2) Which of the following auditor’s defenses usually means nonreliance on the financial
statements by the user?
A) lack of duty
B) non negligent performance
C) absence of causal connections
D) contributory negligence
3) A group typically included as “third parties” in common law is
A)
Actual and potential stockholders
Employees of client
Yes
Yes
B)
Actual and potential stockholders
Employees of client
No
No
C)
Actual and potential stockholders
Employees of client
Yes
No
D)
Actual and potential stockholders
Employees of client
No
Yes
4) The major conclusion of the 1931 Ultramares case was that
A) ordinary negligence is insufficient for liability to third parties.
B) third parties must file criminal charges, not civil charges, against the auditor.
C) fraud or gross negligence is sufficient for liability to third parties.
D) auditors have no liabilities to third parties.
5) Under common law, a foreseen user would be treated the same as
A)
A primary beneficiary
A known third party
Yes
Yes
B)
A primary beneficiary
A known third party
No
No
C)
A primary beneficiary
A known third party
Yes
No
D)
A primary beneficiary
A known third party
No
Yes
6) A broad interpretation of the rights of third-party beneficiaries holds that users the auditor
should have been able to foresee as being likely users of financial statements have the same
rights as those with privity of contract. This is known as the concept of
A) foreseen users.
B) foreseeable users.
C) expected users.
D) four-party contracts.
7) Which of the auditor’s defenses is ordinarily not available when lawsuits are filed by a third
party?
A) absence of causal connections
B) contributory negligence
C) nonnegligent performance
D) lack of duty
8) According to the principle established by the Restatement of Torts, foreseen users must be
members of
A) any potential user group.
B) a legally protected class.
C) a reasonably limited and identifiable user group.
D) a reasonably limited and established user group.
9) Under the Ultramares doctrine, ordinary negligence is insufficient for liability to third parties
unless the third party is
A) a primary beneficiary.
B) an injured party.
C) a foreseen user.
D) a bank.
10) Under common law, an individual or company that (1) does not have a contract with an
auditor, (2) is known by the auditor in advance of the audit, and (3) will use the auditor’s report
to make decisions about the client company has:
A) no rights unless an auditor is grossly negligent.
B) no rights unless an auditor is fraudulent.
C) no rights against an auditor.
D) the same rights against an auditor as a client.
11) The basic legal concept which was affirmed in the 1985 New York case, Credit Alliance,
was that
A) the auditor’s defense of privity of contract is still valid against third parties.
B) the auditor is liable for ordinary negligence to specifically foreseen third parties.
C) the auditor is liable for ordinary negligence to reasonably foreseeable third parties.
D) the auditor’s defense of contributory negligence is no longer valid.
12) As a consequence of his failure to adhere to generally accepted auditing standards in the
course of his examination of the Lamp Corp., Harrison, CPA, did not detect the embezzlement of
a material amount of funds by the company’s controller. As a matter of common law, to what
extent would Harrison be liable to the Lamp Corp. for losses attributable to the theft?
A) He would have no liability, since the ordinary examination cannot be relied upon to detect
thefts of assets by employees.
B) He would have no liability because privity of contract is lacking.
C) He would be liable for losses attributable to his negligence.
D) He would be liable only if it could be proven that he was grossly negligent.
13) If an auditor is unsuccessful in using the lack of duty defense to have a case dismissed in a
third-party suit, the preferred defense is
A) lack of duty to perform.
B) nonnegligent performance.
C) absence of causal connection.
D) client fraud.
14) Three approaches to the application of the foreseen users’ concept are (1) the Credit Alliance
approach, (2) the Restatement of Torts approach, and (3) the foreseeable user approach.
Summarize each of these three approaches.
15) Although there is confusion caused by the differing views of liability to third parties under
common law, the movement is clearly away from the foreseeable user approach.
16) The broadest interpretation of the right of third-party beneficiaries is the primary user
concept.
17) The Credit Alliance approach to the concept of foreseen users states that to be liable to third
parties, an auditor (1) must know and intend that the work product would be used by the third-
party for a specific purpose, and (2) the knowledge and intent must be evidenced by the auditor’s
conduct.
5.6 Learning Objective 5-6
1) An adequate system of internal control for SEC registrants was originally required by the
A) Sarbanes-Oxley Act of 2002.
B) Securities Act of 1933.
C) Foreign Corrupt Practices Act of 1977.
D) Securities Act of 1934.
2) The increased litigation under the federal securities laws has resulted from
A)
The availability of class-
action litigation
The strict liability standards
imposed on CPAs by the
securities laws
An excess of attorneys
Yes
Yes
Yes
B)
The availability of class-
action litigation
The strict liability standards
imposed on CPAs by the
securities laws
An excess of attorneys
Yes
No
No
C)
The availability of class-
action litigation
The strict liability standards
imposed on CPAs by the
securities laws
An excess of attorneys
Yes
Yes
No
D)
The availability of class-
action litigation
The strict liability standards
imposed on CPAs by the
securities laws
An excess of attorneys
No
No
No
3) Under the Securities Act of 1933, the auditor’s responsibility for making sure the financial
statements were fairly stated extends to
A) the date of the financial statements.
B) the date the registration statement becomes effective.
C) the date of the audit report.
D) one year beyond the date of the financial statements.
4) Under the Securities Exchange Act of 1934, which type of organization is required to submit
audited financial statements to the SEC?
A) every company with securities traded on national and over-the-counter exchanges
B) every corporation
C) every company issuing new securities
D) every corporation which is chartered by a state government
5) The Securities and Exchange Commission can impose all but which of the following
sanctions?
A) suspend a CPA from auditing SEC clients
B) prohibit a CPA from accepting new SEC clients for a period of time
C) require a CPA to participate in continuing-education programs and make changes in their
practice
D) revoke a CPA license
6) The Foreign Corrupt Practices Act (FCPA) of 1977
A) requires auditors to review and evaluate systems of internal control as a part of an audit.
B) requires SEC registrants to maintain a reasonably complete and accurate set of records and an
adequate system of internal control.
C) requires auditors to review client’s internal control system in a manner which is thorough
enough to judge whether client meets the requirements of the FCPA.
D) requires auditors to file a report with the SEC if client’s internal control system is inadequate.
7) While the Foreign Corrupt Practices Act of 1977 remains in effect, its internal control
provisions have been largely superseded by which of the following?
A) Sarbanes-Oxley Act of 2002
B) Racketeer Influenced and Corrupt Organization Act
C) Federal False Statements Statute
D) Federal Mail Fraud Statute
8) Which of the following is an accurate statement regarding recent actions brought against
accountants by clients and third parties?
A) Litigants will first seek state remedies because of the availability of class-action litigation.
B) Gross negligence by the auditor must be proven under the Securities Acts of 1933 and 1934.
C) The greatest growth in CPA liability litigation bas been under the federal securities laws.
D) The amount of damages that plaintiffs can receive is greater under common law than under
the federal securities laws.
9) A major purpose of federal securities regulations is to
A) provide sufficient reliable information to the investing public who purchase securities in the
marketplace.
B) establish the qualifications for accountants who are members of the profession.
C) eliminate incompetent attorneys and accountants who participate in the registration of
securities to be offered to the public.
D) provide a set of uniform standards and tests for accountants, attorneys, and others who
practice before the Securities and Exchange Commission.
10) The 2012 news of a massive alleged bribery scheme involving Wal-Mart has brought charges
against the company under the
A) Securities Act of 1933.
B) Securities Act of 1934.
C) Foreign Corrupt Practices Act of 1977.
D) Sarbanes-Oxley Act of 2002
11) Which of the following statements about the Securities Act of 1933 is not true?
A) A third party that purchased securities described in the registration statement may sue the
auditor for material misrepresentations or omissions in the audited financial statements.
B) A third party user does not have the burden of proof that he/she relied on the financial
statements.
C) A third party user has the burden of proof that the auditor was either negligent or fraudulent in
doing the audit.
D) A third party user does not have the burden of proof that the loss was caused by the
misleading statements.
12) The most significant audit issue that came as a result of the court decision in the Escott et al.
v. BarChris Construction Corporation case in 1968 was
A) the court’s reaffirmation that the burden of proof was on the plaintiff to prove the auditor was
negligent.
B) the affirmation of an increase in the auditor’s responsibility when performing a review of
events subsequent to the balance sheet date (S-1 review) for registration statements.
C) the increased auditor responsibility when associated with unaudited financial statements.
D) the court’s refusal to allow the percentage-of-completion method of accounting for revenues.
13) One significant result of the Escott et al. v. BarChris Construction Corporation case was
A) a greater emphasis on subsequent events procedures.
B) new standards for unaudited statements.
C) a broader definition of third party beneficiaries.
D) a requirement that more companies file annual reports with the SEC.
14) Under the Securities Exchange Act of 1934, most of the litigation against the auditor has
been generated because of the auditor’s involvement with the
A) 8-K form.
B) 10-K form.
C) 10-Q form.
D) S-1 form.
15) Section 10 and Rule 10b-5 of the Securities Exchange Act of 1934 are often referred to as
A) the antifraud provisions.
B) the new issues provisions.
C) the full employment act for accountants.
D) the RICO provisions.
16) The U.S. Supreme Court ruled in 1976 in Hochfelder v. Ernst & Ernst that before CPAs
could be held liable for Rule 10b-5 of the Securities Exchange Act of 1934, the auditor’s
________ would be required to be shown to the court.
A) ordinary negligence
B) gross negligence
C) knowledge and intent to deceive
D) financial gain at the expense of the plaintiff
17) Under the Securities Act of 1933,
A) any party who relies on the company’s audited financial statements can recover from the
auditors.
B) third-party users must prove that the auditor was negligent.
C) the burden of proof is on the defendant.
D) auditors face potential legal exposure for information contained in the Form 10-Q.
18) Which of the following is an accurate statement regarding Rule 10b-5 of the Securities
Exchange Act of 1934?
A) The Supreme Court has ruled that liability under Rule 10b-5 does not extend to aiders or
abettors who participated in financial statement misstatements that were not the primary
defendants.
B) Federal court decisions have clarified that Rule 10b-5 applies only to direct sellers.
C) Hochfelder and subsequent court decisions have increased the liability of auditors under Rule
10b-5.
D) According to most recent court decisions, poor judgment is proof of fraud.
19) Discuss the sanctions the Securities and Exchange Commission can impose on auditors.
20) One result from the Escott et al. v. BarChris case was a greater emphasis being placed on the
audit staff’s understanding of the client’s business and industry.
21) The only parties who can recover from auditors under the Securities Act of 1933 are original
purchasers of securities.
22) Under the Securities Act of 1933, a third party plaintiff does not have the burden of proof
that he or she relied on the financial statements or that the auditor was negligent or fraudulent in
doing the audit. Rather, the plaintiff need only prove that the audited financial statements
contained a material misrepresentation or omission.
23) Companies with securities traded on national and over-the-counter exchanges are required to
submit audited financial statements once every three years to the Securities and Exchange
Commission.
24) The same three defenses available to auditors in common lawsuits by third parties—
nonnegligent performance, lack of duty, and absence of causal connection—are also available for
suits under the Securities Exchange Act of 1934.
25) The defense of contributory negligence by a third party is often used by auditors if charged
with a violation of the 1934 Securities Act.
26) The Sarbanes-Oxley Act requires the CEO and CFO of a public company to certify the
annual and quarterly financial statements filed with the PCAOB.
5.7 Learning Objective 5-7
1) In which case were auditors prosecuted for filing false financial statements for a client with
the government?
A) United States v. Natelli
B) United States v. Simon
C) Escott et al. v. BarChris
D) ESM Government Securities v. Alexander Grant & Co.
2) A CPA is subject to criminal liability if the CPA
A) refuses to turn over requested audit documentation to a client.
B) performs an audit in a negligent manner.
C) is knowingly involved with false financial statements.
D) willfully breaches a contract with a client.
3) Critical lessons learned after analyzing major criminal cases against auditors include the fact
that
A) the partner, but not the audit staff, must be independent.
B) transactions with related parties are an indication of fraud.
C) an investigation of the integrity of management is an important part of deciding whether to
accept a new client.
D) accounting principles can be relied on exclusively in deciding if the financial statements are
fairly presented.
4) The Sarbanes-Oxley Act of 2002 makes it a felony to destroy or create documents to impede
or obstruct a federal investigation. Those provisions were adopted following which of the
following legal cases?
A) United States v. Natelli
B) United States v. Andersen
C) ESM Government Securities v. Alexander Grant & Co.
D) United States v. Simon
5) CPAs can be held liable for criminal activity under both state and federal laws. Infamous
cases include United States vs. Natelli and ESM Government Securities v. Alexander Grant and
Co. Discuss what occurred in each case.
6) The Sarbanes-Oxley Act of 2002 makes destruction of audit documentation punishable by up
to 10 years in prison.
5.8 Learning Objective 5-8
1) Which of the following resulted in a federal law passed in 1995 that significantly reduced
potential damages in securities-related litigation?
A) Private Securities Litigation Reform Act
B) Public Securities Damages and Settlements Act
C) Racketeer Influenced and Corrupt Organization Act
D) U.S. Securities Claims Reform Act
2) In order to protect themselves from legal liability, it is important that CPAs
A) are organized as sole-proprietors.
B) accept client representations.
C) understand the client’s business.
D) use engagement letters, not representation letters.
3) Discuss at least 3 steps the AICPA and the accounting profession as a whole can and are
taking to reduce the practitioner’s exposure to lawsuits.
4) Match eight of the following terms (a-n) with the definitions provided below (1-8):
a. Foreign Corrupt Practices Act
b. Securities Exchange Act of 1934
c. Securities Litigation Uniform Standards Act of 1998
d. Securities Act of 1933
e. Ultramares doctrine
f. audit risk
g. audit failure
h. standards failure
i. business failure
j. absence of causal connection
k. contributory negligence
l. lack of duty to perform
m. nonnegligent performance
________ 1. a situation in which an incorrect audit opinion is issued because it failed to comply
with the requirements of auditing standards
________ 2. a federal statute dealing with companies that trade securities on national and over-
the-counter exchanges. Auditors are involved because the annual reporting requirements include
audited financial statements.
________ 3. an auditor’s legal defense under which the auditor claims that the client’s own
actions either resulted in the loss that is the basis for damages or interfered with the conduct of
the audit in such a way that prevented the auditor from discovering the cause of the loss
________ 4. a federal statute that makes it illegal to offer a bribe to an official of a foreign
country
________ 5. a common-law approach to third-party liability in which ordinary negligence is
insufficient for liability to third parties, because of the lack of privity of contract between the
third-party and the auditor unless the third-party is a primary beneficiary
________ 6. a federal statute designed to significantly reduce the potential damages in federal
securities-related litigation by providing for proportionate liability in most cases
________ 7. an auditor’s legal defense under which the auditor claims that the audit was
performed in accordance with generally accepted auditing standards
________ 8. an auditor’s legal defense under which the auditor claims that the failure to follow
auditing standards did not cause the damages suffered by the client
5) Discuss some of the steps practicing auditors can take to minimize their legal liability.
6) The Private Securities Litigation Reform Act of 1995 capped damage awards against auditors
to the amount of the audit fees charged.