Huffman & Whitman (H&W), a large regional public accounting firm, was engaged by the Ritter Tire Wholesale Company to audit its financial statements for the year ended January 31. H&W had a busy audit engagement schedule from December 31 through April 1, and they decided to audit Ritters purchase vouchers and related cash disbursements on a sample basis. They instructed staff accountants to select a random sample of 130 purchase transactions and gave directions about the important deviations, including missing receiving reports. Boyd, the assistant in charge, completed the working papers, properly documenting the fact that 13 of the purchases in the sample had been recorded and paid without the receiving report (required by stated internal control procedures) being included in the file of supporting documents. Whitman, the partner in direct charge of the audit, showed the findings to Lock, Ritters chief accountant. Lock appeared surprised but promised that the missing receiving reports would be inserted into the files before the audit was over. Whitman was satisfied, noted in the working papers that the problem was solved, and did not say anything to Huffman about it and he did not recheck or obtain more evidence about the matter for nonprofessional reasons.

Unfortunately, H&W did not discover the fact that Lock was involved in a fraudulent scheme in which he diverted shipments to a warehouse leased in his name and sent the invoices to Ritter for payment. He then sold the tires for his own profit. Internal auditors discovered the scheme during a study of slow-moving inventory items. Ritters inventory was overstated by about $500,000 (20%)the amount Lock had diverted.

Required:

1- Do you think H&W will be held liable to audit client in this case? And Why?

2- In what basis or grounds a third party known to H&W can sue the audit firm?

3- Do you think auditors in statuary audit should be liable for all employee embezzlement?