ACCT 402 CH 4 HW

4-28 g) Under the Securities and Exchange Act of 1934, auditors and other defendants are generally faced with: 1) Joint liability 2) Joint and several liability 3) Proportionate liability 4) Limited Liability

3) Proportionate liability

Comment on the following statement: While engagement letters are useful for audit engagements, they are not necessary for compilation and review engagements.

Engagement letters are important both for audits and for accounting and review services performed by CPAs. Oral arrangements are unsatisfactory when a dispute arises as to the services to be rendered by the CPAs.

4-28 f) Under common law, the CPAs who were negligent may mitigate some damages to a client by proving: 1) Contributory negligence 2) The CPAs' fee was not material 3) The CPAs were not competent to accept the engagement 4) The CPAs' negligence was caused by the fact that they had too much work

1) Contributory negligence

State briefly a major distinction between the Securities Act of 1933 and the Securities Exchange Act of 1934 with respect to the type of transactions regulated

The Securities Act of 1933 regulates the initial sale of securities in interstate commerce (new issues), and the Securities Exchange Act of 1934 regulates trading of securities after initial distribution.

4-28 k) The most significant result of the Continental Vending case was that it: 1) Created a more general awareness of the possibility of auditor criminal prosecution 2) Extended the auditor's responsibility to all information included in registration statements 3) Defined the CPA's responsibilities for unaudited financial statements 4) Established a precedent for auditors being held liable to third parties under common law for ordinary negligence

1) Created a more general awareness of the possibility of auditor criminal prosecution

4-28 e) Which of the following cases reaffirmed the principles in the Ultramares case? 1) Credit Alliance Corp. v. Arthur Andersen & Co. 2) Rosenblum v. Adler 3) Ernst & Ernst v. Hochfelder 4) Escott v. BarChris Construction Corporation

1) Credit Alliance Corp. v. Arthur Andersen & Co.

4-28 a) 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: 1) Strict liability for all damages incurred 2) Gross negligence 3) Either ordinary or gross negligence 4) Breach of contract

2) Gross negligence

4-28 c) In cases of breach of contract, plaintiffs generally have to prove all of the following except: 1) The CPAs had a duty 2) The CPAs made a false statement 3) The client incurred losses related to the CPAs' performance 4) The CPAs breached their duty

2) The CPAs made a false statement

4-28 b) Which of the following approaches to auditors' liability is least desirable from the CPA's perspective? 1) The Ultramares approach 2) The Rosenblum approach 3) The Restatement of Torts approach 4) The Forseen User approach

2) The Rosenblum approach

4-28 l) The 1136 Tenants' case was important because of its emphasis upon the legal liability of the CPA when associated with: 1) A review of annual statements 2) Unaudited financial statements 3) An audit resulting in a disclaimer of opinion 4) Letters for underwriters

2) Unaudited financial statements

4-28 i) Which of the following elements is most frequently necessary to hold a CPA liable to a client? 1) Acted with scienter or guilty knowledge 2) Was not independent of the client 3) Failed to exercise due care 4) Did not use an engagement letter

3) Failed to exercise due care

4-28 j) 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? 1) The purchasers of securities must prove ordinary negligence by the auditors and reliance on the audited financial statements 2) The purchasers of securities must prove that the financial statements were misleading and that they relied on them to purchase the securities 3) 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" 4) The purchasers of securities must prove that the financial statements were misleading and the auditors were negligent

3) 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"

4-28 d) If the CPAs provided negligent tax advice to a public company, the client would bring suit under: 1) The Securities Act of 1933 2) The Securities Exchange Act of 1934 3) The federal income tax law 4) Common law

4) Common law

4-28 h) 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? 1) The investor has not proved fraud or negligence by the CPA 2) The investor did not actually rely upon the false statement 3) The CPA detected the false statement after the audit date 4) The false statement is immaterial in the overall context of the financial statements

4) The false statement is immaterial in the overall context of the financial statements

Distinguish between ordinary negligence and gross negligence within the context of the CPAs' work.

Ordinary negligence means lack of reasonable care. Gross negligence means lack of even slight care, indicative of reckless disregard for duty. An oversight by a CPA resulting in a misstatement in a financial statement might be considered ordinary negligence, whereas if a CPA failed substantially to comply with generally accepted auditing standards the charge might be gross negligence.

Briefly describe the differences in liability to third parties under the known user, foreseen user, and foreseeable user approaches to CPA liability

The primary difference between the Ultramares and the Restatement approaches relates to whether the CPA has liability for ordinary negligence to third parties not specifically identified as users of the CPA's report. Under the Ultramares approach a CPA may be held liable for ordinary negligence only to a third party specifically identified as the primary user of the financial statements (a primary beneficiary). Under the Restatement approach the specific identity of the third parties need not be known to the CPA to establish liability for ordinary negligence. However, such liability for ordinary negligence is only to a limited class of known or intended users of the audited financial statements.

Explain why the potential liability of auditors for professional "malpractice" exceeds that of physicians or other professionals

There are several reasons why the potential legal liability of CPAs for professional "malpractice" exceeds that of physicians and other professionals. One reason is the vast number of people who may sustain damages. If a physician or attorney commits a serious error, the number of injured parties generally is limited to one individual patient or client. When a CPA's report is in error, literally millions of investors may sustain losses. Second, the federal Securities Acts regarding CPAs' liability are unique in that much of the burden of proof is shifted to the defendant. Normally, defendants are "presumed innocent until proven guilty." Under the federal Securities Acts, however, CPAs charged with "malpractice" must prove their innocence. Finally, when investors sustain losses in the many millions of dollars, the economics of the situation dictates bringing suit against the CPAs even if the prospects for recovery appear remote. When the possible dollar recovery is smaller, which usually is the case in other professional malpractice suits, the plaintiffs are more likely to be deterred from filing suit simply by the costs of litigation.

Contrast joint and several liability with proportionate liability.

Under joint and several liability one defendant may be required to pay the losses attributed to the actions of other defendants who do not have the financial resources to pay. Thus, if two parties were negligent and found each to be 50% liable, if one was unable to pay, the other party could be required to pay the entire 100%. Under proportionate liability a defendant is liable only for his or her proportion of fault. Using the previous example, neither defendant could be required to pay more than 50% of the damages.