Accountant's Liability. In 1995, JTD Health Systems, Inc, hired Tammy Heiby as ac-counting coordinator. Apparently overwhelmed by the duties of the position, Heiby failed to make payroll tax payments to the Internal Revenue Service (IRS) in 1995 and

Question

1996. Heiby tried to hide this omission by falsifying journal entries and manually writing three checks out of se-quence, totaling $1.7 million and payable to a bank, from JTD's cash account (to dispose of ex-cess funds that should have been paid in taxes). JTD hired Pricewaterhouse Coopers, LLP, to review JTD's internal accounting procedures and audit its financial statements for 1995. Coop-ers's inexperienced auditor was aware that the cash account had not been balanced in months and knew about the checks but never questioned them. The auditor instead mistakenly ex-plained that the unbalanced account was due to changes in Medicaid/Medicare procedures and recommended no further investigation. In 1996, the IRS asked JTD to remit the unpaid taxes, plus interest and penalties. JTD filed a suit in an Ohio state court against Coopers, alleging common law negligence and breach of contract. Should Coopers be held liable to JTD on these grounds? Why or why not?

Answer 1

Accountants' liability
On the ground of negligence for failure to discover the lack of tax payments, a jury returned a verdict in favor of JTD (although the jury found that JTD was 38 percent comparatively negli-gent, thus reducing the damages). Coopers appealed to a state intermediate appellate court, which affirmed the judgment of the lower court. The appellate court held that, as regards the negligence claim, "a reasonable person could find that Coopers had breached its professional duty to JTD." The court explained that "Coopers had departed from generally accepted auditing standards by failing to properly supervise its inexperienced employee, failing to review JTD's internal controls over cash, failing to investigate an unusual transaction, and failing to reconcile the cash account." As for the breach of contract claim, the court pointed out that "[t]he engagement letter between Coopers and JTD states that Coopers will review the internal control structure and notify JTD of deficiencies in the internal control structure. The testimony shows that Coopers was aware that the cash account had not been reconciled in several months. Coopers was also aware that approximately $1.7 million in checks payable to [the] bank were outstanding at the time of the audit. Thus, a reasonable person could conclude that there was a significant deficiency in the control structure somewhere."