Auditing & Assurance Services 6th Edition by Timothy Louwers

Exercise 67

Subsequently Discovered Facts. On June 1, Sidney Faultless of A. J. Faultless Co., CPAs, noticed some disturbing information about the firm's client, Hopkirk Company. A story in the local paper mentioned the indictment of Tony Baker, whom Faultless knew as the assistant controller at Hopkirk. The charge was mail fraud. Faultless made discreet inquiries with the controller at Hopkirk's headquarters and learned that Baker had been speculating in foreign currency futures. In fact, part of Baker's work at Hopkirk involved managing the company's foreign currency. Unfortunately, Baker had violated company policy, lost a small amount of money, and then decided to speculate some more, lost some more, and eventually lost $7 million of company funds.
The mail fraud was involved in Baker's attempt to cover his activity until he recovered the original losses. Most of the events were in process on March 1, when Faultless had signed and dated the unmodified opinion on Hopkirk's financial statements for the year ended on the previous December 31.
Faultless determined that the information probably would affect the decisions of external users and advised Hopkirk's chief executive to make the disclosure. She flatly refused to make any disclosure, arguing that the information was immaterial. On June 17, Faultless provided the subsequent information in question to a news reporter, and it was printed in The Wall Street Journal with a statement that the financial statements and accompanying auditor's report on the company's financial statements could not be relied on.
Required:
Evaluate the actions of Faultless Co., CPAs, with respect to the information discovered. What other action could Faultless Co. have taken? What are the possible legal effects of the firm's actions, if any?