Vera Crosden & Beryl Sykes, a medium-sized accounting firm, was engaged to audit posh supply company ltd. Several staff were involved in the audit, all of whom had attended the firms in-house training program in effective auditing methods. Throughout the audit, Crosden 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 Crosden knew that the inventory was Pledged as collateral to the national commercial bank for a large loan. In reviewing Poshs inventory count procedures, Crosden told the managing director that she believed the method of counting inventory at different locations on different days was highly undesirable. The managing director stated that it was impractical to count all inventory on the same day because of personnel shortages and customer preference. After considerable discussion, Crosden agreed to permit the practice is the managing director would sign a statement that no other method was practical. The audit firm had one person at each site to audit the inventory count procedures and actual count. There were 17 locations.

Eighteen months later. Crosden learned that the worst had happened. Management below the managing directors level had conspired to materially overstate inventory as a means of covering up obsolete inventory and inventory losses due to mismanagement. The misstatement had occurred by physically transporting inventory at night to other locations after it had been counted in a given locations. The accounting records were inadequate to uncover these illegal transfers.

Both Posh Supply Company Ltd and the National Commercial Bank sued Vera Crosden & Beryl Sykes.

• What defence should Crosden & Sykes use in the action by posh?
• What defence should Crosden & Sykes use in the action by the National Commercial Bank?
• Is Crosden likely to be successful in her defence?
• Would the issues or outcome be significantly different if the action were brought under the competition and consumer Act?