The public interest is defined as the collective well-being of
the community of people and institutions the profession serves.
.02 In discharging their professional responsibilities, members may encounter conflicting pressures from
among each of those groups. In resolving those conflicts, members should act with integrity, guided by the
precept that when members fulfill their responsibility to the public, clients’ and employers’ interests are best
served.
.03 Those who rely on certified public accountants expect them to discharge their responsibilities with
integrity, objectivity, due professional care, and a genuine interest in serving the public. They are
expected to provide quality services, enter into fee arrangements, and offer a range of services—all in a
manner that demonstrates a level of professionalism consistent with these Principles of the Code of
Professional Conduct.
.04 All who accept membership in the American Institute of Certified Public Accountants commit
themselves to honor the public trust. In return for the faith that the public reposes in them, members
should seek continually to demonstrate their dedication to professional excellence.
©2000 AICPA
7
CURTIS W. BILY, et al Plaintiffs and
Respondents, v. PEAT YOUNG & COMPANY,
Defendant and Appellant.
Plaintiffs, in this case, were investors in the
Company. They include individuals as well as
pension and venture capital investment funds.
Several plaintiffs purchased warrants from the
Company as part of the warrant transaction.
Others purchased the common stock of the
Company during early 1983.
No. YU56823
SUPREME COURT OF GREEN
The Company retained defendant Peat Young
& Company (“Peat Young”), one of the then-“Big
Eight” public accounting firms, to perform audits
and issue audit reports on its 1981 and 1982
financial statements. In its role as auditor, Peat
Young’s responsibility was to review the annual
financial statements prepared by the Company’s
in-house accounting department, examine the
books and records of the Company, and issue
an audit opinion on the financial statements.
August 27, 1991, Decided
COUNSEL:
Marie L. Fiala, for Defendant and
Appellant. Thomas G. Redmon & Matthew W.
Powell on behalf of Defendant and Appellant.
OPINIONBY: WOODS, C. J.
Peat Young issued unqualified or “clean” audit
opinions on the Company’s 1981 and 1982
financial statements.
OPINION:
I. Summary of Facts
Each opinion appeared on Peat Young’s
letterhead, was addressed to the Company, and
stated in essence: (1) Peat Young had
performed an examination of the accompanying
financial statements in accordance with the
accounting profession’s “Generally Accepted
Auditing Standards” (GAAS); (2) the statements
had been prepared in accordance with
“Generally Accepted Accounting Principles”
(GAAP); and (3) the statements “present[ed]
fairly” the Company’s financial position. The
1981 financial statement showed a net operating
loss of approximately $1 million on sales of $6
million. The 1982 financial statements included a
” Consolidated Statement of Operations” which
revealed a modest net operating profit of
$69,000 on sales of more than $68 million.
This litigation emanates from the meteoric rise
and equally rapid demise of Norne Computer
Corporation (the “Company”). Founded in 1980
by entrepreneur Adam Osborne, the Company
manufactured the first portable personal
computer for the mass market. Shipments
began in 1981. By fall 1982, sales of the
Company’s sole product, the Osborne I
computer, had reached $ 10 million per month,
making the Company one of the fastest growing
enterprises in the history of American business.
In late 1982, the Company began planning for
an early 1983 initial public offering of its stock,
engaging three investment banking firms as
underwriters. At the suggestion of the
underwriters, the offering was postponed for
several months, in part because of uncertainties
caused by the Company’s employment of a new
chief executive officer and its plans to introduce
a new computer to replace the Osborne I. In
order to obtain “bridge” financing needed to
meet the Company’s capital requirements until
the offering, the Company issued warrants to
Investors in exchange for direct loans or letters
of credit to secure bank loans to the Company
(the “warrant transaction”). The warrants entitled
their holders to purchase blocks of the
Company’s stock at favorable prices that were
expected to yield a sizable profit if and when the
public offering took place.
Peat Young’s audit opinion on the 1982
financial statements was issued on February 11,
1983. The Peat Young partner in charge of the
audit personally delivered 100 sets of the
professionally printed opinion to the Company.
Plaintiffs testified that their investments were
made in reliance on Peat Young’s unqualified
audit opinion on the Company’s 1982 financial
statements.
As the warrant transaction closed on April 8,
1983, the Company’s financial performance
began to falter. Sales declined sharply because
of manufacturing problems with the Company’s
new “Executive” model computer. When the
8
Executive appeared on the market, sales of the
Osborne I naturally decreased, but were not
being replaced because Executive units could
not be produced fast enough. In June 1983, the
IBM personal computer and IBM- compatible
software became major factors in the small
computer market, further damaging the
Company’s sales. The public offering never
materialized. The Company filed for bankruptcy
on September 13, 1983. Plaintiffs ultimately lost
their investments.
The case was tried to a jury for 13 weeks. At
the close of the evidence and arguments, the
jury returned a verdict in the plaintiffs’ favor
based on professional negligence. No
comparative negligence on the plaintiffs’ part
was found. The jury awarded compensatory
damages of approximately $4.3 million,
representing approximately 75 percent of each
investment made by plaintiffs. The Court of
Appeal affirmed the resulting judgment in
plaintiffs’ favor with respect to all matters
relevant to the issue now before us.
Plaintiffs brought separate lawsuits against Peat
Young in the Santa Maria County Superior
Court. The focus of plaintiffs’ claims was Peat
Young’s audit and audit opinion of the
Company’s 1982 financial statements. The
theory of liability pursued was negligence.
II. The Audit Function in Public Accounting
Although certified public accountants (CPA’s)
perform a variety of services for their clients,
their primary function, which is the one that most
frequently generates lawsuits against them by
third persons, is financial auditing. “An audit is a
verification of the financial statements of an
entity through an examination of the underlying
accounting records and supporting evidence.”
(Hagen, supra, 13 J. Contemp. Law at p. 66.) “In
an audit engagement, an accountant reviews
financial statements prepared by a client and
issues an opinion stating whether such
statements fairly represent the financial status of
the audited entity.” (Siliciano, supra, 86
Mich.L.Rev. at p. 1931.)
Plaintiffs’ principal expert witness, William J.
Baedecker, reviewed the 1982 audit and offered
a critique identifying more than 40 deficiencies in
Peat Young’s performance amounting, in
Baedecker’s view, to gross professional
negligence. In his opinion, Peat Young did not
perform its examination in accordance with
GAAS. He found the liabilities on the Company’s
financial statements to have been understated
by approximately $3 million. As a result, the
Company’s supposed $69,000 operating profit
was, in his view, a loss of more than $3 million.
He also determined that Peat Young had
discovered material weaknesses in the
Company’s accounting controls, but failed to
report its discovery to management.
In a typical audit, a CPA firm may verify the
existence of tangible assets, observe business
activities, and confirm account balances and
mathematical computations. It might also
examine sample transactions or records to
ascertain the accuracy of the client Company’s
financial and accounting systems. For example,
auditors often select transactions recorded in the
Company’s books to determine whether the
recorded entries are supported by underlying
data (vouching). Or, approaching the problem
from the opposite perspective, an auditor might
choose particular items of data to trace through
the client’s accounting and bookkeeping process
to determine whether the data have been
properly recorded and accounted for (tracing).
(Hagen, supra, 13 J. Contemp. Law at pp. 6667).
Although most of Baedecker’s criticisms
involved matters of oversight or nonfeasance,
e.g., failures to detect weaknesses in the
Company’s accounting procedures and systems,
he also charged that Peat Young had actually
discovered deviations from GAAP, but failed to
disclose them as qualifications or corrections to
its audit report. For example, by January 1983, a
senior auditor with Peat Young identified $1.3
million in unrecorded liabilities including failures
to account for customer rebates, returns of
products, etc. Although the auditor
recommended that a letter be sent to the
Company’s board of directors disclosing material
weaknesses in the Company’s internal
accounting controls, his superiors at Peat Young
did not adopt the recommendation; no
weaknesses were disclosed. Peat Young
rendered its unqualified opinion on the 1982
statements a month later.
For practical reasons of time and cost, an audit
rarely, if ever, examines every accounting
transaction in the records of a business. The
end product of an audit is the audit report or
opinion. The report is generally expressed in a
9
letter addressed to the client. The body of the
report refers to the specific client-prepared
financial statements which are attached. In the
case of the so-called “unqualified report” (of
which Peat Young’s report on the Company’s
1982 financial statement is an example), two
paragraphs are relatively standard.
commentator summarizes: “In the first instance,
this unqualified opinion serves as an assurance
to the client that its own perception of its
financial health is valid and that its accounting
systems are reliable. The audit, however,
frequently plays a second major role: it assists
the client in convincing third parties that it is safe
to extend credit or invest in the client.” (Siliciano,
supra, at p. 1932.)
In a scope paragraph, the CPA firm asserts that
it has examined the accompanying financial
statements in accordance with GAAS. GAAS are
promulgated by the American Institute of
Certified Public Accountants (AICPA), a national
professional organization of CPA’s, whose
membership is open to persons holding certified
public accountant certificates issued by state
boards of accountancy. (Hagen, supra, 13 J.
Contemp. Law at pp. 72-73.)
III. Prima Facie Case for Negligence
A.
Negligence in general: “[N]egligence is
conduct which falls below the standard
established by law for the protection of others.”
(Rest.2d Torts, § 282.) “Every one is [*397]
responsible, not only for the result of his willful
acts, but also for an injury occasioned to another
by his want of ordinary care or skill in the
management of his property or person, except
so far as the latter has, willfully or by want of
ordinary care, brought the injury upon himself.”
(§ 1714, subd. (a).)
In an opinion paragraph, the audit report
generally states the CPA firm’s opinion that the
audited financial statements, taken as a whole,
are in conformity with GAAP and present fairly in
all material respects the financial position,
results of operations, and changes in the
financial position of the client in the relevant
periods.
A. Duty of care: The threshold element of a
cause of action for negligence is the existence of
a duty to use due care toward an interest of
another that enjoys legal protection against
unintentional invasion. (Rest.2d Torts, § 281).
“Courts, however, have invoked the concept of
duty to limit generally ‘the otherwise potentially
infinite liability which would follow from every
negligent act ….’ ” ( Thompson v. County of
Alameda (1980).
The GAAP are an amalgam of statements
issued by the AICPA through the successive
groups it has established to promulgate
accounting principles: the Committee on
Accounting Procedure, the Accounting
Principles Board, and the Financial Accounting
Standards Board. Like GAAS, GAAP includes
broad statements of accounting principles
amounting to aspirational norms as well as more
specific guidelines and illustrations.
The complex nature of the audit function and
its economic implications has resulted in
different approaches to the question of whether
CPA auditors owe a duty of care to third parties
who read and rely on audit reports. Presently,
there are three schools of thought on the matter.
A number of jurisdictions follow the lead of Chief
Judge Cardozo’s 1931 opinion for the New York
Court of Appeals in Ultramares, supra, at p. 441,
by denying recovery to third parties for auditor
negligence in the absence of privity. From the
cases cited by the parties, it appears at least
nine states purport to follow privity or near privity
rules restricting the liability of auditors to parties
with whom they have a contractual relationship.
However, most jurisdictions have abandoned
this restrictive standard because it does not
impose upon accountants a duty commensurate
with the significance of their role in current
business and financial affairs.
Peat Young correctly observes that clients may
commission audits for different purposes.
Nonetheless, audits of financial statements and
the resulting audit reports are very frequently (if
not almost universally) used by businesses to
establish the financial credibility of their
enterprises in the perceptions of outside persons
(e.g., existing and prospective investors,
financial institutions, and others who extend
credit to an enterprise or make risk-oriented
decisions based on its economic viability). The
unqualified audit report of a CPA firm,
particularly one of the “Big Five,” is often an
admission ticket to venture capital markets–a
necessary condition precedent to attracting the
kind and level of outside funds essential to the
client’s financial growth and survival. As one
10
In contrast, a handful of jurisdictions, spurred by
law review commentary, have recently allowed
recovery based on auditor negligence to third
parties whose reliance on the audit report was
“foreseeable.” Arguing that accountants should
be subject to liability to third persons on the
same basis as other tortfeasors, Justice Howard
Wiener advocated rejection of the rule of
Ultramares in a 1983 law review article. In its
place, he proposed a rule-based on
foreseeability of injury to third persons.
that one who negligently supplies false
information “for the guidance of others
in their business transactions” is liable for
economic loss suffered by the recipients in
justifiable reliance on the information. (Id., subd.
(1).) But the liability created by the general
principle is expressly limited to loss suffered:
“(a) [B]y the person or one of a limited group of
persons for whose benefit and guidance he
intends to supply the information or knows that
the recipient intends to supply it; and (b) through
reliance upon it in a transaction that he intends
the information to influence or knows that the
recipient so intends.” (Id., subd. (2).) To
paraphrase, under the restatement view, the
accountants retain control over their liability
exposure. The restricted group includes third
parties whom the accountants intend to
influence or those whom the accountants know
their clients intend to influence. Accordingly,
liability is fixed by the accountants’ particular
knowledge at the moment the audit is published,
not by the foreseeable path of harm envisioned
by jurists years following an unfortunate
business decision. Accordingly, the Restatement
adopts the cautious position that an accountant
may be liable to a third party with whom the
accountant is not in privity, but not every
reasonably foreseeable consumer of financial
information may recover.
Criticizing what he called the “anachronistic
protection” given to accountants by the
traditional rules limiting third person liability, he
concluded: “Accountant liability based on
foreseeable injury would serve the dual
functions of compensation for injury and
deterrence of negligent conduct. Moreover, it is
a just and rational judicial policy that the same
criteria govern the imposition of negligence
liability, regardless of the context in which it
arises. The accountant, the investor, and the
general public will in the long run benefit when
the liability of the of the certified public
accountant for negligence is measured by the
foreseeability standard.” ( at p. 260.) From a
public policy standpoint, the courts that have
adopted the foreseeability test have emphasized
the potential deterrent effect of a liabilityimposing rule on the conduct and cost of audits:
“The imposition of a duty to foreseeable users
may cause accounting firms to engage in more
thorough reviews. This might entail setting up
stricter standards and applying closer
supervision, which should tend to reduce the
number of instances in which liability would
ensue. Much of the additional cost incurred
either because of more thorough auditing review
or increased insurance premiums would be
borne by the business entity and its stockholders
or its customers.” ( Rosenblum v. Adler, supra,
at p. 152.) In the nearly 10 years since it was
formally proposed,
