Question 1

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 2

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 3

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 4

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 5

Fabio recently sold his restaurant for $650 000, the value of the net assets as reported on the balance sheet. After the sale, Fabio realized that he could've sold the restaurant for as much as $950 000 as the fair value of the assets was $300 000 higher than what was reported on the balance sheet. Fabio is suing the auditors for his loss. The auditor's best defence is

Accepted Answer

A)  absence of a misstatement. 
B)  lack of duty. 
C)  no damages. 
D)  absence of causal connection.

Question 6

There are a number of things that the CPA, representing the profession as a whole, can do to reduce the practitioner's exposure to lawsuits. One of them is to

Accepted Answer

A)  sanction members for improper conduct and performance. 
B)  deal only with clients possessing integrity. 
C)  hire qualified auditors and train and supervise them. 
D)  perform quality audits.

Question 7

An example of a breach of contract would be

Accepted Answer

A)  a bank's claim that an auditor had a duty to uncover material errors in financial statements that had been relied on in making a loan. 
B)  an auditor's refusal to return a client's records until the client paid last year's audit fees. 
C)  a public accounting firm's failure to deliver a tax return on the agreed-upon date because the firm had a backlog of other work that was more lucrative. 
D)  an auditor's failure to complete the audit by the agreed-upon date because the client's financial records had been destroyed.

Question 8

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?

Accepted Answer

The answer of Musical Productions Limited has had declining sales...

Question 9

Pierre, a CPA, was convicted of stealing money from his clients and deliberately preparing personal tax returns that were false. In addition, Pierre will likely

Accepted Answer

A)  need to take additional training courses to upgrade his tax skills. 
B)  need to defend himself to prove non-negligent performance. 
C)  be charged with misconduct by his professional institution (or order). 
D)  have lack of privity with the federal and provincial tax authorities.

Question 10

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?

Accepted Answer

A)  absence of misstatement 
B)  contributory negligence 
C)  non-negligent performance 
D)  duty of care

Question 11

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

Accepted Answer

A)  known third party liability. 
B)  client liability. 
C)  liability under provincial securities law. 
D)  criminal liability.

Question 12

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.

Accepted Answer

The answer of A) Describe some of the steps the...

Question 13

Enron and Equity Funding are companies that suffered from large frauds by corporate management. One important lesson with respect to such cases is that

Accepted Answer

A)  when a company does really well financially it is important to suspect that such results are always inflated. 
B)  an investigation of the integrity of management is an important part of deciding upon the extent of audit work. 
C)  securities and exchange commissions expect auditors to be perfect in their assessment of management. 
D)  partners and staff should cooperate in preparing working papers that prove the accuracy of the financial statements.

Question 14

Many PAs prepare tax returns for individuals and for corporations. Under what circumstances is liability insurance required to cover the preparation of tax returns?

Accepted Answer

A)  When the PA is a member of a professional accounting association. 
B)  When any number of tax returns are prepared, including no-charge tax returns. 
C)  When fees are being charged and more than a handful of returns are being prepared. 
D)  When the bulk of the PA's income comes from preparing tax returns.

Question 15

A client is suing a PA firm, claiming that the firm is responsible for the losses suffered from a fraud in the payroll department that was not uncovered during the year-end testing done by the auditor. The auditors did indicate to management that controls over payroll calculations and payments were weak, as there was improper segregation of duties. The auditor's best defence is

Accepted Answer

A)  contributory negligence. 
B)  absence of negligence. 
C)  absence of causal connection. 
D)  no damages.

Question 16

Danford, a PA, is setting up his accounting firm as a sole practitioner. Which of the following is not an important way that Danford can reduce legal liability with respect to the work completed by his office?

Accepted Answer

A)  participate in the standard-setting process for audit engagements 
B)  find out when his practice is due for practice inspection 
C)  hire only qualified personnel and train them well 
D)  sanction other PAs who engage in improper conduct

Question 17

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 18

Laws that have been passed through federal or provincial governments are

Accepted Answer

A)  statutory law. 
B)  judicial law. 
C)  criminal law. 
D)  common law.

Question 19

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

Accepted Answer

A)  customer expectation gap. 
B)  audit failure. 
C)  fiduciary duty. 
D)  business failure.

Question 20

A common way for a public accounting firm to demonstrate its defence of a lack of duty to perform is by use of a(n)

Accepted Answer

A)  engagement letter. 
B)  letter of representation. 
C)  confirmation letter. 
D)  expert witness.

Exam 3: Legal Liability