Fraud, PPP loan
Tax return preparation, financial statement preparation
Al Highsmith, the owner of an auto repair and restoration business, Classy Chassis, in the New England area, has had financial difficulties with the business for many years, partly because he “borrows” money from the business for personal expenses but does not repay the money.
Highsmith is interested in selling Classy before its financial condition gets worse. He consults with his CFO, Tom Kaye, who is also unhappy with Classy’s financial condition and with the way the numbers look on the financial statements. They agree to work on getting the financial statements to look better before Highsmith tries to sell the company.
Their CPA, Jane Jones, has provided tax return preparation services to Classy and individually to Highsmith for many years, and she provides accounting services as well financial statement preparation services for Classy. She had warned Highsmith several times in phone conversations about Classy’s financial problems, but Highsmith always paid her fees on time and was otherwise a good and loyal client.
At one point, Kaye had asked Jones to show the amounts Highsmith has “borrowed” from the company as a loan that is being repaid at a rate of $7,500 per month, even though repayments are not being made, essentially asking Jones to fabricate and change numbers on the financial statements. Jones declined to go along with this request.
Kaye had also arranged for a $650K PPP loan for Classy, hoping the loan would improve Classy’s financials. Classy had laid off several employees during the pandemic, and Kaye was disappointed to learn that the PPP loan forgiveness amount is based partly on the number of employees retained, resulting in a smaller amount than he had expected. Kaye then asked Classy’s payroll staff to use W-2 forms for Classy’s contractors instead of 1099 forms so that Classy could gain a larger amount of loan forgiveness under the PPP loan.
When Jones learned of Kaye’s W-2 scheme, she became extremely uncomfortable. Making matters worse, she was cleaning up some of Classy’s accounting records one day and discovered that revenue had been moved from one quarter into other quarters. She also learned from an internal memo in the files that the moves were part of an effort to qualify for a second PPP loan.
After reading the following questions, select the one answer that is the best response.
- What should the CPA do in response to learning about fraudulent activity?
- Since the client had been loyal and well-paying for so many years, the CPA should reciprocate the loyalty by continuing to service the client despite the problems.
- The CPA should immediately disengage from the client.
- The CPA should consult with her risk advisor and professional liability carrier on the best ways to disengage from the client.
- What could the CPA have done during the engagement to reduce her liability exposure?
- The CPA could have documented the warnings she had provided to the client in conversation.
- The CPA could have documented her declining the CFO’s request to fabricate and change numbers on the financial statements.
- Both a. and b.
- 1.a. Incorrect. Loyalty to a client does not take precedence over maintaining professional standards of integrity, independence and objectivity.
- 1.b. Correct, but there is a better answer. Discovery of fraud is cause for disengaging immediately, but disengaging without an appropriate disengagement letter can cause additional problems. For example, the client may allege that the CPA damaged the client by causing the client to miss deadlines or business opportunities.
- 1.c. Correct. The best course of action is to consult with a risk advisor. CAMICO consults with CPA policyholders to help them evaluate engagements and craft an appropriate disengagement letter that includes important wording and details, such as descriptions of work in process, due dates, and filing deadlines.
- 2.a. Correct, but there is a better answer.
- 2.b. Correct, but there is a better answer.
- 2.c. Correct. Defensive documentation is of utmost importance, beginning with the engagement letter and continuing with written memorialization of significant client meetings. Such documentation clarifies the understanding between the CPA and the client and leaves little room for misunderstanding. It also helps to ensure that both you and the client are proceeding with the same expectations and assumptions.
“War Stories” are drawn from CAMICO claims files and illustrate some of the dangers and pitfalls in the accounting profession. All names have been changed.