Reference no: EM132835820

Question - Stuart Turley, CPA is being engaged to conduct an audit on Hilux Corporation. This is a private company and its fiscal year ends at June 30. Hilux applied and received a significant amount of credit from a bank. Approval of the bank credit was conditioned upon the receiving of audited financial statements latest by September 30. The bank wanted that Hilux's audited financial statements would show a current ratio of at least 2 to 1. However, suddenly on 24th September, just prior to the audit report was to be issued, Stuart received an anonymous letter stating that a five-year lease by Hilux, as lessee, of a factory building that was accounted for in the financial statements as an operating lease was in fact a capital lease. They indicated that there was a secret written agreement with the lessor modifying the lease and creating a capital lease.

Stuart challenged the CEO of Hilux, who finally admitted that a secret agreement really existed but said it was necessary to treat the lease as an operating lease to meet the current ratio requirement of the pending loan and that nobody would ever discover the secret agreement with the lessor. The CEO said that, if Stuart did not issue his report by September 30, Hilux would sue Stuart for substantial damages that would result from not getting the loan. Under this pressure and because the working papers contained a copy of the five-year lease agreement supporting the operating lease treatment, Stuart issued his report with an unqualified opinion on September 29. In spite of the fact that the loan was received, Hilux went bankrupt. The bank is suing Auditor Stuart to recover its losses on the loan and the lessor is also suing Stuart in order to recover uncollected rents.

Required -

Explain why or why not the Auditor is liable to the lender?

What are the rationales you consider to conclude that the Auditor is liable or not to the Lessor? Explain.

Provide your justification whether the auditor was independent and objective or not?