Deck 4: The Legal Liability of Auditors Part Two: Planning and Risk

Question 1

Due professional care does not require:

A) critical review at every level of supervision of work done and judgment exercised.
B) good faith and integrity.
C) appointment of the auditor by the shareholders.
D) compliance with the auditing standards.

Answer 1

C

Question 2

The CLERP 9 reforms now provide for limitation of auditor's liability through:

A) a statutory cap.
B) proportionate liability.
C) incorporation.
D) All of the given answers are correct.

Answer 2

D

Question 3

Common law requires that the auditor:

A) guarantee their work.
B) perform their work with due care.
C) discover all fraud.
D) check all transactions.

Answer 3

B

Question 4

The court found that Casey, an auditor, had performed a negligent audit of Royal Treatment Ltd, but the plaintiff did not receive damages because the court found insufficient proof of causation. Causation means that:

A) the auditor caused the misstatement of the financial report.
B) the auditor's failure to perform a proper audit caused the damages.
C) the auditor was negligent, but the plaintiff suffered no real damages.
D) the plaintiff was an unforeseen third-party user of the financial report.

Question 5

If an audit firm is being sued by a third party for common-law fraud based upon a materially false financial report, which of the following is the best defence which the auditors could assert?

A) Lack of a contractual relationship.
B) Contributory negligence on the part of the client.
C) Disclaimer contained in the engagement letter.
D) Lack of causation.

Question 6

When performing an audit, an auditor would most likely be considered negligent if they failed to:

A) detect all of the client's fraudulent activities.
B) include a negligence disclaimer in the client engagement letter.
C) warn the client of any known internal control weaknesses.
D) warn the client's customers of embezzlement by the client's employees.

Question 7

Which of the following statements best describes the auditor's responsibility regarding the detection of fraud?

A) The auditor must extend auditing procedures to actively search for fraud.
B) The auditor is responsible for the failure to detect fraud only when an unmodified auditor's opinion is issued.
C) The auditor is responsible for fraud when such failure results from non-performance of procedures described in the engagement letter.
D) The auditor must plan the audit so as to have a reasonable expectation of discovering material fraud.

Question 8

Smart issued an unmodified auditor's opinion on the 2012 financial report of Max Ltd, which was filed with ASIC.Smart did not detect material misstatements in the financial report as a result of negligence in the performance of the audit. Based upon the financial report, Bird purchased shares in Max Ltd. Shortly afterwards, Max Ltd
Became insolvent, causing the price of the shares to decline drastically. Bird has commenced legal action
Against Smart for damages. Smart's best defence to such an action would be that:

A) Bird lacks a contractual relationship as a basis to sue.
B) the engagement letter specifically disclaimed all liability to third parties.
C) there is no proof of proximity.
D) there has been no subsequent sale for which a loss can be calculated.

Question 9

The Pacific Acceptance case established that:

A) reasonable care and skill means following the auditing standards.
B) auditors have a duty to closely supervise and review the work of inexperienced audit staff.
C) auditors are only liable for the proportion of damages attributable to their actions.
D) auditors have a duty of care only to the shareholders as a group.

Question 10

The auditor's responsibility for the detection of an illegal act is the same as the auditor's responsibility for the detection of an error when the illegal act:

A) creates a material contingent liability that must be disclosed.
B) involves financial matters such as embezzlement or violations of securities laws.
C) has a direct and material effect on the determination of a financial report amount.
D) has consequences material to the presentation and disclosure of financial position or operating results.

Question 11

An auditor discovers a likely fraud during an audit, but concludes that its effects, if any, could not be material enough to affect the auditor's opinion. The auditor should:

A) perform additional audit procedures to determine whether fraud has occurred and, if so, the amount thereof.
B) report the finding to the appropriate level of the client with the recommendation that it be pursued to a conclusion.
C) notify the proper authorities.
D) note in the working papers that the amount is immaterial and that no further action is required.

Question 12

In the Caparo case, the court held that the auditor owes a duty of care to:

A) all users of the published financial report.
B) only those parties specified in the engagement letter.
C) the shareholders as a body but not individual shareholders or third parties.
D) all shareholders but not third parties.

Question 13

A claim for a breach of duty of care might arise against an auditor if:

A) an existing shareholder suffered losses because he increased his investment in the company based on figures in the audited financial report.
B) a bank made a loss due to a loan made to the company based on figures in an audited financial report commissioned by the bank.
C) a new investor suffered losses because she purchased shares in the company based on figures in the annual audited financial report.
D) a stockbroker made a loss due to a loan made to the company based on figures in an audited financial report commissioned by the company.

Question 14

FMC Electronics Ltd engaged the accounting firm of Crosby, Seals & Anderson to perform its annual audit. The firm performed the audit in a competent, non-negligent manner and billed FMC for $16 000, the agreed fee. Shortly
After delivery of the audited financial report, Robert Hightower, the assistant controller, disappeared, taking with him
$28000 of FMC's funds. It was then discovered that Hightower had been engaged in a highly sophisticated, novel
Defalcation scheme during the past year. He had previously embezzled $35 000 of FMC's funds. FMC has refused
To pay the auditor's fee and is seeking to recover the $63 000 that was stolen by Hightower. Which of the following
Is correct?

A) The auditor cannot recover the audit fee and is liable for $63 000.
B) The auditor is entitled to collect the audit fee and is not liable for $63 000.
C) FMC is entitled to recover the $28 000 defalcation and is not liable for the $16 000 fee.
D) FMC is entitled to rescind the audit contract and thus is not liable for the $16 000 fee, but it cannot recover damages.

Question 15

Mars Ltd wished to acquire the ordinary shares of Saturn Ltd and engaged Sarah & Co. to audit the financial report of Saturn Ltd. Sarah & Co. failed to discover a significant liability when performing the audit. In a common law action
Against Sarah & Co., Mars Ltd, at a minimum, must prove:

A) negligence on the part of Sarah & Co.
B) fraud on the part of Sarah & Co.
C) that Sarah & Co. knew that the liability existed.
D) All of the given answers are correct.

Question 16

Smith & Jones rendered an unmodified auditor's opinion on the financial report of a company that sold shares in a public offering. Based on a false statement in the financial report, Smith & Jones is being sued by an investor
Who purchased shares in this public offering. Which of the following represents a viable defence?

A) The investor has not met the burden of proving fraud or negligence by Smith & Jones.
B) The false statement is immaterial in the overall context of the financial report.
C) Detection of the false statement by Smith & Jones occurred after the date of the auditor's report.
D) The investor did not actually rely upon the false statement.

Question 17

An auditor's duty of care to a client would most likely be breached if the auditor failed to:

A) meet their reporting deadline.
B) detect all of a client's fraudulent activities.
C) conduct the audit for the most competitive price.
D) comply with all relevant auditing standards.

Question 18

The AWA case established that:

A) reasonable care and skill means following the auditing standards.
B) auditors have a duty to closely supervise and review the work of inexperienced audit staff.
C) auditors are only liable for the proportion of damages attributable to their actions.
D) auditors have a duty of care only to the shareholders as a group.

Question 19

The 'Second Report of the Inquiry into the Law of Joint and Several Liability' in January 1995 recommended:

A) proportionate liability in all circumstances.
B) proportionate liability when the plaintiff is partly at fault.
C) proportionate division of insolvent defendant's share.
D) proportionate liability and defendant's degree of fault.

Question 20

ASA 240 (ISA 240) provides that primary responsibility for fraudulent reporting rests with:

A) the board of directors.
B) management.
C) the external auditor.
D) the audit committee.

Question 21

The auditor should assess the risk that errors and fraud may cause the financial report to be materially misstated and, based on that assessment:

A) design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial report.
B) plan the audit to search for errors or fraud that could be material to the financial report.
C) perform the audit with an awareness that errors or fraud could occur and cause a material misstatement of the financial report.
D) apply substantive tests to detect material misstatements except those perpetrated by means of forgery or collusion.

Question 22

An auditor finds evidence that warehouse staff are fraudulently claiming overtime. The auditor should:

A) further investigate the matter and report it to management when concrete evidence has been obtained.
B) report the matter to management in the year-end management letter.
C) report the matter to management immediately if the expected financial effect of the fraud is material.
D) report the matter to management immediately.

Question 23

If an illegal act is discovered during the audit of a publicly held company, the auditor should:

A) notify the regulatory authorities.
B) determine who was responsible for the illegal act.
C) intensify the audit.
D) report the act to high-level personnel within the client's organisation.

Question 24

Which of the following statements best describes the auditor's responsibility regarding the detection of fraud?

A) The auditor is responsible for the failure to detect fraud only when such failure clearly results from non-performance of audit procedures specifically described in the engagement letter.
B) The auditor must extend auditing procedures to actively search for evidence of fraud in all situations.
C) The auditor should design auditing procedures to provide reasonable assurance that fraud material to the financial report is detected.
D) The auditor is responsible for the failure to detect fraud only when an unmodified opinion is issued.