Trevor Hoots amp; Matthew Smith are the partners of TM Associates, a medium-sized accounting firm. TM Associates wereengaged to audit Ginger Supply…

Trevor Hoots & Matthew Smith are the partners of TM Associates, a medium-sized accounting firm. TM Associates wereengaged to audit Ginger Supply Company Ltd. Several staff wereinvolved in the audit, all of whom had attended the firm’s in-house training program in effective auditing methods. Throughout the audit, Hoots spent most of histime 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 summarisation of inventory. Inventory was highly significant to the financial statements, and Hootsknew that the inventory was pledged as collateral to the National Bank for a largeloan. In reviewing Ginger’s inventory count procedures, Hootstold the managing director that hebelieved 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, Hootsagreed to permit the practice if 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, Hootslearned that the worst had happened. Management below the managing director’s 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 locationso it could be counted again to show a higher inventory count and value. The accounting records were inadequate to uncover these illegal transfers. Both GingerSupply Company Ltd and the National Bank sued TrevorHoots& Matthew Smith.

Required:(a)What defenceshould Hoots& Smith use in the action by Ginger?

(b)What defence should Hoots& Smith use in the action by the National Bank?

(c)Is Hootslikely to be successful in hisdefence?

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