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ACCT 460 Chapter 4
Auditing 460
60
Accounting
04/17/2010

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Term
b. Gross negligence
Definition
If a CPA performs an audit recklessly the CPA will be liable to third parties who were unknown and not foreseeable to the CPA for:
a. Strict liability for all damages incurred
b. Gross negligence
c. Either ordinary or gross negligence
d. Breach of contract
Term
b. The Rosenblum approach
Definition
Which of the following approaches to auditors’ liability is least desirable from the CPA’s perspective?
a. The Ultramares approach
b. The Rosenblum approach
c. The Restatement of Torts approach
d. The Foreseen User approach
Term
b. The CPAs made a false statement
Definition
In cases of breach of contract, plaintiffs generally have to prove all of the following except:
a. The CPAs had a duty
b. The CPAs made a false statement
c. The client incurred losses related to the CPAs performance
d. The CPAs breached their duty
Term
d. Common Law
Definition
If the CPAs provided negligent tax advice to a public co. the client would bring suit under:
a. The Securities Act of 1933
b. The Securities Exchange Act of 1934
c. The Federal Income Tax Law
d. Common Law
Term
a. Credit Alliance Corp. v. Arthur Andersen & Co.
Definition
Which of the following cases reaffirmed the principles in the Ultramares case?
a. Credit Alliance Corp. v. Arthur Andersen & Co.
b. Rosenblum v. Adler
c. Ernst & Ernst v. Hochfelder
d. Escott v. BarChris Construction Corporation
Term
a. Contributory negligence
Definition
Under common law the CPAs who were negligent may mitigate some damages to a client by proving:
a. Contributory negligence
b. The CPAs' fee was not material
c. The CPAs were not competent to accept the engagement
d. The CPAs' negligence was caused by the fact that they had too much work
Term
c. Proportionate liability
Definition
Under securities and Exchange act of 1934 auditors and other defendants are faced with:
a. Joint liability
b. Joint and several liability
c. Proportionate liability
d. Limited liability
Term
d. The false statement is immaterial in the overall context of the financial statement
Definition
A CPA issued an unqualified opinion on the financial statements of a co. that sold common stock in a public offering subject to the securities act of 1933. Based on a misstatement in the financial statements, the cpa is being sued by an investor who purchased shares of this public offering. Which of the following represents a viable defense?
a. The investor has not proved fraud or negligence by the CPA
b. The investor did not actually rely upon the false statement
c. The CPA detected the false statement after the audit date
d. The false statement is immaterial in the overall context of the financial statement
Term
c. Failed to exercise due care
Definition
Which of the following elements is most frequently necessary to hold a cpa liable to a client?
a. Acted with scienter or guilty knowledge
b. Was not independent of the client
c. Failed to exercise due care
d. Did not use an engagement letter
Term
c. The purchasers of securities must prove that the financial statements were misleading; then, the burden of proof is shifted to the auditors to show that the audit was performed with "due diligence"
Definition
Which statement best expresses the factors that purchasers of securities registered under the securities act of 1933 need to prove to recover losses from the auditors?
a. The purchasers of securities must prove ordinary negligence by the auditors and reliance on the audited financial statements
b. The purchasers of securities must prove that the financial statements were misleading and that they relied on them to purchase the securities
c. The purchasers of securities must prove that the financial statements were misleading; then, the burden of proof is shifted to the auditors to show that the audit was performed with "due diligence"
d. The purchasers of securities must prove that the financial statements were misleading and the auditors were negligent
Term
a. Created a more general awareness of the possibility of auditor criminal prosecution
Definition
The most significant results of the continental vending case was that it:
a. Created a more general awareness of the possibility of auditor criminal prosecution
b. Extended the auditor's reponsibility to all information included in registration statements
c. Defined the CPA's responsibilities for unaudited financial statements
d. Established a precedent for auditors being held liable to third parties under common law for ordinary negligence
Term
b. Unaudited financial statements
Definition
The 1136 tenants’ case was important because of its emphasis upon the legal liability of the cpa when associated with:
a. A review of annual statements
b. Unaudited financial statements
c. An audit resulting in a disclaimer of opinion
d. Letters for underwriters
Term
c. He would be liable for losses attributable to his negligence.
Definition
As a consequence of his failure to adhere to generally accepted auditing standards in the course of his examination of the Lamp Corp, Harrison, CPA, did not detect the embezzlement of a material amount of funds by the company’s controller. As a matter of common law, to what extent would Harrison be liable to the Lamp Corp. for losses attributable to the theft?
a. He would have no liability, since the ordinary examination cannot be relied upon to detect thefts of assets by employees.
b. He would have no liability because privity of contract is lacking.
c. He would be liable for losses attributable to his negligence.
d. He would be liable only if it could be proven that he was grossly negligent.
Term
c. when such failure clearly results from failure to comply with generally accepted auditing standards.
Definition
According to Statement on Auditing Standards No. 1, the auditor’s responsibility for failure to detect fraud arises
a. whenever the amounts involved are material.
b. only when such failure clearly results from negligence so gross as to sustain an inference of fraud on the part of the auditor.
c. when such failure clearly results from failure to comply with generally accepted auditing standards.
d. only when the examination was specifically designed to detect fraud.
Term
b. CloseCo will recover damages for breach of contract.
Definition
You have recently opened your CPA practice and have been engaged to issue your opinion on the financial statements of a closely-held corporation, CloseCo, who is selling out to a potential buyer. You diligently plan and begin working on the engagement. You are then requested to bid on providing ongoing audit services to another corporation. Because of the potential for recurring work, you postpone your work with CloseCo to pursue this new opportunity. CloseCo’s potential buyers lose interest because of the delay in obtaining audited financial statements, and they decide not to buy your client’s company. CloseCo sues you. Given this data, what is the likely outcome?
a. You will be compensated for the work you have performed to date.
b. CloseCo will recover damages for breach of contract.
c. CloseCo will recover both punitive damages and damages for breach of contract.
d. Neither you nor CloseCo will recover anything.
Term
c. The Securities Act of 1933 imposes substantial additional potential liability to the CPA firm.
Definition
If a client decides to go public, which of the following statements is true?
a. The Securities Act of 1933 does not apply.
b. If the client does not plan to be listed on an organized exchange, the Securities Exchange Act of 1934 will not apply.
c. The Securities Act of 1933 imposes substantial additional potential liability to the CPA firm.
d. Because the CPA firm and the client operate only within one state, federal securities laws do not apply.
Term
a. The auditor has no responsibility for searching for indirect-effect illegal acts.
Definition
Which of the following statements is correct with respect to the auditor’s responsibilities relative to the detection of indirect-effect illegal acts?
a. The auditor has no responsibility for searching for indirect-effect illegal acts.
b. The auditor has the same responsibility for searching for indirect-effect illegal acts as any other potential misstatement that may occur.
c. Auditors have responsibility for searching for any illegal act, whether direct-effect or indirect-effect.
d. None of the above is correct.
Term
A. Maintain public confidence in the profession
Definition
An auditor strives to achieve independence in appearance in order to:
A. Maintain public confidence in the profession
B. Become independent in fact
C. Maintain an unbiased mental attitude
D. Comply with the generally accepted auditing standards of fieldwork
Term
D. The misstatement is immaterial in the overall context of the financial statements.
Definition
A CPA issued an unqualified opinion on the financial statements of a company that sold common stock in a public offering subject to the Securities Act of 1933. Based on a misstatement in the financial statements, the CPA is being sued by an investor who purchased shares of this public offering. Which of the following represents a viable defense?
A. The investor has not proven CPA negligence.
B. The investor did not rely upon the financial statement.
C. The CPA detected the misstatement after the audit report date.
D. The misstatement is immaterial in the overall context of the financial statements.
Term
B. CPAs are liable for either ordinary or gross negligence to identified third parties for whose benefit the audit was performed.
Definition
Which of the following is a correct statement related to CPA legal liability under common law?
A. CPAs are normally liable to their clients, the shareholders, for either ordinary or gross negligence.
B. CPAs are liable for either ordinary or gross negligence to identified third parties for whose benefit the audit was performed.
C. CPAs may escape all personal liability through incorporation as a limited liability corporation.
D. CPAs are guilty until they prove that they performed the audit with "good faith."
Term
D. Either ordinary or gross negligence.
Definition
An auditor knew that the purpose of her audit was to render reasonable assurance on financial statements that were to be used for the application for a loan; the auditor did not know the identity of the bank that would eventually give the loan. Under the foreseeable third party approach the auditor is generally liable to the bank which subsequently grants the loan for:
A. Lack of due diligence.
B. Lack of good faith.
C. Gross negligence, but not ordinary negligence.
D. Either ordinary or gross negligence.
Term
B. Existence of scienter.
Definition
Under Section 10 of the 1934 Securities Exchange Act auditors are liable to security purchasers for:
A. Lack of due diligence.
B. Existence of scienter.
C. Ordinary negligence.
D. Auditors have no liability to security purchasers under this act.
Term
C. He performed the audit with due diligence.
Definition
Jones, CPA, is in court defending himself against a lawsuit filed under the 1933 Securities Act. The charges have been filed by purchasers of securities covered under that act. If the purchasers prove their required elements, in general Jones will have to prove that:
A. He is not guilty of gross negligence.
B. He performed the audit with good faith.
C. He performed the audit with due diligence.
D. The plaintiffs did not show him to be negligent.
Term
D. Either ordinary or gross negligence.
Definition
An auditor knew that the purpose of her audit was to render reasonable assurance on financial statements that were to be used for the application for a loan; the auditor did not know the identity of the bank that would eventually give the loan. Under the Restatement of Torts approach to liability the auditor is generally liable to the bank which subsequently grants the loan for:
A. Lack of due diligence.
B. Lack of good faith.
C. Gross negligence, but not ordinary negligence.
D. Either ordinary or gross negligence.
Term
B. Limited liability partnership.
Definition
Which of the following forms of organization is most likely to protect the personal assets of any partner, or shareholder who has not been involved on an engagement resulting in litigation?
A. Professional corporation.
B. Limited liability partnership.
C. Partnership.
D. Subchapter M Incorporation.
Term
D. Rosenblum Approach.
Definition
Under which common law approach are auditors most likely to be held liable for ordinary negligence to a "reasonably foreseeable" third party?
A. Due Diligence Approach.
B. Ultramares Approach.
C. Restatement of Torts Approach.
D. Rosenblum Approach.
Term
C. Due professional care.
Definition
CPAs should not be liable to any party if they perform their services with:
A. Ordinary negligence.
B. Regulatory providence.
C. Due professional care.
D. Good faith.
Term
C. Joint and several liability.
Definition
Assume that $500,000 in damages are awarded to a plaintiff, and the CPA's percentage of responsibility established at 10%, while others are responsible for the other 90%. Assume the others have no financial resources. As a result the CPA has been required to pay the entire $500,000. The auditor's liability is most likely based upon which approach to assessing liability?
A. Absolute liability
B. Contributory negligence
C. Joint and several liability.
D. Proportional liability.
Term
D. Proportional liability.
Definition
Assume that $500,000 in damages are awarded to a plaintiff, and the CPA's percentage of responsibility established at 10%, while others are responsible for the other 90%. Assume the others have no financial resources. The CPA has been required to pay $50,000. The auditor's liability is most likely based upon which approach to assessing liability?
A. Absolute liability.
B. Contributory negligence.
C. Joint and several liability.
D. Proportional liability.
Term
C. Contributory negligence.
Definition
Assume that a client has encountered a $500,000 fraud and that the CPA's percentage of responsibility established at 10%, while the company itself was responsible for the other 90%. Under which approach to liability is the CPA most likely to avoid liability entirely?
A. Absolute negligence.
B. Comparative negligence.
C. Contributory negligence.
D. Joint Negligence.
Term
A. Rosenblum v. Adler.
Definition
In which of the following court cases was a precedent set increasing liability to third parties arising from audits under common law?
A. Rosenblum v. Adler.
B. Hochfelder v. Ernst.
C. 1136 Tenants Corporation v. Rothenberg.
D. Continental Vending.
Term
C. Greater than the Securities Act of 1933.
Definition
The burden of proof that must be proven to recover losses from the auditors under the Securities Exchange Act of 1934 is generally considered to be:
A. Less than the Securities Act of 1933.
B. The same as the Securities Act of 1933.
C. Greater than the Securities Act of 1933.
D. Indeterminate in relation to the Securities Act of 1933.
Term
B. Either ordinary or gross negligence.
Definition
The Second Restatement of the Law of Torts provides for auditor liability to a limited class of foreseen third parties for:
A. Only criminal acts.
B. Either ordinary or gross negligence.
C. Only gross negligence.
D. Only fraud.
Term
B. Client contributory negligence.
Definition
A principle that may reduce or entirely eliminate auditor liability to a client is:
A. Client constructive negligence.
B. Client contributory negligence.
C. Auditor ordinary negligence.
D. Auditor gross negligence.
Term
A. Plaintiff.
Definition
Under the Securities Act of 1933 the burden of proof that the plaintiff sustained a loss must be proven by the:
A. Plaintiff.
B. Defendant.
C. SEC.
D. Jury.
Term
D. Common law.
Definition
A case by a client against its CPA firm alleging negligence would be brought under:
A. The Securities Act of 1933.
B. The Securities Exchange Act of 1934.
C. The state blue sky laws.
D. Common law.
Term
B. A loss sustained by a lender not in privity of contract in a suit brought in a state court which adheres to the Ultramares v. Touche precedent.
Definition
Assume that a CPA firm was negligent but not grossly negligent in the performance of an engagement. Which of the following plaintiffs probably would not recover losses proximately caused by the auditors' negligence?
A. A loss sustained by a client in a suit brought under common law.
B. A loss sustained by a lender not in privity of contract in a suit brought in a state court which adheres to the Ultramares v. Touche precedent.
C. A loss sustained by initial purchasers of stock in a suit brought under the Securities Act of 1933.
D. A loss sustained by a bank named as a third-party beneficiary in the engagement letter in a suit brought under common law.
Term
D. 1136 Tenants Corporation v. Rothenberg.
Definition
Which of the following court cases highlighted the need for obtaining engagement letters for professional services?
A. Ultramares v. Touche.
B. Rosenblum v. Adler.
C. Hochfelder v. Ernst.
D. 1136 Tenants Corporation v. Rothenberg.
Term
D. Court cases brought under the Securities Act of 1933.
Definition
In which type of court case is proving "due diligence" essential to the auditors' defense?
A. Court cases brought under the Securities Exchange Act of 1934.
B. Court cases brought by clients under common law.
C. Court cases brought by third parties under common law.
D. Court cases brought under the Securities Act of 1933.
Term
D. Rosenblum v. Adler.
Definition
Which common law approach leads to increased CPA liability to "foreseeable" third parties for ordinary negligence?
A. Ultramares v. Touche.
B. Restatement of Torts.
C. Rule 10b-5.
D. Rosenblum v. Adler.
Term
B. Lack of gross negligence.
Definition
Which of the following is the best defense that a CPA can assert against common law litigation by a stockholder claiming fraud based on an unqualified opinion on materially misstated financial statements?
A. Lack of due diligence.
B. Lack of gross negligence.
C. Contributory negligence on the part of the client.
D. A disclaimer contained in the engagement letter.
Term
C. Material misstatements were contained in the financial statements.
Definition
Which of the following must be proven by the plaintiff in a case against a CPA under the Section 11 liability provisions of the Securities Act of 1933?
A. The CPA knew of the misstatement.
B. The CPA was negligent.
C. Material misstatements were contained in the financial statements.
D. The unqualified opinion contained in the registration statement was relied upon by the party suing the CPA.
Term
A. Audit complied with generally accepted auditing standards.
Definition
A CPA issued a standard unqualified audit report on the financial statements of a client that the CPA knew was in the process of obtaining a loan. In a suit by the bank issuing the loan the CPA's best defense would be that the:
A. Audit complied with generally accepted auditing standards.
B. Client was aware of the misstatements.
C. Bank was not the CPA's client.
D. Bank's identity was known to the CPA prior to completion of the audit.
Term
A. Unknowingly violates the 1934 Securities Exchange Act.
Definition
The Private Securities Litigation Reform Act of 1995 imposes proportionate liability on the CPA who:
A. Unknowingly violates the 1934 Securities Exchange Act.
B. Knowingly or unknowingly violates the 1934 Securities Exchange Act.
C. Unknowingly violates the 1933 Securities Act.
D. Knowingly or unknowingly violates the 1933 Securities Act.
Term
C. It makes recovery against CPAs more difficult under common law litigation.
Definition
Which of the following is not correct relating to the Private Securities Litigation Reform Act of 1995?
A. It provides certain small investors better recovery rights than it does large investors.
B. It retains joint and several liability in certain circumstances.
C. It makes recovery against CPAs more difficult under common law litigation.
D. It eliminates securities fraud as an offense under civil RICO.
Term
C. Eliminates personal liability for some, but not all, partners.
Definition
A limited liability partnership form of organization:
A. Decreases liability of all partners of a CPA firm.
B. Has similar liability requirements to that of a professional corporation.
C. Eliminates personal liability for some, but not all, partners.
D. Eliminates personal liability for all partners.
Term
C. A CPA may be exposed to criminal as well as civil liability.
Definition
Which of the following is accurate with respect to litigation involving CPAs?
A. A CPA will not be found liable for an audit unless the CPA has audited all affiliates of that company.
B. A CPA may not successfully assert as a defense that the CPA had no motive to be part of a fraud.
C. A CPA may be exposed to criminal as well as civil liability.
D. A CPA is primarily responsible, while the client is secondarily responsible for the notes in an annual report filed with the SEC.
Term
C. Failed to exercise due care.
Definition
Starr Corp. approved a plan of merger with Silo Corp. One of the determining factors in approving the merger was the strong financial statements of Silo which were audited by Cox & Co., CPAs. Starr had engaged Cox to audit Silo's financial statements. While performing the audit, Cox failed to discover certain instances of fraud which have subsequently caused Starr to suffer substantial losses. In order for Cox to be liable under common law, Starr at a minimum must prove that Cox:
A. Acted recklessly or with lack of reasonable grounds for belief.
B. Knew of the instances of fraud.
C. Failed to exercise due care.
D. Was grossly negligent.
Term
A. That the audit was performed in accordance with GAAS.
Definition
Dexter and Co., CPAs, issued an unqualified opinion on the 20X3 financial statements of Bart Corp. Late in 20X4, Bart determined that its treasurer had embezzled over $1,000,000. Dexter was unaware of the embezzlement. Bart has decided to sue Dexter to recover the $1,000,000. Bart's suit is based upon Dexter's failure to discover the missing money while performing the audit. Which of the following is Dexter's best defense?
A. That the audit was performed in accordance with GAAS.
B. Dexter had no knowledge of the embezzlement.
C. The financial statements were presented in conformity with GAAP.
D. The treasurer was Bart's agent and as such had designed the controls which facilitated the embezzlement.
Term
A. Must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.
Definition
Under common law, when performing an audit, a CPA:
A. Must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.
B. Must strictly adhere to generally accepted accounting principles.
C. Is strictly liable for failures to discover client fraud.
D. Is not liable unless the CPA commits gross negligence or intentionally disregards generally accepted auditing standards.
Term
D. Fails to follow generally accepted auditing standards.
Definition
A CPA's duty of due care to a client most likely will be breached when a CPA:
A. Gives a client an oral report instead of a written report.
B. Gives a client incorrect advice based on an honest error of judgment.
C. Fails to give tax advice that saves the client money.
D. Fails to follow generally accepted auditing standards.
Term
C. The CPA probably is liable to any person who suffered a loss as a result of the fraud.
Definition
Under common law, which of the following statements most accurately reflects the liability of a CPA who fraudulently gives an opinion on an audit of a client's financial statements?
A. The CPA is liable only to third parties in privity of contract with the CPA.
B. The CPA is liable only to known users of the financial statements.
C. The CPA probably is liable to any person who suffered a loss as a result of the fraud.
D. The CPA probably is liable to the client even if the client was aware of the fraud and did not rely on the opinion.
Term
A. Is the client's creditor who sues the accountant for negligence.
Definition
In a common law action against an accountant, lack of privity is a viable defense if the plaintiff:
A. Is the client's creditor who sues the accountant for negligence.
B. Can prove the presence of gross negligence that amounts to a reckless disregard for the truth.
C. Is the accountant's client.
D. Bases the action upon fraud.
Term
B. Gross negligence.
Definition
If a CPA recklessly departs from the standards of due care when conducting an audit, the CPA will be liable to third parties who are unknown to the CPA based on:
A. Ordinary negligence.
B. Gross negligence.
C. Strict liability.
D. Criminal deceit.
Term
A. Win because there was no privity of contract between Hark and Third.
Definition
Hark, CPA, negligently failed to follow generally accepted auditing standards in auditing Long Corporation's financial statements. Long's president told Hark that the audited financial statements would be submitted to several, at this point undetermined, banks to obtain financing. Relying on the statements, Third Bank gave Long a loan. Long defaulted on the loan. In jurisdiction applying the Ultramares decision, if Third sues Hark, Hark will:
A. Win because there was no privity of contract between Hark and Third.
B. Lose because Hark knew that a bank would be relaying the financial statements.
C. Win because Third was contributory negligent in granting the loan.
D. Lose because Hark was negligent in performing the audit.
Term
b. Parties in privity only
Definition
Under the Ultramares rule, to which of the following parties will an accountant be liable for ordinary negligence?
a. Parties in privity and Foreseen parties
b. Parties in privity only
c. Foreseen parties only
d. Neither parties in privity nor foreseen parties
Term
B. There was a material misstatement in the financial statements.
Definition
Quincy bought Teal Corp. common stock in an offering registered under the Securities Act of 1933. Worth & Co., CPAs, gave an unqualified opinion on Teal's financial statements that were included in the registration statement filed with the SEC. Quincy sued Worth under the provisions of the 1933 Act that deal with omission of facts required to be in the registration statement. Quincy must prove that:
A. There was fraudulent activity by Worth.
B. There was a material misstatement in the financial statements.
C. Quincy relied on Worth's opinion.
D. Quincy was in privity with Worth.
Term
B. $200,000
Definition
Bran, CPA, audited Frank Corporation. The shareholders sued both Frank and Bran for securities fraud under the Federal Securities Exchange Act of 1934. The court determined that there was securities fraud and that Frank was 80% at fault and Bran was 20% at fault due to her negligence in the audit. Both Frank and Bran are solvent and the damages were determined to be $1 million. What is the maximum liability of Bran?
A. $0
B. $200,000
C. $500,000
D. $1,000,000
Term
B. Gross negligence.
Definition
If a CPA recklessly departs from the standards of due care when conducting an audit, the CPA will be liable to third parties who are unknown to the CPA based on
A. Negligence.
B. Gross negligence.
C. Strict liability.
D. Criminal deceit.
Term
a. Registered Public Accounting Firms and Registered Public Accounting Firm Employees
Definition
The Public Company Accounting Oversight Board may conduct investigations and disciplinary proceedings of:
a. Registered Public Accounting Firms and Registered Public Accounting Firm Employees
b. Registered Public Accounting Firms only
c. Registered Public Accounting Firm Employees only
d. Neither Registered Public Accounting Firms nor Registered Public Accounting Firm Employees