The firm of Barney & Fife, CPAs, was retained as the auditor for Ambassador Industries, which was seeking a loan. Prospective banks required audited financial statements to accompany any loan application. The auditors were aware of Ambassadors intended use of the audited financial statements and knew that whichever bank loaned the money was likely to rely on the audited statements. After the audit report was issued, the bank that ultimately made the loan discovered that Ambassadors inventory and accounts receivable were overstated. Ambassador subsequently went bankrupt and defaulted on the loan. The bank alleged that Barney & Fife failed to communicate about the inadequacy of the clients internal recordkeeping and inventory control. Moreover, the bank claimed that the auditors were grossly negligent in not discovering the overvaluation of inventory and accounts receivable. The auditors asserted that there was no way for them to know that the client included in the inventory account $1 million of merchandise in transit to a customer on December 31, 2019. The shipping terms were unclear so the auditors accepted managements representations in that regard (FOB Destination). As for the receivables, the auditors claimed that the client falsified confirmations by sending them to a post office address, retrieving them, and then confirming the stated balances.

Address the following questions in detail:

What would the bank have to prove to successfully bring a lawsuit against Barney & Fife?

What defenses might the auditors use to rebut any charges made about their (deficient) audit?

Critically evaluate the auditors statements about the inventory and receivables with respect to generally accepted auditing standards and the firms ethical responsibilities.