Barney \& Company, CPAs, has been engaged to perform an examination of the financial statements of Waldo, Inc., for several years. The terms of the engagement have been set out in an annual engagement letter signed by both parties. The terms of each engagement included the following:

This being an ordinary examination, it is not primarily or specifically designed, and cannot be relied upon, to disclose defalcations and other similar irregularities, although their discovery may result.

Three years ago Harold Zamp, head cashier of Waldo and an expert in computer operations, devised a previously unheard-of-method of embezzling funds from his employer. At first, Zamp's thefts were small but increased as time went on. During the current year, before Barney began working on the engagement, the thefts became so large that serious variances in certain accounts came to the attention of the controller. When questioned about the variances, Zamp confessed and explained his unique embezzlement scheme. Investigation revealed that Zamp had stolen \(\$ 257,550\). Zamp has no assets with which to repay the thefts.

Waldo submitted its claim for \(\$ 257,550\) to Multi-State Surety Company in accordance with the terms of the fidelity bond covering Zamp. Fulfilling its surety obligation, Multi-State paid the claim and now seeks to recover its losses from Barney.

In defense, Barney asserts, in the alternative, the following defenses:

1. Multi-State has no standing in court to sue because it was not a party to the contract (i.e., lacking in privity) between Barney and its client, Waldo.

2. Even if Multi-State had the standing to sue, its claim should be dismissed because Barney's engagements with Waldo did not specifically include the discovery of defalcations other than those which might arise in the process of an ordinary examination.

3. Even if Barney's contract had made it responsible for discoverable defalcations, it could not have discovered Zamp's defalcations with the exercise of reasonable care. Zamp's technique was so new, unique, and novel that no accounting firm could have discovered the defalcations in any event.

{Required:}

In separately numbered paragraphs, discuss the validity of each of Barney's defenses.