a) What defense should Azman Yusof & Co. use in the suit by Diddy?

Azman Yusof & Co. should defences the suit by Diddy Supply Sdn. Bhd. by stating that
they have made diligent attempts on the part of auditors to follow up any indications of fraud
but the combined efforts of the management below the Managing Director (MD)’s level had
conspired to materially overstate inventory as a means of covering up the inventory that were
no longer been produced and inventory losses resulting from mismanagement has prevented
the auditors from uncovering the fraud. 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.

The audit firm also has meeting auditing standards when they do the audit. It can be seen
in the involvement of experienced staffs whose has been through in-house training program
on effective auditing methods. Azman also done his responsibilities and committed his time
in the field planning the audit, supervising the staff and reviewing their work.

Moreover, Azman Yusof and Co. should use defence of contributory negligence. This
defence exist when the auditor claims the client’s own actions either resulted in the loss that
is the basis of for damages or interfered with the conduct of the audit in such a way that
prevented the auditor from discovering the cause of the loss. If the audit firm had notified the
client (preferably in writing) of a deficiency in internal control that would have prevented the
theft but management did not correct it, the audit firm would have a defense of contributory
negligence. The fraud perpetuated by Diddy Supply was a reasonably complex and difficult
to uncover except by the procedures suggested by Azman.

In most circumstances it would not be necessary to physically count all inventory at

According to the above reasons, Azman Yusof & Co. can claim a defense of contributory
negligence.
 b) What defense should Azman Yusof & Co. use in the suit by First City National Bank?

In this case, First City National Bank is a third party beneficiary. This means a third party
who does not have privity of contract but is known to the contracting parties and is intended
to have certain rights and benefits under the contract. Privity once meant that a contract
between the third party and auditor was required before any liability could exist. However,
courts now overlook traditional privity and apply legal approaches referred to as “near
privity” as well as other approaches, without giving much weight to traditional privity.

There are two defenses Azman Yusof & Co. should use in a suit by First City National
Bank. First there is a lack of privity of contract. Even though this was a known third party, it
does not necessarily mean that there is any duty to that party in this situation. The nature of
the defense depend heavily on the approach to foreseen users in the state and the judicial
jurisdiction of the case. That defense is unlikely to be successful in most jurisdictions today.

If the auditor in unsuccessful in using the lack of duty defense to have a case dismissed,
the preferred defense in third-party suits is nonnegligent performance. The second defense
which Azman Yusof & Co. is more likely to be successful with is that the firm followed
auditing standards in the audit of inventory, including the employment of due care.

Ordinarily it is unreasonable to expect a Certified Public Accountant (CPA) firm to find

He is likely to be successful in his defences against the client because of the contributory
negligence. The company has responsibility for instituting adequate internal controls. The
president's statement that it was impractical to count all inventory on the same day because of
personnel shortages and customer preferences puts considerable burden on the company for
its own loss. After a discussion with the client and they agreed to use the current method that
have been used by Diddy Supply if there is no other method was practical. They even signed
a statement for this agreement.

Moreover, Azman Yusof & Co. had at least one person at each site to audit the Diddy
Supply’s inventory count procedures and actual count to make the audit checking more
strictly and thoroughly.

It is also unlikely that First City National Bank will be successful in a suit. The court is
likely to conclude that Azman Yusof & Co. followed due care in the performance of his
work. The fact that there was not a count of all inventory on the same date is unlikely to be
sufficient for a successful suit. The success of Azman Yusof's defenses is also heavily
dependent upon the jurisdiction's attitude about privity of contract. In this case there is
unlikely to be a claim of extreme negligence. Therefore it would be required for the court to
both ignore the privity of contract precedence and find Azman Yusof & CO. negligent for the
suit to be successful.

After all, company management is responsible for preventing and detecting fraud within
the company, and the auditors remind everyone of that throughout the audit process.
Question 5-19

a) If Thompson alleges and proves negligence on the part of Wong and Jensen, he will
be able to recover his loss.

False. Privity of contract is the relationship that exists between the parties to an agreement.
This relationship is necessary in contracts. If you want to file a lawsuit involving a contract,
you therefore need to show that you and the other person were in privity of contract. In other
words, you were both involved in the contract and had an established contractual relationship.

Two principles underpin the doctrine of privity of contract. First, only a person who is party
to a contract can sue on it. Second, it is generally accepted that consideration must have been
given by the promisee to the promisor. In other words, a person who wants to enforce a
contract must provide something of value in exchange for a promise.

A strict application of the privity rule would prevent a third party C from suing on a contract
between A and B. C could not sue despite the fact that the contract confers a benefit upon C
or extends the protection of an exemption clause to C or gives C an express right to enforce
the contract. Even though one of the contracting parties has already paid (or agreed to pay) to
the other a price for the benefit conferred upon the third party in the contract, the third party
is precluded from enforcing the promise – all because C is not a party to the contract. This
could conceivably lead to the result that “a promise given for good consideration will be
essentially unenforceable for all practical purposes”.

On the other hand, the privity of contract doctrine still has its merits. It might prevent a third
party who is not an intended beneficiary of a particular contract, but only an incidental one,
from suing. It might also protect a third party from being held liable where an agreement
purports to impose an obligation upon the third party.

The privity of contract rule is still regarded as a well-established feature of law in a number
of common law jurisdictions, including most of the Canadian provinces and territories.
However, “its force has been significantly undermined by a growing list of exceptions to the
rule”. Legislators and courts have, over time, recognized various exceptions and other means
to circumvent the rule. t be sufficient for a recovery. There was no privity of contract between
Wong and Jensen and Thompson, therefore, ordinary negligence will usually no be sufficient
for a recovery.
 b) If Thompson alleges and proves constructive fraud (that is, gross negligence on the
part of Wong and Jensen), he will be able to recover his loss.

True. Gross negligence means carelessness in reckless disregard for the safety or lives of
others, which is so great it appears to be a conscious violation of other people's rights to
safety. It is more than simple inadvertence, but it is just shy of being intentionally evil. If one
has borrowed or contracted to take care of another's property, then gross negligence is the
failure to actively take the care one would of his/her own property.

In many types of contracts it is standard industry practice for the party performing the
services or carrying out the work (the Contractor) to request and obtain from the other party
(the Principal) a clause limiting or excluding the Contractor's liability for, as an example,
indirect or consequential losses.

If the Principal accepts this, the Principal will, in turn, require the exclusion clause to exclude
certain situations where it would be unjust for the Contractor to obtain the benefit of the
exclusion or limitation. Typically, these situations include liability for fraud or deliberate
criminal acts or omissions or for wilful default.

The Principal will want the exception to be as wide as possible and may require that
"negligence" be excepted from the exclusion clause. Invariably, the Contractor's response is
to say that "negligence" is too wide and that this should be restricted to "gross negligence".

At common law, the term "negligence" generally describes damage causing conduct that
arises because of the defendant's carelessness or failure to take reasonable care.

A person will be liable in negligence only where they breach a duty of care that the law has
imposed upon them by failing to avoid a risk of damage or injury in circumstances where a
reasonable person would have done so.

The fact that a person's conduct might have involved a gross departure from the standard of
care expected by the law is simply not relevant to an action for breach of a duty of care.

The traditional view therefore, as far as civil proceedings in negligence are concerned, is that
there is no distinction between negligence and gross negligence. If gross negligence is
proven, the Audit firm can and probably will be held liable for losses to third parties.
 c) Thompson does not have a contract with Wong and Jensen.

True. Privity of contract is the relationship that exists between the parties to an
agreement. This relationship is necessary in contracts. If you want to file a lawsuit involving
a contract, you therefore need to show that you and the other person were in privity of
contract. In other words, you were both involved in the contract and had an established
contractual relationship.

Two principles underpin the doctrine of privity of contract. First, only a person who is party
to a contract can sue on it. Second, it is generally accepted that consideration must have been
given by the promisee to the promisor. In other words, a person who wants to enforce a
contract must provide something of value in exchange for a promise.

A strict application of the privity rule would prevent a third party C from suing on a contract
between A and B. C could not sue despite the fact that the contract confers a benefit upon C
or extends the protection of an exemption clause to C or gives C an express right to enforce
the contract. Even though one of the contracting parties has already paid (or agreed to pay) to
the other a price for the benefit conferred upon the third party in the contract, the third party
is precluded from enforcing the promise – all because C is not a party to the contract. This
could conceivably lead to the result that “a promise given for good consideration will be
essentially unenforceable for all practical purposes”.

On the other hand, the privity of contract doctrine still has its merits. It might prevent a third
party who is not an intended beneficiary of a particular contract, but only an incidental one,
from suing. It might also protect a third party from being held liable where an agreement
purports to impose an obligation upon the third party.

The privity of contract rule is still regarded as a well-established feature of law in a number
of common law jurisdictions, including most of the Canadian provinces and territories.
However, “its force has been significantly undermined by a growing list of exceptions to the
rule”. Legislators and courts have, over time, recognized various exceptions and other means
to circumvent the rule. t be sufficient for a recovery. There was no privity of contract between
Wong and Jensen and Thompson, therefore, ordinary negligence will usually no be sufficient
for a recovery.
 d) Unless actual fraud on the part of Wong and Jensen can be shown, Thompson cannot
recover.

False. Gross negligence (constructive fraud) is treated as actual fraud in determining who
may recover from the Audit firm.

Constructive fraud is a legal fiction describing a situation where a person or entity gained an
unfair advantage over another by deceitful or unfair methods. Intent does not need to be
shown as in the case of actual fraud. Some unfair methods may include not telling customers
about defects in a product.

The elements are:

 A duty owning by the party to be charged to the complaining party due to their
relationship
 Violation of that duty by the making of deceptive material misrepresentations of the
past or existing facts or remaining silent when a duty speak exists
 Reliance thereon by the complaining party
 Injury to the complaining party as a proximate result thereof
 The gaining of an advantage by the party to be charged at the expense of the
complaining party.
 e) Thompson is a third-party beneficiary of the contract Wong and Jensen made with
Regal Jewelry.*

False. Thompson is an unknown third party and will probably be able to recover damages
only in the case of gross negligence or fraud. . This means a third party who does not have
privity of contract but is known to the contracting parties and is intended to have certain
rights and benefits under the contract. Privity once meant that a contract between the third
party and auditor was required before any liability could exist. However, courts now overlook
traditional privity and apply legal approaches referred to as “near privity” as well as other
approaches, without giving much weight to traditional privity.

In recent years the auditor's liability to a third party has become affected by whether the
party is known or unknown. Now a known third party, under common law, usually has the
same rights as the party that is privy to the contract. An unknown third party usually has
fewer rights. The approach followed in most states is the Restatement of Torts approach to
the foreseen users concept. Under the Restatement of Torts approach, foreseen users must be
members of a reasonably limited and identifiable group of users that have relied on the
CPA’s work, even though those persons were not specifically known to the CPA at the time
the work was done.
REFRENCE

Bibliography

Arens, A. A. (2014). Auditing and Assurance Services in Malaysia. Kuala Lumpur: Pearson
Malaysia Sdn Bhd.

M.Feinman, J. (n.d.). LIABILITY OF ACCOUNTANTS FOR NEGLIGENT AUDITING:

Nguyen, V. (2008). An analysis of the Auditors' Liability to Third Parties in Australia.

Pany, K. (2010). Principle in Auditing and others Assurance Service. The McGraw-Hill
Companies.

Sterna, S. (2013, May 1). Defending third-party audit claims. Retrieved from Journal of
Accountancy: http://www.journalofaccountancy.com/issues/2013/may/20137570.html