You are the auditor of Bella Incorporated, a public company with a December 2022 year end. Your firm has audited Bella for the past three years. Bella manufactures and develops portable music players and sells them to retailers and wholesalers. The following issues were documented in the working paper files for the prior year audit: 

 

The company had incurred expenditures of $400,000 related to the development of a new music format for electronic media. The large majority of the costs were related to development of software, hardware, and presentation of the results to customers who participated in research studies. Management had been optimistic that the new music player system would work well, even though research study results indicated poor consumer acceptance. These research and development costs had been fully capitalized. 

 

About 40% of the company's revenues were from one customer. That contract had been due for renewal on April 15, 2023, ten days after the audit report had been issued. During the audit, the auditor reviewed documents that indicated Bella's customer seemed likely to renew the contract, although there had been several disputes related to quality control. On April 14, 2023, Bella was informed that the contract would not be renewed.

 

Bella has defaulted on its bank loans and the bank is suing you (the auditor), saying that the financial statements presented last year were false and misleading due to inadequate disclosure, and that the auditor was negligent regarding the audit of research and development costs.

 

Required:

1) Explain the possible defenses the auditor could use.  How likely is it that the auditor will be successful in defending this suit?  Justify your response.