Tammy Potter, a new partner with the regional CPA firm of Tower & Tower, was recently appointed to the board of directors of a local civic organization. The chairman of the board of the civic organization is Lewis Edmond, who is also the owner of a real estate development firm, Tierra Corporation. Potter was quite excited when Edmond indicated that his corporation needed an audit and he wished to discuss the matter with her. During the discussion, Potter was told that Tierra Corporation needed the audit to obtain a substantial amount of additional financing to acquire another company. Presently, Tierra Corporation is successful, profitable, and committed to growth. The audit fee for the engagement should be substantial. Since Tierra Corporation appeared to be a good client prospect, Potter tentatively indicated that Tower & Tower wanted to do the work. Potter then mentioned that Tower & Tower’s quality control policies require an investigation of new clients and approval by the managing partner, Lee Tower.
Potter obtained the authorization of Edmond to make the necessary inquiries for the new client investigation. Edmond was found to be a highly respected member of the community. Also, Tierra Corporation was highly regarded by its banker and its attorney, and the Dun & Bradstreet report on the corporation reflected nothing negative. As a final part of the investigation process, Potter contacted Edmond’s former tax accountant, Bill Turner. Potter was surprised to discover that Turner did not share the others’ high opinion of Edmond. Turner related that on an IRS audit 10 years ago, Edmond was questioned about the details of a large capital loss reported on the sale of a tract of land to a trust. Edmond told the IRS agent that he had lost all the supporting documentation for the transaction, and that he had no way of finding out the names of the principals of the trust. A search by an IRS
auditor revealed that the land was recorded in the name of Edmond’s married daughter and that Edmond himself was listed as the trustee. The IRS disallowed the loss and Edmond was assessed a civil fraud penalty. Potter was concerned about these findings, but eventually concluded that Edmond had probably matured to a point where he would not engage in such activities.
Based on the case above, respond to the following prompts:
a. Present arguments supporting a decision to accept Tierra Corporation as an audit client.
b. Present arguments supporting a decision not to accept Tierra Corporation as an audit
client.
c. Assuming that you are Lee Tower, set forth your decision regarding acceptance of the client,
identifying those arguments from part (a) or part (b) that you found most persuasive.
Strong Reputation: Tierra Corporation has a solid reputation in the community, as evidenced by its highly regarded status among its banker, attorney, and the local civic organization’s chairman, Lewis Edmond. This indicates a history of trustworthiness and reliability, making it a desirable client.
Profitable and Committed to Growth: Tierra Corporation is a successful and profitable business that is committed to growth. This indicates financial stability and potential for future business, which can be lucrative for Tower & Tower.
No Negative Dun & Bradstreet Report: The Dun & Bradstreet report on Tierra Corporation did not reveal any negative information. This suggests that there are no significant red flags in the company’s financial history or creditworthiness.
Opportunity for Substantial Audit Fee: The audit engagement for Tierra Corporation is expected to yield a substantial fee. This presents a lucrative opportunity for the CPA firm, which can contribute positively to its financial performance.
Past Tax Evasion Incident: The incident involving Lewis Edmond’s questionable handling of a capital loss on a land sale to a trust raises concerns about his integrity and ethical behavior. Edmond’s involvement in a civil fraud penalty is a significant red flag that cannot be ignored.
Ethical Risks: Associating with a client who has a history of tax evasion and unethical behavior could pose ethical risks for Tower & Tower. It might jeopardize the firm’s reputation and integrity, as well as expose it to potential legal and regulatory issues.
Professional Responsibility: CPAs have a professional responsibility to exercise due diligence in assessing potential clients. The past IRS audit incident suggests a lack of transparency and honesty, which is contrary to the ethical standards of the accounting profession.
As the managing partner of Tower & Tower, my decision would be not to accept Tierra Corporation as an audit client. While the prospect of a substantial audit fee and Tierra Corporation’s overall positive reputation are appealing, the ethical and reputational risks associated with Lewis Edmond’s past tax evasion incident are too significant to ignore.
The incident from ten years ago involving the IRS audit raises serious concerns about Edmond’s integrity and honesty, which are essential qualities in a client. Given the nature of the audit work and the importance of trust in financial reporting, it is not prudent to enter into a professional relationship with a client who has a history of questionable ethical behavior.
Protecting the firm’s reputation and adhering to professional standards must take precedence over potential financial gains. It is crucial to maintain the highest ethical standards in the practice of accounting, and associating with a client with a history of tax evasion would compromise those standards. Therefore, I would decline the engagement, prioritizing ethical considerations and the long-term reputation of Tower & Tower.
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