Cable Corporation orally engaged Drake & Company, CPAs, to audit its financial statements. Though the financial statements Drake audited included a materially overstated accounts receivable balance, Drake issued an unqualified opinion. Cable used the fina
violate generally accepted auditing standards in performing the audit.
Which of the following best describes whether a CPA has met the required standard of care in auditing an entity's financial statements?
Whether the CPA conducted the audit with the same skill and care expected of an ordinarily prudent CPA under the circumstances.
Jenna Corporation approved a merger plan with Cord Corporation. One of the determining factors in approving the merger was the financial statements of Cord, which had been audited by Frank & Company, CPAs. Jenna had engaged Frank to audit Cord's financial
failed to exercise due care.
Brown & Company, CPAs, issued an unqualified opinion on the financial statements of its client King Corporation. Based on the strength of King's financial statements, Safe Bank loaned King $500,000. King Corporation and Safe Bank are both located in a sta
not be liable to Safe, because there was a lack of privity of contract.
How does the Securities Act of 1933, which imposes civil liability on auditors for misrepresentations or omissions of material facts in a registration statement, expand auditors' liability to purchasers of securities beyond that of common law?
Privity with purchasers is not a necessary element of proof.
To be successful in a civil action under Section 11 of the Securities Act of 1933 concerning liability for a misleading registration statement, the plaintiff must prove
Defendant's Intent to Deceive: No
Plaintiff's Reliance on theRegistration Statement:No
Dart Corporation engaged Jay Associates, CPAs, to assist in a public stock offering. Jay audited Dart's financial statements and gave an unqualified opinion, despite knowing that the financial statements contained misstatements. Jay's opinion was included
the misstatements contained in Dart's financial statements were material.
Dart Corporation engaged Jay Associates, CPAs, to assist in a public stock offering. Jay audited Dart's financial statements and gave an unqualified opinion, despite knowing that the financial statements contained misstatements. Jay's opinion was included
monetary damages comparable to the loss suffered.
Fritz Corporation, whose shares are publicly traded, engaged Hay Associates, CPAs, to audit its financial statements. Hay gave an unqualified opinion, despite knowing that the financial statements contained misstatements. Hay's opinion was included in Fri
samson was a foreseen user of the financial statements.
Auditors' defenses against client negligence claims include the:
client suffered no loss
client was negligent
statute of limitations has expired
Common law does not require
that a public accountant guarantee his or her work product
If the client breaches its obligations under the engagement letter, the auditor is
excuses from his or her contractual obligations
If an engagement is performed without due care, the public accountant may be held liable for an actionable tort in
negligence
To recover against an auditor in a negligence case, the client must prove the:
client suffered actual losses or damages
auditor breached duty by failing to act with due professional care
auditor had a duty to the client to conform to a required standard of care
If an accounting firm is sanctioned or suspended by the SEC
its client may not be able to file reports on a timely basis
The Sarbanes-Oxley Act grants the PCAOB
disciplinary authority over registered public accounting firms and person associated with such firms
ability to conduct investigations concerning acts involving auditors of publicly traded firms that may violate provisions of the act
Auditors sued under section 11 of the 1933 act can use the defense of
due dilligence
The private securities litigation reform act of 1995 allows ____________ to control class action litigation
class members with the greatest financial loss
The Sarbanes-Ocley Act:
ended decades of self-regulation by the accounting profession
brought about stricter independence rules
created the PCAOB
The SEC can suspend any person the privilege of appearing and practicing before it for
lacking in character or integrity
having a CPA license suspended or revoked
engaging in unethical or improper professional conduct
A third party claiming ordinary negligence against an auditor must prove
the auditor breached duty by failing to act with due care
a direct causal connection between the negligence and third party injury
common law requires that a public accountant perform professional services with
due care
A defense available to auditors sued under section 11 of the securities act of 1933 is the
auditor made a reasonable investigation of the facts regarding the information included in the registration statement
common-law standards for determining third parties that can successfully sue auditors for ordinary negligence include
forseen third parties
There are four general stages in the initiation and disposition of audit-related disputes
1. the occurrence of events that result in losses for users of the f/s (bankruptcy or financial distress)
2. the investigation by plaintiff attorneys before filing suit to link the user losses with allegations of material omissions or misstatements of f/s
auditors can be sued by clients, investors, creditors, and the government for failure to
perform professional services with due professional care
common law
case law developed over time by judges who issue legal opinions when deciding a case
statutory law
written law enacted by the legislative branch of federal and state governments
Breach of contract
occurs when the client or auditor fails to meet the terms and obligations established in the contract
civil law
all law that does not related to criminal matters
class action
lawsuit filed by one or more individuals on behalf of all persons who may have invested on the basis of the same false and misleading information
criminal law
statutory law that defines the duties citizens owe to society and prescribes penalties for violations
fraud
actions taken with the knowledge and intent to deceive
gross negligence (constructive fraud)
An extreme, flagrant, or reckless departure from professional standards of due care
ordinary negligence
an absence of reasonable or due care in the conduct of an engagement
privity
a contract or specific agreement exists between two parties
scienter
acting with intent to deceive, defraud, or with knowledge of a false representation
tort
a wrongful act, other than a breach of contract, for which civil action may be taken
under common law, auditors can be held
civilly but not criminally liable
under common law, an auditor can be held liable to clients for
breach of contract
negligence
gross negligence/constructive fraud
fraud
the law applicable to a common-law case depends on
the location where the case is tried
under statutory law an auditor can be held
civilly or criminally liable
under common law, an auditor can be held liable to third parties for
negligence
gross negligence/ constructive fraud
fraud
under statutory law, an auditor can be held civilly liable for
negligence
gross negligence/ constructive fraud
fraud
under statutory law, and auditor can be held criminally liable for
willful violation of federal statutes
common law does not require
that the public accountant guarantee his or her work product
due care or due professional care requires
that the auditor perform his or her professional services with the same degree of skill, knowledge, and judgement possessed by other members of the profession
To recover against an auditor in a negligence case, the client must prove
1. the auditor had a duty to the client to conform to a required standard
2. the auditor breached that duty by failing to act with due professional care
3. there was a direct causal connection between the auditor's negligence and the client's damage
4. th
Auditors' defenses against client negligence claims
1. no duty was owed
2. the client was negligent
3. the auditors work was performed in accordance with professional standards
4. the client suffered no loss
5. the alleged auditor negligence did not substantially contribute to the client's loss (lack of ca
most common-law claims are decided in
state courts
to prevail in a suit alleging negligence, the third party must prove all of the following
1. the auditor had a duty to the plaintiff to exercise due care
2. the auditor breached that duty by failing to act with due professional care
3. there was a direct causal connection between the auditor's negligence and the third party's injury
4. the thi
damages that return a plaintiff to a position equivalent to where they would have been in the absence of the auditor's negligence are called
compensatory damages
in the Ultramares case, the judge opened the door to third parties without privity to sue for
gross negligence
constructive fraud
fraud
Dodd-Frank Act grants the PCAOB
the ability to share inspection findings with regulators in other countries
the privity requirement under the ultramares doctrine does not apply when the auditor is charged with
fraud
under the securities act of 1933, the plaintiff must prove
the audited f/s contained a material omission or misstatement
a loss was suffered by investing in the registered security
section 18 of the securities and exchange act of 1934 imposes liability on any person who
makes a false or misleading statement in documents filed with the SEC
the landmark decision in the area of privity is
ultramares
damages awarded to punish outrageous conduct are called
punitive damages
the CAFA of 2005 is based in part on legal experts belief that federal judges
are more likely than state judges to dismiss dubious claims
when the damages to the plaintiff can be apportioned between contributing parties, the auditor is
only liable for his or her share of the total damages
the foreign corrupt practices act
imposes internal control requirements on public companies
prohibits corporate officers from participating in bribing foreign officials
under rule 10b-5, some courts have ruled that gross negligence or reckless behavior is sufficient to satisfy the
scienter element
1933 Act
Applies to issuance of new securities
potential liability to original investors
plaintiff must show incurred loss & material misstatement
1934 Act
applies to any publicly traded security
potential liability to any investor
plaintiff must show incurred loss, material misstatement, rely on f/s, & intent of fraud (scienter)
review for contingent liabilities
existing condition or set of circumstances that we are not certain on how it will play out
probable
the future event is likely to occur (if reasonably estimated- accrue the loss, if not reasonably estimated- disclose)
reasonably possible
the chance of the future event occurring is more than remote, but less than probable. disclosure is required
remote
the chance of the future event occurring is slight
recognized event (type I)
those events that provide additional information about conditions that existed at the f/s date. requires adjustment
unrecognized event (type II)
those that provide information about conditions that did not exist at the f/s date. never acquires adjustment, may require disclosure
dual dating
used to indicate that auditors responsibility for the "late" subsequent event is limited to that event only
final steps and evidence accumulation
1. perform final analytical procedures (required)
2. obtain a representation letter from management (mandatory)
3. working paper review
4. final evaluation of audit results
5. evaluate f/s presentation and disclosure
6. independent engagement quality revi
the likelihood that the future event will result in a loss is to be assessed using three categories
probable
reasonably possible
remote
examples of contingent liabilities include
pending or threatened litigation
actual or possible claims and assessments
income tax disputes
product warranties or defects
guarantees of obligations to others
agreements to repurchase receivables that have been sold
5 procedure examples that can help the auditor identify contingent liabilities include
1. reading the minutes of the meetings of the BOD, committees of the board, and stockholders
2. reviewing contracts, loan agreements, leases, and correspondence from government agencies
3. reviewing tax returns, IRS reports, and schedules supporting the e
auditing standards require auditors to communicate certain matters to "those charged with governance". for publicly traded companies, this refers to the
audit committee
The sarbanes-oxley acts main objectives are
to restore investor confidence in the securities markets and to deter future corporate frauds
For what types of actions are auditors liable to a client under common law? Why would the client prefer to sue the auditor for a tort action rather than for a breach of contract?
An auditor can be liable to a client under common law for breach of contract, negligence, gross negligence/constructive fraud, and fraud. Any of the previously stated actions can create a situation where a client may sue the auditor. A client may prefer t
proportionate liability
Proportionate liability is where each defendant is liable solely for the portion of the damages that correspond to the percentage of responsibility of that defendant.
Contrast this legal doctrine with the doctrine of joint and several liability.
Under the doctrine of joint and several liability, each defendant is held fully liable for all assessed damages, regardless of the extent to which they contributed to the injury.
What are the four standards that have evolved for defining auditors' liability for ordinary negligence to third parties under common law
The four standards that have evolved for defining the extent of the auditor's liability to third parties are:
(1) privity,
(2) near privity,
(3) foreseen persons or classes, and
(4) reasonably foreseeable third parties.
an emphasis of matter paragraph
refers to a matter that has been appropriately presented or disclosed in the financial statements
is used when the auditor has substantial doubt about an entity's ability to continue as a going concern
is used when there is a lack of consistency in the f/
8 elements to the auditor's standard unqualified audit report
1. title
2. addressee
3. introductory paragraph
4. scope paragraph
5. opinion paragraph
6. explanatory paragraph
7. name of the auditor
8. audit report date
the term "unmodified" in the ASB report is the equivalent of the term "unqualified" in the PCAOB report-
they both refer to a "clean" opinion
There are four situations that require the auditor to add an explanatory paragraph to a standard unqualified report on an entity's financial statements:
1. Reference to the report on the audit of internal control for public companies.
2. Substantial doubt about an entity's ability to continue as a going concern.
3. Lack of consistency in the application of accounting principles due to accounting changes.
the explanatory paragraph follows the
opinion paragraph
Auditing standards refer to the following accounting changes as affecting both comparability and consistency and requiring an explanatory or emphasis-of-matter paragraph:
1. Change in accounting principle. An example is a change from straight-line depreciation to an accelerated method for depreciating equipment.
2. Change in reporting entity. An example is the consolidation of a major subsidiary's financial statements with
Other changes may affect comparability but not consistency in the use of accounting principles. These include:
1. Change in accounting estimate. A change in an accounting estimate, such as reducing the expected service life of a garbage truck from 7 to 5 years, can affect the comparability of financial statements with no change in accounting principles.
2. Change
Two examples of situations that might cause the auditor to add explanatory language in an emphasis-of-matter paragraph are
significant related-party transactions that are appropriately disclosed by the entity and important events occurring after the balance sheet date.
scope limitation
results from an inability to collect sufficient appropriate evidence, such as when management or some set of circumstances prevents the auditor from conducting an audit procedure that the auditor considers necessary
departure from GAAP
exists when the f/s are prepared or presented in a manner that conflicts with GAAP, whether due to error or fraud
lack of independence of the auditor
arises when the auditor and the entity have any financial, business, or personal relationship prohibited by professional standards
the three types of reports available to the auditor other than unqualified are
qualified
disclaimer
adverse
The auditor disclaims an opinion on the financial statements either because
here is insufficient appropriate evidence to form an opinion on the overall financial statements or because there is a lack of independence.
The auditor qualifies his or her opinion when either
a scope limitation or a specific departure from GAAP exists, but overall the financial statements present fairly in conformity with GAAP
a qualified report always uses the words
except for
The auditor issues an adverse opinion when the
financial statements do not present fairly due to a GAAP departure that materially affects the financial statements overall.
Auditing standards use the term pervasive to describe
the potential effects of a scope limitation or departure from GAAP on the auditor's report
Immaterial Scope Limitation
unqualified
immaterial departure from GAAP
unqualified
Pervasive scope limitation
qualified
Pervasive departure from GAAP
qualified
highly pervasive scope limitation
disclaimer
highly pervasive departure from GAAP
adverse