Lawyers for professional services group RSM Tenon have raised "serious concerns" about the quality of PwC's audit and advised Tenon may have a legal claim, according to reports.
The Times reports Britain's biggest accountancy firm has responded by accusing Tenon of misleading its audit team "through both omission and deliberate misrepresentation", documents show.
Ian Powell, PwC's senior partner, is understood to have met Adrian Martin, Tenon's chairman, to try to defuse the situation. Both firms refused to comment to the Times.
Tenon revealed in January its two top directors had stepped aside amid mounting losses and it would have to restate its last full-year accounts.
The Times reports the extent of its financial troubles only came to light after Tenon had been approached by a potential private equity buyer in the second half of last year.
HgCapital initially made a 43p a share cash offer, valuing Tenon at £140m. However, after bringing in Deloitte, PwC's Big Four rival, to conduct due diligence, it "completely lost confidence in Tenon's historic and current financial statements together with Tenon's ability to forecast its future finances", documents seen by the Times show.
A revised offer of 5p per share, with additional payments of £25m to reduce Tenon's debt and £20m to boost working capital, also fell through.
Lawyers from Reynolds Porter Chamberlain, who reviewed PwC's work, told Tenon's board: "It is remarkable to see the accounts of a public company ... audited by a Big Four firm undermined so comprehensively through pre-acquisition due diligence."
RPC claimed PwC's failure to uncover errors in Tenon's last full-year accounts contributed to the collapse of the HgC deal and advised Tenon may be able to seek damages from its auditor.
However, PwC blamed Tenon for the errors in the accounts. In a letter to Tenon's audit committee from Bowker Andrews, a veteran partner responsible for the Tenon audit, PwC claimed it had been given draft accounts for the year ended June 30, 2011, that included "what may have been knowingly incorrect accounting treatment".
In February, Tenon revealed an £84m first-half loss after taking a £61m writedown on goodwill. It admitted to "significant errors" in its last full-year accounts.
Tenon's shares closed on Friday at 8½p, down nearly 90% compared with the start of last year.
PwC was fined a record £1.4m by the audit watchdog in January for failing to spot its client JP Morgan had not properly protected billions of dollars of client money. A separate investigation is reviewing its audit of Cattles, the failed sub-prime lender, according the Times reports.
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