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42 Multiple choice questions

  1. To be liable, an auditor must (1) know and intend that the work product would be used by the third party for a specific purpose, and (2) the knowledge and intent must be evidenced by the auditor's conduct.
  2. A business failure occurs when a business is unable to repay its lenders or meet the expectations of its investors because of economic or business conditions.
  3. actual and potential stockholders, vendors, bankers and other creditors, employees, and customers.
  4. any third party who purchased securities described in the registration statement may sue the auditor for material misrepresentation or omissions in audited financial statements included in the registration statement; third-party users do not have the burden of proof that they relied on the financial statements or that the auditor was negligent or fraudulent in doing the audit. Users must only prove that the audited financial statements contained a material misrepresentation; the auditor has the burden of demonstrating as a defense that (1) an adequate audit was conducted or (2) all or a portion of the plaintiff's loss was caused by factors other than the misleading financial statements. The 1933 act is the only common or statutory law where the burden of proof is on the defendant
  5. liability to clients - client sues auditor for not discovering a material fraud during the audit; liability to third parties under common law - bank sues auditor for not discovering that a borrower's financial statements are materially misstated; civil liability under federal securities laws - combined group of stockholders sues auditor for not discovering materially misstated financial statements; criminal liability - federal government prosecutes auditor for knowingly issuing an incorrect audit report
  6. Only 3 of the 4, lack of duty to perform the service, nonnegligent performance, and absence of causal connection.
  7. The Securities Act of 1933 deals only with the reporting requirements for companies issuing new securities, including the information in registration statements and prospectuses.
  8. sanction or suspend practitioners from doing audits for SEC companies, generally because of lack of appropriate qualifications or having engaged in unethical or improper professional conduct.
  9. Existence of extreme or unusual negligence even though there was no intent to deceive or do harm. Constructive fraud is also termed recklessness. Recklessness in the case of an audit is present if the auditor knew an adequate audit was not done, but still issued an opinion, even though there was no intention of deceiving statement users.
  10. Audit risk represents the possibility that the auditor concludes after conducting an adequate audit that the financial statements were fairly stated when, in fact, they were materially misstated. Audit risk is unavoidable, because auditors gather evidence only on a test basis and because well-concealed frauds are extremely difficult to detect.
  11. Currently used by only two states. Under this concept, any users that the auditor should have reasonably been able to foresee as likely users of the client's financial statements have the same rights as those with privity of contract.
  12. lack of duty to perform the service, nonnegligent performance, contributory negligence, and absence of causal connection.
  13. Lack of even slight care, tantamount to reckless behavior, that can be expected of a person. Some states do not distinguish between ordinary and gross negligence.
  14. The assessment against a defendant of that portion of the damage caused by the defendant's negligence. For example, if the courts determine that an auditor's negligence in conducting an audit was the cause of 30% of a loss to a defendant, only 30% of the aggregate damage will be assessed to the CPA firm.
  15. The liability of auditors under the Securities Exchange Act of 1934 often centers on the audited financial statements issued to the public in annual reports submitted to the SEC as part of annual form 10-K reports.
  16. Laws that have been passed by the U.S. Congress and other governmental units. The Securities Act of 1933 and 1934 and Sarbanes-Oxley Act of 2002 are important statutory laws affecting auditors.
  17. The act makes it illegal for all U.S. domestic firms, public or private, to offer a bribe to an official of a foreign country for the purpose of exerting influence and obtaining or retaining business.
  18. A third party who does not have privity of contract but is known to the contracting parties and is intended to have certain rights and benefits under the contract. An example is a bank that has a large loan outstanding at the balance sheet date and requires an audit as part of its loan agreement.
  19. One of four CPA firm defenses. A defense of contributory negligence exists when the auditor claims the client's own actions either resulted in the loss that is the basis for damages or interfered with the conduct of the audit in such a way that prevented the auditor from discovering the cause of the loss. Examples include a CPA firm notifying a client in writing of a deficiency in internal control that would have prevented theft, but management did not correct it, or the auditor was lied to and given false documents by a credit manager when reviewing accounts receivable.
  20. Absence of reasonable care that can be expected of a person in a set of circumstances. For auditors, it is in terms of what other competent auditors would have done in the same situation.
  21. The U.S. Supreme Court; scienter, which is knowledge and intent to deceive
  22. the date of issuance, up to the date the registration statement becomes effective, which can be several months later.
  23. the original purchasers of securities.
  24. failure to meet auditing standards
  25. The 1933 act
  26. One of four CPA firm defenses. The lack of duty to perform the service means that the CPA firm claims that there was no implied or expressed contract.
  27. Occurs when a misstatement is made and there is both knowledge of its falsity and the intent to deceive.
  28. Audit failure occurs when the auditor issues an incorrect audit opinion because it failed to comply with the requirements of auditing standards, such as assigning unqualified assistants to perform certain audit tasks.
  29. understanding two concepts: 1. The difference between a business failure and an audit failure. 2. The difference between an audit failure and audit risk.
  30. One of four CPA firm defenses.To succeed in an action against the auditor, the client must be able to show that there is a close causal connection between the auditor's failure to follow auditing standards and the damages suffered by the client.
  31. The same as common-law suits by third parties - nonnegligent performance, lack of duty, and absence of causal connection.
  32. Section 10 and Rule 10b-5 are; antifraud provisions of the 1934 act
  33. 1) Liability to clients. 2) Liability to third parties under common law. 3) Civil liability under the federal securities laws. 4) Criminal liability.
  34. Failure of one or both parties in a contract to fulfill the requirements of the contract. An example is the failure of a CPA firm to deliver a tax return on the agreed-upon date. Parties who have a relationship that is established by contract are said to have privity of contract.
  35. CPAs do not have the right to withhold information from the courts on the grounds that the information is privileged under common law. A CPA can refuse to testify in the state with privileged communications statutes, however, that privilege does not extend to federal courts.
  36. Liability for the act of others is a legal concept pertinent to lawsuits involving CPAs. The partners, or shareholders in the case of a professional corporation, are jointly liable for the civil actions against any owner. If the firm is, however, an LLP, LLC, general corporation, or a professional corporation with limited liability, then partners or shareholders' liabilities do not extend to another owners personal assets. The firm's assets are always subject to the damages that arise. Also, partners may be liable for the work of others that they rely on under the laws of agency, such as employees, other CPA firms, or specialists.
  37. Laws that have been developed through court decisions rather than through government statutes.
  38. 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. For example, if management intentionally misstates financial statements, an auditor can be assessed the entire loss to shareholders if the company is bankrupt and management is unable to pay.
  39. One of four CPA firm defenses. For nonnegligent performance in an audit, the CPA firm claims that the audit was performed in accordance with auditing standards. The prudent person concept also establishes in law that the CPA firm is not expected to be infallible.
  40. Members of a limited class of users that the auditor knows will rely on the financial statements. The three leading approaches taken by the courts are credit alliance (narrow), restatement of torts (more broad), and foreseeable user (most broadest).
  41. Used by most states, the Restatement Rule is that foreseen users must be members of a reasonably limited and identifiable group of users that have relied on the CPA's work, such as creditors, even though those persons were not specifically known to the CPA at the time the work was done.
  42. The prudent person concept is a legal concept pertinent to lawsuits involving CPAs. The auditor is expected only to conduct the audit with due care, and is not expected to be perfect.