Lauren Yost & Co., a medium-sized CPA firm, was engaged to audit Stuart Supply Company. Several staff were involved in

the audit, all of whom had attended the firm's in-house training program on effective auditing methods. Throughout the

audit, Yost spent most of her time in the field planning the audit, supervising the staff, and reviewing their work.

A significant part of the audit entailed verifying the physical count, cost, and summarization of inventory. Inventory was

highly significant to the financial statements, and Yost knew the inventory was pledged as collateral for a large loan to First

City National Bank. In reviewing Stuart's inventory count procedures, Yost told the president she believed the method of

counting inventory at various locations on different days was highly undesirable. The president stated that it was

impractical to count all inventory on the same day because of personnel shortages and customer preference. After

considerable discussion, Yost agreed to permit the practice if the president signed a statement that no other method was

practical. The CPA firm had at least one person at each site to audit the inventory count procedures and actual count.

There were more than 40 locations.

Eighteen months later, Yost found out that the worst had happened. Management below the president's level had

conspired to materially overstate inventory as a means of covering up obsolete inventory and inventory losses resulting

from mismanagement. The misstatement occurred by physically transporting inventory at night to other locations after it

had been counted in a given location. The accounting records were inadequate to uncover these illegal transfers.

What defense should Lauren Yost & Co. use in the suit by Stuart?

Yost and Co. should use the defenses of (1) _____ and (2) _____. The fraud perpetuated by Stuart Supply Company was reasonably (3) _____ one and (4) _____ to uncover except by the procedures suggested by Yost. In most circumstances it (5) _____ be necessary to physically count all inventory at different locations on the same day. Furthermore, the president of the company contributed to the failure of finding the fraud by (6) _____. There is evidence of that through his signed statement.

Is Yost likely to be successful in her defenses?

She is likely to be (7) _____ in her defense against the client because (8) _____. She is likely to be (9) _____ in her defense against the bank because (10) _____.

Would the issues or outcome be significantly different if the suit was brought under the Securities Exchange Act of 1934?

The issues and outcomes should be (11) _____ under the suit brought under the Securities Exchange Act of 1934. If the suit were brought uner Rule 10b-5, it is certainly (12) _____ that the plaintiff would be successful, inasmuch as there was (13) _____.

1. Absence of causal connection, breach of contract, joint and several liability, nonnegligent performance
2. Constructive fraud, contributory negligence, criminal liability, lack of duty to perform
3. Complex, simple
4. difficult, easy
5. would, would not
6. allowing management to perpetrate fraud, physically transporting inventory and conspiring to materially overstate inventory, refusing to follow Yost's suggestion, signing the engagement letter
7. successful, unsuccessful
8. of the breach of contract by the client, of the contributory negligence by the client, of the lack of due care in her audit of inventory, of the signed statement by the president of Stuart
9. successful, unsuccessful
10. of the constructive fraud by the client, of the employment of due care in her audit of inventory, she recklessly misrepresented information for the third party use, the accounting records were inadequate to uncover the illegal transfers
11. different, the same
12. likely, unlikely
13. a lack of duty to perform, intent to deceive, negligent to performance, no intent to deceive