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Auditing and Assurance Services, 14e (Arens)
Chapter 5 Legal Liability
Learning Objective 5-1
1)Discuss three major factors that have contributed to the recent increase in the
number of lawsuits against auditors and the size of awards to plaintiffs.
Answer: Major factors include:
• The growing awareness of the responsibilities of public accountants by users of financial
statements.
• An increased consciousness on the part of the Securities and Exchange Commission
regarding its responsibility for protecting investors' interests.
• The complexity of auditing and accounting functions caused by the increasing size of
businesses, the globalization of business, and the complexities of business operations.
• Large civil court judgments against CPA firms.
• The tendency of society to accept lawsuits by injured parties against anyone who might
be able to provide compensation, regardless of who was at fault, coupled with joint and
several liability doctrine.
• The willingness of CPA firms to settle legal problems out of court to avoid costly
legal fees and adverse publicity, rather than pursuing resolution through the judicial
process.
• The difficulty judges and jurors have understanding and interpreting technical
accounting and auditing matters.
Terms: Major factors that have contributed to the recent increase in the number of lawsuits against
auditors
Diff: Moderate
Objective: LO 5-1
AACSB: Reflective thinking skills
Learning Objective 5-2
1)A(n) ________ failure occurs when an auditor issues an erroneous opinion because it
failed to comply with requirements of auditing standards.
A)
business
B) audit C)
ethics D)
process
Answer: B
Terms: Failure which occurs when an auditor issues an erroneous opinion
Diff: Easy
Objective: LO 5-2
AACSB: Reflective thinking skills
2)Distinguish between what is meant by business failure and audit failure.
Answer: Business failure occurs when a business is unable to repay its lenders or meet
expectations of its investors because of economic or business conditions, such as
recession, poor management decisions, or unexpected competition in the industry. Audit
failure occurs when the auditor issues an incorrect audit opinion because it failed to
comply with the requirements of auditing standards.
Terms: Business failure and audit failure
Diff: Easy
Objective: LO 5-2
AACSB: Reflective thinking skills
1
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3)Audit risk is the risk there will be an audit failure for a given audit
engagement. A) True
B) False
Answer:
B
Terms: Audit risk
Diff: Moderate
Objective: LO 5-2
AACSB: Reflective thinking skills
4)The term "audit failure" refers to the situation when the auditor has followed auditing
standards yet still fails to discover that the client's financial statements are materially
misstated.
A) True
B) False
Answer:
B
Terms: Audit failure; Followed audit standards and fail to discover material misstatement
Diff: Moderate
Objective: LO 5-2
AACSB: Reflective thinking skills
Learning Objective 5-3
1) In the performance of an audit, a CPA:
A) is legally liable for not detecting client fraud.
B) must strictly follow GAAS for privately held clients.
C)must strictly follow PCAOB auditing standards for publicly held clients.
D)must exercise due professional care in the performance of their audit
responsibilities. Answer: D
Terms: Performance of an audit
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
2)Auditors who fail to exercise due care in their performance of professional services
may be liable for: A) punitive liability.
B) breach of
contract. C)
excess liability. D)
criminal charges.
Answer: B
Terms: Liability when auditors fail to exercise due care
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
2
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3)Recklessness in the case of an audit is present if the auditor knew an adequate audit
was not done but still issued an opinion, even though there was no intent to deceive
financial statement users. This description is the legal term for:
A) ordinary
negligence. B) gross
negligence.
C) constructive
fraud. D) fraud.
Answer: C
Te rms: Legal term for reckless in an audit with not intent to deceive
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
4)The standard of due care to which the auditor is expected to adhere to in the
performance of the audit is referred to as the:
A) prudent person
concept. B) common
law doctrine. C) due
care concept.
D) vigilant person
concept. Answer: A
Terms: Standard of due care
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
5)Auditors may be liable to their clients for:
A)
Punitive damages Compensatory damages
Yes Yes
B)
Punitive damages Compensatory damages
No No
C)
Punitive damages Compensatory damages
Yes No
D)
Punitive damages Compensatory damages
No Yes
Answer: A
Terms: Auditor liability to
clients
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking
skills
3
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6)Under the laws of agency, partners of a CPA firm may be liable for the work of others
on whom they rely. This would not include:
A) employees of the CPA
firm. B) employees of the
audit client.
C) other CPA firms engaged to do part of the audit work.
D) specialists employed by the CPA firm to provide technical advice on
the audit. Answer: B
Terms: Laws of agency. Partners of CPA firm liable for work of others on whom they rely
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
7)"Absence of reasonable care that can be expected of a person in a set of circumstances"
defines:
A) pecuniary negligence.
B) gross negligence.
C) extreme negligence.
D)ordinary
negligence. Answer:
D
Terms: Absence of reasonable care
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
8) An example of a breach of contract would likely include:
A) an auditor's refusal to return the client's general ledger book until the client paid last
year's audit fees.
B) a bank's claim that an auditor had a duty to uncover material errors in financial
statements that had been relied on in making a loan.
C)a CPA firm's failure to complete an audit on the agreed-upon date because the firm
had a backlog of other work which was more lucrative.
D)an auditor's claim that the client staff is unqualified.
Answer: C
Terms: Breach of contract
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
9)Privity of contract exists
between: A) auditor and the
federal government. B) auditor
and third parties.
C) auditor and client.
D) auditor and client
attorney. Answer: C
Terms: Privity of contract
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
4
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Auditing and Assurance Services, 14e (Arens)
Chapter 5 Legal Liability
Learning Objective 5-1
1)Discuss three major factors that have contributed to the recent increase in the
number of lawsuits against auditors and the size of awards to plaintiffs.
Answer: Major factors include:
• The growing awareness of the responsibilities of public accountants by users of financial
statements.
• An increased consciousness on the part of the Securities and Exchange Commission
regarding its responsibility for protecting investors' interests.
• The complexity of auditing and accounting functions caused by the increasing size of
businesses, the globalization of business, and the complexities of business operations.
• Large civil court judgments against CPA firms.
• The tendency of society to accept lawsuits by injured parties against anyone who might
be able to provide compensation, regardless of who was at fault, coupled with joint and
several liability doctrine.
• The willingness of CPA firms to settle legal problems out of court to avoid costly
legal fees and adverse publicity, rather than pursuing resolution through the judicial
process.
• The difficulty judges and jurors have understanding and interpreting technical
accounting and auditing matters.
Terms: Major factors that have contributed to the recent increase in the number of lawsuits against
auditors
Diff: Moderate
Objective: LO 5-1
AACSB: Reflective thinking skills
Learning Objective 5-2
1)A(n) ________ failure occurs when an auditor issues an erroneous opinion because it
failed to comply with requirements of auditing standards.
A)
business
B) audit C)
ethics D)
process
Answer: B
Terms: Failure which occurs when an auditor issues an erroneous opinion
Diff: Easy
Objective: LO 5-2
AACSB: Reflective thinking skills
2)Distinguish between what is meant by business failure and audit failure.
Answer: Business failure occurs when a business is unable to repay its lenders or meet
expectations of its investors because of economic or business conditions, such as
recession, poor management decisions, or unexpected competition in the industry. Audit
failure occurs when the auditor issues an incorrect audit opinion because it failed to
comply with the requirements of auditing standards.
Terms: Business failure and audit failure
Diff: Easy
Objective: LO 5-2
AACSB: Reflective thinking skills
1
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
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3)Audit risk is the risk there will be an audit failure for a given audit
engagement. A) True
B) False
Answer:
B
Terms: Audit risk
Diff: Moderate
Objective: LO 5-2
AACSB: Reflective thinking skills
4)The term "audit failure" refers to the situation when the auditor has followed auditing
standards yet still fails to discover that the client's financial statements are materially
misstated.
A) True
B) False
Answer:
B
Terms: Audit failure; Followed audit standards and fail to discover material misstatement
Diff: Moderate
Objective: LO 5-2
AACSB: Reflective thinking skills
Learning Objective 5-3
1) In the performance of an audit, a CPA:
A) is legally liable for not detecting client fraud.
B) must strictly follow GAAS for privately held clients.
C)must strictly follow PCAOB auditing standards for publicly held clients.
D)must exercise due professional care in the performance of their audit
responsibilities. Answer: D
Terms: Performance of an audit
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
2)Auditors who fail to exercise due care in their performance of professional services
may be liable for: A) punitive liability.
B) breach of
contract. C)
excess liability. D)
criminal charges.
Answer: B
Terms: Liability when auditors fail to exercise due care
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
2
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
, To
To downloaddownload moremore ebooks,ebooks, slides,slides, SMSM andand TBTB visit:visit: http://testbanklancerhtp:/testbanklancer..blogspotblogspot..comcom
3)Recklessness in the case of an audit is present if the auditor knew an adequate audit
was not done but still issued an opinion, even though there was no intent to deceive
financial statement users. This description is the legal term for:
A) ordinary
negligence. B) gross
negligence.
C) constructive
fraud. D) fraud.
Answer: C
Te rms: Legal term for reckless in an audit with not intent to deceive
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
4)The standard of due care to which the auditor is expected to adhere to in the
performance of the audit is referred to as the:
A) prudent person
concept. B) common
law doctrine. C) due
care concept.
D) vigilant person
concept. Answer: A
Terms: Standard of due care
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
5)Auditors may be liable to their clients for:
A)
Punitive damages Compensatory damages
Yes Yes
B)
Punitive damages Compensatory damages
No No
C)
Punitive damages Compensatory damages
Yes No
D)
Punitive damages Compensatory damages
No Yes
Answer: A
Terms: Auditor liability to
clients
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking
skills
3
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
, To
To downloaddownload moremore ebooks,ebooks, slides,slides, SMSM andand TBTB visit:visit: http://testbanklancerhtp:/testbanklancer..blogspotblogspot..comcom
6)Under the laws of agency, partners of a CPA firm may be liable for the work of others
on whom they rely. This would not include:
A) employees of the CPA
firm. B) employees of the
audit client.
C) other CPA firms engaged to do part of the audit work.
D) specialists employed by the CPA firm to provide technical advice on
the audit. Answer: B
Terms: Laws of agency. Partners of CPA firm liable for work of others on whom they rely
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
7)"Absence of reasonable care that can be expected of a person in a set of circumstances"
defines:
A) pecuniary negligence.
B) gross negligence.
C) extreme negligence.
D)ordinary
negligence. Answer:
D
Terms: Absence of reasonable care
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
8) An example of a breach of contract would likely include:
A) an auditor's refusal to return the client's general ledger book until the client paid last
year's audit fees.
B) a bank's claim that an auditor had a duty to uncover material errors in financial
statements that had been relied on in making a loan.
C)a CPA firm's failure to complete an audit on the agreed-upon date because the firm
had a backlog of other work which was more lucrative.
D)an auditor's claim that the client staff is unqualified.
Answer: C
Terms: Breach of contract
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
9)Privity of contract exists
between: A) auditor and the
federal government. B) auditor
and third parties.
C) auditor and client.
D) auditor and client
attorney. Answer: C
Terms: Privity of contract
Diff: Easy
Objective: LO 5-3
AACSB: Reflective thinking skills
4
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
