Professional Documents
Culture Documents
ch03 - Maintaining Professional Responsibility - Regulation and Legal Liability
ch03 - Maintaining Professional Responsibility - Regulation and Legal Liability
2.
ANSWER:
3.
The CPA firm of Knox and Knox has been subpoenaed to testify
and produce its correspondence and workpapers in connection
with a lawsuit brought by a third party against one of their
clients. Knox considers the subpoenaed documents to be
privileged communication and therefore seeks to avoid
admission of such evidence in the lawsuit. Which of the
following is correct?
a.
Federal law recognizes such a privilege if the
accountant is a Certified Public Accountant.
b.
The privilege is available regarding the workpapers
since the CPA is deemed to own them.
c.
The privileged communication rule as it applies to a
CPA/client relationship is the same as that of
attorney-client.
d.
In the absence of a specific statutory provision, the
law does not recognize the existence of the
privileged
communication rule between a CPA and his
client.
ANSWER: D
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4.
5.
6.
Privity of contract.
Contributory liability.
Statutory liability.
Common law liability.
ANSWER:
7.
ANSWER:
8.
ANSWER:
9.
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23
ANSWER:
11.
ANSWER:
14.
24
a.
b.
c.
d.
ANSWER:
15.
b.
c.
d.
ANSWER:
ANSWER:
17.
16.
Reliance
No
Yes
No
Yes
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a.
b.
c.
d.
ANSWER:
20.
26
ANSWER: B
Working papers prepared by a CPA in connection with an audit
engagement are owned by the CPA, subject to certain
limitations. The rationale for this rule is to
a.
Protect the working papers from being subpoenaed.
b.
Provide the basis for excluding admission of the
working papers as evidence because of the
privileged
communication rule.
c.
Provide the CPA with evidence and documentation which
may be helpful in the event of a lawsuit.
d.
Establish a continuity of relationship with the client
whereby indiscriminate replacement of CPAs is
discouraged.
22.
ANSWER:
23.
Mead Corp. orally engaged Dex & Co., CPAs, to audit its
financial statements. The management of Mead informed
Dex
that it suspected that the accounts receivable were
materially overstated. Although the financial
statements
audited by Dex did, in fact, include a
materially
overstated accounts receivable balance, Dex issued an
unqualified opinion. Mead relied on the financial
statements in deciding to obtain a loan from City Bank to
expand its operations. City relied on the financial
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24.
to
ascertain whether individuals meeting stated criteria are
assigned increased degrees of responsibility. This is
evidence of the CPA firm's adherence to prescribed
a.
Standards of due professional care.
b.
Quality control standards.
c.
Supervision and review standards.
d.
Reporting standards.
ANSWER:
25.
West & Co., CPAs, was engaged by Sand Corp. 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, which Reed relied upon when purchasing
Sand
stock. West was not aware of the
misrepresentations nor was
it negligent in performing the
audit. If Reed sues West for
damages based upon Section
10(b) and rule 10b-5 of the
Securities Exchange Act of
1934, West will
a.
Lose, because Reed relied upon the financial
statements.
b.
Lose, because the statements contained negligent
misrepresentations.
c.
Prevail, because some element of scienter must be
proved.
d.
Prevail, because Reed was not in privity of contract
with West.
ANSWER:
26.
27.
28.
28
29
29.
31.
CPA
32.
Failure
members
Failure
members
Failure
control
ANSWER:
33.
34.
30
COMPLETION:
35.
31
36.
37.
38.
INCORPORATED BY REFERENCE
42.
ORDINARY NEGLIGENCE
41.
CONSTRUCTIVE FRAUD
40.
is defined as negligence so
flagrant as to border on deceit.
ANSWER:
39.
EXPECTATION GAP
SCIENTER
STATUTORY
COMFORT LETTER
32
MATCHING:
45.
33
SOLUTION:
1.
2.
3.
4.
5.
6.
7.
8.
b
e
h
c
f
d
a
g
ESSAY
46.An auditor is sued for negligence by the stockholders of an
audit client. The auditor had issued an unqualified opinion on
the clients financial statements. It was later determined that
the statements were materially distorted due to errors and fraud.
Required:
a.
Under what conditions, in common law may an auditor be
held liable to third parties for negligence?
b.
Describe two approaches for differentiating between
ordinary negligence and gross negligence. Cite examples to
support your approaches.
c.
SOLUTION:
a.
The doctrine of privity states that auditors are liable
to third parties for fraud but not for negligence. Subsequent
court decisions, such as Ultramares v. Touche, however, have
construed gross negligence as constructive fraud. Auditors,
therefore, may be held liable to injured third parties for gross
negligence, but not for ordinary negligence. In addition,
privity may extend to specifically identified third parties known
by the auditor to be relying on the audited financial statements.
b.
Two approaches to distinguishing ordinary negligence
from gross negligence are materiality and internal control.
Performing an audit with due care should permit the auditor to
detect a material misstatement not cleverly concealed. For
example, an inventory extension error (price x quantity) that
overstates the ending inventory by 25 percent and results in a
material overstatement of net income should be detected in the
ordinary course of the audit.
34
35
36
37
3.
The CPA will probably lose in this case. Although not
grossly negligent, privity will likely be extended to the bank
because the CPA knew the bank was the primary beneficiary of the
audited financial statements. Negligence may be inferred by the
fact that the auditor did not examine the work orders and did not
inspect any of the additions.