Deck 20: Legal Liability Cases

Question 1

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

Answer 1

B

Question 2

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.

Answer 2

B

Question 3

The landmark case of Ultramares Corporation v.Touche (1931)resulted in which precedent-setting doctrine?

A)An audit cannot be held liable to third party claimants,due to lack of privity of contract.
B)Auditor's owe a duty of care to all known third party claimants.
C)An auditor's duty of care extends to all third parties for losses that resulted from ordinary auditor negligence.
D)An auditor's duty of care extends to all third parties when the auditor commits fraud or constructive fraud.

Answer 3

D

Question 4

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.

Question 5

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.

Question 6

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

Question 7

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.

Question 8

The relationship of direct involvement between parties to a contract is also known as _________.

A)statutory obligation
B)association
C)privity
D)causal connection

Question 9

Smith & Smith,CPAs,audit the financial statements of ABC Company,who require audited financial statements be provided to Acme Bank,who provides ABC Company with an operating line and several loans.Smith & Smith are aware of Acme Bank's reliance on their audit report to decide on granting financing to ABC Company.ABC's management also uses the audited statements to make management decisions and sometimes provide copies to their suppliers to evaluate ABC's credit.In this scenario,who is (are)the primary beneficiary (beneficiaries)of Smith & Smith's audit of ABC Company's financial statements?

A)Acme Bank.
B)ABC Company's shareholders.
C)ABC Company's management.
D)Suppliers to ABC Company.

Question 10

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.

Question 11

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

Question 12

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

Question 13

Which landmark Canadian case confirmed that auditors owe a duty to third parties where they have "actual knowledge of the limited class that will use and rely on the statements"?

A)Hedley Byrne v.Heller.
B)Haig v.Banford.
C)Ultramares v.Touche.
D)Foss v.Harbottle.

Question 14

Which important Canadian case concluded that the auditor's liability extends to those third parties to whom the auditor has actual knowledge of the limited class that will use and rely on the statements"?

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.

Question 15

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

Question 16

Which of the following statements represents an audit failure?

A)A client goes bankrupt or has serious financial difficulty.
B)An auditor failed to detect a material misstatement in the financial statements.
C)An auditor cannot collect the audit fees from the client.
D)An auditor is sued by a third party.

Question 17

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

Question 18

Reasonably 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)Members of a limited class of third parties,known by the auditor,who potentially will rely on the audit but are not specifically known by the auditor

Question 19

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.

Question 20

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.

Question 21

To better protect themselves from legal liability,auditors ought to take all of the following precautions in their engagements,EXCEPT FOR:

A)Perform quality audits.
B)Know (thoroughly)the client's business.
C)Be wary of what kinds of clients are accepted.
D)Always maintain a very close,personal relationship with the client.

Question 22

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.

Question 23

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

Question 24

Which of the following statements concerning the liability provisions of The Securities Act (1933),is true?

A)All people who might be included in a registration legal action must prove that they made a "reasonable investigation" of the financial statements.
B)The major burdens of affirmative proof in a suit against the auditor shift from the injured plaintiff to the expert accountant.
C)The purchaser-plaintiff must prove that they relied on the financial statements in the registration statement.
D)The provisions of the Securities Act do not apply to companies who file a registration statement.

Question 25

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

Question 26

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

Question 27

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

Question 28

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

Question 29

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

Question 30

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

Question 31

Which of the following statements the Foreign Corrupt Practices Act of 1977 (the FCPA)and its effect on the accounting profession is FALSE?

A)The FCPA requires companies registered with the SEC to devise and maintain a system of internal accounting control.
B)When a company's accountants are taken to court with FCPA violations,the case is litigated (decided by a judge).
C)The FCPA requires companies registered with the SEC to keep books,records,and accounts that,in reasonable detail,accurately and fairly reflect the transactions and dispositions of the company's assets.
D)The auditor of an entity subject its provisions can also be held directly responsible under the provisions of the FCPA.

Question 32

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

Question 33

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 grossly negligent in conducting the audit.
B)The purchaser must prove that Larson knew of the material misstatements.
C)Larson will not be liable if it was reasonable for an auditor to conclude that the financial statements were accurate.
D)Larson will be liable unless the purchaser did not rely on the financial statements.

Question 34

If the courts conclude that the auditor is associated with misleading financial statements,even if these statements are in conformity with GAAP,they may conclude that the auditors are fraudulently negligent.

Question 35

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.

Question 36

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

Question 37

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.

Question 38

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

Question 39

The Ultramares doctrine established that auditor liability does not extend to third parties in cases involving ordinary negligence.

Question 40

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

Question 41

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.

Question 42

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).

Question 43

If a public accountant becomes suspicious about a client's source of financing during the course of an engagement,the public accountant should refrain from investigating any further,to avoid being charged as a co-conspirator to money laundering activities.

Question 44

Explain why the decision rendered in Hercules Managements Ltd.et al.v.Ernst & Young e al (the Hercules Management Case)was considered so controversial.

Question 45

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?

Question 46

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

Question 47

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

Question 48

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.

Question 49

Under Bill C-22,a public accountant could be charged with possession or laundering by accepting a payment from a client that came as a result of the client engaging in a criminal enterprise,even if the accountant didn't specifically know how the money was originally obtained.

Question 50

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

Question 51

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.

Question 52

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

Question 53

What is a primary beneficiary?

Question 54

The SEC has the power to establish accounting rules and regulations in the United States.

Question 55

What is privity?

Question 56

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