Chapter 20 Legal Liability

Which of the following is not required for establishing an auditor's liability for negligence?

• An undetected material misstatement.

• Failure to exercise due care.

• A connection between the auditor's negligence and a plaintiff's loss.

• A duty to conform to a standard of care.

An auditor, using the same degree of due care as other members of the profession, fails to identify an inadequate allowance for bad debts. This occurrence is an example of:

• negligence.

• fraud.

• an error in judgment.

• constructive negligence.

An audit client loses a lawsuit and the judgment is for an amount in excess of the contingent liability the client had recorded in the audited financial statements. The auditor, using the typical degree of due care as other members of the profession, determined that the amount of contingent liability recorded by the client in the financial statements for the pending lawsuit was reasonable, given the facts at the time of the audit. This judgment by the auditor is likely to result in:

• sanctions by the PCAOB levied against the individual auditor as well as the accounting firm.

• a successful lawsuit claiming auditor negligence.

• a successful lawsuit claiming breach of contract.

• no legal action whatsoever since due care was exercised.

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

• Gross negligence in applying generally accepted auditing standards.

• Ordinary negligence in applying generally accepted accounting principles.

• Identified third party users.

• Scienter.

Which of the following is not one of the four general stages in the initiation and disposition of audit-related disputes?

• Discovery of fraud subsequent to issuance of the audit report.

• Users of financial statements incur losses.

• The legal process commencing with the filing of a lawsuit.

• Final resolution of the dispute.

The Securities Exchange Act of 1934:

• established a voluntary disclosure mechanism for issuers of publicly traded securities.

• primarily relates to initial sales of securities to the public.

• regulates all sales of securities.

• regulates trading of securities subsequent to issuance.

Which of the following is not within the class of foreseen users of an accountant's work product?

• A prospective shareholder of the client.

• A lender bank when the accountant knows only that the client will use the financial statements to obtain a loan from an unspecified source.

• A bank when the accountant knows the client will rely on the financial statements as the basis for a loan from the bank.

• An investor if the accountant knows that the client is seeking capital from a select group of investors.

A CPA's duty of due care to a client most likely will be breached when a CPA:

• gives a client a written audit report.

• gives a client incorrect advice based on an honest error of judgment.

• fails to give tax advice that saves the client money.

• fails to follow generally accepted auditing standards.

When performing an audit, a CPA:

• must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.

• must strictly adhere to generally accepted accounting principles.

• is strictly liable for failing to discover client fraud.

• is not liable under any legal standard unless the CPA commits gross negligence or intentionally disregards generally accepted auditing standards.

Which of the following is the best statement of the duty owed by an accountant in his or her professional work?

• To do the job correctly and discover all irregularities.

• To follow generally accepted accounting principles (GAAP) and generally accepted auditing standards (GAAS).

• To act as a professional and not commit fraud.

• To exercise the skill and care of the ordinarily prudent accountant in the same circumstances.