Question: Common Law Liability to Third Parties. Flacco, CPA, conducted the audit of Raven Company and issued an unmodified opinion that concluded that the financial statements presented its financial condition, results of operations, and cash flows according to GAAP. As part of the preaudit conference, Flacco was informed by Raven's management that its audited financial statements would be presented to Baltimore National Bank to secure financing for a significant expansion opportunity.
Using these financial statements, as well as Flacco's opinion on those statements, Raven obtained financing from the following parties:
(1) Baltimore National Bank,
(2) Regional State Bank, and
(3) Maryland Equity Partners (a private equity firm). Each of these parties specifically requested audited financial statements and relied on these statements in providing financing to Raven. Six months after obtaining financing, Raven's financial condition worsened, and it declared bankruptcy, forcing Raven to default on its payments to Baltimore National Bank and Regional State Bank. In addition, Maryland Equity Partners' investment in Raven became worthless. After the bankruptcy, the parties that had provided financing to Raven determined that Raven had intentionally misstated its financial statements by recording fictitious revenues and accounts receivable. These parties decided to file suit against Flacco for failure to identify the fictitious revenues and accounts receivable.
Required: a. Define the following type of third parties:
(1) primary beneficiary,
(2) foreseen third parties, and
(3) foreseeable third parties.
b. Considering the three types of third parties identified in
(a) how would you classify
(1) Baltimore National Bank,
(2) Regional State Bank, and
(3) Maryland Equity Partners?
c. Assume that court proceedings concluded that Flacco's work failed to comply with generally accepted auditing standards, but that Flacco was not aware of the misstatements nor was he grossly negligent in his performance. Which of the parties would be likely to prevail in its claim against Flacco?
d. Assume that court proceedings concluded that Flacco failed to send confirmations to Raven's customers and simply mathematically verified the summary listing of accounts receivable provided to him by Raven. Which of the parties would be likely to prevail in its claim against Flacco?