Surety Bond Quarterly - Fall 2014 - 35

Starting with the last question first,
fixing of the blame, just as all politics
are local, the answer to this question
is determined by local law. Basically,
the question is whether the surety
has the right to rely upon the audits
and, therefore, has the right to sue if
the audits are negligently performed.
I will use Texas as an example, as
Texas is one of the states where the
author is licensed and Texas follows a
fairly modern view on the issue. Texas
follows the modern legal approach,
as set forth in the restatement of
Torts, adopted by some states, which
allows an intended third party (such
as a surety), justifiably relying upon
the audit, to bring a cause of action
against the CPA for negligent misrepresentation.
See Grant Thornton
LLP v. Prospect High Income Fund,
314 S.W.3d 913 (Tex. 2010) (Supreme
Court of Texas provides an overview
of auditor liability to third parties
and confirms its adoption of the
restatement approach); restatement
(Second) of Torts § 552(1), Information
Negligently Supplied for the Guidance
of others.
If the surety can rely on the audit
and can sue if the audit is erroneous,
we need to understand how and
why the surety relies on the audit and
why and how the auditor is in a better
position on a number of areas to
have superior knowledge and to be
the cheapest cost avoider.
How the Surety Relies on CPAs
The surety relies on the CPA to be
independent; to maintain professional
skepticism;
to understand
and test the internal controls of the
contractor; and to evaluate, analyze,
and test key issues, including underbillings,
cash flow, profit gain/fade,
and so forth. See Travelers Casualty
and Surety Co. of America v. Ernst &
Young LLP, 542 F.3d 475 (5th Cir. 2008)
(evidence was sufficient to prove that
the surety reasonably relied on the
financial statements negligently prepared
by the accounting firm).
The audit and the validation of the
integrity of the internal controls support
the three Cs - character, capital,
and capacity - in the following manner:
1. Character: The surety must have
the ability to assess the character
for truthfulness of the contractor.
The audit is an important tool in
this pursuit. By validation of the
internal controls showing that the
contractor is fairly and truthfully
reporting its financial condition,
the audit contributes to the transparency
that is critically important
to the surety.
2. Capital: The construction industry
is capital intensive. Some contracting
areas require extensive capital
due to the use of heavy equipment.
There may be long time frames during
which the contractor must wait
for receipt of contract proceeds,
specially fabricate material, and
apply capital for various other reasons.
The audit must be designed
and administered to investigate
and determine that this capital
is real and not illusory. Whether
Madoff, Enron, Stanford, or various
other examples, illusory capital can
be accomplished in many creative
ways. Hard work and experience
and knowledge must be applied to
determine validity of stated capital.
3. Capacity: The audit applies to
capacity relative to work program,
backlog, and so on.
Why the Surety Relies on CPAs
The surety relies on CPAs because,
among other things, its underwriters
are likely not accountants, much
less certified public accountants;
the underwriters may not be geographically
located in close proximity
to the contractor's offices and
projects; and they do not have the
specialized knowledge, training, and
experience in construction accounting
that an auditor of a construction
company has.
The CPA auditing a construction
company holds herself or himself
out to have particular knowledge,
expertise, and skill with construction
accounting. Construction accounting
is a specialized area. It requires
understanding of the construction
process, capital structure, the percentage
of completion method of
accounting, payments, retainage,
claims, and other issues. In order
to successfully audit a construction
company client, a CPA must understand
these issues. For these reasons,
and more, it is critical for a construction
contractor or subcontractor seeking
a CPA to examine the background
of the potential CPA to ensure that
she or he is immersed in construction
industry knowledge and experience.
The CPA also has superior knowledge
due to access to the contractor,
the management of the contractor, the
locational advantage by having personnel
literally on the ground where
the contractor's office is located and
the books and records are maintained
and often where the projects are
located, and the permission of the
contractor to communicate with third
parties such as owners and other parties
contracting with the contractor.
There can be a risk of too much familiarity
if the CPA spends too much time
with clients. Professional CPAs, however,
are acutely aware of this risk and
should work to minimize any erosion
of professional skepticism.
The CPA also generally has yearover-year
knowledge about performance
of the contractor on
long-duration projects and can reconcile
issues across audit years. In all
of these things, according to GAAS,
it is the job of the CPA to exercise
professional judgment and maintain
professional skepticism throughout
the planning and performance of
the audit, including identifying and
assessing risks of material misstatement,
whether due to fraud or error.
The AICPA professional standards
state that GAAS means that the
auditor must understand the entity
and its environment, including the
entity's internal control; must obtain
sufficient appropriate audit evidence
about whether material misstatements
exist, through designing and
implementing appropriate responses
to the assessed risk; and form an
opinion on the financial statements
based on an evaluation of the audit
evidence obtained. See Travelers
Casualty and Surety Co. of America,
542 F.3d at 486 ("the applicable
accounting standards required an
NatioNal assoCiatioN of surety BoNd ProduCers | WWW.NASBP.orG 35
http://WWW.NASBP.orG

Surety Bond Quarterly - Fall 2014

Table of Contents for the Digital Edition of Surety Bond Quarterly - Fall 2014

2014-2015 NASBP Executive Committee
NASBP Upcoming Meetings and Workshops
From the CEO: Successful construction relationships require the right relationship
Practical Insights: What you need to know - bond and lien notice pitfalls
SuretyLearn.org: An invaluable resource
Advocacy update
Nov. 12-3 Conference addresses the twists and turns of best value selection - and other timely topics
Surety Bond Guarantee Program changes for the better
Front Line Underwriting: Choosing a quality construction CPA
Getting in the weeds: Requirements of marijuana surety bonds
Encrypting email
It’s Finally Here: The new revenue recognition standard
CPAs standing in the GAAP
Resource Directory
Index to Advertisers
Surety Bond Quarterly - Fall 2014 - cover1
Surety Bond Quarterly - Fall 2014 - cover2
Surety Bond Quarterly - Fall 2014 - 3
Surety Bond Quarterly - Fall 2014 - 4
Surety Bond Quarterly - Fall 2014 - 5
Surety Bond Quarterly - Fall 2014 - 6
Surety Bond Quarterly - Fall 2014 - NASBP Upcoming Meetings and Workshops
Surety Bond Quarterly - Fall 2014 - From the CEO: Successful construction relationships require the right relationship
Surety Bond Quarterly - Fall 2014 - 9
Surety Bond Quarterly - Fall 2014 - Practical Insights: What you need to know - bond and lien notice pitfalls
Surety Bond Quarterly - Fall 2014 - 11
Surety Bond Quarterly - Fall 2014 - SuretyLearn.org: An invaluable resource
Surety Bond Quarterly - Fall 2014 - 13
Surety Bond Quarterly - Fall 2014 - Advocacy update
Surety Bond Quarterly - Fall 2014 - 15
Surety Bond Quarterly - Fall 2014 - Nov. 12-3 Conference addresses the twists and turns of best value selection - and other timely topics
Surety Bond Quarterly - Fall 2014 - 17
Surety Bond Quarterly - Fall 2014 - Surety Bond Guarantee Program changes for the better
Surety Bond Quarterly - Fall 2014 - 19
Surety Bond Quarterly - Fall 2014 - 20
Surety Bond Quarterly - Fall 2014 - 21
Surety Bond Quarterly - Fall 2014 - Front Line Underwriting: Choosing a quality construction CPA
Surety Bond Quarterly - Fall 2014 - 23
Surety Bond Quarterly - Fall 2014 - 24
Surety Bond Quarterly - Fall 2014 - 25
Surety Bond Quarterly - Fall 2014 - Getting in the weeds: Requirements of marijuana surety bonds
Surety Bond Quarterly - Fall 2014 - 27
Surety Bond Quarterly - Fall 2014 - Encrypting email
Surety Bond Quarterly - Fall 2014 - 29
Surety Bond Quarterly - Fall 2014 - 30
Surety Bond Quarterly - Fall 2014 - 31
Surety Bond Quarterly - Fall 2014 - It’s Finally Here: The new revenue recognition standard
Surety Bond Quarterly - Fall 2014 - 33
Surety Bond Quarterly - Fall 2014 - CPAs standing in the GAAP
Surety Bond Quarterly - Fall 2014 - 35
Surety Bond Quarterly - Fall 2014 - 36
Surety Bond Quarterly - Fall 2014 - 37
Surety Bond Quarterly - Fall 2014 - 38
Surety Bond Quarterly - Fall 2014 - Resource Directory
Surety Bond Quarterly - Fall 2014 - 40
Surety Bond Quarterly - Fall 2014 - 41
Surety Bond Quarterly - Fall 2014 - 42
Surety Bond Quarterly - Fall 2014 - 43
Surety Bond Quarterly - Fall 2014 - 44
Surety Bond Quarterly - Fall 2014 - 45
Surety Bond Quarterly - Fall 2014 - 46
Surety Bond Quarterly - Fall 2014 - 47
Surety Bond Quarterly - Fall 2014 - 48
Surety Bond Quarterly - Fall 2014 - 49
Surety Bond Quarterly - Fall 2014 - 50
Surety Bond Quarterly - Fall 2014 - 51
Surety Bond Quarterly - Fall 2014 - 52
Surety Bond Quarterly - Fall 2014 - 53
Surety Bond Quarterly - Fall 2014 - 54
Surety Bond Quarterly - Fall 2014 - 55
Surety Bond Quarterly - Fall 2014 - 56
Surety Bond Quarterly - Fall 2014 - 57
Surety Bond Quarterly - Fall 2014 - Index to Advertisers
Surety Bond Quarterly - Fall 2014 - cover3
Surety Bond Quarterly - Fall 2014 - cover4
https://www.nxtbook.com/naylor/SBPQ/SBPQ0118
https://www.nxtbook.com/naylor/SBPQ/SBPQ0417
https://www.nxtbook.com/naylor/SBPQ/SBPQ0317
https://www.nxtbook.com/naylor/SBPQ/SBPQ0217
https://www.nxtbook.com/naylor/SBPQ/SBPQ0117
https://www.nxtbook.com/naylor/SBPQ/SBPQ0416
https://www.nxtbook.com/naylor/SBPQ/SBPQ0316
https://www.nxtbook.com/naylor/SBPQ/SBPQ0216
https://www.nxtbook.com/naylor/SBPQ/SBPQ0116
https://www.nxtbook.com/naylor/SBPQ/SBPQ0415
https://www.nxtbook.com/naylor/SBPQ/SBPQ0315
https://www.nxtbook.com/naylor/SBPQ/SBPQ0215
https://www.nxtbook.com/naylor/SBPQ/SBPQ0115
https://www.nxtbook.com/naylor/SBPQ/SBPQ0414
https://www.nxtbook.com/naylor/SBPQ/SBPQ0314
https://www.nxtbook.com/naylor/SBPQ/SBPQ0214
https://www.nxtbookmedia.com