Auditing Services in Public Accounting Firms

The public accounting firm of Hanson and Brown was expanding very rapidly. Consequently, it hired several staff assistants, includingJames Small. Subsequently, the partners of the firm became dissatisfied with Small’s production and warned him that they would beforced to discharge him unless his output increased significantly. At that time, Small was engaged in audits of several clients. Hedecided that, to avoid being fired, he would reduce or omit entirely some of the required auditing procedures listed in the audit planprepared by the partners. One of the public accounting firm’s non-SEC clients, Newell Corporation, was in serious financial difficultyand had adjusted several of its accounts being examined by Small to appear financially sound. Small prepared fictitious workingpapers in his home at night to support purported completion of auditing procedures assigned to him, although he in fact did notexamine the Newell adjusting entries. The public accounting firm rendered an unqualified opinion on Newell's financial statements,which were grossly misstated. Several creditors, relying upon the audited financial statements, subsequently extended large sums ofmoney to Newell Corporation.
Required:
Would the public accounting firm be liable to the creditors who extended the money in reliance on the erroneous financial statementsif Newell Corporation should fail to pay its creditors? Explain.