Question 1

When an auditor issues an erroneous opinion as the result of an underlying failure to comply with the requirements of generally accepted auditing standards, it results in

Accepted Answer

A)  business failure. 
B)  audit failure. 
C)  audit risk. 
D)  business risk.

Question 2

The Ultramares doctrine is that ordinary negligence is insufficient for liability of auditors to third parties because of the lack of privity of contract between the third party and the auditor. What type of behaviour on the part of an auditor would result in liability to more general third parties according to this doctrine?

Accepted Answer

A)  conducting an audit engagement when a review engagement had been contracted 
B)  completing work in accordance with a contract that was signed with the client 
C)  deliberate misstatement of the financial statements by management remaining undetected 
D)  fraud or constructive fraud with respect to the working papers

Question 3

To succeed in an action against the auditor, the client must be able to show that

Accepted Answer

A)  the auditor was grossly negligent. 
B)  the auditor was fraudulent. 
C)  there is a close causal connection between the auditor's breach of the standard of due care and the damages suffered by the client. 
D)  there was a written contract.

Question 4

Which of the following lawsuits resulted in a decision that shareholders could not sue the auditors for the loss in the value of their shares?

Accepted Answer

A)  Haig v. Bamford et al.(1976) 
B)  Hercules Management Ltd. v. Ernst & Young (1997) 
C)  Ultramers Corporation v. Touche (1931) 
D)  United States v. Anderson (2002)

Question 5

The court ruled that Jones did not rely on the financial statements in his decision to purchase shares of Manumite Limited. Instead, Jones relied upon his discussions with the owners and with financial analysts. This result illustrates

Accepted Answer

A)  absence of negligence. 
B)  lack of privity. 
C)  contributory negligence. 
D)  absence of causal connection.

Question 6

PA has been recently appointed auditor of Foible Ltd., a company that exports high-cost knickknacks. To facilitate the rapid preparation of the financial statements, management had the physical inventory counted in October, rather than at the December year-end. During the inventory count, PA noticed that several of the boxes were labelled with receiving documents from a competitor. PA was told that the new warehouse supervisor worked part-time at the competitor and must have picked up the wrong boxes.
Several employees have sued Foible Ltd. for wrongful dismissal, claiming that they were promised a job that would last at least one year and would be provided with low cost accommodations. They are suing for the balance of the year's wages and are claiming that they were brought into the country under false pretenses. These employees are all from an Eastern-European country. The law firm has responded in a legal letter that this suit is without merit.
During the year, Foible obtained legal services from a firm in which Foible's Chairman of the Board of is a partner. Fees and disbursements for these services for the year were $125 000, a material amount.
During the audit, employees often spoke in a foreign language among themselves before responding to PA. Then one employee would respond after some (often heated) discussion.
Subsequent to the year end, the warehouse supervisor was arrested on criminal charges of theft, and Foible was charged with selling stolen goods. PA was charged as an accomplice to money laundering, as all of the management for Foible were members of a criminal group found to be laundering money from Eastern Europe.
Required:
Discuss the actions that PA could have taken during the engagement to prevent these charges.

Accepted Answer

The answer of PA has been recently appointed auditor of...

Question 7

Most accounting and auditing professionals agree that when an audit has failed to uncover material misstatements, and the wrong type of audit opinion is issued, the audit firm

Accepted Answer

A)  has failed to follow generally accepted auditing standards (GAAS). 
B)  deserves to lose the lawsuit. 
C)  should be asked to defend the quality of the audit. 
D)  should not be held responsible for the financial loss suffered by others.

Question 8

A bank sues the auditor after making a loan to Klaxxon, a company that went bankrupt. The bank indicates that they relied on the year-end financial statements of Klaxxon to make the lending decision. The bank analyst indicates that the audit opinion was unqualified so he assumed that Klaxxon was a going concern. The auditor defends himself by referring to a note disclosure in the financial statements about the company's economic dependence on one buyer, Dexters Corp. Dexters Corp had experienced some significant financial trouble for the past year and went bankrupt three months after the financial statements of Klaxxon were released. The PA's liability is likely

Accepted Answer

A)  contributory negligence. 
B)  fraud. 
C)  breach of contract. 
D)  gross negligence.

Question 9

PA was engaged by Microcomputer Distributor Limited (MDL) to conduct a review engagement. The financial statements are used primarily by the shareholders, management, and by the bank. Recently, an employee was fired for stealing computer parts, primarily chips and boards that could easily be placed in a pocket. MDL is suing PA because they believed that audit procedures, such as counting inventory, would have detected this fraud. What is PA's best defence?

Accepted Answer

A)  absence of causal connection 
B)  lack of negligence 
C)  contributory negligence 
D)  duty of care not required

Question 10

Individuals who accept fees (or property) and know or are willfully blind to the fact that the property was obtained illegally can be charged with money laundering, a criminal offence. Which of the following techniques will help a PA prevent such charges?

Accepted Answer

A)  Ensure that the financial statements are in accordance with an acceptable reporting framework. 
B)  Require that clients carefully document the sources of their funds. 
C)  Carefully assess management integrity. 
D)  Obtain a detailed letter of representation from management confirming the sources of their funds.

Question 11

Conflict between financial statement users and auditors often arises because of the

Accepted Answer

A)  high cost of performing an audit. 
B)  extremely technical vocabulary auditors use in their reports. 
C)  placement of the auditor's report in the back of the client's annual report, where it is hard to locate. 
D)  expectation gap.

Question 12

Describe each of the six defences a public accounting firm can normally use when facing legal claims by clients.

Accepted Answer

The answer of Describe each of the six defences a...

Question 13

An example of an audit failure is when the

Accepted Answer

A)  auditor issues an erroneous audit opinion as the result of a failure to comply with the requirements of GAAS. 
B)  audit opinion is qualified. 
C)  company files for bankruptcy less than 12 months after receiving an unqualified opinion. 
D)  auditor issues an erroneous audit opinion as the result of an undiscovered fraud that took place in the period being audited.

Question 14

Sandra is a new partner at a PA firm. Sandra recently signed a new contract with Gretchen Fabrics to become its auditor. In the process of accepting the client and planning the first year's audit, Sandra did the following:
- Sandra contacted the previous auditor to enquire if there were any reasons not to accept the audit of this client. Unfortunately, the previous auditor was on vacation and did not respond to Sandra before she accepted the client.
- Upon his return, the previous auditor did communicate with Sandra and indicated that the client had aggressive expense deferral policies that they disagreed on. Sandra asked to review the working papers of the previous auditor with regards to these expenses and found them to be right below the materiality threshold.
- Gretchen Fabrics imports most of its fabrics and has two production facilities in Asia. The company therefore has a complex tax structure and many import duties. Since this is not the area of expertise of Sandra, she asked another auditing firm to provide the required audit procedures for the international taxes and duties expense. When selecting the other audit firm, Sandra researched the firm online. She also ensured that they had their professional designation and enquired with the CPA and provincial association if the firm had any complaints or litigation outstanding for malpractice.
- Since the bidding process took time, Sandra had to start the audit almost right after learning she had the winning bid. She did not prepare an engagement letter before starting the work. She does not see this as being a problem since waiting until the audit has begun will provide her with a better idea of what work has to be done and what the engagement letter should include.
Required:
Identify the good and bad steps that Sandra has undertaken in reducing her exposure to legal liability.

Accepted Answer

The answer of Sandra is a new partner at a...

Question 15

According to the CPA Handbook, the auditor's responsibility for failure to detect fraud arises

Accepted Answer

A)  when such failure clearly results from failure to comply with generally accepted auditing standards. 
B)  whenever the amounts involved are material. 
C)  only when the examination was specifically designed to detect fraud. 
D)  only when such failure clearly results from negligence so gross as to sustain an inference of fraud on the part of the auditor.

Exam 3: Legal Liability