Test Bank for Auditing,, A Practical Approach 3rd Edition Robyn Moroney, Fiona Campbell, Jane Hamilton

TESTBANK TO ACCOMPANY AUDITING: A PRACTICAL APPROACH 3E BY MORONEY ET AL. Chapter 2: Ethics, legal liability and client acceptance True/False 1. The fundamental ethical principles that apply to all members of the professional bodies are to act with integrity, objectivity, professional competence and due care, confidentiality and professional behaviour. *a. True b. False Correct answer: a Learning Objective 2.1 ~ explain the fundamental principles of professional ethics 2. Compliance with the fundamental ethical principles is mandatory for all members of the accounting profession. *a. True b. False Correct answer: a Learning Objective 2.1 ~ explain the fundamental principles of professional ethics 3. For an auditor to be truly independent they must possess independence of mind and independence of appearance. *a. True b. False Correct answer: a Learning Objective 2.2 ~ define and assess auditor independence 4. An example of an advocacy threat is encouraging others to buy shares or bonds being sold by the client. *a. True b. False Correct answer: a Learning Objective 2.2 ~ define and assess auditor independence Independence in appearance is the ability to act with integrity, objectivity and professional scepticism. a. True *b. False Correct answer: b 5. Learning Objective 2.2 ~ define and assess auditor independence 6. An effective audit committee will enhance the independence of the external audit function. *a. True b. False Correct answer: a Learning Objective 2.3 ~ describe the relationship between an auditor and key groups they have a professional link with during the audit engagement 7. The role of the Internal Auditors will enhance the work of the external auditors by further developing the findings of the external auditors between engagements. a. True *b. False Correct answer: b Learning Objective 2.3 ~ describe the relationship between an auditor and key groups they have a professional link with during the audit engagement 8. A famous statement by Lord Justice Lopes in the Pacific Acceptance case was that an auditor "…is a watchdog, but not a bloodhound." a. True *b. False Correct answer: b Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 9. The key difficulty for third parties in successfully claiming against the auditor is establishing that the client's management contributed to the third party's loss. a. True *b. False Correct answer: b Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 10. For auditors to be liable to third parties for negligence, a duty of care must exist. *a. True b. False Correct answer: a Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 11. Third parties are anyone other than the client and its shareholders that uses the financial report to make a decision. *a. True b. False Correct answer: a Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 12. Ensuring compliance with auditing regulations will not assist auditors to avoid litigation. a. True *b. False Correct answer: b Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 13. The judgement in the Esanda case has made it far easier for third parties to establish that a duty of care is owed by the auditor. a. True *b. False Correct answer: b Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 14. Being negligent means not exercising due care. *a. True b. False Correct answer: a Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 15. Auditors can avoid litigation by implementing policies and procedures that ensure all work is fully documented. *a. True b. False Correct answer: a Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 16. An engagement letter is prepared by the auditors and signed by the client at the conclusion of the audit process. a. True *b. False Correct answer: b Learning Objective 2.5 ~ categorise the factors to consider in the client acceptance or continuance decision 17. An engagement letter does not include an overview of the client's responsibility for the preparation of the financial report. a. True *b. False Correct answer: b Learning Objective 2.5 ~ categorise the factors to consider in the client acceptance or continuance decision 18. When assessing client integrity, the auditor will consider the appropriateness of the client's interpretation of accounting rules. *a. True b. False Correct answer: a Learning Objective 2.5 ~ categorise the factors to consider in the client acceptance or continuance decision 19. An engagement letter sets out the terms of the engagement. *a. True b. False Correct answer: a Learning Objective 2.5 ~ categorise the factors to consider in the client acceptance or continuance decision Multiple-choice questions 20. Professional competence refers to the to the members of a professional body; a. Maintain the knowledge to adequately operate in their clients industry. b. Maintain a level of understanding of their clients business operations. c. Maintain a level of commitment to their industry associations. *d. Maintain their level of knowledge and skill required by the professional body. Correct answer: d Learning Objective 2.1 ~ explain the fundamental principles of professional ethics 21. Professional behaviour refers to the obligation that all members of the professional bodies: a. refrain from disclosing information to people outside of their workplace that is learned as a result of their employment. b. not allow their personal feelings or prejudices to influence their professional judgement. *c. ensure that they do not harm the reputation of the accounting profession. d. be straightforward and honest. Correct answer: c Learning Objective 2.1 ~ explain the fundamental principles of professional ethics 22. Which of the following is a fundamental principle of professional ethics? a. integrity. b. objectivity. c. confidentiality. *d. all of the above. Correct answer: d Learning Objective 2.1 ~ explain the fundamental principles of professional ethics 23. Objectivity 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. refrain from disclosing information to people outside of their workplace that is learned as a result of their employment. c. be straightforward and honest. *d. not allow their personal feelings or prejudices to influence their professional judgement. Correct answer: d Learning Objective 2.1 ~ explain the fundamental principles of professional ethics 24. Threats to the independence of auditors include: a. self-interest threats. b. familiarity threats. c. advocacy threats. *d. all of the above. Correct answer: d Learning Objective 2.2 ~ define and assess auditor independence 25. Independence in appearance is: *a. the belief that independence of mind has been achieved. b. the ability to act with integrity, objectivity and professional scepticism. c. also referred to as actual independence. the ability to make a decision that is free from bias, personal beliefs and client pressures. Correct answer: a d. Learning Objective 2.2 ~ define and assess auditor independence 26. Auditor independence is: a. defined as acting with integrity, objectivity and professional scepticism. essential when complying with the ethical principles to act with integrity and objectivity. *c. both a and b. d. not fundamental to every audit. Correct answer: c Learning Objective 2.2 ~ define and assess auditor independence b. 27. 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 holdings a senior position with the client. Correct answer: d Learning Objective 2.2 ~ define and assess auditor independence 28. A self-interest threat refers to the threat that can occur when an accounting firm or its staff: a. needs to form an opinion on their own work or work performed by others in the firm. *b. has a financial interest in an audit client. c. is threatened by the client's staff or directors. d. acts on behalf of its assurance client. Correct answer: b Learning Objective 2.2 ~ define and assess auditor independence 29. Intimidation threats to independence include: a. a close business relationship with the client. *b. the threat that that the client will use a different assurance firm next year. c. preparing information for the client that is then assured. d. representing the client in a legal dispute. Correct answer: b Learning Objective 2.2 ~ define and assess auditor independence 30. What type of threat to independence arises when an accounting firm acts on behalf of its assurance client results? a. self-interest threat. *b. advocacy threat. c. self-review threat. d. intimidation threat. Correct answer: b Learning Objective 2.2 ~ define and assess auditor independence 31. Having policies and procedures to ensure the quality of an accounting firm's service is an example of a safeguard to independence created by: a. the Corporations Act. b. the client's audit committee. c. the client's board of directors. *d. None of the above. Correct answer: d Learning Objective 2.2 ~ define and assess auditor independence 32. Safeguards to independence are created by: a. clients. b. the profession, legislation or regulation. c. accounting firms. *d. all of the above. Correct answer: d Learning Objective 2.2 ~ define and assess auditor independence 33. An example of a safeguard to independence created by accounting firms is: *a. the existence of client acceptance and continuation procedures. b. legislation that requires that an auditor be independent. c. the establishment of a code of ethics. d. the establishment of an audit committee. Correct answer: a Learning Objective 2.2 ~ define and assess auditor independence 34. The main recipients of the financial report and the attached audit report are acknowledged as: a. the audit committee. *b. the shareholders or members. c. the board of directors. d. the Australian Securities and Investments Commission. Correct answer: b Learning Objective 2.3 ~ describe the relationship between an auditor and key groups they have a professional link with during the audit engagement 35. It is the responsibility of the board of directors to: a. provide an opinion on the truth and fairness of the financial statements. b. direct the auditors to audit specific financial statement accounts. *c. ensure that the financial report is prepared so as to provide a true and fair view. d. none of the above. Correct answer: c Learning Objective 2.3 ~ describe the relationship between an auditor and key groups they have a professional link with during the audit engagement 36. Examples of board committees include the: a. nomination committee. b. remuneration committee. c. risk committee. *d. all of the above. Correct answer: d Learning Objective 2.3 ~ describe the relationship between an auditor and key groups they have a professional link with during the audit engagement 37. According to the ASX Corporate Governance Council, an audit committee should: a. be chaired by the chairman of the board of directors. *b. consist of a majority of independent directors. c. not have a formal charter. d. have at least four members. Correct answer: b Learning Objective 2.3 ~ describe the relationship between an auditor and key groups they have a professional link with during the audit engagement 38. 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. Correct answer: d Learning Objective 2.3 ~ describe the relationship between an auditor and key groups they have a professional link with during the audit engagement 39. Which of the following was an observation or recommendation by Justice Owen in the HIH Royal Commission Report? a. audit reports should be addressed to shareholders. b. auditor independence is not a critical element in establishing the credibility of an auditor's report. c. boards of directors should establish an audit committee. *d. an independent and objective audit, conducted with an appropriate degree of professional scepticism, is required. Correct answer: d Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 40. The principles established by Justice Moffitt in the Pacific Acceptance case do not include: a. auditors have a duty to use reasonable skills and care. b. auditors must properly document procedures used. *c. auditors are watchdogs but not bloodhounds. d. auditors must audit the whole year. Correct answer: c Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 41. Under tort law, to prove that and auditor has been negligent the plaintiff must establish: a. a duty of care was owed by the auditor. b. a loss was suffered as a result of the breach of duty of care. c. there was a breach of the duty of care. *d. all of the above. Correct answer: d Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 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. Correct answer: d Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 43. Which of these cases established the legal principle that auditors owe a duty of care to shareholders as a group and not to individual shareholders? *a. Caparo. b. Esanda. c. Pacific Acceptance. d. Scott Group. Correct answer: a Learning Objective 2.4 ~ illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 44. An auditor's assessment of their client's integrity would not include: a. the client's attitude to audit fees and its willingness to pay a fair amount. *b. whether the auditor has sufficiently competent staff to complete the audit. c. the reputation of the client and its management. d. the client's attitude to risk exposure and management. Correct answer: b Learning Objective 2.5 ~ categorise the factors to consider in the client acceptance or continuance decision 45. The final stage in the client acceptance and continuance decision process involves: a. the auditor preparing an independence declaration statement. b. the auditor obtaining a management representation letter from the client. *c. the preparation of an engagement letter. d. the client's audit committee meeting with the auditor. Correct answer: c Learning Objective 2.5 ~ categorise the factors to consider in the client acceptance or continuance decision Short answer questions 46. Explain the five fundamental principles of professional ethics. Answer: The fundamental ethical principles that apply to all members of the professional bodies are to act with integrity, objectivity, professional competence and due care, confidentiality and professional behaviour (APES 110, s. 100.4). Integrity refers to the obligation that all members of the professional bodies be straightforward and honest. Objectivity refers to the obligation that all members of the professional bodies not allow their personal feelings or prejudices to influence their professional judgement. Professional competence and due care refers to the obligation that all members of the professional bodies maintain their knowledge and skill at a level required by the professional bodies. Confidentiality refers to the obligation that all members of the professional bodies refrain from disclosing information to people outside of their workplace that is learned as a result of their employment. Professional behaviour refers to the obligation that all members of the professional bodies comply with rules and regulations and ensure that they do not harm the reputation of the profession. Learning Objective 2.1 ~ explain the fundamental principles of professional ethics 47. Describe the three categories of safeguards to an auditor's independence. Answer: Safeguards are mechanisms that have been developed by the accounting profession, legislators, regulators, clients and accounting firms (APES 110, s. 290). The accounting profession, legislation and regulation have created a range of safeguards including education of accountants about the threats to independence, the establishment of a code of ethics, and legislation that requires that an auditor be independent. Clients can put in place appropriate mechanisms that will reduce the threat to independence. These include having appropriate corporate governance mechanisms, such as the establishment of an audit committee and establishing policies and procedures dedicated to ensuring that the financial report is true and fair. Accounting firms also have in place a range of safeguards to ensure independence such as policies and procedures to ensure the quality of their service and providing continuing education for their staff regarding these policies and procedures. Learning Objective 2.2 ~ define and assess auditor independence 48. Distinguish between independence of mind and independence in appearance. Answer: Independence is essential when complying with the ethical principles to act with integrity and objectivity. Independence of mind is the ability to act with integrity, objectivity and professional scepticism. It is the ability to make a decision that is free from bias, personal beliefs and client pressures. Independence of mind is also referred to as actual independence. Independence in appearance is the belief that independence of mind has been achieved. It is not enough for an auditor to be independent of mind; they must also be seen to be independent. Learning Objective 2.2 ~ define and assess auditor independence 49. Discuss the findings in the Esanda case as they relate to an auditor's liability to a third party. Answer: The High Court of Australia found in favour of the auditor and ruled that for a third party to be able to establish that an auditor owes them a duty of care they would need to show the following: The report was prepared on the basis that it would be communicated to a third party. The report was likely to be relied upon by that third party. The third party ran the risk of suffering a loss if the report was negligently prepared. Learning Objective 2.3 ~ describe the relationship between an auditor and key groups they have a professional link with during the audit engagement 50. Explain the purpose and major contents of an engagement letter between the auditor and their client. Answer: The engagement letter is a form of contract between an auditor and their client. Its purpose is to set out the terms of the audit engagement, to avoid any misunderstandings between the auditor and their client. The letter will confirm the obligations of the client and the auditor in accordance with the Corporations Act. It also includes an explanation of the scope of the audit, the timing of the completion of various aspects of the audit, an overview of the client's responsibility for the preparation of the financial report, the requirement that the auditor have access to all information required, independence considerations and fees. Learning Objective 2.5 ~ categorise the factors to consider in the client acceptance or continuance decision Essay questions 51. Audit committees have been widely recommended as being an important mechanism for enhancing the external auditor's independence. What are the important characteristics of audit committees and discuss why these characteristics are considered so important to a committee's effective and efficient operation. 52. The key difficulty for third parties in 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 principles relating to an auditor's duty of care to third parties with reference to specific case law. 53. 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.