Exam 3: Legal Liability

Amin is distraught. Six months ago, a big-box stereo store opened just down the street from his independent stereo and music business and now he is unable to continue operating his business. Only eight months ago, you issued an unqualified audit opinion on his financial statements that showed the financial results of a well-run, profitable store. Amin's business is experiencing

In connection with the examination of financial statements, an auditor could be responsible for failure to detect a material fraud if

In the auditing environment, failure to meet generally accepted auditing standards is often

An auditor would be found negligent if he/she

Laws that have been passed through federal or provincial governments are

Joan talked to the owners of Fancy Clothing Limited before investing. She obtained a copy of their financial statements and saw that profits were low, even considering the fact that the owners had not taken any money for themselves in the current year. However, she decided to invest in the company because she believed her superior knowledge of the clothing industry would turn the business around, resulting in enough profits for all owners. Unfortunately, this did not occur and the company went bankrupt. Joan is suing the auditors because she relied upon the financial statements during her investment decision. What is the auditor's best defence?

A) List the four items a defendant must prove in an action for negligence against a public accountant. B) Discuss what is meant by the term "expectation gap."

The assessment against a defendant of the full loss suffered by a plaintiff regardless of the extent to which other parties shared in the wrongdoing is called

Small Town Lumberyard Limited (STLL) needed an additional bank loan to finance its operations. To make its financial statements look better, the company overstated its inventory and overstated its accounts payable. The auditors did not detect this deliberate misstatement because they conducted limited tests of inventory and did not confirm accounts payable. Other auditors agreed that the procedures conducted during this audit were inadequate. The auditors of STLL would likely be considered to be

Musical Productions Limited has had declining sales as more and more media are being presented online rather than on CD or DVD. It diversified its business by moving into backup systems, but is still having trouble boosting income. The audit team was led by Theresa Sanford, who obtained her CPA last year. Theresa had two assistants, Marv and Uhta, who did the work in the accounts receivable and inventory areas. Theresa felt that they did not require supervision, as they had been with the firm for two years and were expected to do well on their professional exams this year. Marv found that the accounts receivable had many old accounts and customers were tough to get hold of. Accordingly, he decided to accept management's representations with respect to the balances. Similarly, Uhta noted that there were still many CDs in inventory that had been there for over three years. Management insisted on recording these at cost. Uhta accepted managements' valuation. Two months after the audit report was issued, Musical Productions Limited went bankrupt. It was found that many accounts receivable were for fictitious customers and the receiver was only able to obtain five cents on the dollar for the inventory, which was sold as scrap. The bank is suing the auditors to recover its bank loan, which had been renegotiated based upon the results of the financial statements. Required: Will the bank be successful in its suit? Why or why not?

The principal issue to be resolved in cases involving alleged negligence is usually

An example of a breach of contract would be

A) Describe some of the steps the CPA and the accounting profession as a whole can and are taking to reduce practitioners' exposure to lawsuits. B) Describe some of the steps individual practising auditors can take to minimize their legal liability.

There are four major sources of auditors' legal liability. Briefly summarize the four sources.

Winston Chang, a PA, conducted the audit of Manra Manufacturing Ltd., a small company that produces a variety of machined parts for the automotive and computer industries. The audit showed that the company produced a small profit after paying the owners of the company a high salary. Manra was purchased by a competitor, Cheblay. Cheblay had hoped to produce efficiencies by combining the two companies but was unable to do so. Cheblay sued Chang because it relied upon the financial statements when purchasing the company's shares, claiming that the machines, which were about fifteen years old, had been overvalued. The machines were recorded at cost, which was below net realizable value. What is the auditor's best defence?

A bank sues an auditor after having lost a significant amount of money from a loan granted to a client based on the financial statements that contained a material error. The source of the legal liability is

The King Surety Company wrote a general fidelity bond covering defalcations by the employees of Wilson, Inc. Thereafter, Cooney, an employee of Wilson, embezzled $17 200 of company funds. When the activities were discovered, King paid Wilson the full amount in accordance with the terms of the fidelity bond, and then sought recovery against Wilson's auditors, Lynch & Merritt, public accountants. Which of the following would be Lynch & Merritt's best defence?

There are a number of things that a practising auditor can do to reduce liability in lawsuits. One of them is to

In rare cases, auditors have been held liable for criminal acts. A criminal conviction against an auditor can result only when it is demonstrated that the auditor

Your firm has been the auditor of Chappello Design and Construction Limited for several years. During the current year, a consultant on staff at your firm assisted Chappello in the selection and implementation of a new computer system. The audit staff were not involved in this process. The new system was an enterprise-wide system that was to be implemented without modification using the direct cut-over approach (the old system was discontinued and the new one continued the next day). Unfortunately, staff had extreme difficulty using the system and discontinued it after two months. During that time, Chappello was unable to document and bill its work for progress billings, and borrowed heavily to continue to pay its employees while work continued. The company reverted to its old system and claims that it has lost hundreds of thousands of dollars in revenues as it was unable to issue quotes and bid on new contracts. Chappello has sued your firm for negligence with respect to the implementation of the computer system. Required: Which defences should the firm use? Support your answer with reasons.