Cereal Byproducts Co. v. Hall

Citations: 132 N.E.2d 27; 8 Ill. App. 2d 331Docket: Gen. 46,622

Court: Appellate Court of Illinois; February 27, 1956; Illinois; State Appellate Court

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Cereal Byproducts Company appealed a judgment favoring defendants, certified public accountants, after a trial without a jury regarding alleged negligence in auditing the company’s books for 1947. The accounting firm, employing the defendants, conducted annual audits from 1932 to 1949, with defendant Penny overseeing audits since 1936. Delays in the 1948 audit were attributed to bookkeeper R.C. Zastrow, who later committed suicide after the firm uncovered significant embezzlement totaling $66,645.05 for 1948, along with earlier and later losses. The embezzlement was executed through alterations of checks and unauthorized payments. The company recovered some funds, including $19,500 from its bank and $7,252.60 from Zastrow's assistant. Following advice in 1950 that a proper audit would have detected the fraud, the company sued for $66,333.03, alleging breach of contract and negligence. The defendants denied negligence, claimed contributory negligence on the part of the plaintiff, and argued that a settlement with the bank and a payment for services constituted a release of liability. The trial court found insufficient evidence of negligence by the defendants while rejecting the contributory negligence defense, without addressing the affirmative defenses raised by the defendants.

The balance sheet of Cereal Byproducts Company as of December 31, 1947, along with its income and surplus statements for the year, underwent an examination that adhered to generally accepted auditing standards. The review included an assessment of the company's internal control and accounting procedures, although it did not involve a detailed audit of all transactions. The examination concluded that the financial statements fairly represent the company's position and operations, consistent with generally accepted accounting principles.

Five certified public accountants provided expert testimony, with three for the plaintiff and two for the defendants. They generally agreed that the primary goal of an ordinary examination is to offer an opinion on the financial statements rather than to uncover defalcations. However, there was a significant divergence among the experts regarding the specific steps required for verifying the accuracy of financial records, which led to uncertainty for the trial court. This uncertainty contributed to the court's finding in favor of the defendant on negligence claims.

The plaintiff identified six areas of alleged negligence in the audit, focusing on one key issue: the confirmation of accounts receivable. Evidence indicated that during audits from 1943 to 1947, certain accounts receivable were not confirmed based on directives from Zastrow, without Becker's knowledge. In 1947, 29 accounts totaling $28,964 were listed for non-confirmation at Zastrow's instruction. The defendants did send bank confirmations for other accounts, adhering to a practice of confirming significant balances while omitting certain accounts based on internal decisions.

Zastrow identified at least ten accounts that were overstated in the audit conducted on December 31, 1947. The defendants argued that their reliance on Zastrow's list of accounts not to be confirmed was justified because Zastrow was present during prior audits in 1944 and 1945 and had become a stockholder of the plaintiff. However, the court found these arguments unconvincing. Zastrow’s presence did not grant him authority to create a list years later, and his stock ownership did not confer management authority, which the defendants likely recognized. The defendants, responsible for auditing under Zastrow's direction, acted negligently by accepting Zastrow’s list without Becker's or any other officer's knowledge. The court ruled that the trial court correctly dismissed the defense of contributory negligence, as no evidence suggested any contributing factors to the defendants' negligence. The trial court did not address the affirmative defenses raised by the defendants, preventing their consideration on appeal. Consequently, the judgment was reversed, and the case was remanded for a determination of the defendants' negligence in the 1947 audit and for further proceedings aligned with this opinion.