Walter, a chartered accountant, provided services to ABC Manufacturing Inc. owned by Mr. White. Walter took care of all of ABC's financing, bookkeeping, payroll management, financial statement preparation and tax planning and preparation. Early in January, White came to Walter to inform him that he was thinking of selling the business. He explained that the slow economy had considerably dampened his sales and that he wished to sell the business as a going concern before the situation became critical and he might be forced to sell at a loss or liquidate assets to satisfy creditors. Walter listened carefully but suggested that White should wait and sell after he prepared some current financial statements from which he could offer some constructive advice about the fortunes of the company. Walter also told White that, based on his understanding of the situation, ABC could easily be restored to financial health. Walter prepared draft statements using certain assumptions about the availability, terms and cost of bridge financing and the reduction in operating expenses that could be achieved by rearranging production in certain ways. The assumptions were not fully explained on the statements as Walter preferred to meet with White and discuss the matter fully. However, a footnote stated that "the figures are based on receipt of interim financing and predicted cost reductions." Walter then sent the statements to White for his review and invited further discussion.
Two weeks later, Walter received a telephone call from White who told him he had sold the business at a substantial profit to Black. The purchaser had been impressed with the financial position of the company based on Walter's most recent statements and had taken the statements to his bank in order to secure a loan for the purchase price. The loan was granted. Within the first six months under Black's ownership, ABC's sales continued to fall. Black's new accountant prepared financial statements that portrayed a much more dismal situation than had Walter's. Within another month, one of ABC's major suppliers forced the company into bankruptcy.
Discuss the liability of the parties in this case, if any, and render a decision.

Question

David Oloyede · Accepted Answer

Final Answer :

This case looks at the issue of professional negligence and the duty of care owed by professional accountants. As accountants are generally aware that their statements may be relied upon by third parties, they have a high duty of care to ensure that their work reflects the True financial position of the company to which it applies. Failure to take all reasonable steps to ensure its accuracy would fall below the acceptable standard and constitute a breach of the duty, which, if loss resulted, would incur liability.
Here, the accountant did not intend anyone, including White, to rely on the draft statements. Although the purpose of the statements was to present a viable alternative to White to reverse the company's fortunes, Walter failed to meet the standard required of the profession. The assumptions used to generate the statements were not fully explained on their face, thus rendering them inaccurate and misleading. Even in light of the limited purpose for which Walter believed he was preparing these accounts, he ought to have known that they may be relied upon by White or a third party, particularly after White expressed his urgent desire to sell the business.
An action may lie by Black and Black's bank, who relied upon the statements against White and Walter for misrepresenting the company's situation. White may in turn seek indemnity from Walter in the amount for which he is found liable as a result of Walter's professional negligence.
Students may also raise the issue of some intentional misrepresentation or negligence on the part of White. An argument might be made that he either knew or ought to have known that the statements were misleading and took the opportunity to present them to an innocent third party in order to secure a rapid sale of the business.

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