Ethical Dilemmas: Remember the Old Adage About Making Assumptions?
Beyond Numbers · September 2008
By Chris Utley, CA
Director of Ethics
Ignoring your gut instincts, relying blindly on the work of others, and taking shortcuts. None are recommended, and each can lead you to a meeting with the PCEC, as Dennis,* one of our sole-practitioner members, recently discovered.
Between 2002 and 2007, Dennis performed review engagements for his client Jet Engineering Inc. (Jet), a company that sold and serviced aircraft parts. All seemed well until Jet began to experience serious cash flow problems in 2007, and the companyís owner, Jason Winston, decided to sell.
Impressed by Jetís 2004-2006 financial statements, an entrepreneur named Robert Smith* expressed interest in purchasing the company. The 2007 statements had not yet been completed, but Jason assured Robert that he would provide the statements at a later date. In the meantime, he asked Robert to show good faith by providing a deposit of $100,000. Robert agreed, and the deposit was secured by a promissory note from Jet and Jason.
Robert eventually received the 2007 financial statements, but decided not to go through with the purchase after incurring some unexpected losses in his personal investments. When he tried to get his deposit back, however, Robert discovered that Jason had declared personal bankruptcy and Jet had fallen into receivership.
During the ensuing bankruptcy proceedings, Robert learned that Jet had an additional PST liability of almost $1 million resulting from a 2006 audit by the tax department. Although this assessment covered the period from 2002 to 2006, it hadnít been recorded in the companyís books until after the release of the 2007 financial statements. So, in an effort to recover his $100,000 deposit, Robert commenced legal action against Dennis, alleging that Dennis had failed to complete his review engagements according to professional standards. Robert pointed out that heíd paid his deposit based on Jetís 2004-2006 financial statementsóstatements that did not reflect the companyís additional PST liability.
The BC Supreme Court found Robert 75% liable because heíd failed to heed the advice of his legal counsel by not securing the $100,000 deposit in a trust account. Dennis, for his part, was found 25% liable for not performing due diligence on Jetís PST payable account.
In his decision, the judge stated that Dennisís conduct had fallen below the standard of care required of a public accountant on a review engagement, and said Dennisís unqualified opinion amounted to negligent misrepresentation. The judge accepted the expert opinion of another CA who testified that Dennis, at a minimum, should have tested the plausibility or reasonableness of the amount of taxes actually paid and the reported PST payable; all this would have required is that Dennis multiply sales by 7% and compare that number with the sum of the twelve PST payments made during a given year.
The court case subsequently came to the attention of the PCEC, and the Institute authorized an investigation.
The PCEC investigator noted that while Jetís monthly sales had been in the range of $300,000 to $400,000 in each of the past five years, its PST monthly remittances had averaged only $3,000 to $4,000. Asked about this glaring discrepancy, Dennis said he had checked for consistency by comparing the PST payable at year-end with historical information. He explained that heíd focused his review procedures on the inventory he thought had a high risk of misstatement, and said the PST payable account wasnít one of them. In addition, Dennis said heíd felt comfortable with the PST liability, but had perhaps been lulled into accepting its plausibility because a fellow CA, Eric, had performed Jetís bookkeeping for several years. Finally, Dennis claimed that he was not aware of the tax audit or the assessment at the time of his 2006 and 2007 work, and, therefore, could not have ensured that the liability was recorded.
The PCEC agreed with the BC Supreme Court and found Dennis in contravention of the following ICABC Rules: 201.1 (Maintenance of Reputation of the Profession); 202 (Due Care); 203 (Professional Competence); 205 (Misleading Documents); and 206.1 (Compliance with Professional Standards). The PCEC maintained that Dennis had failed to exercise professional skepticism with regard to Jetís relatively small PST monthly remittances.
The PCEC reprimanded Dennis and required him to pay a significant fine and the costs of the investigation. He was also required to update his professional skills through courses on review
Skepticism is a fundamental tenet of the CA profession. Dennis had assumed that the bookkeeping for Jetís PST was complete and accurate because the amounts paid monthly and the annual liability were consistent from year to year, and because Jetís bookkeeper was a CA. But where was Dennisís professional skepticism? Sales taxes are normally proportionate to sales volume; if theyíre not, a CA should find out why.
Finally, you may be wondering about Eric, the CA bookkeeper. Well, the PCECís subsequent investigation into Ericís professional conduct will be the subject of my next column.
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*Please note: This fictionalized account is based loosely on an actual case before the PCEC (Professional Conduct Enquiry Committee). Names and circumstances have been changed to preserve anonymity. The contents of this article are only intended for the general guidance of readers. The PCEC deals with each case individually, based on its specific facts and circumstances.