Chapter 20 – Legal Liability
1. Common law is written law enacted by the legislative branches of governments.
2. An auditor can be sued by a client for negligence under common law.
3. An auditor can be sued by a third party under statutory law for willful violation of federal
statutes.
Chapter 20 – Legal Liability
4. An auditor can be guilty under federal statutory law if s/he was reckless in performance of
her/his professional duties.
5. Common law requires the auditor perform professional services with due care.
6. The auditor failing to complete the services agreed to in the contract with the client is subject
to liability under breach of contract.
Chapter 20 – Legal Liability
7. A tort is a breach of contract for which civil action may be taken.
8. To recover against an auditor in a negligence case, the client must prove that the client
sustained an actual loss or damage.
9. To prevail in a suit alleging negligence, a third party must prove that the auditor had a duty to
the auditor’s client to exercise due care.
Chapter 20 – Legal Liability
10. Privity of contract is the most restrictive view for plaintiffs under common law.
11. Which of the following is not one of the four general stages in the initiation and disposition
of audit-related disputes?
Chapter 20 – Legal Liability
12. Which of the following elements, if present, would support a finding of constructive fraud
on the part of a CPA?
13. An audit client loses a lawsuit and the judgment is for an amount in excess of the contingent
liability the client had recorded in the audited financial statements. The auditor, using the
typical degree of due care as other members of the profession, determined that the amount of
contingent liability recorded by the client in the financial statements for the pending lawsuit
was reasonable, given the facts at the time of the audit. This judgment by the auditor is likely to
result in
Chapter 20 – Legal Liability
14. An auditor, using the same degree of due care as other members of the profession, fails to
create an adequate allowance for bad debts. This occurrence is an example of
15. Which of the following is not required for establishing an auditor’s liability for negligence?
Chapter 20 – Legal Liability
16. Which of the following is the best statement of the general standard of performance owed
by an accountant in his or her professional work?
17. When performing an audit, a CPA
Chapter 20 – Legal Liability
18. A CPA will most likely be negligent when the CPA fails to
19. A CPA’s duty of due care to a client most likely will be breached when a CPA
Chapter 20 – Legal Liability
20. Which of the following is not within the class of foreseen users of an accountant’s work
product?
21. Beckler & Associates, CPAs, audited and gave an unqualified opinion on the financial
statements of Queen Co. The financial statements contained misstatements that resulted in a
material overstatement of Queen’s net worth. Queen provided the audited financial statements
to Mac Bank in connection with a loan made by Mac to Queen. Beckler knew that the financial
statements would be provided to Mac. Queen defaulted on the loan. Mac sued Beckler for
ordinary negligence to recover for its losses associated with Queen’s default. Which of the
following must Mac prove in order to recover?
I. Beckler was negligent in conducting the audit.
II. Mac relied on the financial statements.
Chapter 20 – Legal Liability
22. The Securities Exchange Act of 1934
23. What is the primary reason that Congress passed the Securities Litigation Uniform
Standards Act of 1998?
Chapter 20 – Legal Liability
24. Why are plaintiffs motivated to bring actions under RICO?
25. Under the Rusch Factors doctrine, to which of the following parties will an accountant be
liable for negligence?
Chapter 20 – Legal Liability
26. Ritz Corporation wished to acquire the stock of Stale, Inc. In conjunction with its plan of
acquisition, Ritz hired Fein, CPA, to audit the financial statements of Stale. Based on the
audited financial statements and Fein’s unqualified opinion, Ritz acquired Stale. Within 6
months, it was discovered that the inventory of Stale had been overstated by $500,000. Ritz
commenced an action against Fein. Ritz believes that Fein failed to exercise the knowledge,
skill, and judgment commonly possessed by CPAs in the locality, but is not able to prove that
Fein either intentionally deceived it or showed a reckless disregard for the truth. Ritz also is
unable to prove that Fein had any knowledge that the inventory was overstated. Which of the
following two causes of action would provide Ritz with proper bases upon which Ritz would
most likely prevail?
27. In a common law action against an accountant in a state following the Ultramares doctrine,
lack of privity is a viable defense if the plaintiff
Chapter 20 – Legal Liability
28. Ford & Co., CPAs, issued an unqualified opinion on Owens Corp.’s financial statements.
Relying on these financial statements, Century Bank lent Owens $750,000. Ford was unaware
that Century would receive a copy of the financial statements or that Owens would use them to
obtain a loan. Owens defaulted on the loan. To succeed in a common law fraud action against
Ford, Century must prove, in addition to other elements, that Century was
29. Under the “Ultramares” doctrine, to which of the following parties will an accountant be
liable for negligence?
Chapter 20 – Legal Liability
30. While conducting an audit, Larson Associates, CPAs, failed to detect material
misstatements included in its client’s financial statements. Larson’s unqualified opinion was
included with the financial statements in a registration statement and prospectus for a public
offering of securities made by the client. Larson knew that its opinion and the financial
statements would be used for this purpose. In a suit by a purchaser against Larson for
common-law negligence, Larson’s best defense would be that the
31. Gold, CPA, rendered an unqualified opinion on the financial statements of Eastern Power
Company. Egan purchased Eastern bonds in a public offering subject to the Securities Act of
1933. The registration statement filed with the SEC included the audited financial statements.
Gold is being sued by Egan under Section 11 of the Securities Act of 1933 for the misstatements
contained in the financial statements. To prevail, Egan must prove
Chapter 20 – Legal Liability
32. An auditor can be held criminally liable for
33. The Sarbanes-Oxley Act enhances prosecutorial tools available in major fraud cases by
Chapter 20 – Legal Liability
34. A CPA who fraudulently performs an audit of a corporation’s financial statements will
35. Hark, CPA, failed to follow generally accepted auditing standards in auditing Long Corp.’s
financial statements. Long’s management had told Hark that the audited statements would be
submitted to several banks to obtain financing. Relying on the statements, Third Bank gave
Long a loan. Long defaulted on the loan. In a jurisdiction applying the Ultramares doctrine, if
Third sues Hark, Hark will
Chapter 20 – Legal Liability
36. Under common law, which of the following statements most accurately reflects the liability
of a CPA who fraudulently gives an opinion on an audit of a client’s financial statements?
37. Common law