Question

Barry Yellen, CPA, is a sole practitioner. The largest audit client in his office is Rooster Sportswear. Rooster is a privately owned company in Chicken Heights, Idaho, with a 12-person board of directors. Barry is in the process of auditing Rooster's financial statements for the year ended December 31, 2019. He just discovered a related-party transaction that has him worried. For one thing, the relationship has existed for the past two years, but Barry did not discover it. What's just as troubling is that the client hid it from him. Rooster bought out Hen Sportswear two years ago but still operates it as a separate entity, and since then has systematically failed to disclose to the private investors related-party transactions involving the CEO of Rooster, Frank Footer. It seems that Footer is borrowing money from Hen and is deeply in debt to the CEO of that company, who is his brother-in-law. Also, Hen has hired relatives of Footer, most of whom are unqualified for their jobs, and pays them an above-market salary. This has been hidden from Barry as well. Barry was informed by an anonymous tipster that Rooster operates a secret off-balance-sheet cash account to pay for cash bonuses to senior officers, travel and entertainment expenses, an apartment rental for Footer, and cash and noncash gifts to local government officials to "grease the wheels" when permits need to be expedited in favor of Rooster. Barry doesn't know what to make of it, because he is too focused right now on the related-party transactions with Hen Sportswear. Barry is in the process of questioning Hans Burger, CPA, who is the CFO of Rooster, about these transactions. Burger explains that he had raised these issues with Footer but was instructed in no uncertain terms to leave them alone. He did just that. Burger told Barry he needed this job and wouldn't jeopardize it out of a sense of "ethics." Barry is in his office back at the firm and reflecting on how best to handle this matter.

Questions

3. Has fraud been committed in this case? Explain. If so, what are Barry's obligations in this regard?

Answer 1

Has Fraud been Committed?

Yes fraud has been committed.The reasons are :

1. Company has intentionaly hidden the fact of acquisition of Hen Sportswear

2. CEO of both the companies are related and have transactions

3. Relatives not having due merit are hired and paid unfairly

4. Off Balancesheet transactions exist

5. The CFO was clearly asked to "avoid" looking into these

All above clearly establish malafide and fraudulent intent.

Barry's Obligation:

First of all Barry needs to establish with proper evidence the existence of "Related Party" relationship and "off balance sheet" items.

Just because he has failed to detect these anamolies in past two years doesnot make him guilty of crime though his audit technique could be missing on some check parameters which he needs to rectify.Now since he also has a clear indication from CFO he cannot avoid reporting the whole scam / fraud.His responsibility is greater towards the Investors rather to the Company's Board.