Audit Chapter 4

Which of the following court cases highlighted the need for obtaining engagement letters for professional services? Ultramares v. Touche. Rosenblum v. Adler. Hochfelder v. Ernst. 1136 Tenants Corporation v. Rothenberg.

1136 Tenants Corporation v. Rothenberg.

Bailey CPA, audited Lincoln Corporation. The shareholders sued both Lincoln and Bailey for securities fraud under the Federal Securities Exchange Act of 1934. The court determined that there was securities fraud and that Lincoln was 80% at fault and Bailey was 20% at fault due to her negligence in the audit. Both Lincoln and Bailey are solvent and the damages were determined to be $2 million. What is the maximum liability of Bailey? $0 $400,000 $1,000,000 $2,000,000

400,000

In addition to proving a loss, which of the following must be proven by a third party suing a CPA under Section 10 of the 1934 Securities Exchange Act? Misleading Financial Statements Reliance on financial statements A. Yes Yes B. Yes No C. No Yes D. No No

A

The Public Company Accounting Oversight Board may conduct investigations and disciplinary proceedings of: Registered Public Accounting Firms Registered Public Accounting Firm Employees A. Yes Yes B. Yes No C. No Yes D. No No

A

Under which act (or acts) may liability charges be filed against a CPA who has performed a financial statement review for a public company? Securities Act of 1933 Securities Exchange Act of 1934 A. Yes Yes B. Yes No C. No Yes D. No No

A

under which act (or acts) may criminal charges against a CPA be filed? Securities Act of 1933 Securities Exchange Act of 1934 A. Yes Yes B. Yes No C. No Yes D. No No

A

Which of the following is accurate with respect to litigation involving CPAs? A CPA will not be found liable for an audit unless the CPA has audited all affiliates of that company. A CPA may not successfully assert as a defense that the CPA had no motive to be part of a fraud. A CPA may be exposed to criminal as well as civil liability. A CPA is primarily responsible, while the client is secondarily responsible for the notes in an annual report filed with the SEC.

A CPA may be exposed to criminal as well as civil liability.

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 loss sustained by a client in a suit brought under common law. 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. A loss sustained by initial purchasers of stock in a suit brought under the Securities Act of 1933. A loss sustained by a bank named as a third-party beneficiary in the engagement letter in a suit brought under common law.

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.

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: Audit complied with generally accepted auditing standards. Client was aware of the misstatements. Bank was not the CPA's client. Bank's identity was known to the CPA prior to completion of the audit.

Audit complied with generally accepted auditing standards.

Under the Ultramares rule, to which of the following parties will an accountant be liable for ordinary negligence? Parties in privity Foreseen parties A. Yes Yes B. Yes No C. No Yes D. No No

B

Which of the following is a correct statement related to CPA legal liability under common law? CPAs are normally liable to their clients, the shareholders, for either ordinary or gross negligence. CPAs are liable for either ordinary or gross negligence to identified third parties for whose benefit the audit was performed. CPAs may escape all personal liability through incorporation as a limited liability corporation. CPAs are guilty until they prove that they performed the audit with "good faith."

CPAs are liable for either ordinary or gross negligence to identified third parties for whose benefit the audit was performed.

A principle that may reduce or entirely eliminate auditor liability to a client is: Client constructive negligence. Client contributory negligence. Auditor ordinary negligence. Auditor gross negligence.

Client contributory negligence.

If the CPAs provided negligent tax advice to a public company, the client would bring suit under: The Securities Act of 1933. The Securities Exchange Act of 1934. The federal income tax law. Common law.

Common law

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

Contributory negligence

Assume that a client has encountered a $800,000 fraud and that the CPA's percentage of responsibility established at 20%, while the company itself was responsible for the other 80%. Under which approach to liability is the CPA most likely to avoid liability entirely? Absolute negligence. Comparative negligence. Contributory negligence. Joint Negligence.

Contributory negligence.

In which type of court case is proving "due diligence" essential to the auditors' defense? Court cases brought under the Securities Exchange Act of 1934. Court cases brought by clients under common law. Court cases brought by third parties under common law. Court cases brought under the Securities Act of 1933.

Court cases brought under the Securities Act of 1933.

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

Created a more general awareness of the possibility of auditor criminal prosecution.

Which of the following cases reaffirmed the principles in the Ultramares case? Credit Alliance Corp. v. Arthur Andersen & Co. Rosenblum v. Adler. Ernst & Ernst v. Hochfelder. Escott v. BarChris Construction Corporation.

Credit Alliance Corp. v. Arthur Andersen & Co.

Under which act (or acts) must a client prove that a CPA has performed an audit with due diligence to establish that CPA's liability? Securities Act of 1933 Securities Exchange Act of 1934 A. Yes Yes B. Yes No C. No Yes D. No No

D

CPAs should not be liable to any party if they perform their services with: Ordinary negligence. Regulatory providence. Due professional care. Good faith.

Due professional care

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? Lack of due diligence. Due professional care. Contributory negligence on the part of the client. A disclaimer contained in the engagement letter.

Due professional care.

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: Lack of due diligence. Lack of good faith. Gross negligence, but not ordinary negligence. Either ordinary or gross negligence.

Either ordinary or gross negligence.

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: Lack of due diligence. Lack of good faith. Gross negligence, but not ordinary negligence. Either ordinary or gross negligence.

Either ordinary or gross negligence.

Bugle Corp. approved a plan of merger with Stanley Corp. One of the determining factors in approving the merger was the strong financial statements of Stanley which were audited by Dennis & Co., CPAs. Bugle had engaged Dennis to audit Stanley's financial statements. While performing the audit, Dennis failed to discover certain instances of fraud which have subsequently caused Bugle to suffer substantial losses. In order for Dennis to be liable under common law, Bugle, at a minimum, must prove that Dennis: Acted recklessly or with lack of reasonable grounds for belief. Knew of the instances of fraud. Failed to exercise due care. Was grossly negligent.

Failed to exercise due care.

A CPA's duty of due care to a client most likely will be breached when a CPA: Gives a client an oral report instead of a written report. Gives a client incorrect advice based on an honest error of judgment. Fails to give tax advice that saves the client money. Fails to follow generally accepted auditing standards.

Fails to follow generally accepted auditing standards.

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: Less than the Securities Act of 1933. The same as the Securities Act of 1933. Greater than the Securities Act of 1933. Indeterminate in relation to the Securities Act of 1933.

Greater than the Securities Act of 1933.

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: Ordinary negligence. Gross negligence. Strict liability. Criminal deceit.

Gross negligence

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 Negligence. Gross negligence. Strict liability. Criminal deceit.

Gross negligence.

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: Ordinary negligence. Gross negligence. Strict liability. Criminal deceit.

Gross negligence.

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: He is not guilty of gross negligence. He performed the audit with good faith. He performed the audit with due diligence. The plaintiffs did not show him to be negligent.

He performed the audit with due diligence.

Under Section 10 of the 1934 Securities Exchange Act auditors are liable to security purchasers for: Lack of due diligence. Intent to deceive or defraud. Ordinary negligence. Auditors have no liability to security purchasers under this act.

Intent to deceive or defraud.

In a common law action against an accountant, lack of privity is a viable defense if the plaintiff: Is the client's creditor who sues the accountant for negligence. Can prove the presence of gross negligence that amounts to a reckless disregard for the truth. Is the accountant's client. Bases the action upon fraud.

Is the client's creditor who sues the accountant for negligence.

Which of the following is not correct relating to the Private Securities Litigation Reform Act of 1995? It provides certain small investors better recovery rights than it does large investors. It retains joint and several liability in certain circumstances. It makes recovery against CPAs more difficult under common law litigation. It eliminates securities fraud as an offense under civil RICO.

It makes recovery against CPAs more difficult under common law litigation.

Assume that $800,000 in damages are awarded to a plaintiff, and the CPA's percentage of responsibility established at 20%, while others are responsible for the other 80%. Assume the others have no financial resources. As a result the CPA has been required to pay the entire $800,000. The auditor's liability is most likely based upon which approach to assessing liability? Absolute liability. Contributory negligence. Joint and several liability. Proportional liability.

Joint and several liability.

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? Professional corporation. Limited liability partnership. Partnership. Subchapter M Incorporation.

Limited liability partnership.

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? The CPA knew of the misstatement. The CPA was negligent. Material misstatements were contained in the financial statements. The unqualified opinion contained in the registration statement was relied upon by the party suing the CPA.

Material misstatements were contained in the financial statements.

Under common law, when performing an audit, a CPA: Must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances. Must strictly adhere to generally accepted accounting principles. Is strictly liable for failures to discover client fraud. Is not liable unless the CPA commits gross negligence or intentionally disregards generally accepted auditing standards.

Must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.

Under the Securities Act of 1933, the burden of proof that the plaintiff sustained a loss must be proven by the: Plaintiff. Defendant. SEC. Jury.

Plaintiff.

Assume that $800,000 in damages are awarded to a plaintiff, and the CPA's percentage of responsibility established at 20%, while others are responsible for the other 80%. Assume the others have no financial resources. The CPA has been required to pay $160,000. The auditor's liability is most likely based upon which approach to assessing liability? Absolute liability. Contributory negligence. Joint and several liability. Proportional liability.

Proportional liability.

Under the Securities and Exchange Act of 1934, auditors and other defendants are generally faced with: Joint liability. Joint and several liability. Proportionate liability. Limited liability.

Proportionate liability.

Under which common law approach are auditors most likely to be held liable for ordinary negligence to a "reasonably foreseeable" third party? Due Diligence Approach. Ultramares Approach. Restatement of Torts Approach. Rosenblum Approach.

Rosenblum Approach.

In which of the following court cases was a precedent set increasing liability to third parties arising from audits under common law? Rosenblum v. Adler. Hochfelder v. Ernst. 1136 Tenants Corporation v. Rothenberg. Continental Vending.

Rosenblum v. Adler.

Which common law approach leads to increased CPA liability to "foreseeable" third parties for ordinary negligence? Ultramares v. Touche. Restatement of Torts. Rule 10b-5. Rosenblum v. Adler.

Rosenblum v. Adler.

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? The CPA is liable only to third parties in privity of contract with the CPA. The CPA is liable only to known users of the financial statements. The CPA probably is liable to any person who suffered a loss as a result of the fraud. The CPA probably is liable to the client even if the client was aware of the fraud and did not rely on the opinion.

The CPA probably is liable to any person who suffered a loss as a result of the fraud.

In cases of breach of contract, plaintiffs generally have to prove all of the following, except: The CPAs had a duty. The CPAs made a false statement. The client incurred losses related to the CPAs' performance. The CPAs breached their duty.

The CPAs made a false statement.

Which of the following approaches to auditors' liability is least desirable from the CPA's perspective? The Ultramares approach. The Rosenblum approach. The Restatement of Torts approach. The Foreseen User approach.

The Rosenblum approach.

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? The investor has not proven CPA negligence. The investor did not rely upon the financial statement. The CPA detected the misstatement after the audit report date. The audit work was adequate to support the CPA's opinion.

The audit work was adequate to support the CPA's opinion.

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? The investor has not proved fraud or negligence by the CPA. The investor did not actually rely upon the false statement. The CPA detected the false statement after the audit date. The false statement is immaterial in the overall context of the financial statements.

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

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? The purchasers of securities must prove ordinary negligence by the auditors and reliance on the audited financial statements. The purchasers of securities must prove that the financial statements were misleading and that they relied on them to purchase the securities. 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." The purchasers of securities must prove that the financial statements were misleading and the auditors were negligent.

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."

Wilson bought Zimmer Corp. common stock in an offering registered under the Securities Act of 1933. Baldridge & Co., CPAs, gave an unqualified opinion on Zimmer's financial statements that were included in the registration statement filed with the SEC. Wilson sued Baldridge under the provisions of the 1933 Act that deal with omission of facts required to be in the registration statement. Wilson must prove that: There was fraudulent activity by Baldridge. There was a material misstatement in the financial statements. Wilson relied on Baldridge's opinion. Wilson was in privity with Baldridge.

There was a material misstatement in the financial statements.

In addition to proving a loss, which of the following must be proven by a third party suing a CPA under Section 11 of the 1933 Securities Act? Misleading Financial Statements Reliance on financial statements A. Yes Yes B. Yes No C. No Yes D. No No

b

the 1136 Tenants' case was important because of its emphasis upon the legal liability of the CPA when associated with: A review of annual statements. Unaudited financial statements. An audit resulting in a disclaimer of opinion. Letters for underwriters.

Unaudited financial statements.

The Private Securities Litigation Reform Act of 1995 imposes proportionate liability on the CPA who: Unknowingly violates the 1934 Securities Exchange Act. Knowingly or unknowingly violates the 1934 Securities Exchange Act. Unknowingly violates the 1933 Securities Act. Knowingly or unknowingly violates the 1933 Securities Act.

Unknowingly violates the 1934 Securities Exchange Act.

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: Win because there was no privity of contract between Hark and Third. Lose because Hark knew that a bank would be relaying the financial statements. Win because Third was contributory negligent in granting the loan. Lose because Hark was negligent in performing the audit.

Win because there was no privity of contract between Hark and Third.

A case by a client against its CPA firm alleging negligence would be brought under: The Securities Act of 1933. The Securities Exchange Act of 1934. The state blue sky laws. Common law.

common law

Which of the following elements is most frequently necessary to hold a CPA liable to a client? Acted with scienter or guilty knowledge. Was not independent of the client. Failed to exercise due care. Did not use an engagement letter.

failed to exercise due care

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: Strict liability for all damages incurred. Gross negligence. Either ordinary or gross negligence. Breach of contract.

gross negligence

The Second Restatement of the Law of Torts provides for auditor liability to a limited class of foreseen third parties for: Only criminal acts. Either ordinary or gross negligence. Only gross negligence. Only fraud.

Either ordinary or gross negligence.

A limited liability partnership form of organization: Decreases liability of all partners of a CPA firm. Has similar liability requirements to that of a professional corporation. Eliminates personal liability for some, but not all, partners. Eliminates personal liability for all partners.

Eliminates personal liability for some, but not all, partners.

Fleming and Co., CPAs, issued an unqualified opinion on the 20X3 financial statements of Walton Corp. Late in 20X4, Walton determined that its controller had embezzled over $2,000,000. Fleming was unaware of the embezzlement. Walton has decided to sue Fleming to recover the $2,000,000. Waltons suit is based upon Fleming's failure to discover the missing money while performing the audit. Which of the following is Fleming's best defense? That the audit was performed in accordance with GAAS. Fleming had no knowledge of the embezzlement. The financial statements were presented in conformity with GAAP. The controller was Walton's agent and as such had designed the controls which facilitated the embezzlement.

That the audit was performed in accordance with GAAS.