Reference no: EM131624728

Question: Liability in a Review Engagement. Mason & Dilworth (M&D), CPAs, were auditors for Hotshot Company, a closely held corporation owned by 30 residents of the area. Hotshot had previously engaged M&D to perform some compilation and tax work. Bubba Crass, Hotshot's president and holder of 15 percent of the stock, said he needed something more than these services. He told Mason, the partner in charge, that he wanted financial statements for internal use, primarily for management purposes but also to obtain short-term loans from financial institutions. Mason recommended a "review" of the financial statements and did not prepare an engagement letter. During the review work, Mason had some reservations about the financial statements. Mason told Dilworth at various times he was "uneasy about certain figures and conclusions," but he would "take Crass's word about the validity of certain entries since the review was primarily for internal use in any event and was not an audit." M&D did not discover a material act of fraud committed by Crass. The fraud would have been detected had Mason not relied so much on the unsupported statements Crass made concerning the validity of the entries about which he had felt so uneasy.

Required: a. What potential liability might M&D have to Hotshot Company and other stockholders?

b. What potential liability might M&D have to financial institutions that used the financial statements in connection with making loans to Hotshot Company?