$he growing awareness of the responsibilities of public accountants b% users of financial statements. # $he comple(it% of auditing and accounting functions caused b% the increasing size of businesses+ the globalization of business+ and the comple(ities of business operations. $he willingness of ), firms to settle legal problems out of court to avoid costl% legal fees and adverse publicit%+ rather than pursuing resolution through the judicial process.
$he growing awareness of the responsibilities of public accountants b% users of financial statements. # $he comple(it% of auditing and accounting functions caused b% the increasing size of businesses+ the globalization of business+ and the comple(ities of business operations. $he willingness of ), firms to settle legal problems out of court to avoid costl% legal fees and adverse publicit%+ rather than pursuing resolution through the judicial process.
$he growing awareness of the responsibilities of public accountants b% users of financial statements. # $he comple(it% of auditing and accounting functions caused b% the increasing size of businesses+ the globalization of business+ and the comple(ities of business operations. $he willingness of ), firms to settle legal problems out of court to avoid costl% legal fees and adverse publicit%+ rather than pursuing resolution through the judicial process.
Learning Objective 5-1 1) Discuss three major factors that have contributed to the recent increase in the number of lawsuits against auditors and the size of awards to plaintiffs. nswer! "ajor factors include! # $he growing awareness of the responsibilities of public accountants b% users of financial statements. # n increased consciousness on the part of the &ecurities and '(change )ommission regarding its responsibilit% for protecting investors* interests. # $he comple(it% of auditing and accounting functions caused b% the increasing size of businesses+ the globalization of business+ and the comple(ities of business operations. # Large civil court judgments against ), firms. # $he tendenc% of societ% to accept lawsuits b% injured parties against an%one who might be able to provide compensation+ regardless of who was at fault+ coupled with joint and several liabilit% doctrine. # $he willingness of ), firms to settle legal problems out of court to avoid costl% legal fees and adverse publicit%+ rather than pursuing resolution through the judicial process. # $he difficult% judges and jurors have understanding and interpreting technical accounting and auditing matters. # $he global recession and tough economic times result in business failures+ which prompt sta-eholders to see- restitution from others+ including e(ternal auditors. $erms! "ajor factors that have contributed to the recent increase in the number of lawsuits against auditors Diff! "oderate Objective! LO 5-1 )&.! /eflective thin-ing s-ills Learning Objective 5-0 1) 1n) 22222222 failure occurs when an auditor issues an erroneous opinion because it failed to compl% with re3uirements of auditing standards. ) business .) audit )) ethics D) process nswer! . $erms! 4ailure which occurs when an auditor issues an erroneous opinion Diff! 'as% Objective! LO 5-0 )&.! /eflective thin-ing s-ills 1 )op%right 5 0617 ,earson 'ducation+ 8nc. 0) $he e(pectation gap! ) e(ists between the auditor and the &'). .) e(ists because auditors guarantee the accurac% of the financial statements. )) often results in unwarranted lawsuits against the auditor. D) is a legal concept supported b% the federal courts. nswer! ) $erms! '(pectation gap Diff! "oderate Objective! LO 5-0 )&.! /eflective thin-ing s-ills 9) Distinguish between what is meant b% business failure and audit failure. nswer! .usiness failure occurs when a business is unable to repa% its lenders or meet e(pectations of its investors because of economic or business conditions+ such as recession+ poor management decisions+ or une(pected competition in the industr%. udit failure occurs when the auditor issues an incorrect audit opinion because it failed to compl% with the re3uirements of auditing standards. $erms! .usiness failure and audit failure Diff! 'as% Objective! LO 5-0 )&.! /eflective thin-ing s-ills 7) udit ris- is the ris- there will be an audit failure for a given audit engagement. ) $rue .) 4alse nswer! . $erms! udit ris- Diff! "oderate Objective! LO 5-0 )&.! /eflective thin-ing s-ills 5) $he term :audit failure: refers to the situation when the auditor has followed auditing standards %et still fails to discover that the client*s financial statements are materiall% misstated. ) $rue .) 4alse nswer! . $erms! udit failure; 4ollowed audit standards and fail to discover material misstatement Diff! "oderate Objective! LO 5-0 )&.! /eflective thin-ing s-ills 0 )op%right 5 0617 ,earson 'ducation+ 8nc. Learning Objective 5-9 1) 8n the performance of an audit+ a ),! ) is legall% liable for detecting an immaterial client fraud. .) must strictl% follow <, for privatel% held clients. )) must e(ercise constructive professional care in the performance of their audit responsibilities. D) must e(ercise due professional care in the performance of their audit responsibilities. nswer! D $erms! ,erformance of an audit Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 0) 8f an auditor fails to fulfill a certain re3uirement in the contract+ the% ma% be guilt% of! ) contract fraud. .) breach of contract. )) constructive fraud. D) criminal neglect. nswer! . $erms! Liabilit% when auditors fail to e(ercise due care Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 9) /ec-lessness in the case of an audit is present if the auditor -new an ade3uate audit was not done but still issued an opinion+ even though there was no intent to deceive financial statement users. $his description is the legal term for! ) ordinar% negligence. .) gross negligence. )) constructive fraud. D) fraud. nswer! ) $erms! Legal term for rec-less in an audit with not intent to deceive Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 9 )op%right 5 0617 ,earson 'ducation+ 8nc. 7) $he standard of due care to which the auditor is e(pected to adhere to in the performance of the audit is referred to as the! ) prudent person concept. .) common law doctrine. )) constructive care concept. D) vigilant person concept. nswer! $erms! &tandard of due care Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 5) uditors ma% be liable to their clients if the% are found guilt% of! ) Ordinar% negligence <ross negligence =es =es .) Ordinar% negligence <ross negligence >o >o )) Ordinar% negligence <ross negligence =es >o D) Ordinar% negligence <ross negligence >o =es nswer! $erms! uditor liabilit% to clients Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills ?) @nder the laws of agenc%+ partners of a ), firm ma% be liable for the wor- of others on whom the% rel%. $his would not include! ) emplo%ees of the ), firm. .) emplo%ees of the audit client. )) other ), firms engaged to do part of the audit wor-. D) specialists emplo%ed b% the ), firm to provide technical advice on the audit. nswer! . $erms! Laws of agenc%. ,artners of ), firm liable for wor- of others on whom the% rel% Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 7 )op%right 5 0617 ,earson 'ducation+ 8nc. A) :bsence of reasonable care that can be e(pected of a person in a set of circumstances: defines! ) pecuniar% negligence. .) gross negligence. )) e(treme negligence. D) ordinar% negligence. nswer! D $erms! bsence of reasonable care Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills B) n e(ample of a breach of contract would li-el% include! ) an auditor*s refusal to return the client*s general ledger boo- until the client paid last %ear*s audit fees. .) a ban-*s claim that an auditor had a dut% to uncover material errors in financial statements that had been relied on in ma-ing a loan. )) a ), firm*s failure to complete an audit on the agreed-upon date because the firm had a bac-log of other wor- which was more lucrative. D) an auditor*s claim that the client staff is un3ualified. nswer! ) $erms! .reach of contract Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills C) ,rivit% of contract e(ists between! ) auditor and the federal government. .) auditor and third parties. )) auditor and client. D) auditor and client attorne%. nswer! ) $erms! ,rivit% of contract Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 5 )op%right 5 0617 ,earson 'ducation+ 8nc. 16) n individual who is not part% to the contract between a ), and the client+ but who is -nown b% both and is intended to receive certain benefits from the contract is -nown as! ) a third part%. .) a common law inheritor. )) a tort. D) a third-part% beneficiar%. nswer! D $erms! 8ndividual who is not a part% to the contract between a ), and client+ but who is -nown Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 11) Laws that have been passed b% the @.&. )ongress and other governmental units are! ) statutor% laws. .) judicial laws. )) federal laws. D) common laws. nswer! $erms! Laws passed through state legislatures Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 10) $he assessment against a defendant of the full loss suffered b% a plaintiff regardless of the e(tent to which other parties shared in the wrongdoing is called! ) separate and proportionate liabilit%. .) shared liabilit%. )) unitar% liabilit%. D) joint and several liabilit%. nswer! D $erms! ssessment against a defendant of the full loss suffered b% a plaintiff Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 19) $he assessment against a defendant of that portion of the damage caused b% the defendant*s negligence is called! ) separate and proportionate liabilit%. .) joint and several liabilit%. )) shared liabilit%. D) unitar% liabilit%. nswer! $erms! ssessment against a defendant of that portion of the damages Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 17) 4raud occurs when! ? )op%right 5 0617 ,earson 'ducation+ 8nc. ) a misstatement is made and there is both -nowledge of its falsit% and the intent to deceive. .) a misstatement is made and there is -nowledge of its falsit% but no intent to deceive. )) the auditor lac-s even slight care in the performance in performing the audit. D) the auditor has an absence of reasonable care in the performance of the audit. nswer! $erms! 4raud and errors Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 15) Dhich of the following most accuratel% describes constructive fraudE ) bsence of reasonable care .) Lac- of slight care )) Fnowledge and intent to deceive D) '(treme or unusual negligence without the intent to deceive nswer! D $erms! Describes constructive fraud Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 1?) Dhich of the following most accuratel% describes fraudE ) bsence of reasonable care .) Lac- of slight care )) Fnowledge and intent to deceive D) '(treme or unusual negligence without the intent to deceive nswer! ) $erms! Describes fraud Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 1A) third-part% beneficiar% is one which! ) has failed to establish legal standing before the court. .) does not have privit% of contract and is un-nown to the contracting parties. )) does not have privit% of contract+ but is -nown to the contracting parties and intended to benefit under the contract. D) ma% establish legal standing before the court after a contract has been consummated. nswer! ) $erms! $hird-part% beneficiar% Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills A )op%right 5 0617 ,earson 'ducation+ 8nc. 1B) 8f the ), negligentl% failed to properl% prepare and file a client*s ta( return+ the ), ma% be liable for! ) the penalties the client owes the 8/&. .) the penalties and interest the client owes. )) the penalties and interest the client owes+ plus the ta( preparation fee the ), charged. D) the penalties and interest+ the ta( preparation fee+ and the amount of ta( that was underpaid. nswer! ) $erms! Liabilit% when a ), negligentl% failed to properl% prepare and file ta( return Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 1C) )onstructive fraud! ) is also -nown as rec-lessness. .) re3uires an intent to deceive. )) involves collusion with the client. D) is also -nown as breach of contract. nswer! $erms! &upport a finding of constructive fraud Diff! "oderate Objective! LO 5-9 )&.! nal%tic s-ills B )op%right 5 0617 ,earson 'ducation+ 8nc. 06) Dhich of the following statements is trueE ) <ross negligence ma% constitute constructive fraud 4raud re3uires the intent to deceive ll fraud should be detected during audit =es =es >o .) <ross negligence ma% constitute constructive fraud 4raud re3uires the intent to deceive ll fraud should be detected during audit >o =es >o )) <ross negligence ma% constitute constructive fraud 4raud re3uires the intent to deceive ll fraud should be detected during audit =es >o =es D) <ross negligence ma% constitute constructive fraud 4raud re3uires the intent to deceive ll fraud should be detected during audit >o >o >o nswer! $erms! <ross negligence+ fraud+ and constructive fraud Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 01) $he laws that have been developed through court decisions are called! ) common laws. .) criminal laws. )) statutor% laws. D) civil laws. nswer! $erms! )ommon law Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills C )op%right 5 0617 ,earson 'ducation+ 8nc. 00) <regor% G Hedric-+ a medium-sized ), firm+ emplo%ed 'lise as a staff accountant. 'lise was negligent while auditing several of the firm*s clients. @nder these circumstances+ which of the following statements is trueE ) 'lise would have no personal liabilit% for negligence. .) <regor% G Hedric- is not liable for 'lise*s negligence because ),s are generall% considered to be independent contractors. )) <regor% G Hedric- would not be liable for 'lise*s negligence if 'lise disobe%ed specific instructions in the performance of the audits. D) <regor% G Hedric- can recover against its insurer on its malpractice polic% even if one of the partners was also negligent in reviewing 'lise*s wor-. nswer! D $erms! uditor negligent while auditing Diff! )hallenging Objective! LO 5-9 )&.! /eflective thin-ing s-ills 09) $he legal term for when an auditor issues an audit opinion+ -nowing that an ade3uate audit was not performed is a! ) breach of contract. .) tort action for negligence. )) constructive fraud. D) fraud. nswer! ) $erms! 4ailure of part% to meet its obligations+ causing injur% to another part% Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 07) Define ordinar% negligence+ gross negligence+ and constructive fraud. nswer! Ordinar% negligence is the absence of reasonable care that can be e(pected of a person is a set of circumstances. 4or auditors+ it is in terms of what other competent auditors would have done in the same situation. <ross negligence is the lac- of even slight care+ tantamount to rec-less behavior+ that can be e(pected of a person in a set of circumstances.
)onstructive fraud is the e(istence of e(treme or unusual negligence even though there was no intent to deceive or to do harm. 8t is also termed rec-less+ in the case of an audit is present if the auditor -new an ade3uate audit was not done but still issued an opinion+ even though there was no intention of deceiving statement users. $erms! Ordinar% negligence+ gross negligence+ and constructive fraud Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 16 )op%right 5 0617 ,earson 'ducation+ 8nc. 05) n important concept in contract law for accountants to understand is the :third-part% beneficiar% doctrine.: '(plain and give an e(ample. nswer! third part% who does not have privit% of contract but is -nown to the contracting parties and is intended to have certain rights and benefits under the contract. '(ample! ban- has a large loan outstanding at the balance sheet date and re3uires an audit as part of the loan agreement. $erms! )ontract law; $hird-part% beneficiar% doctrine Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 0?) Distinguish between constructive fraud and fraud. nswer! )onstructive fraud is the e(istence of e(treme or unusual negligence even though there was no intent to deceive or do harm. 8n contrast+ fraud occurs when a misstatement is made and there is both -nowledge of its falsit% and the intent to deceive. $erms! )onstructive fraud and fraud Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 0A) Distinguish between :joint and several liabilit%: and :separate and proportionate liabilit%.: nswer! @nder joint and several liabilit%+ the defendant can be assessed the full loss suffered b% the plaintiff+ regardless of the e(tent to which other parties shared in the wrongdoing. 8n contrast+ under separate and proportionate liabilit%+ the defendant is assessed that portion of the damage caused b% the defendant*s negligence. $erms! Ioint and several liabilit% and separate and proportionate liabilit% Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 11 )op%right 5 0617 ,earson 'ducation+ 8nc. 0B) "atch seven of the legal terms 1a-j) with the definitions provided below 11-A)! a. )ommon law b. )onstructive fraud c. .reach of contract d. Ioint and several liabilit% e. Ordinar% negligence f. $hird-part% beneficiar% g. <ross negligence h. &tatutor% law i. 4raud j. &eparate and proportionate liabilit% 22222222 1. Laws that have been passed b% the @.&. )ongress and other governmental units. 22222222 0. bsence of reasonable care that can be e(pected of a person in a set of circumstances. 22222222 9. Lac- of even slight care+ tantamount to rec-less behavior that can be e(pected of a person. 22222222 7. $he assessment against a defendant of that portion of the damage caused b% the defendant*s negligence. 22222222 5. 4ailure of one or both parties in a contract to fulfill the re3uirements of the contract. 22222222 ?. $he assessment against a defendant of the full loss suffered b% a plaintiff regardless of the e(tent to which other parties shared in the wrongdoing. 22222222 A. '(istence of e(treme or unusual negligence even though there was no intent to deceive or do harm; also termed rec-lessness. nswer! 1. h 0. e 9. g 7. j 5. c ?. d A. b $erms! )onstructive fraud; .reach of contract; Ioint and several liabilit%; &eparate and proportionate liabilit%; <ross negligence; Ordinar% negligence; &tatutor% law Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 10 )op%right 5 0617 ,earson 'ducation+ 8nc. 0C) $he standard of due care to which the auditor is e(pected to be held is referred to as the prudent person concept. ) $rue .) 4alse nswer! $erms! &tandard of due care; ,rudent person concept Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 96) 8n a ), firm operating as a limited liabilit% partnership 1LL,)+ the liabilit% for one partner*s actions does not e(tend to another partner*s personal assets. ) $rue .) 4alse nswer! $erms! ), firm operating as a limited liabilit% partnership Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 91) 8n a ), firm operating as a limited liabilit% partnership 1LL,)+ the liabilit% for one partner*s actions e(tends to the firm*s assets. ) $rue .) 4alse nswer! $erms! ), firm operating as a limited liabilit% partnership Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 90) &tatutor% laws are laws that have been developed through court decisions rather than through the @.&. )ongress and other governmental units. ) $rue .) 4alse nswer! . $erms! &tatutor% laws Diff! 'as% Objective! LO 5-9 )&.! /eflective thin-ing s-ills 19 )op%right 5 0617 ,earson 'ducation+ 8nc. 99) $he doctrine of joint and several liabilit% is one factor that has contributed to the recent increase in the number of lawsuits against auditors and the size of awards to plaintiffs. ) $rue .) 4alse nswer! $erms! Doctrine of joint and several liabilit%; )ontributed to increase in lawsuits Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 97) &everal states have statutes that permit privileged communication between the client and auditor+ allowing a ), to refuse to testif% in state and federal courts. ) $rue .) 4alse nswer! . $erms! ), and privileged communication Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills 95) <ross negligence is the e(istence of e(treme or unusual negligence with the intent to deceive. ) $rue .) 4alse nswer! . $erms! <ross negligence; '(treme or unusual negligence; 8ntent to deceive Diff! "oderate Objective! LO 5-9 )&.! /eflective thin-ing s-ills Learning Objective 5-7 1) $he principal issue in cases involving alleged negligence is usuall%! ) if an an engagement letter was issued. .) the level of care re3uired. )) if fraud was committed b% upper-level management. D) whether the auditor is liable under civil or criminal laws. nswer! . $erms! Level of care; >egligence Diff! 'as% Objective! LO 5-7 )&.! /eflective thin-ing s-ills 17 )op%right 5 0617 ,earson 'ducation+ 8nc. 0) 8n third-part% suits+ which of the auditor*s defenses contends no implied or e(pressed contractE ) Lac- of dut% .) >on-negligent performance )) )ontributor% negligence D) bsence of causal connections nswer! $erms! $hird-part% suits; uditor defenses contends lac- of privit% contract Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 9) 8n connection with the audit of financial statements+ an independent auditor could be responsible for failure to detect a material fraud if! ) statistical sampling techni3ues were not used on the audit engagement. .) the auditor planned the audit in a negligent manner. )) accountants performing important parts of the wor- failed to discover a close relationship between the treasurer and the cashier. D) the fraud was perpetrated b% one emplo%ee who circumvented the e(isting internal controls. nswer! . $erms! 8ndependent auditor could be responsible for failure to detect material fraud Diff! 'as% Objective! LO 5-7 )&.! /eflective thin-ing s-ills 7) Dhich of the following is an illustration of liabilit% to clients under common lawE ) )lient sues auditor for not discovering a theft of assets b% an emplo%ee. .) .an- sues auditor for not discovering that borrower*s financial statements are misstated. )) )ombined group of stoc-holders sue auditor for not discovering materiall% misstated financial statements. D) $he federal government prosecutes the auditor for -nowingl% issuing an incorrect audit report. nswer! $erms! Liabilit% to clients under common law Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 15 )op%right 5 0617 ,earson 'ducation+ 8nc. 5) Dhich of the following is an illustration of liabilit% under the federal securities actsE ) client sues the auditor for not discovering a theft of assets b% an emplo%ee. .) ban- sues the auditor for not discovering that the borrower*s financial statements are misstated. )) combined group of stoc-holders sues the auditor for not discovering materiall% misstated financial statements. D) $he auditor sues a client for not cooperating during the engagement. nswer! ) $erms! Liabilit% under federal securities acts Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills ?) ), firm normall% uses one or a combination of four defenses when there are legal claims b% clients. Dhich one of the following is generall% not a defenseE ) Lac- of dut% .) >onnegligent performance )) )ontributor% negligence D) 4oreseeable users nswer! D $erms! Defenses when there are legal claims Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills A) $ort actions against ),s are more common than breach of contract actions because! ) there are more torts than contracts. .) the burden of proof is on the auditor rather than on the person suing. )) the person suing need prove onl% negligence. D) the amounts recoverable are normall% larger. nswer! D $erms! $ort actions against ),s are more common than breach of contract Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills B) $he principal issue to be resolved in cases involving alleged negligence is usuall%! ) the amount of the damages suffered b% plaintiff. .) whether to impose punitive damages on defendant. )) the level of care e(ercised b% the ),. D) whether defendant was involved in fraud. nswer! ) $erms! ,rincipal issue to be resolved in cases involving alleged negligence Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 1? )op%right 5 0617 ,earson 'ducation+ 8nc. C) 8n the auditing environment+ failure to meet auditing standards is often! ) an accepted practice. .) a suggestion of negligence. )) conclusive evidence of negligence. D) tantamount to criminal behavior. nswer! ) $erms! 4ailure to meet auditing standards Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 16) common wa% for a ), firm to demonstrate a lac- of dut% to perform is b% use of a1n)! ) e(pert witness* testimon%. .) engagement letter. )) management representation letter. D) confirmation letter. nswer! . $erms! )ommon wa% to demonstrate lac- of dut% to perform Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 11) $o succeed in an action against the auditor+ the client must be able to show that! ) the auditor was fraudulent. .) the auditor was grossl% negligent. )) there was a written contract. D) there is a close causal connection between the auditor*s behavior and the damages suffered b% the client. nswer! D $erms! $o succeed in an action against the auditor+ client must show that Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 10) "atthews G )o.+ ),s+ issued an un3ualified opinion on Dodgers )orporation. "illennium .an-+ which relied on the audited financial statements+ granted a loan of J066+66+666 to Dodgers )orporation. Dodgers subse3uentl% defaulted on the loan. $o succeed in an action against "atthews G )o.+ "illennium .an- must prove that the ban- was! ) in privit% of contract with Dodgers. .) in privit% of contract with "illennium. )) free from contributor% negligence. D) justified in rel%ing on the financial statements in granting the loan. nswer! D $erms! Legal action where ban- relied audited financial statements+ granted loan on which customer defaulted Diff! )hallenging Objective! LO 5-7 )&.! nal%tic s-ills 1A )op%right 5 0617 ,earson 'ducation+ 8nc. 19) One of the changes in auditing procedure which was brought about as a result of the 119? $enants case was that auditors were encouraged to begin using! ) letters of representation. .) confirmation letters. )) engagement letters. D) billet dou( letters. nswer! ) $erms! udit procedure brought about b% 119? $enants case Diff! )hallenging Objective! LO 5-7 )&.! /eflective thin-ing s-ills 17) $he Fing &uret% )ompan% wrote a general fidelit% bond covering thefts of assets b% the emplo%ees of Dilson+ 8nc. $hereafter+ )oone%+ an emplo%ee of Dilson+ embezzled J1A+066 of compan% funds. Dhen the activities were discovered+ Fing paid Dilson the full amount in accordance with the terms of the fidelit% bond+ and then sought recover% against Dilson*s auditors+ L%nch G "erritt+ ),s. Dhich of the following would be L%nch G "erritt*s best defenseE ) Fing is not in privit% of contract. .) $he shortages were the result of clever forgeries and collusive fraud which would not be detected b% an e(amination made in accordance with generall% accepted auditing standards. )) L%nch G "erritt were not guilt% either of gross negligence or fraud. D) L%nch G "erritt were not aware of the Fing-Dilson suret% relationship. nswer! . $erms! Defense in recover% against auditors with emplo%ee theft Diff! )hallenging Objective! LO 5-7 )&.! nal%tic s-ills 15) $here are four major sources of an auditor*s legal liabilit%. One source is liabilit% to the audit client. List the other three sources. nswer! $he other three sources of auditor*s legal liabilit% are! # Liabilit% to third parties under common law. # )ivil liabilit% under federal securities laws. # )riminal liabilit%. $erms! &ources of auditor*s legal liabilit% Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 1B )op%right 5 0617 ,earson 'ducation+ 8nc. 1?) Discuss each of the four defenses a ), firm can normall% use when facing legal claims b% clients. Dhich of these defenses is ordinaril% not available against third-part% suitsE nswer! Lack of duty. $he ), firm claims that there was no implied or e(pressed contract. Non-negligent performance. $he ), firm claims that the audit was performed in accordance with auditing standards.
Contributory negligence. $he ), firm claims that the client*s own actions resulted in the loss that is the basis for the damages+ or interfered with the conduct of the audit in such a wa% that prevented that auditor from discovering the cause of the loss. $his defense is not available in third-part% suits. Absence of causal connection. $he ), firm claims that the auditor*s failure to follow auditing standards did not cause the damages suffered b% the client. $erms! 4our defenses a ), firm can normall% use when facing legal claims b% clients Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 1A) n e(ample of auditor legal liabilit% to third parties under common law would be the federal government prosecuting an auditor for -nowingl% issuing an incorrect audit report. ) $rue .) 4alse nswer! . $erms! Legal liabilit% to third parties under common law Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 1B) $he 1136 Tenants case was a criminal case concerning a ),*s failure to uncover fraud during a financial statement audit. ) $rue .) 4alse nswer! . $erms! 119? $enants case Diff! "oderate Objective! LO 5-7 )&.! /eflective thin-ing s-ills 1C) "an% litigation e(perts believe that a well written engagement letter significantl% reduces the li-elihood of adverse legal actions. ) $rue .) 4alse nswer! $erms! 'ngagement letter Diff! 'as% Objective! LO 5-7 )&.! /eflective thin-ing s-ills 1C )op%right 5 0617 ,earson 'ducation+ 8nc. Learning Objective 5-5 1) financial institution sues the audit firm for failure to discover that a borrower*s financial statements are materiall% misstated. $his is an e(ample of which of the following legal liabilit% conceptsE ) Liabilit% to clients .) Liabilit% to third parties under common law )) )ivil liabilit% under federal securities law D) )riminal liabilit% nswer! . $erms! Legal liabilit% in audit of financial statements that are materiall% misstated Diff! 'as% Objective! LO 5-5 )&.! /eflective thin-ing s-ills 0) Dhich of the following auditor*s defenses usuall% means nonreliance on the financial statements b% the userE ) Lac- of dut% .) >onnegligent performance )) bsence of causal connections D) )ontributor% negligence nswer! ) $erms! uditor defenses which means non-reliance on the financial statements Diff! 'as% Objective! LO 5-5 )&.! nal%tic s-ills 06 )op%right 5 0617 ,earson 'ducation+ 8nc. 9) group t%picall% included as :third parties: in common law is! ) ctual and potential stoc-holders 'mplo%ees of client =es =es .) ctual and potential stoc-holders 'mplo%ees of client >o >o )) ctual and potential stoc-holders 'mplo%ees of client =es >o D) ctual and potential stoc-holders 'mplo%ees of client >o =es nswer! $erms! $hird-parties in common law Diff! "oderate Objective! LO 5-5 )&.! /eflective thin-ing s-ills 7) $he major conclusion of the 1C91 Ultramares case was that! ) ordinar% negligence is insufficient for liabilit% to third parties. .) third parties must file criminal charges+ not civil charges+ against the auditor. )) fraud or gross negligence is sufficient for liabilit% to third parties. D) auditors have no liabilities to third parties. nswer! $erms! "ajor conclusion of 1C91 @ltramares case Diff! "oderate Objective! LO 5-5 )&.! /eflective thin-ing s-ills 01 )op%right 5 0617 ,earson 'ducation+ 8nc. 5) @nder common law+ a foreseen user would be treated the same as! ) primar% beneficiar% -nown third part% =es =es .) primar% beneficiar% -nown third part% >o >o )) primar% beneficiar% -nown third part% =es >o D) primar% beneficiar% -nown third part% >o =es nswer! $erms! 4oreseen user under common law treated the same as Diff! "oderate Objective! LO 5-5 )&.! /eflective thin-ing s-ills ?) broad interpretation of the rights of third-part% beneficiaries holds that users that the auditor should have been able to foresee as being li-el% users of financial statements have the same rights as those with privit% of contract. $his is -nown as the concept of! ) foreseen users. .) foreseeable users. )) e(pected users. D) four-part% contracts. nswer! . $erms! /ights of third-part% beneficiaries; ,rivit% of contract Diff! "oderate Objective! LO 5-5 )&.! /eflective thin-ing s-ills A) Dhich of the auditor*s defenses is ordinaril% not available when lawsuits are filed b% a third part%E ) bsence of causal connections .) )ontributor% negligence )) >on-negligent performance D) Lac- of dut% nswer! . $erms! uditor defenses not available when lawsuits filed b% a third part% Diff! "oderate Objective! LO 5-5 )&.! /eflective thin-ing s-ills 00 )op%right 5 0617 ,earson 'ducation+ 8nc. B) ccording to the principle established b% the estatement of Torts case+ foreseen users must be members of! ) an% potential user group. .) a legall% protected class. )) a reasonabl% limited and identifiable user group. D) a reasonabl% limited and established user group. nswer! ) $erms! ,rinciple established b% /estatement of $orts; 4oreseen users must be members Diff! "oderate Objective! LO 5-5 )&.! /eflective thin-ing s-ills C) 8n an action against a ), in a jurisdiction that follows the @ltramares doctrine+ lac- of privit% is a viable defense provided the plaintiff! ) is the client*s creditor who sued the ), for negligence. .) can prove gross negligence. )) violated the &ecurities ct of 1C99. D) violated the &ecurities ct of 1C97. nswer! $erms! @ltramares doctrine; Lac- of privit% is viable defense Diff! "oderate Objective! LO 5-5 )&.! /eflective thin-ing s-ills 16) @nder common law+ an individual or compan% that 11) does not have a contract with an auditor+ 10) is -nown b% the auditor in advance of the audit+ and 19) will use the auditor*s report to ma-e decisions about the client compan% has! ) no rights unless an auditor is grossl% negligent. .) no rights unless an auditor is fraudulent. )) no rights against an auditor. D) the same rights against an auditor as a client. nswer! D $erms! )ommon law third-part% rights Diff! )hallenging Objective! LO 5-5 )&.! nal%tic s-ills 09 )op%right 5 0617 ,earson 'ducation+ 8nc. 11) $he basic legal concept which was affirmed in the 1CB5 >ew =or- case+ Credit Alliance+ was that! ) the auditor*s defense of privit% of contract is still valid against third parties. .) the auditor is liable for ordinar% negligence to specificall% foreseen third parties. )) the auditor is liable for ordinar% negligence to reasonabl% foreseeable third parties. D) the auditor*s defense of contributor% negligence is no longer valid. nswer! $erms! .asic legal concept affirmed in 1CB5 case+ )redit lliance Diff! )hallenging Objective! LO 5-5 )&.! nal%tic s-ills 10) s a conse3uence of his failure to adhere to generall% accepted auditing standards in the course of his e(amination of the Lamp )orp.+ Harrison+ ),+ did not detect the embezzlement of a material amount of funds b% the compan%*s controller. s a matter of common law+ to what e(tent would Harrison be liable to the Lamp )orp. for losses attributable to the theftE ) He would have no liabilit%+ since the ordinar% e(amination cannot be relied upon to detect thefts of assets b% emplo%ees. .) He would have no liabilit% because privit% of contract is lac-ing. )) He would be liable for losses attributable to his negligence. D) He would be liable onl% if it could be proven that he was grossl% negligent. nswer! ) $erms! @nder common law+ e(tent of liabilit% where auditor failed to adhere to generall% accepted auditing standards in e(amination of client and failed to detect emplo%ee embezzlement Diff! )hallenging Objective! LO 5-5 )&.! nal%tic s-ills 19) $he preferred defense in third part% suits is! ) lac- of dut% to perform. .) nonnegligent performance. )) absence of causal connection. D) client fraud. nswer! . $erms! ,referred defense in third-part% suits Diff! "oderate Objective! LO 5-5 )&.! /eflective thin-ing s-ills 07 )op%right 5 0617 ,earson 'ducation+ 8nc. 17) $hree approaches to the application of the foreseen users* concept are 11) the )redit Alliance approach+ 10) the restatement of torts approach+ and 19) the foreseeable user approach. &ummarize each of these three approaches. nswer! $he Credit Alliance approach upholds the concept of privit% of contract established b% the Ultramares Corporation !. Touc"e case. @nder this approach+ for an auditor to be liable to third parties+ the auditor 11) must -now and intend that the wor- product would be used b% the third-part% for a specific purpose+ and 10) the -nowledge and intent must be evidenced b% the auditor*s conduct. @nder the restatement of torts approach+ foreseen users must be members of a reasonabl% limited and identifiable group of users that have relied on the ),*s wor-+ such as creditors+ even though those persons were not specificall% -nown to the ), at the time the wor- was done. @nder the foreseeable user approach+ an% users that the auditor should have reasonabl% been able to foresee as li-el% users of the client*s financial statements have the same rights as those with privit% of contract. $erms! $hree approaches to the application of foreseen users* concepts; )redit lliance approach; /estatement of torts approach; foreseeable user approach Diff! )hallenging Objective! LO 5-5 )&.! /eflective thin-ing s-ills 15) lthough there is confusion caused b% the differing views of liabilit% to third parties under common law+ the movement is clearl% awa% from the foreseeable user approach. ) $rue .) 4alse nswer! $erms! )redit lliance approach; /estatement of torts approach; 4oreseeable user approach Diff! "oderate Objective! LO 5-5 )&.! /eflective thin-ing s-ills 1?) $he restatement of torts approach to the concept of foreseen users states that an% users that the auditor should have reasonabl% been able to foresee as being li-el% users of financial statements have the same rights as those with privit% of contract. ) $rue .) 4alse nswer! . $erms! /estatement of torts approach; 4oreseen users; ,rivit% of contract Diff! )hallenging Objective! LO 5-5 )&.! /eflective thin-ing s-ills 05 )op%right 5 0617 ,earson 'ducation+ 8nc. 1A) $he Credit Alliance approach to the concept of foreseen users states that to be liable to third parties+ an auditor 11) must -now and intend that the wor- product would be used b% the third- part% for a specific purpose+ and 10) the -nowledge and intent must be evidenced b% the auditor*s conduct. ) $rue .) 4alse nswer! $erms! )redit lliance approach; 4oreseen users; Liabilit% to third parties Diff! )hallenging Objective! LO 5-5 )&.! /eflective thin-ing s-ills Learning Objective 5-? 1) n ade3uate s%stem of internal control for &') registrants was originall% re3uired b% the! ) &arbanes-O(le% ct of 0660. .) &ecurities ct of 1C99. )) 4oreign )orrupt ,ractices ct of 1CAA. D) &ecurities ct of 1C97. nswer! ) $erms! /e3uired an ade3uate s%stem of internal control for &') registrants Diff! 'as% Objective! LO 5-? )&.! /eflective thin-ing s-ills 0? )op%right 5 0617 ,earson 'ducation+ 8nc. 0) $he increased litigation under the federal securities laws has resulted from! ) $he availabilit% of class- action litigation $he strict liabilit% standards imposed on ),s b% the securities laws n e(cess of attorne%s =es =es =es .) $he availabilit% of class- action litigation $he strict liabilit% standards imposed on ),s b% the securities laws n e(cess of attorne%s =es >o >o )) $he availabilit% of class- action litigation $he strict liabilit% standards imposed on ),s b% the securities laws n e(cess of attorne%s =es =es >o D) $he availabilit% of class- action litigation $he strict liabilit% standards imposed on ),s b% the securities laws n e(cess of attorne%s >o >o >o nswer! ) $erms! 8ncreased litigation under federal securities law resulted from Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 9) @nder the &ecurities ct of 1C99+ the auditor*s responsibilit% for ma-ing sure the financial statements were fairl% stated e(tends to! ) the date of the financial statements. .) the date the registration statement becomes effective. )) the date of the audit report. D) one %ear be%ond the date of the financial statements. nswer! . $erms! &ecurities ct of 1C99; uditor responsibilit% for ma-ing sure financial statements were fairl% stated e(tends Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 0A )op%right 5 0617 ,earson 'ducation+ 8nc. 7) @nder the &ecurities '(change ct of 1C97+ which t%pe of organization is re3uired to submit audited financial statements to the &')E ) 'ver% compan% with securities traded on national and over-the-counter e(changes .) 'ver% corporation )) 'ver% compan% issuing new securities D) 'ver% corporation which is chartered b% a state government nswer! $erms! &ecurities ct of 1C97; Organizations re3uired to submit audited financial statements Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 5) $he &ecurities and '(change )ommission can impose all but which of the following sanctionsE ) &uspend a ), from auditing &') clients. .) ,rohibit a ), from accepting new &') clients for a period of time. )) /e3uire a ), to participate in continuing-education programs and ma-e changes in their practice. D) /evo-e a ), license. nswer! D $erms! &ecurities and '(change )ommission can impose sanctions Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills ?) $he 4oreign )orrupt ,ractices ct 14),) of 1CAA! ) re3uires auditors to review and evaluate s%stems of internal control as a part of an audit. .) re3uires &') registrants to maintain a reasonabl% complete and accurate set of records and an ade3uate s%stem of internal control. )) re3uires auditors to review client*s internal control s%stem in a manner which is thorough enough to judge whether client meets the re3uirements of the 4),. D) re3uires auditors to file a report with the &') if client*s internal control s%stem is inade3uate. nswer! . $erms! 4oreign )orrupt ,ractices ct of 1CAA Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 0B )op%right 5 0617 ,earson 'ducation+ 8nc. A) Dhile the 4oreign )orrupt ,ractices ct of 1CAA remains in effect+ its internal control provisions have been largel% superseded b% which of the followingE ) $he &arbanes-O(le% ct of 0660 .) $he /ac-eteer 8nfluenced and )orrupt Organization ct )) $he 4ederal 4alse &tatements &tatute D) $he 4ederal "ail 4raud &tatute nswer! $erms! 4oreign )orrupt ,ractices ct of 1CAA; 8nternal control provisions Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills $opic! &OK B) Dhich of the following is an accurate statement regarding recent actions brought against accountants b% clients and third partiesE ) Litigants will first see- state remedies because of the availabilit% of class-action litigation. .) <ross negligence b% the auditor must be proven under the &ecurities cts of 1C99 and 1C97. )) $he greatest growth in ), liabilit% litigation bas been under the federal securities laws. D) $he amount of damages that plaintiffs can receive is greater under common law than under the federal securities laws. nswer! ) $erms! 4actor in increase in number of lawsuits and sizes of awards Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills C) major purpose of federal securities regulations is to! ) provide sufficient reliable information to the investing public who purchase securities in the mar-etplace. .) establish the 3ualifications for accountants who are members of the profession. )) eliminate incompetent attorne%s and accountants who participate in the registration of securities to be offered to the public. D) provide a set of uniform standards and tests for accountants+ attorne%s+ and others who practice before the &ecurities and '(change )ommission. nswer! $erms! "ajor purpose of federal securities regulations Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 0C )op%right 5 0617 ,earson 'ducation+ 8nc. 16) $he 0610 news of a massive alleged briber% scheme involving Dal-"art has brought charges against the compan% under the! ) &ecurities ct of 1C99. .) &ecurities ct of 1C97. )) 4oreign )orrupt ,ractices ct of 1CAA. D) &arbanes-O(le% ct of 0660 nswer! ) $erms! 4oreign )orrupt ,ractices ct of 1CAA Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 11) Dhich of the following statements about the &ecurities ct of 1C99 is not trueE ) third part% that purchased securities described in the registration statement ma% sue the auditor for material misrepresentations or omissions in the audited financial statements. .) third part% user does not have the burden of proof that heLshe relied on the financial statements. )) third part% user has the burden of proof that the auditor was either negligent or fraudulent in doing the audit. D) third part% user does not have the burden of proof that the loss was caused b% the misleading statements. nswer! ) $erms! &ecurities ct of 1C99 Diff! )hallenging Objective! LO 5-? )&.! nal%tic s-ills 10) $he most significant audit issue that came as a result of the court decision in the #scott et al. !. $ar C"ris Construction Corporation case in 1C?B was! ) the court*s reaffirmation that the burden of proof was on the plaintiff to prove the auditor was negligent. .) the affirmation of the increased auditor*s responsibilit% when performing an &-1 review+ a review of events subse3uent to the balance sheet+ for registration statements. )) the increased auditor responsibilit% when associated with unaudited financial statements. D) the court*s refusal to allow the percentage-of-completion method of accounting for revenues. nswer! . $erms! &ignificant audit issue from 'scott et al v. .ar )hris )onstruction )orporation case in 1C?B Diff! )hallenging Objective! LO 5-? )&.! /eflective thin-ing s-ills 96 )op%right 5 0617 ,earson 'ducation+ 8nc. 19) @nder the federal securities acts+ one significant result occurring directl% due to the #scott et al. !. $ar C"ris Construction Corporation case was that && was changed to re3uire! ) greater emphasis on subse3uent events procedures. .) new standards for unaudited statements. )) a broader definition of third part% beneficiaries. D) more companies to file annual reports with the &'). nswer! $erms! &ignificant result from 'scott et al v. .ar )hris )onstruction )orporation case Diff! )hallenging Objective! LO 5-? )&.! /eflective thin-ing s-ills 17) @nder the &ecurities '(change ct of 1C97+ most of the litigation against the auditor has been generated because of the auditor*s involvement with the! ) B-F form. .) 16-F form. )) 16-M form. D) &-1 form. nswer! . $erms! &ecurities '(change ct of 1C97 Diff! )hallenging Objective! LO 5-? )&.! /eflective thin-ing s-ills 15) &ection 16 and /ule 16b-5 of the &ecurities '(change ct of 1C97 are often referred to as! ) the antifraud provisions. .) the new issues provisions. )) the full emplo%ment act for accountants. D) the /8)O provisions. nswer! $erms! &ecurities '(change ct of 1C97 &ection 16 and /ule 16b-5 Diff! )hallenging Objective! LO 5-? )&.! /eflective thin-ing s-ills 91 )op%right 5 0617 ,earson 'ducation+ 8nc. 1?) 8n a leading securities law and ), liabilities case+ the @.&. &upreme )ourt ruled in 1CA? in %oc"felder v. #rnst & #rnst that before ),s could be held liable for /ule 16b-5 of the &ecurities '(change ct of 1C97+ what would be re3uired to be shown to the court was the auditor*s! ) ordinar% negligence. .) gross negligence. )) -nowledge and intent to deceive. D) financial gain at the e(pense of the plaintiff. nswer! ) $erms! &ecurities '(change ct of 1C97 /ule 16b-5; @.&. &upreme )ourt ruled in 1CA? in Hochfelder v. 'rnst G 'rnst Diff! )hallenging Objective! LO 5-? )&.! /eflective thin-ing s-ills 1A) @nder the &ecurities ct of 1C99! ) an% part% who relies on the compan%*s audited financial statements can recover from the auditors. .) third-part% users must prove that the auditor was negligent. )) the burden of proof is on the defendant. D) auditors face potential legal e(posure for information contained in the 4orm 16-M. nswer! ) $erms! &ecurities and '(change )ommission Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 1B) $he partnership of .ooth G Ha%nes+ ),s+ has been engaged to e(amine the financial statements of ,aul+ 8nc.+ in connection with the registration of ,aul*s securities with the &ecurities and '(change )ommission. @nder these circumstances+ which of the following statements is trueE ) .ooth G Ha%nes is assuming much greater third-part% liabilit% than it assumes on engagements under common law. .) 8f its e(amination is not fraudulent+ .ooth G Ha%nes ma% issue an appropriate disclaimer to the financial statements and thereb% avoid liabilit%. )) .ooth G Ha%nes must incorporate if the% wish to practice before the &'). D) .ooth G Ha%nes must be a large interstate firm if the% wish to practice before the &'). nswer! $erms! ),s engaged to e(amine financial statements in connection with registration of securities with the &ecurities and '(change )ommission Diff! "oderate Objective! LO 5-? )&.! nal%tic s-ills 90 )op%right 5 0617 ,earson 'ducation+ 8nc. 1C) Discuss the sanctions the &ecurities and '(change )ommission can impose on auditors. nswer! $he &') has the power in certain circumstances to sanction or suspend practitioners from doing audits for &') companies. $he &')*s /ules of ,ractice permit them to temporaril% or permanentl% den% a ), or ), firm from being associated with financial statements of public companies+ either because of lac- of appropriate 3ualifications or having engaged in unethical or improper professional conduct. 8n recent %ears+ the &') has temporaril% suspended a number of individual ),s from doing an% audits of &') clients. 8t has also prohibited a number of ), firms from accepting an% new &') clients for a period. 8n some cases+ the &') has re3uired an e(tensive review of a major ), firm*s practices b% another ), firm+ or made ), firms ma-e changes in their practices. 8ndividual ),s and their firms have also been re3uired to participate in continuing education programs. &anctions such as these are published b% the &') and are often reported in the business press+ ma-ing them a significant embarrassment to those involved. $erms! &anctions the &ecurities and '(change )ommission can impose on auditors Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 06) One result from the #scott et al. !. $ar C"ris case was a greater emphasis being placed on audit staff understanding the client*s business and industr%. ) $rue .) 4alse nswer! $erms! /esult from 'scott et al. v. .ar )hris Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 01) $he onl% parties who can recover from auditors under the &ecurities ct of 1C99 are original purchasers of securities. ) $rue .) 4alse nswer! $erms! &ecurities ct of 1C99 Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 99 )op%right 5 0617 ,earson 'ducation+ 8nc. 00) @nder the &ecurities ct of 1C99+ a third part% plaintiff does not have the burden of proof that he or she relied on the financial statements or that the auditor was negligent or fraudulent in doing the audit. /ather+ the plaintiff need onl% prove that the audited financial statements contained a material misrepresentation or omission. ) $rue .) 4alse nswer! $erms! &ecurities ct of 1C99; .urden of proof Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 09) )ompanies with securities traded on national and over-the-counter e(changes are re3uired to submit audited financial statements once ever% three %ears to the &ecurities and '(change )ommission. ) $rue .) 4alse nswer! . $erms! &ecurities ct )ommission; &ecurities traded on national e(changes Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 07) $he same three defenses available to auditors in common lawsuits b% third parties nonnegligent performance+ lac- of dut%+ and absence of causal connectionNare also available for suits under the &ecurities '(change ct of 1C97. ) $rue .) 4alse nswer! $erms! &ecurities ct of 1C97; Defenses available to auditors in common law suits b% third parties Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 05) $he @nited &tates &upreme )ourt has ruled that outside professionals such as accountants who don*t help run corrupt businesses cannot be sued under the provisions of the 4oreign )orrupt ,ractices ct. ) $rue .) 4alse nswer! . $erms! @nited &tates &upreme )ourt; 4oreign )orrupt ,ractices ct Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills 97 )op%right 5 0617 ,earson 'ducation+ 8nc. 0?) $he &arbanes-O(le% ct re3uires the )'O and )4O of a public compan% to certif% the annual and 3uarterl% financial statements filed with the ,)O.. ) $rue .) 4alse nswer! . $erms! &arbanes-O(le% ct Diff! "oderate Objective! LO 5-? )&.! /eflective thin-ing s-ills Learning Objective 5-A 1) 8n which case were auditors prosecuted for filing false financial statements for a client with the governmentE ) United 'tates !. Natelli .) United 'tates !. 'imon )) #scott et al. !. $ar C"ris D) #'( )o!ernment 'ecurities !. Ale*ander )rant & Co. nswer! . $erms! )ase where auditors were prosecuted for filing false financial statements Diff! "oderate Objective! LO 5-A )&.! /eflective thin-ing s-ills 0) ), is subject to criminal liabilit% if the ),! ) refuses to turn over re3uested audit documentation to a client. .) performs an audit in a negligent manner. )) is -nowingl% involved with false financial statements. D) willfull% breaches a contract with a client. nswer! ) $erms! ), subject to criminal liabilit% Diff! "oderate Objective! LO 5-A )&.! /eflective thin-ing s-ills 9) )ritical lessons learned after anal%zing major criminal cases against auditors include the fact that! ) the partner+ but not the audit staff+ must be independent. .) transactions with related parties are an indication of fraud. )) an investigation of the integrit% of management is an important part of deciding whether to accept a new client. D) accounting principles can be relied on e(clusivel% in deciding if the financial statements are fairl% presented. nswer! ) $erms! ),s held liable for criminal activit% and federal laws; 8nfamous cases Diff! "oderate Objective! LO 5-A )&.! /eflective thin-ing s-ills 95 )op%right 5 0617 ,earson 'ducation+ 8nc. 7) $he &arbanes-O(le% ct of 0660 ma-es it a felon% to destro% or create documents to impede or obstruct a federal investigation. $hose provisions were adopted following which of the following legal casesE ) United 'tates !. Natelli .) United 'tates !. Andersen )) #'( )o!ernment 'ecurities !. Ale*ander )rant & Co. D) United 'tates !. 'imon nswer! . $erms! &imilarit% between @nited &tates v. >atelli case 1i.e.+ the >ational &tudent "ar-eting case of 1CA5)+ and the '&" <overnment &ecurities v. le(ander <rant G )o. case of 1CB? Diff! "oderate Objective! LO 5-A )&.! nal%tic s-ills 5) ),s can be held liable for criminal activit% under both state and federal laws. 8nfamous cases have involved United 'tates !s. Natelli and #'( )o!ernment 'ecurities !. Ale*ander )rant and Co. Discuss what occurred and prepare a summar% of the court findings. nswer! NatelliNtwo auditors were convicted of criminal liabilit% under the 1C97 act for certif%ing financial statements of >ational &tudent "ar-eting )orporation that contained inade3uate disclosures. #'(Nmanagement revealed to the partner in charge of the audit of '&" that the previous %ear*s financial statements contained a material misstatement. /ather than compl%ing with the profession and firm standards+ the partner agreed to sa% nothing in the hope that management would wor- its wa% out of the problem during the current %ear. $he partner was convicted of criminal charges for his role in sustaining the fraud $erms! ),s held liable for criminal activit% and federal laws; 8nfamous cases Diff! "oderate Objective! LO 5-A )&.! /eflective thin-ing s-ills ?) $he &arbanes-O(le% ct of 0660 ma-es destruction of audit documentation punishable b% up to 16 %ears in prison. ) $rue .) 4alse nswer! . $erms! &arbanes-O(le% ct of 0660; Destruction of audit documentation punishable Diff! )hallenging Objective! LO 5-A )&.! /eflective thin-ing s-ills $opic! &OK 9? )op%right 5 0617 ,earson 'ducation+ 8nc. Learning Objective 5-B 1) Dhich of the following resulted in a federal law passed in 1CC5 that significantl% reduced potential damages in securities-related litigationE ) ,rivate &ecurities Litigation /eform ct .) ,ublic &ecurities Damages and &ettlements ct )) /ac-eteer 8nfluenced and )orrupt Organization ct D) @.&. &ecurities )laims /eform ct nswer! $erms! 4ederal law passed in 1CC5 significantl% reduced potential damages Diff! )hallenging Objective! LO 5-B )&.! /eflective thin-ing s-ills 0) 8n order to protect themselves from legal liabilit%+ it is important that ),s! ) are organized as sole-proprietors. .) accept client representations. )) understand the client*s business. D) use engagement letters+ not representation letters. nswer! ) $erms! ,rotecting individual ),s from legal liabilit% Diff! )hallenging Objective! LO 5-B )&.! /eflective thin-ing s-ills 9) Discuss at least 9 steps the 8), and the accounting profession as a whole can and are ta-ing to reduce the practitioner*s e(posure to lawsuits. nswer! &teps the profession is ta-ing to reduce practitioners* e(posure to lawsuits include! # &et standards and revise them the meet the changing needs of auditing. # Oppose lawsuits. # 'ducate investors and other users of financial statements as to the meaning of the opinion of the auditors and the nature of the auditor*s wor-. # &anction members for improper conduct and performance. # Lobb% for changes in laws. $erms! &teps the 8), and accounting profession ta-ing to reduce practitioner*s e(posure to lawsuits Diff! "oderate Objective! LO 5-B )&.! /eflective thin-ing s-ills 9A )op%right 5 0617 ,earson 'ducation+ 8nc. 7) "atch eight of the following terms 1a-n) with the definitions provided below 11-B)! a. 4oreign )orrupt ,ractices ct b. &ecurities '(change ct of 1C97 c. &ecurities Litigation @niform &tandards ct of 1CCB d. &ecurities ct of 1C99 e. Ultramares doctrine f. udit ris- g. udit failure h. &tandards failure i. .usiness failure j. bsence of causal connection -. )ontributor% negligence l. Lac- of dut% to perform m. ,rivate &ecurities Litigation /eform ct n. >onnegligent performance 22222222 1. situation in which an incorrect audit opinion is issued because it failed to compl% with the re3uirements of auditing standards. 22222222 0. federal statute dealing with companies that trade securities on national and over- the-counter e(changes. uditors are involved because the annual reporting re3uirements include audited financial statements. 22222222 9. n auditor*s legal defense under which the auditor claims that the client*s own actions either resulted in the loss that is the basis for damages or interfered with the conduct of the audit in such a wa% that prevented the auditor from discovering the cause of the loss. 22222222 7. federal statute that ma-es it illegal to offer a bribe to an official of a foreign countr%. 22222222 5. common-law approach to third-part% liabilit% in which ordinar% negligence is insufficient for liabilit% to third parties+ because of the lac- of privit% of contract between the third-part% and the auditor unless the third-part% is a primar% beneficiar%. 22222222 ?. federal statute designed to significantl% reduce the potential damages in federal securities-related litigation b% providing for proportionate liabilit% in most cases. 22222222 A. n auditor*s legal defense under which the auditor claims that the audit was performed in accordance with generall% accepted auditing standards. 22222222 B. n auditor*s legal defense under which the auditor claims that the failure to follow auditing standards did not cause the damages suffered b% the client. 9B )op%right 5 0617 ,earson 'ducation+ 8nc. nswer! 1. g 0. b 9. - 7. a 5. e ?. c A. n B. j $erms! udit failure; &ecurities '(change ct of 1C97; )ontributor% negligence; 4oreign )orrupt ,ractices ct; &ecurities Litigation @niform &tandards ct of 1CCB; @ltramares doctrine; >onnegligent performance; bsence of causal connection Diff! "oderate Objective! LO 5-0+ LO 5-7+ LO 5-5+ LO 5-? and LO 5-B )&.! /eflective thin-ing s-ills 5) Discuss some of the steps individual practicing auditors can ta-e to minimize their legal liabilit%. nswer! $here are man% steps individual practitioners can ta-e to minimize legal liabilit% including! # Deal onl% with clients possessing integrit%. # Hire 3ualified personnel and train and supervise them properl%. # 4ollow the standards of the profession. # "aintain independence. # @nderstand the client*s business. # ,erform 3ualit% audits. # Document the wor- properl%. # Obtain an engagement letter and a representation letter. # "aintain confidential relations. # )arr% ade3uate insurance. # )onsult with e(perienced legal counsel. # )hoose a form of organization that provides some form of legal liabilit% protection to owners. # '(ercise professional s-epticism. $erms! &teps auditors can ta-e to minimize legal liabilit% Diff! 'as% Objective! LO 5-9 and LO 5-B )&.! /eflective thin-ing s-ills 9C )op%right 5 0617 ,earson 'ducation+ 8nc. ?) $he ,rivate &ecurities Litigation /eform ct of 1CC5 capped damage awards against auditors to the amount of the audit fees charged. ) $rue .) 4alse nswer! . $erms! ,rivate &ecurities Litigation /eform ct of 1CC5 Diff! 'as% Objective! LO 5-B )&.! /eflective thin-ing s-ills 76 )op%right 5 0617 ,earson 'ducation+ 8nc.