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

fails to follow generally accepted auditing standards.

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.

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

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.

In a common law action against an accountant in a state following the Ultramares doctrine , lack of privity is a viable defense if the plaintiff:

is the client's creditor who sues the accountant for negligence.

can prove the presence of gross negligence which amounts to a reckless disregard for the truth.

What is the primary reason that Congress passed the Securities Litigation Uniform Standards Act of 1998?

As a result of concerns that plaintiff attorneys could get around the Private Securities Litigation Reform Act of 1995 by filing class action lawsuits involving nationally traded securities in state courts.

To overturn the Private Securities Litigation Reform Act of 1995.

To provide for joint and several liability rather than proportionate liability.

To ensure that all publicly-held companies receive similar audits.

Ritz Corporation wished to acquire the stock of Stale, Inc. In conjunction with its plan of acquisition, Ritz hired Fein, CPA, to audit the financial statements of Stale. Based on the audited financial statements and Fein's unqualified opinion, Ritz acquired Stale. Within 6 months, it was discovered that the inventory of Stale had been overstated by $500,000. Ritz commenced an action against Fein. Ritz believes that Fein failed to exercise the knowledge, skill, and judgment commonly possessed by CPAs in the locality, but is not able to prove that Fein either intentionally deceived it or showed a reckless disregard for the truth. Ritz also is unable to prove that Fein had any knowledge that the inventory was overstated. Which of the following two causes of action would Ritz need to prove to prevail in a lawsuit?

Negligence and breach of contract.

Negligence and gross negligence.

Gross negligence and breach of contract.

Why are plaintiffs motivated to bring actions under RICO?

It provides for treble damages.

It pertains exclusively to auditors' actions.

It guarantees that cases will be heard in state courts.

It holds auditors to standards that exceed reasonable assurance.

Under the Rusch Factors doctrine, to which of the following parties will an accountant be liable for negligence?

Both parties in privity and reasonably foreseeable third parties.

Only parties in privity and not those reasonably foreseeable third parties.

Only reasonably foreseeable third parties and not those parties in privity.

Neither reasonably foreseeable third parties nor parties in privity.

An auditor can be held criminally liable for:

illegal acts under statutory law.

negligent acts when the third party has privity status.

tort of contract for failing to follow due professional care.

While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included 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 defense would be that the:

audit was conducted in accordance with generally accepted auditing standards.

client was aware of the misstatements.

purchaser was not in privity of contract with Larson.

Under the "Ultramares" doctrine, to which of the following parties will an accountant be liable for negligence?

Parties in privity but not foreseen parties.

Parties in privity and foreseen parties.

Foreseen parties but not parties in privity.

Neither foreseen parties nor parties in privity.

Ford & Co., CPAs, issued an unqualified opinion on Owens Corp.'s financial statements. Relying on these financial statements, Century Bank lent Owens $750,000. Ford was unaware that Century would receive a copy of the financial statements or that Owens would use them to obtain a loan. Owens defaulted on the loan. To succeed in a common law fraud action against Ford, Century must prove, in addition to other elements, that:

the accountant intended to induce Century to rely on false representations.

Century was free from contributory negligence.

Century was in privity of contract with Ford.

Century was in privity of contract with Owens.

requires that the auditor performs work with due care.

requires that the CPA guarantee their work.

requires that the auditor performs work with due diligence.

does not recognize the concept of constructive fraud.

Under common law, which of the following statements most accurately reflects the liability of a CPA who fraudulently gives an opinion on an audit of a client's financial statements?

The CPA probably is liable to any person who suffered a loss as a result of the fraud.

The CPA is liable only to third parties in privity of contract with the CPA.

The CPA is liable only to known users of the financial statements.

The CPA probably is liable to the client even if the client was aware of the fraud and did not rely on the opinion.

Hark, CPA, failed to follow all generally accepted auditing standards in auditing Long Corp.'s financial statements, but the failure would not amount to gross negligence. Long's management had told Hark that the audited statements would be submitted to several banks to obtain financing. Relying on the statements, Third Bank gave Long a loan. Long defaulted on the loan. In a jurisdiction applying the Ultramares doctrine, if Third sues Hark, Hark will:

win because there was no privity of contract between Hark and Third.

lose because Hark knew that banks would be relying on the financial statements.

win because there was contributory negligence on the part of Third in granting the loan.

lose because Hark was negligent in performing the audit.

The Sarbanes-Oxley Act enhances prosecutorial tools available in major fraud cases by:

expanding laws against fraud and obstruction of justice.

increasing criminal penalties for fraud and its cover-up.

strengthening sentencing guidelines applicable to large-scale frauds.

A CPA who fraudulently performs an audit of a corporation's financial statements will:

probably be liable to any person who suffered a loss as a result of the fraud.

be liable only to the corporation and to third parties who are members of a class of intended users of the financial statements.

probably be liable to the corporation even though its management was aware of the fraud and did not rely on the financial statements.

be liable only to third parties in privity of contract with the CPA.

Which statement is correct concerning an auditor's statutory legal liability?

The auditor has a greater burden of defense under the Securities Act of 1933 than under the Securities Exchange Act of 1934.

The Securities Act of 1933 broadened the auditor's common law liability and the Securities Exchange Act of 1934 narrowed it.

Criminal liability only arises under state law.

Statutory liability usually modifies the auditor's liability to the client.

Under Section 11 of the Securities Act of 1933, which of the following standards may a CPA use as a defense?

The auditor exercised due diligence in following PCAOB auditing standards but not generally accepted fraud detection standards.

The auditor exercised due diligence in following PCAOB auditing standards and generally accepted fraud detection standards.

The auditor exercised due diligence in following PCAOB fraud detection standards but not generally accepted auditing standards.

The auditor exercised due diligence in following neither PCAOB auditing standards nor generally accepted fraud detection standards.

While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included 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. Which of the following statements is correct with regard to a suit against Larson and the client by a purchaser of the securities under Section 11 of the Securities Act of 1933?

Larson will not be liable if it had reasonable grounds, based on work performed, to believe the financial statements were accurate.

The purchaser must prove that Larson was negligent in conducting the audit.

The purchaser must prove that Larson knew of the material misstatements.

Larson will be liable unless the purchaser did not rely on the financial statements.

Quincy bought Teal Corp. common stock in an offering registered under the Securities Act of 1933. Worth & Co., CPAs, gave an unqualified opinion on Teal's financial statements that were included in the registration statement filed with the SEC. Quincy sued Worth under the provisions of the 1933 Act that deal with omission of facts required to be in the registration statement. Quincy must prove that:

there was a material misstatement in the financial statements.

there was fraudulent activity by Worth.

Quincy relied on Worth's opinion.

Quincy was in privity with Worth.

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:

neither the plaintiff's reliance on the registration statement nor the defendant's intent to deceive.

the plaintiff's reliance on the registration statement and the defendant's intent to deceive.

the plaintiff's reliance on the registration statement but not the defendant's intent to deceive.

the defendant's intent to deceive but not the plaintiff's reliance on the registration statement.

Jay and Co., CPAs, audited the financial statements of Maco Corp. Jay intentionally gave an unqualified opinion on the financial statements even though material misstatements were discovered as a result of the audit. The financial statements and Jay's unqualified opinion were included in a 10-K (annual report filed with the SEC) for the company. Which of the following statements is correct regarding Jay's liability to a purchaser of the offering under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934?

Jay will be liable if the purchaser relied on Jay's unqualified opinion on the financial statements.

Jay will be liable if Jay was negligent in conducting the audit.

Jay will not be liable if the purchaser's loss was under $500.

Jay will not be liable if the misstatement resulted from an omission of a material fact by Jay.

Which of the following is something that the plaintiff must prove in order for an accountant to be liable for damages under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934?

The accountant was ordinarily negligent.

The security involved was stock.

The security was part of an original issuance.

West & Company, CPAs, was engaged by Sand Corporation to audit its financial statements. West issued an unqualified opinion on Sand's financial statements. Sand has been accused of making negligent misrepresentations in the financial statements that Reed relied upon when purchasing Sand's stock. West was not aware of the misrepresentations and was not negligent in performing the audit. If Reed sues West for damages based on Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, West will:

prevail, because some element of scienter must be proved.

lose, because the statements contained negligent misrepresentations.

lose, because Reed relied upon the financial statements.

prevail, because Reed was not in privity of contract with West.

Rule 10b-5 under Section 10(b) of the Securities Exchange Act of 1934 imposes liability on an accountant for violation of certain duties. Which of the following is an investor not required to prove to recover from a CPA?

The security price was artificially inflated as a result of the materially misstated financial statements.

A material, factual misrepresentation or omission.

Reliance by the plaintiff on the financial statements.

Damages suffered as a result of reliance on the financial statements.

Which of the following is the best defense a CPA firm can assert in a suit for common law fraud based on its unqualified opinion on materially false financial statements?

Contributory negligence on the part of the client.

A disclaimer contained in the engagement letter.

When performing an audit, a CPA will most likely be considered negligent when the CPA fails to:

warn a client of known internal control weaknesses.

detect all of a client's fraudulent activities.

include a negligence disclaimer in the client engagement letter.

warn a client's customers of embezzlement by the client's employees.

The Foreign Corrupt Practices Act requires that:

public companies devise and maintain an adequate system of internal control.

auditors engaged to examine the financial statements of public companies report all illegal payments to the SEC.

public companies establish independent audit committees to monitor the effectiveness of their system of internal control.

U.S. firms doing business abroad report sizable payments to non-U.S. citizens to the Justice Department.

This act increased legal protections available to whistleblowers.

Securities Litigation Uniform Standards Act of 1998.

In regards to the Foreign Corrupt Practices Act (FCPA), external auditors:

should immediately report any discovered violation of the FCPA to the client's management.

are responsible for ensuring that sufficient internal controls are maintained.

should verify compliance with corporate codes of conduct.

are not subject to any penalties.

Ocean and Associates, CPAs, audited the financial statements of Drain Corporation. As a result of Ocean's negligence in conducting the audit, a material misstatement in the financial statements went undetected. Ocean was unaware of this fact. The financial statements and Ocean's unqualified opinion were included in a registration statement and prospectus for an initial public offering of stock by Drain. Sharp purchased shares in the offering. Sharp received a copy of the prospectus prior to the purchase but did not read it. The shares declined in value as a result of the misstatements in Drain's financial statements becoming known. Under which of the following acts is Sharp most likely to prevail in a lawsuit against Ocean?

The Securities Exchange Act of 1934, the Securities Act of 1933, and the Sarbanes-Oxley Act of 2002 provide equal likelihoods of prevailing.

The Sarbanes-Oxley Act of 2002.

Under the liability provisions of Section 11 of the Securities Act of 1933, a CPA may be liable to any purchaser of a security for certifying materially misstated financial statements that are included in the security's registration statement. Under Section 11, which of the following must be proven by a purchaser of the security?)

Neither that the CPA committed fraud, nor that the purchaser relied on the financial statements.

The CPA committed fraud and the purchaser relied on the financial statements.

The purchaser relied on the financial statements, but not that the CPA committed fraud.

The CPA committed fraud, but not that the purchaser relied on the financial statements.

Under the liability provisions of Section 11 of the Securities Act of 1933, a CPA may be liable to any purchaser of a security for certifying materially misstated financial statements that are included in the security's registration statement. Under Section 11, a CPA usually will not be liable to the purchaser:

if the CPA can prove due diligence.

if there is contributory negligence on the part of the purchaser.

unless the purchaser can prove privity with the CPA.

unless the purchaser can prove scienter on the part of the CPA.

In general, the third-party (primary) beneficiary rule as applied to a CPA's legal liability in conducting an audit is relevant to which of the following causes of action against a CPA?

Negligence, but not fraud or constructive fraud.

Fraud and constructive fraud, but not negligence.

Fraud, but not constructive fraud or negligence.

Constructive fraud and negligence, but not fraud.

While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included 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 suit by a purchaser against Larson for common-law fraud, Larson's best defense would be that:

Larson did not have actual or constructive knowledge of the misstatements and the auditor followed PCAOB Auditing Standards in the audit.

Larson's client knew or should have known of the misstatements.

Larson did not have actual knowledge that the purchaser was an intended beneficiary of the audit.

Larson was not in privity of contract with its client.

The Sarbanes-Oxley Act of 2002 is considered the most sweeping securities law since the 1933 and 1934 Acts. Which item in the list below was not part of the Sarbanes-Oxley Act of 2002?

Legislates new guidelines for ethics and integrity for public accounting firms.

Enhances prosecutorial tool available in fraud cases.

Expands statutory prohibitions against fraud and obstruction of justice.

Increases authorized penalties for securities and financial fraud.

Strengthens the legal protections accorded whistleblowers.

Chapter 20 Legal Liability

Authored by Maggie Dekreon

Life Skills

University

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46 questions

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MULTIPLE CHOICE QUESTION

3 mins • 1 pt

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.

MULTIPLE CHOICE QUESTION

3 mins • 1 pt

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.

MULTIPLE CHOICE QUESTION

3 mins • 1 pt

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.

MULTIPLE CHOICE QUESTION

3 mins • 1 pt

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.

MULTIPLE CHOICE QUESTION

3 mins • 1 pt

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.

MULTIPLE CHOICE QUESTION

3 mins • 1 pt

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.

MULTIPLE CHOICE QUESTION

3 mins • 1 pt

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.

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