Question

20-16 Jenna Corporation approved a merger plan with Cord Corporation. One of the determining factors in approving the merger was the financial statements of Cord, which had been audited by Frank Company, CPAs. Jenna had engaged Frank to audit Cord's financial statements. While performing the audit, Frank failed to discover fraud that later caused Jenna to suffer substantial losses. For Frank to be liable under common-law negligence, Jenna at a minimum must prove that Frank

1) Knew of the fraud.
2) Failed to exercise due care.
3) Was grossly negligent.
4) Acted with scienter.

Answer 1

Jenna Corporation must prove that Frank Company, CPAs failed to exercise due care in their audit to hold them liable for common-law negligence after an undiscovered fraud resulted in substantial losses for Jenna.

Step-by-step explanation:

For Frank Company, CPAs to be liable under common-law negligence to Jenna Corporation due to failing to discover fraud in the financial statements of Cord Corporation, Jenna must prove that Frank failed to exercise due care in the performance of the audit. Knowing of the fraud (scienter) or being grossly negligent represents a higher standard of misconduct than just negligence. Under common law principles, a plaintiff alleging negligence must generally show that the defendant owed a duty to the plaintiff, breached that duty by failing to act with the care that a reasonably prudent person would have exercised under similar circumstances, and caused the plaintiff to suffer damages as a direct result of the breach. In the context of an audit, due care refers to the level of judgment, caution, and attentiveness the auditor is expected to exercise in the auditing process.