Deck 2: Ethics, Legal Liability and Client Acceptance

Question 1

Phillip Montain wrote up an advertisement for his firm. In his draft to the local newspaper he indicated that the firm was able to provide servicthat he knew it could not deliver. Which part of the profession's standards or codof conduct was Phillip breaking?

A) objectivity
B) professional behaviour
C) confidentiality
D) communication

Answer 1

B

Question 2

Luanne Phong just joined the firm of Moses, Denson, and Etchevery (MDE). She found out that she owns sharin a client company of MDE. She is going to divest herself of these shares. Which threat to her independence will she be eliminating?

A) self-interest threat
B) self-review threat
C) familiarity threat
D) advocacy threat

Answer 2

A

Question 3

Objectivity refers to the obligation that all members of the professional bodibe straightforward and honest.

Answer 3

False

Question 4

An engagement letter donot include an overview of the client's responsibility for the preparation of the financial statements.

Question 5

When Jonathon Gerinum, CPA, tried to collect last year's audit fees, he was told that he would receive the fefor the previous year and the current year upon finishing this year's work and issuing a "clean" audit opinion. This was non-negotiable and he was told that if he did not want to go along with it, the client would get another auditor. When he decided to leave his client, what threat to his independence did he mitigate?

A) self-interest threat
B) self-review threat
C) advocacy threat
D) none of these

Question 6

Ensuring compliance with auditing regulations will not assist auditors in avoiding litigation.

Question 7

Compliance with the fundamental ethical principlis mandatory for all members of the accounting profession.

Question 8

Independence in appearance is the ability to act with integrity, objectivity and professional scepticism.

Question 9

An example of an advocacy threat is encouraging others to buy sharor bonds being sold by the client.

Question 10

An effective audit committee will enhance the independence of the external audit function.

Question 11

When assessing client integrity, the auditor will consider the appropriateness of the client's interpretation of accounting rules.

Question 12

Auditors can avoid litigation by implementing policiand procedurthat ensure all work is fully documented.

Question 13

Shayna Kirschfield audits a company that has market capitalization of $20,000,000. There is also a requirement that the partners in her firm be rotated every seven years and the audit committee must pre-approve all servicprovided to the client by Shayna's firm. What kind of client is this?

A) small business
B) diversified
C) reporting issuer
D) partnership

Question 14

Third partiare anyone other than the client and its shareholders that use the financial statements to make a decision.

Question 15

The key difficulty for third partiin successfully claiming against the auditor is establishing that the client's management contributed to the third party's loss.

Question 16

Joanna Whittaker, CPA, livin the same neighbourhood as one of her major clients. She and her children are involved in the Lower ThamYacht Club, as are many of her client's management employees. How would her independence threat best be described?

A) self-interest threat
B) self-review threat
C) advocacy threat
D) none of these

Question 17

When auditors divest themselvof sharowned in a client company, they are eliminating their self-review threat to independence.

Question 18

Cliff Marsden has been an audit manager at Copeland & Cahoon, CA's the past ten years. Two years ago he performed human resourcand internal audit functions for 9 months while his client underwent a major restructuring. His firm has a policy of changing audit partners and managers every five to seven years. He is reluctant to take on the audit because he believthere is an independence threat. Which threat is in play?

A) integrity threat
B) familiarity threat
C) self-review threat
D) advocacy threat

Question 19

An engagement letter sets out the terms of the engagement.

Question 20

Being negligent means not exercising due care.

Question 21

Threats to the independence of auditors include:

A) familiarity threats.
B) self-interest threats. c.) advocacy threats.
D) all of the above.

Question 22

What type of threat to independence ariswhen an accounting firm acts on behalf of its assurance client?

A) advocacy threat
B) self-interest threat
C) intimidation threat
D) self-review threat

Question 23

Management failed to put in a system of adequate internal controls. The public accounting firm uncovered the weakness, but did not report it to the Board members of the company. What kind of liability, if any, would the auditors be exposed to?

A) breach of contract
B) contributory negligence
C) a and b
D) no liability

Question 24

Rob Wood has reviewed the engagement letter his firm has prepared for a client. Which of these elements would he be surprised to find?

A) unrestricted access to persons within the entity in order to obtain audit evidence
B) references to Canadian generally accepted auditing standards
C) management's responsibilities
D) previous year's internal control issues

Question 25

Having policiand procedurto ensure the quality of an accounting firm's service is an example of a safeguard to independence created by:

A) the client's audit committee.
B) the Canada Business Corporations Act.
C) the client's board of directors.
D) None of the above.

Question 26

Safeguards to independence are created by:

A) accounting firms.
B) the profession, legislation or regulation.
C) clients.
D) all of the above.

Question 27

Independence in appearance is:

A) the ability to act with integrity, objectivity and professional scepticism.
B) the belief that independence of mind has been achieved.
C) the ability to make a decision that is free from bias, personal beliefs and client pressures.
D) also referred to as actual independence.

Question 28

The firm of McMaster and Martin, CPA, CA's is concerned that its client's current corporate culture may have an impact on the firm's independence. What kinds of safeguards can the client introduce or create to reduce the threat to independence?

A) introduce appropriate corporate governance mechanisms such as the establishment of an audit committee
B) ensure that the responsibility for the appointment and removal of an auditor rests with independent directors on the audit committee or the board
C) both a and b
D) none of the above

Question 29

A self-interest threat refers to the threat that can occur when an accounting firm or its staff:

A) is threatened by the client's staff or directors.
B) has a financial interest in an audit client.
C) needs to form an opinion on their own work or work performed by others in the firm.
D) acts on behalf of its assurance client.

Question 30

Which of the following is a fundamental principle of professional ethics?

A) confidentiality
B) objectivity
C) integrity
D) all of the above

Question 31

It is the responsibility of the board of directors to:

A) ensure that the financial statements are fairly presented.
B) provide an opinion on the fair presentation of the financial statements.
C) direct the auditors to audit specific financial statement accounts.
D) none of the above.

Question 32

An example of a safeguard to independence created by accounting firms is:

A) the establishment of a code of ethics.
B) legislation that requires that an auditor be independent.
C) the existence of client acceptance and continuation procedures.
D) the establishment of an audit committee.

Question 33

Objectivity refers to the obligation that all members of the professional bodies:

A) be straightforward and honest.
B) refrain from disclosing information to people outside of their workplace that is learned as a result of their employment.
C) not allow their personal feelings or prejudices to influence their professional judgment.
D) ensure that they do not harm the reputation of the accounting profession.

Question 34

Professional behaviour refers to the obligation that all members of the professional bodies:

A) ensure that they do not harm the reputation of the accounting profession.
B) not allow their personal feelings or prejudices to influence their professional judgment.
C) refrain from disclosing information to people outside of their workplace that is learned as a result of their employment.
D) be straightforward and honest.

Question 35

Intimidation threats to independence include:

A) the threat that that the client will use a different assurance firm next year.
B) a close business relationship with the client.
C) representing the client in a legal dispute.
D) preparing information for the client that is then assured.

Question 36

Which of the following is an example of a familiarity threat to independence?

A) a bank account held with the client
B) performing services for the client that are then assured
C) both a and b
D) a former partner of the assurance firm holding a senior position with the client

Question 37

Examplof board committeinclude the:

A) risk committee.
B) nomination committee.
C) compensation committee.
D) all of the above.

Question 38

The main recipients of the financial statements and the attached audit report are acknowledged as:

A) the board of directors.
B) the shareholders or members.
C) the audit committee.
D) the provincial stock exchanges.

Question 39

Executive directors are:

A) part of the company's management team.
B) full-time employees of the company.
C) not members of the company's board of directors.
D) a and b.

Question 40

Auditor independence is:

A) defined as acting with integrity, objectivity and professional scepticism.
B) essential when complying with the ethical principles to act with integrity and objectivity.
C) both a and b.
D) not fundamental to every audit.

Question 41

Simean & Co, a firm of CPA's, issued an unqualified audit report for its client, Xiing Manufacturing Corporation, a footwear manufacturer in Asia. Xiing Manufacturing, listed its head office in Toronto, Ontario, and its sharwere traded on a Canadian Stock Exchange. Besidthe shareholders, Simean & Co. knew the company was in the process of refinancing a significant bank loan coming due, and the bank was anxious to see the year end results. After an unqualified audit report was issued, the regulator of the stock exchange halted the trading of the sharafter allegations of management fraud came to light. As a result, the share price plummeted and the company went out of business.
Required:
(a) To whom did Simean & Co. owe a duty of care?
(b) What must the bank demonstrate to establish negligence?
(c) What are the defencavailable to Simean & Co?

Question 42

Auditors can avoid litigation by:

A) ensuring compliance with ethical regulations.
B) meeting with the client's nomination committee to discuss any significant audit issues.
C) training their staff and regularly updating their knowledge.
D) a and c.

Question 43

Describe the three categoriof safeguards to an auditor's independence.

Question 44

An auditor's assessment of their client's integrity would not include:

A) whether the auditor has sufficiently competent staff to complete the audit.
B) the client's attitude to audit fees and its willingness to pay a fair amount.
C) the client's attitude to risk exposure and management.
D) the reputation of the client and its management.

Question 45

Explain the five fundamental principlof professional ethics.

Question 46

The principlestablished by Justice Moffitt in the Pacific Acceptance case do not include:

A) auditors are watchdogs but not bloodhounds.
B) auditors must properly document procedures used.
C) auditors have a duty to use reasonable skills and care.
D) auditors must audit the whole year.

Question 47

Audit committehave been widely recommended as being an important mechanism for enhancing the external auditor's independence. What are the important characteristics of audit committeand discuss why these characteristics are considered so important to a committee's effective and efficient operation.

Question 48

For each of the following, indicate if there is a threat to independence. If so, state the threat and a possible safeguard.
(a) John Schmidt, CPA, CA, is unaware that his audit client, Franks Spa and Pool Co. makup 20% of John Schmidt firms revenues.
(b) JamPara goto his assurance client, Bob's Autosalto buy a used car for his daughter. Due to their business relationship, Bob offers Jama vehicle below cost.
(c) Jack Jacobs has been auditing Bob's Pool and Spa Limited for many years. Bob's Pool and Spa Limited has been experiencing financial difficultiand has not been able to pay its audit fefor the last three years. Bob's now owJack Jacobs $50,000 in assurance fees.
(d) Frank Fargo has three review engagements. One of the review engagements is done for Sangha Meatshop Ltd., which is 80% owned by his father-in-law, Sanchez Sangha. The remaining 20% of the Meatshop is owned by Sanchez's four children.

Question 49

Under tort law, to prove that an auditor has been negligent the plaintiff must establish:

A) there was a breach of the duty of care.
B) a loss was suffered as a result of the breach of duty of care.
C) a duty of care was owed by the auditor.
D) all of the above.

Question 50

The key difficulty for third partiin legal action against auditors has been establishing that a duty of care was owed to them by their auditor. Explain the development of the relevant legal principlrelating to an auditor's duty of care to third partiwith reference to specific case law.

Question 51

For the following scenarios, state the violation(s) to the Rulof Professional Conduct:
(a) Bill Williams, CPA, began a telephone campaign to grow his client base. He began calling companilisted in the telephone directly within a twenty mile radius advising them of his accounting services. After making several phone calls, Bill finally landed a new audit client, Big Bob's Autosaland Leasing Ltd. In order to secure this new business, Bill entered into an agreement with Big Bob whereby Bill would receive a flat fee every time he referred one of his clients to Big Bob's. He would also earn a 1% percent commission on any vehicle sale or lease that resulted from the referral. As their business relationship grew overtime, Bill asked Big Bob for a loan claiming he wanted to expand his accounting practice. He in fact took the funds for his own personal use without advising his client.
(b) Paul Lee, CPA, was the CFO of ABC Incorporated. In his role as CFO, he became aware of a material error in the company's inventory for the annual financial statements in the amount of approximately $1.5 million. Paul brought the matters to the attention of senior management, who casually indicated that year end was already completed and thus they did not want to harm investor confidence by reissuing the financial statements, but Paul did not seek assistance or guidance from either the professional body or the securiticommission.
(c) David Collier, CPA, obtained his designation in 2000. Since that time, he has built up a significant tax practice. In late 2015, a new client approached David and asked him to perform an audit engagement. Believing this could lead to a substantial amount of tax work in the future, David agreed, even though he had not taken any accounting or assurance coursfor many years. In performing the audit engagement, David obtained an engagement letter, put the financial statements together based on the clients trial balance, and attached a review engagement report. The financial statements contained a material error.

Question 52

Indicate whether you agree or disagree with the following statements and explain your reasoning.
a) To ensure that it is independent of prospective and continuing clients, an audit firm must review the threats to independence, and make certain that safeguards are put in place to limit or remove those threats.
b) The final stage in the client acceptance and continuance decision process involves assessing independence threats.
c) By signing the engagement letter, management is not necessarily considered to be responsible for the financial statements.
d) To successfully sue an auditor, a plaintiff must only prove that a duty of care was owed by the auditor.

Question 53

Explain the purpose and major contents of an engagement letter between the auditor and their client.

Question 54

The final stage in the client acceptance and continuance decision process involves:

A) the auditor obtaining a management representation letter from the client.
B) the auditor preparing an independence declaration statement.
C) the client's audit committee meeting with the auditor.
D) the preparation of an engagement letter.

Question 55

Independence is considered one of the key characteristics of auditors. Explain why auditor independence is so important to the effectiveness of an audit and explain the various threats to an auditor's independence. CASE

Question 56

Distinguish between independence of mind and independence in appearance.