In confirming accounts receivable on 30 June 20X8, the auditor found 15 discrepancies between the customer's records and the recorded amounts in the subsidiary ledger. A copy of all confirmations that had exceptions was turned over to the company controller to investigate the reason for the difference. She, in turn, had the bookkeeper perform the analysis. The bookkeeper analysed each exception, determined its cause, and prepared an elaborate working paper explaining each difference. Most of the differences in the bookkeeper's report indicated that the errors were caused by timing differences in the client's and customer's records. The auditor reviewed the working paper and concluded that there were no material exceptions in accounts receivable.

Two years after the audit, it was determined that the bookkeeper had stolen thousands of dollars in the past three years by taking cash and overstating accounts receivable. In a legal action by the client against the auditor, an examination of the auditor's 30 June 20X8 accounts receivable working papers indicated that one of the explanations in the bookkeeper's analysis of the exceptions was fictitious. The analysis stated that the error was caused by a sales allowance granted to the customer for defective merchandise the day before the end of the year. The difference was actually caused by the bookkeeper's theft.

REQUIRED

a. What are the legal issues involved in this situation? What should the auditor use as a defence in the event that he is sued?

b. What was the auditor's deficiency in conducting the audit of accounts receivable?