EXAM 2 ACCT 450 QUESTIONS ANSWERED CORRECTLY LATEST UPDATE 2026
Common law - Answers Unwritten law that has developed through court decisions; it represents
judicial interpretation of a society's concept of fairness.
Common law liability develops through case decisions generally arising due to breach of contract,
negligence, and fraud - Answers what are the sources of common law liability?
negligence - Answers failure to perform a duty in accordance with applicable standards, or failure to
exercise due professional care
Gross negligence - Answers Lack of even slight care, indicative of a reckless disregard for one's
professional responsibilities (Substantial failures on the part of an auditor to comply with auditing
standards)
due professional care - Answers A standard of care expected to be demonstrated by a competent
professional in his or her field of expertise, set by GAAS but supplemented in specific implementation
instances by the standard of care expected by a reasonably prudent auditor.
The CPAs accepted a duty of due professional care to exercise skill, prudence, and diligence. The
auditors' duty is defined by AICPA generally accepted or PCAOB auditing standards, the engagement
letter, and legal considerations. - Answers what is duty under common law?
The CPAs breached their duty of due professional care through negligence. In a breach of contract,
the client establishes duty was breached by not performing obligations or not meeting professional
standards.
Defense: When an audit has been performed in accordance with auditing standards, the firm has not
breached its duty and should not be held liable. - Answers what is a breach of due care (duty) under
common law?
Joint and several liability - Answers A legal concept that holds a class of defendants jointly
responsible for losses attributed to the class as well as liable for any share of losses that cannot be
collected from those unable to pay their share. Thus, a financially responsible defendant may be
required to pay losses attributed to defendants that do not have the ability to pay.
If one of more defendants are not able to pay their share of losses, auditors have unlimited joint and
several liability to certain small investors only. To other investors, auditors' liability limited to an
amount not to exceed 50% of the auditors' proportionate share of the losses ((damages x auditors
responsibility) + (damages x auditors responsibility x 50%)), do the 50% calculation if others cannot
pay their share - Answers how do you calculate maximum liability?
client contributory negligence - Answers Negligence on the part of the plaintiff that has contributed
to his or her having incurred a loss. This may be used as a defense because the court may limit or bar
recovery by a plaintiff whose own negligence contributed to the loss. (few states allow this)
Ultramares (known user) approach - Answers Auditors must have been aware that the financial
statements were to be used for a particular purpose by a known third party to be liable to that party
for ordinary negligence (must be stated in the contract as a user to recover losses for ordinary
negligence, but unidentified users can recover losses for fraud or gross negligence)
Restatement of torts (foreseen user) approach - Answers A summary of tort liability, which, when
applied to auditor common law liability, expands auditors' liability for ordinary negligence to include
third parties of a limited class of known or intended users of the audited financial statements.
(Expands the auditors' liability for ordinary negligence to include third parties who are foreseen users
of the audited financial statements (specific identities do not need to be known to the CPAs))
Rosenblum (foreseeable user) approach - Answers CPAs can be held liable for ordinary negligence to
any third party the auditors could reasonably foresee as recipients of the statements for routine
business purposes
Yes, any third party that suffers losses caused by reliance on the auditors' representations can hold
them liable for proven gross negligence and fraud - Answers can any third party recover losses for
fraud or gross negligence?
registered public accounting firms and professional employees. Sanctions include monetary damages,
suspensions of firms and accountants from engagements for publicly traded companies, and referral
of criminal cases to the Justice Department. - Answers who can the PCAOB conduct investigations
on?
No, partners are generally protected from personal liability for another partner's negligence or
misconduct, while benefiting from pass-through taxation - Answers are those in limited liability
partnerships liable for their partners?
, Securities Act of 1933 - Answers A federal securities statute covering registration statements for
securities to be sold to the public. The act requires auditors to exercise "due diligence" and creates
both civil and criminal penalties for misrepresentation.
Securities Act of 1934 - Answers A federal securities statute requiring public companies to file annual
audited financial statements with the SEC. The act requires auditors to "act in good faith" and creates
civil and criminal penalties for misrepresentation.
1933 Act only offers protections to those who initially bought a security offered for sale under the
registration statement, but burden shifts from plaintiff to defendant (only recourse to individuals
acquiring initial distribution of securities).
Plaintiffs must prove that they sustained a loss and the registration statement was misleading (don't
need to prove they relied on it or auditors were negligent). - Answers what are the plaintiff's rights
under 1933 act and what must they prove to receive compensation?
The auditors conducted the audit with due diligence - Answers what is the most common defense to
avoid liability under 1933 act?
1934 Act offers protection to both original and subsequent purchasers and sellers of securities
(recourse to any person buying/ selling securities).
They must prove they sustained losses, financial statements were misleading, and they relied on the
statements - Answers what are the plaintiff's rights under 1934 act and what must they prove to
receive compensation?
1933 - yes
1934 - no, scienter must be proven - Answers can auditors be held liable for ordinary negligence
under 1933 act? what about 1934 act?
auditors may avoid liability by proving good faith, which they will normally be able to establish unless
they have been guilty of gross negligence or fraud. - Answers what is the most common defense to
avoid liability under 1934 act?
1933, as investors must only prove they suffered a loss and the financial statements were materially
misleading. (1934 also requires reliance) - Answers does the 1933 act or 1934 have lower burden of
proof?
known user - only liable to third-party beneficiaries for ordinary negligence (those listed in the
contract)
foreseen user - liable to those of a limited class of known or intended users of the financial
statements for ordinary negligence (CPAs knew the statements would be used for a purpose, but they
don't need to know who)
foreseeable user - liable to any third party that auditors could foresee as recipients for routine
business purposes for ordinary negligence - Answers what are the differences in the 3 approaches
that summarize auditors' liability to third-party financial statement users under common law?
assertions - Answers Representations, explicit or otherwise, with respect to the recognition,
measurement, presentation, and disclosure of information in the financial statements, which are
inherent in management, representing that the financial statements are prepared in accordance with
the applicable financial reporting framework
existence, entity holds rights and obligations, completeness, accuracy, valuation, and allocation,
classification, and presentation - Answers what are the assertions about account balances and
related disclosures at year end?
1. Existence and occurrence (they exist and have occurred)
2. Rights and obligations (company holds the rights)
3. Completeness (they have been recorded)
4. Cutoff (recorded in correct period)
5. Accuracy, valuation, and allocation (at correct amounts)
6. Presentation and disclosure - Answers what is the condensed set of financial statement assertions?
Relevant assertions - Answers those that, without regard for controls, have a reasonable possibility of
containing a material misstatement
(example: existence and completeness for cash)
Assertions are used by the auditor to consider the different types of potential misstatements that may
occur when identifying, assessing, and responding to the risks of material misstatement. - Answers
how are assertions used?
Common law - Answers Unwritten law that has developed through court decisions; it represents
judicial interpretation of a society's concept of fairness.
Common law liability develops through case decisions generally arising due to breach of contract,
negligence, and fraud - Answers what are the sources of common law liability?
negligence - Answers failure to perform a duty in accordance with applicable standards, or failure to
exercise due professional care
Gross negligence - Answers Lack of even slight care, indicative of a reckless disregard for one's
professional responsibilities (Substantial failures on the part of an auditor to comply with auditing
standards)
due professional care - Answers A standard of care expected to be demonstrated by a competent
professional in his or her field of expertise, set by GAAS but supplemented in specific implementation
instances by the standard of care expected by a reasonably prudent auditor.
The CPAs accepted a duty of due professional care to exercise skill, prudence, and diligence. The
auditors' duty is defined by AICPA generally accepted or PCAOB auditing standards, the engagement
letter, and legal considerations. - Answers what is duty under common law?
The CPAs breached their duty of due professional care through negligence. In a breach of contract,
the client establishes duty was breached by not performing obligations or not meeting professional
standards.
Defense: When an audit has been performed in accordance with auditing standards, the firm has not
breached its duty and should not be held liable. - Answers what is a breach of due care (duty) under
common law?
Joint and several liability - Answers A legal concept that holds a class of defendants jointly
responsible for losses attributed to the class as well as liable for any share of losses that cannot be
collected from those unable to pay their share. Thus, a financially responsible defendant may be
required to pay losses attributed to defendants that do not have the ability to pay.
If one of more defendants are not able to pay their share of losses, auditors have unlimited joint and
several liability to certain small investors only. To other investors, auditors' liability limited to an
amount not to exceed 50% of the auditors' proportionate share of the losses ((damages x auditors
responsibility) + (damages x auditors responsibility x 50%)), do the 50% calculation if others cannot
pay their share - Answers how do you calculate maximum liability?
client contributory negligence - Answers Negligence on the part of the plaintiff that has contributed
to his or her having incurred a loss. This may be used as a defense because the court may limit or bar
recovery by a plaintiff whose own negligence contributed to the loss. (few states allow this)
Ultramares (known user) approach - Answers Auditors must have been aware that the financial
statements were to be used for a particular purpose by a known third party to be liable to that party
for ordinary negligence (must be stated in the contract as a user to recover losses for ordinary
negligence, but unidentified users can recover losses for fraud or gross negligence)
Restatement of torts (foreseen user) approach - Answers A summary of tort liability, which, when
applied to auditor common law liability, expands auditors' liability for ordinary negligence to include
third parties of a limited class of known or intended users of the audited financial statements.
(Expands the auditors' liability for ordinary negligence to include third parties who are foreseen users
of the audited financial statements (specific identities do not need to be known to the CPAs))
Rosenblum (foreseeable user) approach - Answers CPAs can be held liable for ordinary negligence to
any third party the auditors could reasonably foresee as recipients of the statements for routine
business purposes
Yes, any third party that suffers losses caused by reliance on the auditors' representations can hold
them liable for proven gross negligence and fraud - Answers can any third party recover losses for
fraud or gross negligence?
registered public accounting firms and professional employees. Sanctions include monetary damages,
suspensions of firms and accountants from engagements for publicly traded companies, and referral
of criminal cases to the Justice Department. - Answers who can the PCAOB conduct investigations
on?
No, partners are generally protected from personal liability for another partner's negligence or
misconduct, while benefiting from pass-through taxation - Answers are those in limited liability
partnerships liable for their partners?
, Securities Act of 1933 - Answers A federal securities statute covering registration statements for
securities to be sold to the public. The act requires auditors to exercise "due diligence" and creates
both civil and criminal penalties for misrepresentation.
Securities Act of 1934 - Answers A federal securities statute requiring public companies to file annual
audited financial statements with the SEC. The act requires auditors to "act in good faith" and creates
civil and criminal penalties for misrepresentation.
1933 Act only offers protections to those who initially bought a security offered for sale under the
registration statement, but burden shifts from plaintiff to defendant (only recourse to individuals
acquiring initial distribution of securities).
Plaintiffs must prove that they sustained a loss and the registration statement was misleading (don't
need to prove they relied on it or auditors were negligent). - Answers what are the plaintiff's rights
under 1933 act and what must they prove to receive compensation?
The auditors conducted the audit with due diligence - Answers what is the most common defense to
avoid liability under 1933 act?
1934 Act offers protection to both original and subsequent purchasers and sellers of securities
(recourse to any person buying/ selling securities).
They must prove they sustained losses, financial statements were misleading, and they relied on the
statements - Answers what are the plaintiff's rights under 1934 act and what must they prove to
receive compensation?
1933 - yes
1934 - no, scienter must be proven - Answers can auditors be held liable for ordinary negligence
under 1933 act? what about 1934 act?
auditors may avoid liability by proving good faith, which they will normally be able to establish unless
they have been guilty of gross negligence or fraud. - Answers what is the most common defense to
avoid liability under 1934 act?
1933, as investors must only prove they suffered a loss and the financial statements were materially
misleading. (1934 also requires reliance) - Answers does the 1933 act or 1934 have lower burden of
proof?
known user - only liable to third-party beneficiaries for ordinary negligence (those listed in the
contract)
foreseen user - liable to those of a limited class of known or intended users of the financial
statements for ordinary negligence (CPAs knew the statements would be used for a purpose, but they
don't need to know who)
foreseeable user - liable to any third party that auditors could foresee as recipients for routine
business purposes for ordinary negligence - Answers what are the differences in the 3 approaches
that summarize auditors' liability to third-party financial statement users under common law?
assertions - Answers Representations, explicit or otherwise, with respect to the recognition,
measurement, presentation, and disclosure of information in the financial statements, which are
inherent in management, representing that the financial statements are prepared in accordance with
the applicable financial reporting framework
existence, entity holds rights and obligations, completeness, accuracy, valuation, and allocation,
classification, and presentation - Answers what are the assertions about account balances and
related disclosures at year end?
1. Existence and occurrence (they exist and have occurred)
2. Rights and obligations (company holds the rights)
3. Completeness (they have been recorded)
4. Cutoff (recorded in correct period)
5. Accuracy, valuation, and allocation (at correct amounts)
6. Presentation and disclosure - Answers what is the condensed set of financial statement assertions?
Relevant assertions - Answers those that, without regard for controls, have a reasonable possibility of
containing a material misstatement
(example: existence and completeness for cash)
Assertions are used by the auditor to consider the different types of potential misstatements that may
occur when identifying, assessing, and responding to the risks of material misstatement. - Answers
how are assertions used?
