Auditing An International Approach 7 Edition By Bewley – Test Bank

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Auditing An International Approach 7 Edition By Bewley – Test Bank

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Student: ___________________________________________________________________________

1. According to generally accepted auditing standards (GAAS), the overall objective of a financial statement audit is ________.

A. to enable the auditor to express an opinion as to whether the financial statements are prepared in accordance with generally accepted accounting principles

 

B. to reduce audit risk to an acceptably low level

 

C. to determine whether the financial principles adopted by management in preparing the financial statements are acceptable

 

D. to obtain reasonable assurance that the financial statements taken as a whole are free from misstatement, whether due to fraud or error

 

2. Which of the following is the first task that the auditor must accomplish to demonstrate proficiency in auditing?

A. Identify the evidence relevant for the audit of assertions that are made by management in its unaudited financial statements and notes.

 

B. Design an audit program to obtain sufficient appropriate evidence about assertions management makes in financial statements and notes.

 

C. Recognize the underlying assertions made by management in the financial statements and notes.

 

D. Evaluate the evidence gathered in the performance of the audit program and decide whether management’s assertions conform to generally accepted accounting principles and reality.

 

3. Auditors try to achieve independence in appearance in order to ________.

A. maintain public confidence in the profession

 

B. become independent in appearance and in fact

 

C. comply with the generally accepted auditing standards

 

D. maintain an unbiased mental attitude

 

4. Control risk is ________.

A. the probability that a material misstatement could occur and not be prevented or detected by the company’s internal control policies and procedures

 

B. the probability that a material misstatement could occur and not be detected by the auditor’s audit procedures

 

C. the risk that the auditor will not be able to complete the audit on a timely basis

 

D. the risk that the auditor will not properly control the staff on the audit engagement

 

5. The primary purpose of obtaining an understanding of the company’s internal controls in the financial statement audit is ________.

A. to help the auditors develop the audit program

 

B. to make suggestions to management to improve internal controls

 

C. to obtain direct sufficient appropriate audit evidence to afford a reasonable basis for an opinion on the financial statements

 

D. to determine whether the company has changed any accounting principles

 

6. An external auditor is conducting an audit of the financial statements of Camden Corporation. The external auditor is expected to ________.

A. certify the correctness of Camden’s financial statements

 

B. make a 100% examination of Camden’s records

 

C. give an opinion on whether Camden’s financial statements are fairly presented in all material respects

 

D. give an opinion on the attractiveness of Camden for investment purposes and critique the wisdom and legality of its business decisions

 

7. Which of the following statements best explains an unmodified report opinion?

A. The financial statements contain a departure from GAAP.

 

B. The auditor was unable to complete the work necessary to form a complete opinion.

 

C. The auditor was not aware of any reasons not to believe the statements are correct.

 

D. Based on the evidence obtained, the auditor believes the statements are free of material error.

 

8. A standard unmodified audit report should be dated ________.

A. no later than the date when the auditor obtained sufficient appropriate audit evidence supporting the auditor’s opinion

 

B. no earlier than the date when the auditor obtained sufficient appropriate audit evidence supporting the auditor’s opinion

 

C. as at the end of the year being reported on

 

D. as at the end of the year the audit work was done

 

9. Several sources of GAAP consulted by an auditor are in conflict as to the application of an accounting principle. Which of the following should the auditor consider to be the most authoritative?

A. CPA Canada Handbook.

 

B. CPA Canada Exposure Drafts.

 

C. Industry practice.

 

D. Federal legislation.

 

10. The reporting standards require that the auditor explicitly report on whether the financial statements ________.

A. contain adequate disclosure of all material matters

 

B. are in accordance with GAAP

 

C. used principles that are appropriate for the circumstances

 

D. were prepared on a consistent basis with the comparative year

 

11. Because of the risk of material misstatement, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of ________.

A. objective judgment

 

B. independent integrity

 

C. professional skepticism

 

D. impartial conservatism

 

12. Three-Party Accountability includes all of the following parties except ________.

A. users

 

B. practitioners

 

C. Audit Committee

 

D. management

 

13. Key features of SOX include all of the following except ________.

A. increased penalties for corporate wrongdoers

 

B. more timely and extensive financial disclosures

 

C. fewer options of recourse for aggrieved shareholders

 

D. increased oversight of auditors

 

14. Which of the following has been established to oversee the auditors of public companies?

A. Canadian Coalition for Good Governance.

 

B. Canadian Public Accountability Board.

 

C. The SOX Board.

 

D. The Canadian Securities Commission.

 

15. An assurance engagement is one in which a CPA is engaged to ________.

A. issue a written communication expressing a conclusion concerning a subject matter for which an accountable party is responsible

 

B. provide tax advice or prepare a tax return based on financial information the CPA has not audited or reviewed

 

C. testify as an expert witness in accounting, auditing, or tax matters, given certain stipulated facts

 

D. assemble prospective financial statements based on the assumptions of the entity’s management without expressing any assurance

 

16. All of the following are examples of assurance engagements except ________.

A. tax planning

 

B. financial statements audit

 

C. internal controls statement

 

D. financial statements review

 

17. The GAAS general standard relating to the audit of financial statements focuses on all of the following except ________.

A. competence

 

B. independence

 

C. due professional care

 

D. planning

 

18. According to IFAC, which of the following is not one of the elements of quality control?

A. Independence.

 

B. Supervision.

 

C. Acceptance and continuance of clients.

 

D. Due professional care.

 

19. In establishing a quality control system, which area should be of a secondary nature?

A. Creating an independence and objectivity checklist.

 

B. Creating a program for continuing professional education.

 

C. Creating an internal review process.

 

D. Controlling access to client files.

 

20. Williams & Co., a large international CPA firm, will be subject to an external peer review. The peer review will most likely be performed by ________.

A. employees and partners of Williams & Co. who are not associated with the particular audits being reviewed

 

B. employees and partners of another CPA firm

 

C. peer review staff of the Ontario Securities Commission

 

D. peer review staff of CPA Canada

 

21. A report giving conclusions about a firm’s compliance with quality control standards is typical of which of the following?

A. Practice inspection.

 

B. Quality inspection.

 

C. Peer review.

 

D. Quality review.

 

22. Practice standards are a general set of standards intended to guide the audits of financial statements.

True    False

 

23. The CPA Canada Handbook recommendations are a step-by-step list of procedures auditors have to complete for each engagement.

True    False

 

24. The general standard of GAAS relates primarily to the personal integrity and professional qualifications of auditors.

True    False

 

25. Control risk is the risk that an accounting firm’s quality control standards will not be adequate.

True    False

 

26. The fourth reporting standard requires the audit report to comment on the consistency of the accounting principles used in preparing the financial statements.

True    False

 

27. Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

True    False

 

28. Reliance on self-regulation of the accounting profession has changed as a result of its perceived failure to detect the problems leading to the corporate scandals of 2002/2003.

True    False

 

29. Appropriate audit evidence, to be reliable and relevant, must be quantitative, objective, and absolutely compelling.

True    False

 

30. A prospectus is the information, usually including financial information, about a firm that accompanies any new issuance of shares in a regulated securities market.

True    False

 

31. The assessment of materiality has a pervasive impact on the audit.

True    False

 

32. Audit committees monitor management’s financial reporting responsibilities.

True    False

 

33. Practice inspection is something a new auditor does as part of his or her training program.

True    False

 

34. Alan Fallon was recently promoted to senior accountant. He was put in charge of the Mellow Markets audit because of his experience with other grocery clients. Mellow Markets has a small, but growing chain of natural food stores. This is the first year Mellow Markets has been audited. Because of its growth, Mellow needs additional capital. Mellow intends to take its audited financial statements to a bank to secure a loan.

Alan has been assigned two inexperienced staff assistants for the audit. Because this is his first audit as a senior, he intends to bring the job in on budget. To save time, he gave the assistants the audit program for Happy Time Food Stores. He told his staff that this would make things go more quickly. He also told them that he could not spend much time with them at the client’s place of business because “my time is billed out at such a high rate, we’ll go right over budget.” He did call them once a day from another audit on which he was working. The assistants told Alan that the audit program did not always match up with what they found at Mellow Markets. Alan responded, “Just cross out whatever is not relevant in the audit program and don’t add anything-it will only make us go over the budget.”

When Alan came out near the end of fieldwork, one assistant communicated her concern that they had not attended the inventory counts at any of the out-of-town locations of Mellow Markets. The audit program had stipulated that inventory should be observed for in-town stores only. Happy Time had only one store not in town while Mellow Markets had three of their five stores in other cities. Alan told the assistant to get inventory sheets from the client for the other stores. He added, “Make sure that the inventory balance in the general ledger agrees with the total for all the inventory sheets.” The next day, Alan reviewed all work papers and submitted the job for review by the manager.

Required:

A. Describe three GAAS examination standards.
B. Do you believe that the Mellow Markets audit is in compliance with these standards? Explain.

 

 

 

 

35. What is the difference between audit procedures and audit standards?

 

 

 

 

36. What is a quality inspection?

 

 

 

 

 

 

c2 Key

1. According to generally accepted auditing standards (GAAS), the overall objective of a financial statement audit is ________.

A. to enable the auditor to express an opinion as to whether the financial statements are prepared in accordance with generally accepted accounting principles

 

B. to reduce audit risk to an acceptably low level

 

C. to determine whether the financial principles adopted by management in preparing the financial statements are acceptable

 

D. to obtain reasonable assurance that the financial statements taken as a whole are free from misstatement, whether due to fraud or error

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #1
Topic: 02-05 Generally Accepted Auditing Standards
 

 

2. Which of the following is the first task that the auditor must accomplish to demonstrate proficiency in auditing?

A. Identify the evidence relevant for the audit of assertions that are made by management in its unaudited financial statements and notes.

 

B. Design an audit program to obtain sufficient appropriate evidence about assertions management makes in financial statements and notes.

 

C. Recognize the underlying assertions made by management in the financial statements and notes.

 

D. Evaluate the evidence gathered in the performance of the audit program and decide whether management’s assertions conform to generally accepted accounting principles and reality.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #2
Topic: 02-07 Generally Accepted Auditing Standards: Ethical Requirements Relating to an Audit of Financial Statements
Topic: 02-08 Competence
 

 

3. Auditors try to achieve independence in appearance in order to ________.

A. maintain public confidence in the profession

 

B. become independent in appearance and in fact

 

C. comply with the generally accepted auditing standards

 

D. maintain an unbiased mental attitude

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #3
Topic: 02-09 Objectivity and Independence
 

 

4. Control risk is ________.

A. the probability that a material misstatement could occur and not be prevented or detected by the company’s internal control policies and procedures

 

B. the probability that a material misstatement could occur and not be detected by the auditor’s audit procedures

 

C. the risk that the auditor will not be able to complete the audit on a timely basis

 

D. the risk that the auditor will not properly control the staff on the audit engagement

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #4
Topic: 02-17 Internal Control Assessment
 

 

5. The primary purpose of obtaining an understanding of the company’s internal controls in the financial statement audit is ________.

A. to help the auditors develop the audit program

 

B. to make suggestions to management to improve internal controls

 

C. to obtain direct sufficient appropriate audit evidence to afford a reasonable basis for an opinion on the financial statements

 

D. to determine whether the company has changed any accounting principles

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #5
Topic: 02-17 Internal Control Assessment
 

 

6. An external auditor is conducting an audit of the financial statements of Camden Corporation. The external auditor is expected to ________.

A. certify the correctness of Camden’s financial statements

 

B. make a 100% examination of Camden’s records

 

C. give an opinion on whether Camden’s financial statements are fairly presented in all material respects

 

D. give an opinion on the attractiveness of Camden for investment purposes and critique the wisdom and legality of its business decisions

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #6
Topic: 02-19 Generally Accepted Auditing Standards: Reporting Standards
Topic: 02-20 Generally Accepted Accounting Principles (GAAP)
 

 

7. Which of the following statements best explains an unmodified report opinion?

A. The financial statements contain a departure from GAAP.

 

B. The auditor was unable to complete the work necessary to form a complete opinion.

 

C. The auditor was not aware of any reasons not to believe the statements are correct.

 

D. Based on the evidence obtained, the auditor believes the statements are free of material error.

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #7
Topic: 02-19 Generally Accepted Auditing Standards: Reporting Standards
 

 

8. A standard unmodified audit report should be dated ________.

A. no later than the date when the auditor obtained sufficient appropriate audit evidence supporting the auditor’s opinion

 

B. no earlier than the date when the auditor obtained sufficient appropriate audit evidence supporting the auditor’s opinion

 

C. as at the end of the year being reported on

 

D. as at the end of the year the audit work was done

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #8
Topic: 02-19 Generally Accepted Auditing Standards: Reporting Standards
 

 

9. Several sources of GAAP consulted by an auditor are in conflict as to the application of an accounting principle. Which of the following should the auditor consider to be the most authoritative?

A. CPA Canada Handbook.

 

B. CPA Canada Exposure Drafts.

 

C. Industry practice.

 

D. Federal legislation.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #9
Topic: 02-20 Generally Accepted Accounting Principles (GAAP)
 

 

10. The reporting standards require that the auditor explicitly report on whether the financial statements ________.

A. contain adequate disclosure of all material matters

 

B. are in accordance with GAAP

 

C. used principles that are appropriate for the circumstances

 

D. were prepared on a consistent basis with the comparative year

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #10
Topic: 02-06 Generally Accepted Auditing Standards: Objectives of the Audit of Financial Statements
Topic: 02-07 Generally Accepted Auditing Standards: Ethical Requirements Relating to an Audit of Financial Statements
 

 

11. Because of the risk of material misstatement, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of ________.

A. objective judgment

 

B. independent integrity

 

C. professional skepticism

 

D. impartial conservatism

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #11
Topic: 02-05 Generally Accepted Auditing Standards
 

 

12. Three-Party Accountability includes all of the following parties except ________.

A. users

 

B. practitioners

 

C. Audit Committee

 

D. management

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-04 Explain the importance of general assurance standards; using examples of assurance matters.
Smieliauskas – Chapter 02 #12
Topic: 02-24 Assurance Standards
 

 

13. Key features of SOX include all of the following except ________.

A. increased penalties for corporate wrongdoers

 

B. more timely and extensive financial disclosures

 

C. fewer options of recourse for aggrieved shareholders

 

D. increased oversight of auditors

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 02-01 Describe the current audit environment; including developments in regulatory oversight and provincial regulation of public accountants in Canada.
Smieliauskas – Chapter 02 #13
Topic: 02-02 The Sarbanes-Oxley Act
 

 

14. Which of the following has been established to oversee the auditors of public companies?

A. Canadian Coalition for Good Governance.

 

B. Canadian Public Accountability Board.

 

C. The SOX Board.

 

D. The Canadian Securities Commission.

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 02-01 Describe the current audit environment; including developments in regulatory oversight and provincial regulation of public accountants in Canada.
Smieliauskas – Chapter 02 #14
Topic: 02-02 The Sarbanes-Oxley Act
Topic: 02-03 Regulation of Public Accounting
 

 

15. An assurance engagement is one in which a CPA is engaged to ________.

A. issue a written communication expressing a conclusion concerning a subject matter for which an accountable party is responsible

 

B. provide tax advice or prepare a tax return based on financial information the CPA has not audited or reviewed

 

C. testify as an expert witness in accounting, auditing, or tax matters, given certain stipulated facts

 

D. assemble prospective financial statements based on the assumptions of the entity’s management without expressing any assurance

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-04 Explain the importance of general assurance standards; using examples of assurance matters.
Smieliauskas – Chapter 02 #15
Topic: 02-24 Assurance Standards
 

 

16. All of the following are examples of assurance engagements except ________.

A. tax planning

 

B. financial statements audit

 

C. internal controls statement

 

D. financial statements review

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-04 Explain the importance of general assurance standards; using examples of assurance matters.
Smieliauskas – Chapter 02 #16
Topic: 02-24 Assurance Standards
 

 

17. The GAAS general standard relating to the audit of financial statements focuses on all of the following except ________.

A. competence

 

B. independence

 

C. due professional care

 

D. planning

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #17
Topic: 02-07 Generally Accepted Auditing Standards: Ethical Requirements Relating to an Audit of Financial Statements
Topic: 02-08 Competence
Topic: 02-09 Objectivity and Independence
Topic: 02-10 Due Professional Care
 

 

18. According to IFAC, which of the following is not one of the elements of quality control?

A. Independence.

 

B. Supervision.

 

C. Acceptance and continuance of clients.

 

D. Due professional care.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 02-05 Explain how requirements of quality control standards are monitored for public accounting firms.
Smieliauskas – Chapter 02 #18
Topic: 02-26 Elements of Quality Control
 

 

19. In establishing a quality control system, which area should be of a secondary nature?

A. Creating an independence and objectivity checklist.

 

B. Creating a program for continuing professional education.

 

C. Creating an internal review process.

 

D. Controlling access to client files.

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Difficult
Learning Objective: 02-05 Explain how requirements of quality control standards are monitored for public accounting firms.
Smieliauskas – Chapter 02 #19
Topic: 02-25 Quality Control Standards
Topic: 02-26 Elements of Quality Control
 

 

20. Williams & Co., a large international CPA firm, will be subject to an external peer review. The peer review will most likely be performed by ________.

A. employees and partners of Williams & Co. who are not associated with the particular audits being reviewed

 

B. employees and partners of another CPA firm

 

C. peer review staff of the Ontario Securities Commission

 

D. peer review staff of CPA Canada

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 02-05 Explain how requirements of quality control standards are monitored for public accounting firms.
Smieliauskas – Chapter 02 #20
Topic: 02-25 Quality Control Standards
Topic: 02-26 Elements of Quality Control
 

 

21. A report giving conclusions about a firm’s compliance with quality control standards is typical of which of the following?

A. Practice inspection.

 

B. Quality inspection.

 

C. Peer review.

 

D. Quality review.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-05 Explain how requirements of quality control standards are monitored for public accounting firms.
Smieliauskas – Chapter 02 #21
Topic: 02-25 Quality Control Standards
Topic: 02-26 Elements of Quality Control
 

 

22. Practice standards are a general set of standards intended to guide the audits of financial statements.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-02 List the various practice standards for independent audits of financial statements.
Smieliauskas – Chapter 02 #22
Topic: 02-04 Practice Standards
 

 

23. The CPA Canada Handbook recommendations are a step-by-step list of procedures auditors have to complete for each engagement.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #23
Topic: 02-05 Generally Accepted Auditing Standards
 

 

24. The general standard of GAAS relates primarily to the personal integrity and professional qualifications of auditors.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #24
Topic: 02-05 Generally Accepted Auditing Standards
Topic: 02-06 Generally Accepted Auditing Standards: Objectives of the Audit of Financial Statements
Topic: 02-07 Generally Accepted Auditing Standards: Ethical Requirements Relating to an Audit of Financial Statements
 

 

25. Control risk is the risk that an accounting firm’s quality control standards will not be adequate.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #25
Topic: 02-17 Internal Control Assessment
 

 

26. The fourth reporting standard requires the audit report to comment on the consistency of the accounting principles used in preparing the financial statements.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #26
Topic: 02-19 Generally Accepted Auditing Standards: Reporting Standards
 

 

27. Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #27
Topic: 02-14 Reasonable Assurance
Topic: 02-15 Audit Risk and Materiality
 

 

28. Reliance on self-regulation of the accounting profession has changed as a result of its perceived failure to detect the problems leading to the corporate scandals of 2002/2003.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-01 Describe the current audit environment; including developments in regulatory oversight and provincial regulation of public accountants in Canada.
Smieliauskas – Chapter 02 #28
Topic: 02-01 The Current Environment of Auditing
 

 

29. Appropriate audit evidence, to be reliable and relevant, must be quantitative, objective, and absolutely compelling.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #29
Topic: 02-08 Competence
Topic: 02-10 Due Professional Care
 

 

30. A prospectus is the information, usually including financial information, about a firm that accompanies any new issuance of shares in a regulated securities market.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-01 Describe the current audit environment; including developments in regulatory oversight and provincial regulation of public accountants in Canada.
Smieliauskas – Chapter 02 #30
Topic: 02-03 Regulation of Public Accounting
 

 

31. The assessment of materiality has a pervasive impact on the audit.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #31
Topic: 02-14 Reasonable Assurance
Topic: 02-15 Audit Risk and Materiality
 

 

32. Audit committees monitor management’s financial reporting responsibilities.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 02-01 Describe the current audit environment; including developments in regulatory oversight and provincial regulation of public accountants in Canada.
Smieliauskas – Chapter 02 #32
Topic: 02-02 The Sarbanes-Oxley Act
 

 

33. Practice inspection is something a new auditor does as part of his or her training program.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 02-05 Explain how requirements of quality control standards are monitored for public accounting firms.
Smieliauskas – Chapter 02 #33
Topic: 02-25 Quality Control Standards
Topic: 02-26 Elements of Quality Control
 

 

34. Alan Fallon was recently promoted to senior accountant. He was put in charge of the Mellow Markets audit because of his experience with other grocery clients. Mellow Markets has a small, but growing chain of natural food stores. This is the first year Mellow Markets has been audited. Because of its growth, Mellow needs additional capital. Mellow intends to take its audited financial statements to a bank to secure a loan.

Alan has been assigned two inexperienced staff assistants for the audit. Because this is his first audit as a senior, he intends to bring the job in on budget. To save time, he gave the assistants the audit program for Happy Time Food Stores. He told his staff that this would make things go more quickly. He also told them that he could not spend much time with them at the client’s place of business because “my time is billed out at such a high rate, we’ll go right over budget.” He did call them once a day from another audit on which he was working. The assistants told Alan that the audit program did not always match up with what they found at Mellow Markets. Alan responded, “Just cross out whatever is not relevant in the audit program and don’t add anything-it will only make us go over the budget.”

When Alan came out near the end of fieldwork, one assistant communicated her concern that they had not attended the inventory counts at any of the out-of-town locations of Mellow Markets. The audit program had stipulated that inventory should be observed for in-town stores only. Happy Time had only one store not in town while Mellow Markets had three of their five stores in other cities. Alan told the assistant to get inventory sheets from the client for the other stores. He added, “Make sure that the inventory balance in the general ledger agrees with the total for all the inventory sheets.” The next day, Alan reviewed all work papers and submitted the job for review by the manager.

Required:

A. Describe three GAAS examination standards.
B. Do you believe that the Mellow Markets audit is in compliance with these standards? Explain.

A.

The examination standards are outlined below.

1. The work should be adequately planned and properly executed using sufficient knowledge of the entity’s business as a basis. If assistants are employed, they should be properly supervised.
2. A sufficient understanding of internal control should be obtained to plan the audit. When control risk is assessed below maximum, sufficient appropriate audit evidence should be obtained through tests of controls to support the assessment.
3. Sufficient appropriate audit evidence should be obtained, by such means as inspection, observation, enquiry, confirmation, computation, and analysis, to afford a reasonable basis to support the content of the report.

B.

1. The Mellow Markets audit is not in compliance with these standards. A proper audit program was not prepared. This, along with the emphasis on cutting time, means that it is also doubtful that a meaningful knowledge of the client’s business was obtained. It appears that the planning portion of the first examination standard was clearly violated. The lack of time and attention the inexperienced staff received from Alan Fallon is indicative of a violation of the supervision part of the first examination standard.
2. There is no indication of any steps taken to understand, evaluate, or test the internal control of Mellow Markets. This is a violation of the second examination standard.
3. The third examination standard also seems to have been violated. First, the deficiencies in meeting the first two examination standards suggest that the auditors could not have obtained sufficient appropriate evidence. In addition, the failure to observe any of the inventory counts in other cities is an additional deficiency-particularly since Mellow is a new client. Finally, ensuring that the inventory sheets agree with the balance in the general ledger account is merely a first step in the audit of inventory. By itself it is not sufficient appropriate evidence.

 

Blooms: Analysis
Difficulty: Difficult
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #34
Topic: 02-11 Generally Accepted Auditing Standards: Examination Standards
 

 

35. What is the difference between audit procedures and audit standards?

Audit standards are audit-quality recommendations that remain the same over time for all audits. Audit procedures, on the other hand, are quite different and include the particular specialized actions auditors take to obtain evidence in a specific audit engagement.

 

Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs).
Smieliauskas – Chapter 02 #35
Topic: 02-11 Generally Accepted Auditing Standards: Examination Standards
Topic: 02-19 Generally Accepted Auditing Standards: Reporting Standards
 

 

36. What is a quality inspection?

A quality inspection is an examination and evaluation of the quality of the overall practice. It is thus aimed at the firm level rather than at individuals. It involves extensive study of a firm’s quality control document and includes interviews with audit personnel as well as a detailed study of the quality of work, adherence to GAAS, and quality control standards on a selection of audit engagements.

 

Blooms: Knowledge
Difficulty: Moderate
Learning Objective: 02-05 Explain how requirements of quality control standards are monitored for public accounting firms.
Smieliauskas – Chapter 02 #36
Topic: 02-25 Quality Control Standards
Topic: 02-26 Elements of Quality Control
 

 

 

c2 Summary

Category # of Questions
Accessibility: Keyboard Navigation 33
Blooms: Analysis 1
Blooms: Comprehension 11
Blooms: Knowledge 24
Difficulty: Difficult 2
Difficulty: Easy 19
Difficulty: Moderate 15
Learning Objective: 02-01 Describe the current audit environment; including developments in regulatory oversight and provincial regulation of public accountants in Canada. 5
Learning Objective: 02-02 List the various practice standards for independent audits of financial statements. 1
Learning Objective: 02-03 Summarize the ethical; examination; and reporting standards that make up generally accepted auditing standards (GAAS) as set out in CPAC’s Canadian Auditing Standards (CASs). 21
Learning Objective: 02-04 Explain the importance of general assurance standards; using examples of assurance matters. 3
Learning Objective: 02-05 Explain how requirements of quality control standards are monitored for public accounting firms. 6
Smieliauskas – Chapter 02 36
Topic: 02-01 The Current Environment of Auditing 1
Topic: 02-02 The Sarbanes-Oxley Act 3
Topic: 02-03 Regulation of Public Accounting 2
Topic: 02-04 Practice Standards 1
Topic: 02-05 Generally Accepted Auditing Standards 4
Topic: 02-06 Generally Accepted Auditing Standards: Objectives of the Audit of Financial Statements 2
Topic: 02-07 Generally Accepted Auditing Standards: Ethical Requirements Relating to an Audit of Financial Statements 4
Topic: 02-08 Competence 3
Topic: 02-09 Objectivity and Independence 2
Topic: 02-10 Due Professional Care 2
Topic: 02-11 Generally Accepted Auditing Standards: Examination Standards 2
Topic: 02-14 Reasonable Assurance 2
Topic: 02-15 Audit Risk and Materiality 2
Topic: 02-17 Internal Control Assessment 3
Topic: 02-19 Generally Accepted Auditing Standards: Reporting Standards 5
Topic: 02-20 Generally Accepted Accounting Principles (GAAP) 2
Topic: 02-24 Assurance Standards 3
Topic: 02-25 Quality Control Standards 5
Topic: 02-26 Elements of Quality Control 6

c20

Student: ___________________________________________________________________________

1. Which of the following statements represents an audit failure?

A. A client goes bankrupt or has serious financial difficulty.

 

B. An auditor failed to conduct an audit in accordance with GAAS.

 

C. An auditor cannot collect the audit fees from the client.

 

D. An auditor is sued by a third party.

 

2. Sun Corp. approved a merger plan with Cord Corp. One of the factors that led to the approval of the merger was the fact that the Cord’s financial statements were audited by Frank & Co. CPAs. Sun had engaged Frank to audit Cord’s financial statements. While performing the audit, Frank failed to discover certain irregularities that later caused Sun to suffer substantial losses. For the lawsuit to be successful, Sun must prove that Frank & Co., CPAs ________.

A. knew of the irregularities

 

B. failed to exercise due care

 

C. was grossly negligent

 

D. acted with scienter

 

3. To protect themselves, before an engagement letter is submitted to a client, what should an auditor complete to assist in deciding whether to accept a particular client for an engagement?

A. Management letter.

 

B. Client acceptance checklist.

 

C. Reliance letter.

 

D. Limited liability letter.

 

4. Third-party plaintiffs bringing action under common law need NOT prove ________.

A. they were damaged or suffered a loss

 

B. reliance on the financial statements

 

C. the financial statements were direct cause of loss

 

D. breach of contract

 

5. When referring to public accountants, what does breach of contract mean?

A. A lawsuit involving a client and an auditor.

 

B. Services were not performed as agreed.

 

C. Auditor bills clients for extra services.

 

D. There is no engagement letter signed by the client.

 

6. In a common law action against an accountant, lack of privity is a viable defence if the plaintiff ________.

A. is the client’s creditor who sues the accountant for negligence

 

B. can prove the presence of gross negligence that amounts to a reckless disregard for the truth

 

C. is the accountant’s client

 

D. bases the action upon fraud

 

7. Which of the following is NOT an element of a successful negligence action against auditors?

A. There must be proof that damage resulted.

 

B. The plaintiff must be a known user of the financial statements.

 

C. There must be a legal duty of care to the plaintiff.

 

D. There must be a reasonable connection between the breach of duty of care and resulting losses.

 

8. Which of the following elements, if present, would support a finding of constructive fraud on the part of a CPA?

A. Gross negligence in applying generally accepted auditing standards.

 

B. Ordinary negligence in applying generally accepted accounting principles.

 

C. Identified third-party users.

 

D. Scienter.

 

9. Beckler & Associates CPAs issued an unqualified opinion on the financial statements of Queen Ltd. The financial statements contained misstatements that resulted in a material overstatement of Queen’s net worth. Queen provided the audited financial statements to Mac Bank in connection with a loan made by Mac to Queen. Beckler knew that the financial statements would be provided to Mac. Queen defaulted on the loan. Mac sued Beckler to recover the losses associated with Queen’s default. Which of the following must Mac prove in order to recover?

I. Beckler was negligent in conducting the audit.
II. Mac relied on the financial statements.

A. I only.

 

B. II only.

 

C. Both I and II.

 

D. Neither I nor II.

 

10. A company whose partners’ liability is limited to the capital they have invested in the business is known as a ________.

A. partnership

 

B. corporation

 

C. proprietorship

 

D. limited liability partnership

 

11. An important case that limits the auditor’s liability to those third parties of which the auditor had knowledge was ________.

A. Dupuis v. Pan American Mines

 

B. Hedley Byrne & Co. Ltd. v. Heller & Partners Ltd.

 

C. Caparo Industries PLC.v. Dickman et al.

 

D. Haig v. Bamford et al.

 

12. Under the common law, in a lawsuit concerning auditor liability, the primary beneficiary is _______.

A. the recipient of funds when someone dies

 

B. a party for whose benefit the audit or service is being performed

 

C. the client

 

D. the shareholders of the company

 

13. Foreseeable third parties are best described as ________.

A. management of the company

 

B. those that have direct involvement through a contract

 

C. those third parties who will rely on the audit and are specifically known by the auditor

 

D. those third parties who potentially will rely on the audit but are not specifically known by the auditor

 

14. Under common law, which of the following statements most accurately reflects the liability of a CPA who gives a fraudulent opinion on an audit of a client’s financial statements?

A. The CPA is liable only to third parties who are in privity of contract with the CPA.

 

B. The CPA is liable only to known users of the financial statements.

 

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

 

D. The CPA probably is liable to the client even if the client was aware of the fraud and did not rely on the opinion.

 

15. When an auditor is found guilty of a fraudulent misrepresentation, there is liability owed to ________.

A. third parties with privity and contracted parties

 

B. any party that suffered a loss

 

C. shareholders only

 

D. all parties with privity

 

16. During a review engagement, CPA discovers that the gross margin has increased by 20% over the last few years. To avoid potential liability due to possibly misstated financial statements, what should CPA do?

A. Correct the gross margin to be consistent with prior years.

 

B. Obtain additional information to correct or substantiate the figures.

 

C. No additional work is required for review engagements.

 

D. Downgrade the assignment to a compilation engagement.

 

17. The lessons for accountants that are inherent in the 1136 Tenants’ Corporation v. Rothenberg & Co. case include all of the following EXCEPT which one?

A. Engagement letters are as essential for accounting engagements as they are for audit engagements.

 

B. Regardless of the nature of the engagement, a public accountant should be alert for and should follow up on any unusual items such as missing invoices.

 

C. Accountants should clearly communicate the extent of their association with financial information.

 

D. Public accountants cannot be held liable to third parties in non-audit or review engagements.

 

18. A CPA may be liable to any purchaser of a security if the CPA issued a clean opinion on materially misstated financial statements. The CPA usually will not be liable to the purchaser ________.

A. if the purchaser is guilty of contributory negligence

 

B. if the CPA can prove due care in the audit

 

C. unless the purchaser can prove privity with the CPA

 

D. unless the purchaser can prove scienter on the part of the CPA

 

19. While conducting an audit, Larson Associates CPAs failed to detect a material misstatement in its client’s financial statements. Larson’s unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. In a suit by a purchaser against Larson for common law negligence, Larson’s best defence would be that the ________.

A. audit was conducted in accordance with generally accepted auditing standards

 

B. client was aware of the misstatements

 

C. purchaser was not in privity of contract with Larson

 

D. identity of the purchaser was not known to Larson at the time of the audit

 

20. While conducting an audit, Larson & Larson Chartered Professional Accountants failed to detect a material misstatement in its client’s financial statements. Larson’s unqualified opinion was included with the financial statements in a prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. Which of the following statements is correct with regard to a suit against Larson and the client by a purchaser of the securities?

A. The purchaser must prove that Larson was negligent in conducting the audit.

 

B. The purchaser must prove that Larson knew of the material misstatements.

 

C. Larson will not be liable if they had reasonable grounds to believe the financial statements were accurate.

 

D. Larson will be liable unless the purchaser did not rely on the financial statements.

 

21. If a professional accountant is able to reasonably foresee a limited class of potential users for his or her work, liability may then be imposed for ________.

A. ordinary negligence

 

B. constructive fraud

 

C. gross negligence

 

D. fraud

 

22. A relationship of direct involvement between parties to a contract is known as privity

True    False

 

23. The Securities and Exchange Commission in the United States will hold a negligent auditor liable under common law.

True    False

 

24. A breach of contract suit is a claim that could be brought by a client against an accountant that accounting services were not performed in the manner agreed upon.

True    False

 

25. In a common law action against an accountant, all that a plaintiff must prove is that the accountant was negligent, grossly negligent, fraudulent, or otherwise responsible for the damages claimed.

True    False

 

26. Accountants are liable under the common law for breach of contract if they fail to fulfill their contractual obligations with their clients and for negligence if they fail to exercise due care in the performance of services for their clients

True    False

 

27. Constructive fraud is characterized by an intentional act designed to deceive, mislead or injure the rights of another person.

True    False

 

28. A plaintiff, who is a normal trade creditor, can collect damages under common law for negligence from the corporation’s auditors.

True    False

 

29. Primary beneficiaries are third parties who have paid to have an audit performed.

True    False

 

30. Due professional care occurs when an auditor observes all the rules of conduct for the profession and applies all the standards of the profession.

True    False

 

31. Due professional care implies that the practitioner is conducting his or her work to the highest possible standard and will make no errors.

True    False

 

32. In the London v.General Bank (1895) case, it was held that the auditor takes complete responsibility for detecting fraud in a set of financial statements they are auditing.

True    False

 

33. Auditors are increasingly obligated to report illegal acts to third parties outside the company in which they occurred.

True    False

 

34. Accountants are not liable for misstatements in compilation or review engagements.

True    False

 

35. A defendant accountant will likely first try to argue that it had no privity relationship with the plaintiff.

True    False

 

36. Under common law, a plaintiff who is owed a legal duty of care must prove reliance on misleading statements and damages suffered because of that reliance.

True    False

 

37. Joint and several liability is a doctrine that allows a successful plaintiff to recover the full amount of damage award from the defendants who have money or insurance.

True    False

 

38. A reasonably foreseeable third party would include current shareholders but not lenders.

True    False

 

39. Even in a review engagement, the accountant cannot merely accept client-supplied information that appears to be false or misleading.

True    False

 

40. The OSC in Canada has powers to decide what is GAAP, similar to the SEC in the United States.

True    False

 

41. The United States was the first nation to make it illegal to bribe foreign officials. This was implemented through the landmark Foreign Corrupt Practices Act of 1977 (FCPA).

True    False

 

42. In contrast to its concern for the quality of accounting principles, the SEC’s involvement in auditing standards and procedural matters has been minimal since the developments of the McKesson and Robbins affair.

True    False

 

43. What is privity?

 

 

 

 

44. Negligence is the failure to perform a duty with the requisite standard of care. What are the four elements of negligence and what would be an auditor’s defence against them?

 

 

 

 

45. Who would be considered a reasonably foreseeable third party for an auditor?

 

 

 

 

46. Sleek Corporation is a public corporation whose stock is traded on several provincial securities exchanges. Sleek engaged Garson & Garson CPAs to audit Sleek’s financial statements. Sleek was planning a business expansion program and needed the audit in order to obtain financing through borrowing and making a public stock offering.

Before the engagement began, Fred Hedge, the president of Sleek, told Garson’s managing partner that the audited financial statements would be submitted to Sleek’s banks to obtain the necessary loans. During the course of the audit, Garson’s managing partner found that Hedge and other Sleek officers had embezzled substantial amounts of money from the corporation. These embezzlements threatened Sleek’s financial stability.

When these findings were brought to Hedge’s attention, Hedge promised that the money would be repaid and begged that the auditor not disclose the fraud. Hedge also told Garson’s managing partner that several friends and relatives of Sleek’s officers had been advised about the projected business expansion and proposed stock offering, and had purchased significant amounts of Sleek’s stock based on this information.

Garson submitted an unqualified opinion on Sleek’s financial statements, which did not include adjustments for or disclosures about the embezzlements and insider stock transactions. The financial statements and audit report were submitted to Sleek’s regular banks including Knox Bank. Knox, relying on the financial statements and Garson’s report, gave Sleek a $2,000,000 loan. Sleek’s audited financial statements were also incorporated into a prospectus. The prospectus filed by Sleek with the OSC offered 100,000 shares of its common stock at $100 per share. An OSC investigation of Sleek disclosed the embezzlements and the insider trading. Trading in Sleek’s stock was suspended and Sleek defaulted on the Knox loan. As a result, the following legal actions were taken:

1. Knox sued Garson.
2. The general public purchasers of Sleek’s stock offering sued Garson.

Required:

A. Would Knox recover from Garson for fraud?
B. Would the general public purchasers of Sleek’s stock offerings recover from Garson?

 

 

 

 

47. Some people argue that there is a legal liability crisis for auditors in Canada. Do you agree or disagree? Provide some evidence supporting this argument, and some evidence contradicting this argument.

 

 

 

 

48. What is a primary beneficiary?

 

 

 

 

49. What are the legal liabilities of professional accountants under the common law?

 

 

 

 

 

 

c20 Key

1. Which of the following statements represents an audit failure?

A. A client goes bankrupt or has serious financial difficulty.

 

B. An auditor failed to conduct an audit in accordance with GAAS.

 

C. An auditor cannot collect the audit fees from the client.

 

D. An auditor is sued by a third party.

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-01 List some examples of potential civil and criminal litigation facing public accountants.
Smieliauskas – Chapter 20 #1
Topic: 20-01 Liability Under Common Law Cases
Topic: 20-02 Characteristics of Common Law Actions
 

 

2. Sun Corp. approved a merger plan with Cord Corp. One of the factors that led to the approval of the merger was the fact that the Cord’s financial statements were audited by Frank & Co. CPAs. Sun had engaged Frank to audit Cord’s financial statements. While performing the audit, Frank failed to discover certain irregularities that later caused Sun to suffer substantial losses. For the lawsuit to be successful, Sun must prove that Frank & Co., CPAs ________.

A. knew of the irregularities

 

B. failed to exercise due care

 

C. was grossly negligent

 

D. acted with scienter

 

Accessibility: Keyboard Navigation
Blooms: Application
Difficulty: Difficult
Learning Objective: 20-01 List some examples of potential civil and criminal litigation facing public accountants.
Smieliauskas – Chapter 20 #2
Topic: 20-01 Liability Under Common Law Cases
Topic: 20-02 Characteristics of Common Law Actions
 

 

3. To protect themselves, before an engagement letter is submitted to a client, what should an auditor complete to assist in deciding whether to accept a particular client for an engagement?

A. Management letter.

 

B. Client acceptance checklist.

 

C. Reliance letter.

 

D. Limited liability letter.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #3
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

4. Third-party plaintiffs bringing action under common law need NOT prove ________.

A. they were damaged or suffered a loss

 

B. reliance on the financial statements

 

C. the financial statements were direct cause of loss

 

D. breach of contract

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #4
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

5. When referring to public accountants, what does breach of contract mean?

A. A lawsuit involving a client and an auditor.

 

B. Services were not performed as agreed.

 

C. Auditor bills clients for extra services.

 

D. There is no engagement letter signed by the client.

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #5
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

6. In a common law action against an accountant, lack of privity is a viable defence if the plaintiff ________.

A. is the client’s creditor who sues the accountant for negligence

 

B. can prove the presence of gross negligence that amounts to a reckless disregard for the truth

 

C. is the accountant’s client

 

D. bases the action upon fraud

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #6
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

7. Which of the following is NOT an element of a successful negligence action against auditors?

A. There must be proof that damage resulted.

 

B. The plaintiff must be a known user of the financial statements.

 

C. There must be a legal duty of care to the plaintiff.

 

D. There must be a reasonable connection between the breach of duty of care and resulting losses.

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #7
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

8. Which of the following elements, if present, would support a finding of constructive fraud on the part of a CPA?

A. Gross negligence in applying generally accepted auditing standards.

 

B. Ordinary negligence in applying generally accepted accounting principles.

 

C. Identified third-party users.

 

D. Scienter.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #8
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

9. Beckler & Associates CPAs issued an unqualified opinion on the financial statements of Queen Ltd. The financial statements contained misstatements that resulted in a material overstatement of Queen’s net worth. Queen provided the audited financial statements to Mac Bank in connection with a loan made by Mac to Queen. Beckler knew that the financial statements would be provided to Mac. Queen defaulted on the loan. Mac sued Beckler to recover the losses associated with Queen’s default. Which of the following must Mac prove in order to recover?

I. Beckler was negligent in conducting the audit.
II. Mac relied on the financial statements.

A. I only.

 

B. II only.

 

C. Both I and II.

 

D. Neither I nor II.

 

Accessibility: Keyboard Navigation
Blooms: Application
Difficulty: Difficult
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #9
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

10. A company whose partners’ liability is limited to the capital they have invested in the business is known as a ________.

A. partnership

 

B. corporation

 

C. proprietorship

 

D. limited liability partnership

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #10
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

11. An important case that limits the auditor’s liability to those third parties of which the auditor had knowledge was ________.

A. Dupuis v. Pan American Mines

 

B. Hedley Byrne & Co. Ltd. v. Heller & Partners Ltd.

 

C. Caparo Industries PLC.v. Dickman et al.

 

D. Haig v. Bamford et al.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #11
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

12. Under the common law, in a lawsuit concerning auditor liability, the primary beneficiary is _______.

A. the recipient of funds when someone dies

 

B. a party for whose benefit the audit or service is being performed

 

C. the client

 

D. the shareholders of the company

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #12
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

13. Foreseeable third parties are best described as ________.

A. management of the company

 

B. those that have direct involvement through a contract

 

C. those third parties who will rely on the audit and are specifically known by the auditor

 

D. those third parties who potentially will rely on the audit but are not specifically known by the auditor

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #13
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

14. Under common law, which of the following statements most accurately reflects the liability of a CPA who gives a fraudulent opinion on an audit of a client’s financial statements?

A. The CPA is liable only to third parties who are in privity of contract with the CPA.

 

B. The CPA is liable only to known users of the financial statements.

 

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

 

D. The CPA probably is liable to the client even if the client was aware of the fraud and did not rely on the opinion.

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #14
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

15. When an auditor is found guilty of a fraudulent misrepresentation, there is liability owed to ________.

A. third parties with privity and contracted parties

 

B. any party that suffered a loss

 

C. shareholders only

 

D. all parties with privity

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #15
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

16. During a review engagement, CPA discovers that the gross margin has increased by 20% over the last few years. To avoid potential liability due to possibly misstated financial statements, what should CPA do?

A. Correct the gross margin to be consistent with prior years.

 

B. Obtain additional information to correct or substantiate the figures.

 

C. No additional work is required for review engagements.

 

D. Downgrade the assignment to a compilation engagement.

 

Accessibility: Keyboard Navigation
Blooms: Application
Difficulty: Difficult
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #16
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

17. The lessons for accountants that are inherent in the 1136 Tenants’ Corporation v. Rothenberg & Co. case include all of the following EXCEPT which one?

A. Engagement letters are as essential for accounting engagements as they are for audit engagements.

 

B. Regardless of the nature of the engagement, a public accountant should be alert for and should follow up on any unusual items such as missing invoices.

 

C. Accountants should clearly communicate the extent of their association with financial information.

 

D. Public accountants cannot be held liable to third parties in non-audit or review engagements.

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #17
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

18. A CPA may be liable to any purchaser of a security if the CPA issued a clean opinion on materially misstated financial statements. The CPA usually will not be liable to the purchaser ________.

A. if the purchaser is guilty of contributory negligence

 

B. if the CPA can prove due care in the audit

 

C. unless the purchaser can prove privity with the CPA

 

D. unless the purchaser can prove scienter on the part of the CPA

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #18
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

19. While conducting an audit, Larson Associates CPAs failed to detect a material misstatement in its client’s financial statements. Larson’s unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. In a suit by a purchaser against Larson for common law negligence, Larson’s best defence would be that the ________.

A. audit was conducted in accordance with generally accepted auditing standards

 

B. client was aware of the misstatements

 

C. purchaser was not in privity of contract with Larson

 

D. identity of the purchaser was not known to Larson at the time of the audit

 

Accessibility: Keyboard Navigation
Blooms: Application
Difficulty: Difficult
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #19
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

20. While conducting an audit, Larson & Larson Chartered Professional Accountants failed to detect a material misstatement in its client’s financial statements. Larson’s unqualified opinion was included with the financial statements in a prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose. Which of the following statements is correct with regard to a suit against Larson and the client by a purchaser of the securities?

A. The purchaser must prove that Larson was negligent in conducting the audit.

 

B. The purchaser must prove that Larson knew of the material misstatements.

 

C. Larson will not be liable if they had reasonable grounds to believe the financial statements were accurate.

 

D. Larson will be liable unless the purchaser did not rely on the financial statements.

 

Accessibility: Keyboard Navigation
Blooms: Analysis
Difficulty: Difficult
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #20
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

21. If a professional accountant is able to reasonably foresee a limited class of potential users for his or her work, liability may then be imposed for ________.

A. ordinary negligence

 

B. constructive fraud

 

C. gross negligence

 

D. fraud

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #21
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

22. A relationship of direct involvement between parties to a contract is known as privity

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #22
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

23. The Securities and Exchange Commission in the United States will hold a negligent auditor liable under common law.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-01 List some examples of potential civil and criminal litigation facing public accountants.
Smieliauskas – Chapter 20 #23
Topic: 20-01 Liability Under Common Law Cases
Topic: 20-02 Characteristics of Common Law Actions
 

 

24. A breach of contract suit is a claim that could be brought by a client against an accountant that accounting services were not performed in the manner agreed upon.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-01 List some examples of potential civil and criminal litigation facing public accountants.
Smieliauskas – Chapter 20 #24
Topic: 20-01 Liability Under Common Law Cases
Topic: 20-02 Characteristics of Common Law Actions
 

 

25. In a common law action against an accountant, all that a plaintiff must prove is that the accountant was negligent, grossly negligent, fraudulent, or otherwise responsible for the damages claimed.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #25
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

26. Accountants are liable under the common law for breach of contract if they fail to fulfill their contractual obligations with their clients and for negligence if they fail to exercise due care in the performance of services for their clients

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #26
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

27. Constructive fraud is characterized by an intentional act designed to deceive, mislead or injure the rights of another person.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #27
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

28. A plaintiff, who is a normal trade creditor, can collect damages under common law for negligence from the corporation’s auditors.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #28
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

29. Primary beneficiaries are third parties who have paid to have an audit performed.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #29
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

30. Due professional care occurs when an auditor observes all the rules of conduct for the profession and applies all the standards of the profession.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #30
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

31. Due professional care implies that the practitioner is conducting his or her work to the highest possible standard and will make no errors.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #31
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

32. In the London v.General Bank (1895) case, it was held that the auditor takes complete responsibility for detecting fraud in a set of financial statements they are auditing.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #32
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

33. Auditors are increasingly obligated to report illegal acts to third parties outside the company in which they occurred.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #33
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

34. Accountants are not liable for misstatements in compilation or review engagements.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #34
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

35. A defendant accountant will likely first try to argue that it had no privity relationship with the plaintiff.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #35
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

36. Under common law, a plaintiff who is owed a legal duty of care must prove reliance on misleading statements and damages suffered because of that reliance.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #36
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

37. Joint and several liability is a doctrine that allows a successful plaintiff to recover the full amount of damage award from the defendants who have money or insurance.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #37
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

38. A reasonably foreseeable third party would include current shareholders but not lenders.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #38
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

39. Even in a review engagement, the accountant cannot merely accept client-supplied information that appears to be false or misleading.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #39
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

40. The OSC in Canada has powers to decide what is GAAP, similar to the SEC in the United States.

FALSE

 

Accessibility: Keyboard Navigation
Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #40
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

41. The United States was the first nation to make it illegal to bribe foreign officials. This was implemented through the landmark Foreign Corrupt Practices Act of 1977 (FCPA).

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-03 Explain how anti-corruption laws have influenced auditor liabilities.
Smieliauskas – Chapter 20 #41
Topic: 20-05 Three Important Laws to Prevent Corruption
Topic: 20-06 Foreign Corrupt Practices Act of 1977
Topic: 20-07 Bill C-22 and Racketeer Influenced and Corrupt Organization Act
 

 

42. In contrast to its concern for the quality of accounting principles, the SEC’s involvement in auditing standards and procedural matters has been minimal since the developments of the McKesson and Robbins affair.

TRUE

 

Accessibility: Keyboard Navigation
Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-04 Recognize U.S. Securities and Exchange Commission (statutory) law liability issues.
Smieliauskas – Chapter 20 #42
Topic: 20-11 Regulation of Auditing Standards
 

 

43. What is privity?

A relationship of direct involvement between parties to a contract is known as privity. When privity exists, a plaintiff usually need only show that the defendant accountant was negligent.

 

Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #43
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

44. Negligence is the failure to perform a duty with the requisite standard of care. What are the four elements of negligence and what would be an auditor’s defence against them?

There existed a legal duty of care to the plaintiff which was breached by the auditor and there is proof that damage resulted from that breach in duty. There must also be a reasonably proximate connection between the breach of duty and the resulting damage. The auditor’s best defence is that one of the four elements is missing. For example, that the duty of care was not breached by the auditor (he followed GAAP and GAAS) and that there was contributory negligence by the plaintiff.

 

Blooms: Knowledge
Difficulty: Easy
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #44
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

45. Who would be considered a reasonably foreseeable third party for an auditor?

A reasonably foreseeable third party would include current shareholders and lenders as well as the limited classes of prospective shareholders and lenders. Auditors owe a duty to third parties of which they have an actual knowledge of the limited class that will actually use and rely on the financial statements. The auditor must be aware of all known third parties and reasonably foreseeable third parties who will rely on the financial statements.

 

Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #45
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

46. Sleek Corporation is a public corporation whose stock is traded on several provincial securities exchanges. Sleek engaged Garson & Garson CPAs to audit Sleek’s financial statements. Sleek was planning a business expansion program and needed the audit in order to obtain financing through borrowing and making a public stock offering.

Before the engagement began, Fred Hedge, the president of Sleek, told Garson’s managing partner that the audited financial statements would be submitted to Sleek’s banks to obtain the necessary loans. During the course of the audit, Garson’s managing partner found that Hedge and other Sleek officers had embezzled substantial amounts of money from the corporation. These embezzlements threatened Sleek’s financial stability.

When these findings were brought to Hedge’s attention, Hedge promised that the money would be repaid and begged that the auditor not disclose the fraud. Hedge also told Garson’s managing partner that several friends and relatives of Sleek’s officers had been advised about the projected business expansion and proposed stock offering, and had purchased significant amounts of Sleek’s stock based on this information.

Garson submitted an unqualified opinion on Sleek’s financial statements, which did not include adjustments for or disclosures about the embezzlements and insider stock transactions. The financial statements and audit report were submitted to Sleek’s regular banks including Knox Bank. Knox, relying on the financial statements and Garson’s report, gave Sleek a $2,000,000 loan. Sleek’s audited financial statements were also incorporated into a prospectus. The prospectus filed by Sleek with the OSC offered 100,000 shares of its common stock at $100 per share. An OSC investigation of Sleek disclosed the embezzlements and the insider trading. Trading in Sleek’s stock was suspended and Sleek defaulted on the Knox loan. As a result, the following legal actions were taken:

1. Knox sued Garson.
2. The general public purchasers of Sleek’s stock offering sued Garson.

Required:

A. Would Knox recover from Garson for fraud?
B. Would the general public purchasers of Sleek’s stock offerings recover from Garson?

A. Knox would recover from Garson for fraud. The elements of fraud are:

a. the misrepresentation of a material fact Garson issued an unqualified opinion on misleading financial statements. Garson’s opinion did not include adjustments for or disclosures about the embezzlements and insider stock trading.
b. a loss was sustained
c. by Knox as a direct result of Sleek’s default on the loan.

B. The general public purchasers of Sleek’s stock offerings would recover from Garson for the same reasons.

a. Under the facts presented, Garson could not establish a due diligence defence because they knew that the prospectus failed to disclose material facts. Garson’s knowledge that the prospectus failed to disclose a material fact, such as the insider trading and the embezzlements, is considered a fraudulent action. The omission was material.
b. Garson’s action was intentional or, at a minimum, a result of gross negligence or recklessness (scienter).
c. These purchasers relied on Garson’s opinion on the financial statements and incurred a loss.

 

Blooms: Application
Difficulty: Difficult
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #46
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

47. Some people argue that there is a legal liability crisis for auditors in Canada. Do you agree or disagree? Provide some evidence supporting this argument, and some evidence contradicting this argument.

Auditors are increasingly being held to high standards by the public and by public regulators who wish to extend audit liability beyond what the courts have held. One result is that auditors have shied away from performing audit services wherever they perceive a high risk of business failure. This has especially hurt smaller companies attempting to raise funds by going public and who need an audit opinion on a prospectus. Because of the extra risks involved, they are unable to get an audit done, and consequently unable to raise funds in Canada.

Another result is that auditors are facing double digit increases in their liability insurance premiums, if they can get it at all. Some firms have had to join together to create their own insurance company in order to protect themselves.

Compared to the United States however, where pending suits total about US$20 billion, it can be argued that there is no crisis. Jury trials are rare in Canada, and judges are appointed to the bench from among skilled lawyers, not elected as they are in the United States. As a result, the outcome will be decided based on a skilled examination of the facts rather than the drama of the courtroom setting.

As well, punitive damages are not available for mere negligence in Canada and class actions are much rarer in Canada. However, class actions are an increasing part of the Canadian legal landscape, as are contingency fees. This reduces the cost of launching a law suit. Often, merely going to court can do enough damage to an auditor’s reputation that an out of court settlement will be negotiated.

The most compelling argument leading to a conclusion that there is a liability crisis for auditors in Canada is the statement by Joel Cohen that auditors are limiting their liability by limiting access to their services. In other words, the public is not being served. If the public is not being served, then something will have to be changed and one definition of a crisis is as a “turning point”.

 

Blooms: Analysis
Difficulty: Difficult
Learning Objective: 20-01 List some examples of potential civil and criminal litigation facing public accountants.
Smieliauskas – Chapter 20 #47
 

 

48. What is a primary beneficiary?

A primary beneficiary is a third party for whose primary benefit the audit or other accounting service s performed. Many cases indicate that proof of ordinary negligence may be sufficient to make accountants liable for damages to primary beneficiaries.

 

Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.
Smieliauskas – Chapter 20 #48
Topic: 20-03 Four Elements of Negligence
Topic: 20-04 Auditors Liability under Statutory Law
 

 

49. What are the legal liabilities of professional accountants under the common law?

Accountants are liable under the common law for breach of contract if they fail to fulfill their contractual obligations with their clients and for negligence if they fail to exercise due care in the performance of services for their clients. Auditors may also be liable to third parties in some circumstances.

 

Blooms: Comprehension
Difficulty: Moderate
Learning Objective: 20-01 List some examples of potential civil and criminal litigation facing public accountants.
Smieliauskas – Chapter 20 #49
Topic: 20-01 Liability Under Common Law Cases
Topic: 20-02 Characteristics of Common Law Actions
 

 

 

c20 Summary

Category # of Questions
Accessibility: Keyboard Navigation 42
Blooms: Analysis 2
Blooms: Application 5
Blooms: Comprehension 21
Blooms: Knowledge 21
Difficulty: Difficult 7
Difficulty: Easy 21
Difficulty: Moderate 21
Learning Objective: 20-01 List some examples of potential civil and criminal litigation facing public accountants. 6
Learning Objective: 20-02 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario. 41
Learning Objective: 20-03 Explain how anti-corruption laws have influenced auditor liabilities. 1
Learning Objective: 20-04 Recognize U.S. Securities and Exchange Commission (statutory) law liability issues. 1
Smieliauskas – Chapter 20 49
Topic: 20-01 Liability Under Common Law Cases 5
Topic: 20-02 Characteristics of Common Law Actions 5
Topic: 20-03 Four Elements of Negligence 41
Topic: 20-04 Auditors Liability under Statutory Law 41
Topic: 20-05 Three Important Laws to Prevent Corruption 1
Topic: 20-06 Foreign Corrupt Practices Act of 1977 1
Topic: 20-07 Bill C-22 and Racketeer Influenced and Corrupt Organization Act 1
Topic: 20-11 Regulation of Auditing Standards 1

 

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