Chapter 3&4

Question and answer

1. Describe the responsibility of the management and the auditor with respect to audit
of financial statements.

a. Management’s responsibility for the fairness of the representations in the financial

statements carries with it the privilege of determining which disclosures it considers
necessary. Although management has the responsibility for the preparation of the
financial statements and the accompanying footnotes, the auditor may assist in the
preparation of financial statements. 

b. The auditor’s responsibility is limited to performing the audit investigation and

reporting the results in accordance with generally accepted auditing standards. In
most cases, any material errors and omissions will be discovered if the audit has
been so performed. 

2. Explain the difference of independence requirement in external audit from that of

internal audit.

 First of all Internal auditors are company employees, while external auditors
work for an outside audit firm.
 Internal audit reports are used by management, while external audit reports are
used by stakeholders, such as investors, creditors, and lenders.
 Internal auditors can be used to provide advice and other consulting assistance
to employees, while external auditors are constrained from supporting an audit
client too closely.
 Internal auditors will examine issues related to company business practices and
risks, while external auditors examine the financial records and issue an opinion
regarding the financial statements of the company.
 Internal audits are conducted throughout the year, while external auditors
conduct a single annual audit. If a client publicly held, external auditors will also
provide review services three times per year.

3. What typical allegations would result to lawsuits filed by clients against auditors?

A. Lawsuits against auditors typically involve alleged misstatements which are usually:
 an improper or inadequate disclosure
 an inappropriate valuation
B. the auditor did not discover an employee defalcation.
C. The auditor did not complete the audit on the agreed date.
D. Inappropriate withdrawal from an audit.
4. Give and discuss at least 2 defenses of an auditor against client suits.

 Lack of duty to perform – they can claim that there was no implied or expressed
contact to perform the service. So which is why engagements letters are
important its your contract so they will say that they did not have a duty to
perform that based on the contract they started the engagement letter we laid
what our responsibilities are would be and what your responsibilities aren’t and
we had no duty to perform that.

 Due reasonable care –the auditor was performed using reasonable care or the
lack of reasonable care did not cause damages

5. Give and discuss at least 2 defenses of an auditor in lawsuits filed by intended users of
financial statements.

 Absence of causal connection –So the loss was caused by other factors not the
financial statements. And the third party must be able to prove that there is a
close causal connection between the auditor’s breach of the standard of due
care and the damages suffered by the third party.

 Non negligent performance - so what the auditor is saying that we did our job
accordance with generally accepted auditing standards although we don’t
provide absolute assurance but we provide a reasonable assurance and based on
the work that we did and the evidence that we collected we did our job
accordance with generally accepted auditing standards, we exercised in good
faith, and due diligence

6. In your personal view, is carefully choosing clients a good shield in order to minimize
exposure to legal liability? If not, what best action/s would you take in order to
balance risks and that your earning potential will not be compromised?

When it comes to audit quality at accounting firms, there's always room for improvement.
While accountants have it in their bloodstream to be meticulous and cover all needed tasks of
a project with the utmost quality, there still needs to be an avoidance of hitting a plateau.

Firms needs to continue to strengthen their focus on systematic and engagement-specific

elements of a project. From project management and monitoring to staff supervision,
continuously looking for new ways to stay current and healthy in the world of auditing will
help to avoid costly mistakes which can lead to legal claims from clients.

While having an accountant liability policy in place to protect against these claims, it's even
more important to practice diligence and avoid stale operating procedures.

Let's see how accounting firms can improve audit quality:

 I. Audit Deficiencies
Audit deficiencies can usually be found while assessing and responding to risks of
material misstatement, auditing internal control over financial reporting, or auditing
accounting estimates, such as fair value measurements.
In addition to remediating deficiencies known within a firm, they still need to focus
heavily on preventative aspects of their quality-control systems.

II. Choose Clients Carefully

Firms can take the first step to avoiding issues by being more diligent in bringing on
new clients. While new business is always good, it pays-literally-to avoid possible
costly claims made down the road. Firms need to do their research on the client and
make sure they pose little risk for the firm.

III. Manage Personnel Effectively

Firm policies in place can ensure that people get assigned the right tasks and roles
within a firm. You wouldn't want to put some underqualified or best suited in another
position in a certain role, only to leave them open to mistakes due to lack of
knowledge or understanding. Firms should make sure to provide necessary training
for all employees as well as understand the right workload per each employee.

IV. Monitor and Assess Moving Forward

One way to avoid future mistakes is to take care of issues in the present. Firms may
need to be more innovative in their analysis of employees and operations, but putting
forth the effort to fix issues should be paramount. There should also be a focus on
long-term fixes to elements within the system of quality control. Having a proactive
approach to leading efficiently, providing the right education, and learning from your
mistakes can all combine for an effective quality assurance environment for a firm
and keep idleness at bay and avoid costly claims.