Hew & Partners, the public accounting firm was engaged to perform an audit of Zenrich Company Bhd., which had been incorporated last year. Hew & Partners were aware that the financial statements accompanying the report would be used to support an application for a substantial loan from the CIMD Bank. The financial statements, released six weeks after year end, reflected tremendous sales growth during the last two months of the year. Hew & Partners had confirmed the accounts receivable as of year end, selecting the accounts on a random sampling basis.

The CIMD bank refused to grant Zenrich the desired loan, but Zenrich got the loan from Haybank. When the second installment became past due, Haybank investigated and discovered that many of the sales near year end had been fictitious and that confirmations had been returned to the auditors by employees of Zenrich Company Bhd., who had set up fictitious companies using their own home address.

Haybank sued the firm of Hew & Partners for negligence in the conduct of their audit and claimed damages equal to the amount of the loan default.

Required:

a) Explain if the auditors will be held liable for negligence under the circumstances described. State your reasons clearly. (15 marks)

b) Explain actions that the auditors could have taken to prevent such a legal action from arising. (4 marks)

c) Identify the potential causes of action against an auditor under a breach of contract lawsuit and suggest some remedies for a breach of contract. (6 marks)