Deck 2: Auditors Legal Environment

Question 1

In the Columbia Coffee and Tea case, the auditors were found to owe a duty of care to a third party because:

A) the criteria established in Al Saudi Banque were satisfied.
B) of a statement contained in the auditor's manual.
C) the party and its intended reliance were known.
D) all of the above

Answer 1

B

Question 2

Statutory regulation affects what areas of auditing?

A) Auditor resignation
B) Auditor appointment
C) Auditor independence
D) All of the above

Answer 2

D

Question 3

To be appointed as the auditor of a corporation under the Corporations Act 2001, the relevant person must be a registered company auditor or an authorised audit company. The criteria for registration by ASIC include:

A) An individual must satisfy requirements in relation to his or her educational qualifications.
B) Established in s. 1280 of the Corporations Act.
C) An individual must satisfy requirements in relation to his or her character.
D) All of the above

Answer 3

D

Question 4

Auditing standards are produced under authority of the:

A) AARF.
B) ASX.
C) CPA Australia and the ICAA.
D) FRC.

Question 5

While performing services for their clients, auditors, as professionals, have a duty to provide a level of care which is:

A) greater than the average auditor.
B) superior to that of other auditors.
C) reasonable.
D) free from judgement errors.

Question 6

It is a criminal offence for an auditor to:

A) conduct an audit without due care.
B) fail to detect material fraud.
C) withhold information from the client.
D) contravene the independence requirements in the Corporations Act.

Question 7

Which one of the following is not one of the four areas of liability in auditing?

A) Criminal liability
B) Professional liability
C) Liability under statutory law
D) Liability under common law

Question 8

To succeed in an action against the auditor, the client must be able to show that:

A) there is a close causal connection between the auditor's breach of the standard of due care and the damages suffered by the client.
B) there was a written contract.
C) the auditor was fraudulent.
D) the auditor was grossly negligent.

Question 9

The Columbia Coffee and Tea judgement:

A) was applied by the High Court in its Esanda decision.
B) sought to apply a common sense approach.
C) endorsed the judgement made in the AGC case.
D) all of the above

Question 10

Section 324CE- CH lists specific conditions of contraventions of the independence requirements. The specific conditions include circumstances where the auditor:

A) is an audit- critical employee of the client company.
B) is an officer of the client company.
C) has an investment in the company.
D) all of the above

Question 11

Auditors are liable to their clients for:

A) presentation of the financial statements.
B) failure to perform the audit with due care.
C) the efficient operations of the audit clients reporting function.
D) errors of judgement made in good faith.

Question 12

The Auditing and Assurance Standards Board is a committee of:

A) AARF employees.
B) FRC appointees.
C) regulators.
D) auditors.

Question 13

In connection with the examination of financial statements, an independent auditor could be responsible for failure to detect a material fraud if:

A) the auditor planned the work in a hasty and inefficient manner.
B) the auditor performing important parts of the work failed to discover a close relationship between the treasurer and the cashier.
C) statistical sampling techniques were not used on the audit engagement.
D) the fraud was perpetrated by one trusted client employee, who circumvented the existing internal controls.

Question 14

In rare cases, auditors have been held liable for criminal acts. A criminal conviction against an auditor can result only when it is demonstrated that the auditor:

A) was involved knowingly in the presentation of false financial statements.
B) employed a negligent assistant.
C) caused a financial loss to an innocent third party.
D) was negligent.

Question 15

The judgement in the Caparo case decreed no auditor liability to a third party because:

A) no loss was suffered.
B) a duty of care could not be established.
C) causation could not be established.
D) a breach of duty of care could not be demonstrated.

Question 16

Under the laws of agency, partners of a public accounting firm may be liable for the works of others on whom they rely. This would NOT include:

A) specialists called upon to provide technical information to the public accounting firm.
B) employees of the public accounting firm.
C) employees of the client.
D) other public accounting firms engaged to do part of the work.

Question 17

In which case was it held that an auditor did not owe a duty of care to potential shareholders?

A) Cambridge Credit
B) London and General Bank
C) Nelson Guarantee Corp Ltd
D) Caparo

Question 18

A privity letter:

A) sets out the terms of a contractual audit engagement.
B) is a written acknowledgement of a third party's reliance on audited financial statements.
C) can be used to disclaim liability in a statutory audit.
D) must be sent to management when control deficiencies are discovered during an audit.

Question 19

Statutory offences of auditors can arise through:

A) failing to take reasonable steps to ensure that a statement is not false or misleading.
B) making or authorising false or misleading statements.
C) both of the above
D) none of the above

Question 20

The AGC case added which one of the following criteria to the tests determining whether a duty of care is owed to a third party?

A) Purpose of reliance must be known
B) Prevailing community standards
C) Intention to induce
D) User must be known

Question 21

The WA Chip and Pulp Co. case reaffirmed:

A) the importance of auditor independence.
B) the duty to conduct the audit with reasonable care and skill.
C) the duty to investigate suspicions of fraud regardless of its materiality.
D) the duty to inform management if there is a suspicion of a material fraud.

Question 22

Mandatory audit rotation applies to:

A) listed companies only.
B) all entities who owe money to the Australian Taxation Office.
C) listed companies and other disclosing entities.
D) charities and other nonprofit organisations only.

Question 23

When the auditor issues an erroneous opinion as the result of an underlying failure to comply with the requirements of Australian auditing standards, it results in:

A) negligent auditing.
B) criminal liability.
C) business failure.
D) both A and B

Question 24

What constitutes reasonable care, skill and caution in an audit depends on the:

A) level of audit risk involved.
B) integrity of management.
C) particular circumstances of each case.
D) auditing standards existing at the time.

Question 25

The Sarbanes- Oxley Act 2002, enacted in the United States, applies to all companies registered with the Securities and Exchange Commission and has which of the main consequences for auditors?

A) Specific auditor independence requirements
B) Established the Public Company Accounting Oversight Board (PCAOB)
C) Mandatory registration
D) All of the above

Question 26

Tort actions against public accounting firms are more common than breach of contract actions because:

A) the person suing need prove only negligence.
B) the amounts recoverable are normally larger.
C) there are more torts than contracts.
D) the burden of proof is on the auditor rather than on the person suing.

Question 27

Auditing is highly regulated, subject to many regulatory influences, including: 1. professional bodies
2) stock exchanges
3) government regulatory agencies
4) state and federal legislation

A) 1, 2, & 4
B) 1, 2, & 3
C) 1, 3, & 4
D) 1, 2, 3, & 4

Question 28

Many of the major legal cases against public accountants have dealt with:

A) disputes over income tax preparation services.
B) disputes arising in the performance of MAS contracts.
C) audited financial statements.
D) disputes over the accuracy of bookkeeping services.

Question 29

Auditors should understand their obligations to clients and third parties under: 1. contract law
2) common law
3) trade practices
4) corporations and securities statutes

A) 1, 2, & 4
B) 1, 2, & 3
C) 1, 3, & 4
D) 1, 2, 3, & 4

Question 30

In the Caparo case, it was stated that the purpose of the audit report is to:

A) provide information to third parties.
B) only provide information to the company and its shareholders.
C) report on the accuracy of the financial statements.
D) all of the above

Question 31

Audit reports are an insufficient basis for financing decisions by a diligent financier because:

A) an inappropriate audit opinion might be issued as a result of not complying with auditing standard.
B) an unqualified audit opinion might be issued when the financial statements are materially misstated.
C) the auditor might be negligent.
D) the audit report is out of date by the time of publication.

Question 32

The reasonable person concept establishes in law that:

A) the courts do not require that the auditor become the insurer or guarantor of the accuracy of the statements.
B) the public accounting firm is not expected to be infallible.
C) an audit in accordance with auditing standards is subject to limitations and cannot be relied upon for complete assurance that all errors and irregularities will be found.
D) All three of the above are true.

Question 33

The London and General Bank Ltd (No.2) case found that:

A) auditors have a duty to report to shareholders.
B) auditors have a duty to report to anyone who may rely on the audited financial reports.
C) auditors have a duty to report to directors and shareholders.
D) auditors have a duty to report to the directors and ASIC.

Question 34

Professionals have long had a legal duty to provide a reasonable level of care while performing work for those they serve because:

A) it is an implied part of the contract entered into by any professional and his or her client.
B) the criminal law of fraud requires it.
C) professional standards require it.
D) all of the above

Question 35

In the Scott Group case, the auditors were found to owe a duty of care to:

A) the body of shareholders as a whole.
B) the contractual parties only.
C) existing creditors.
D) a totally unknown third party.

Question 36

A privity letter should NOT be provided:

A) if the audit is being conducted under the Corporations Act.
B) if the third party seeking it fails to acknowledge in writing the potential inadequacy of the audit report for its purpose.
C) under any circumstances.
D) if reliance is foreseeable.

Question 37

There are a number of things that audit firms can do to reduce their exposure to lawsuits. Which one of the following is NOT such an item?

A) Deal only with clients possessing integrity
B) Hire qualified auditors and train and supervise them
C) Perform quality audits
D) Sanction other firms for improper conduct and performance

Question 38

Which one of the following was NOT set out as a test for establishing a duty of care in Al Saudi Banque?

A) Proximity
B) Reasonableness
C) Foreseeability
D) Intention to induce

Question 39

The duty to inform management was discussed in which case?

A) The AWA case
B) The WA Chip & Pulp Co case
C) The Pacific Acceptance case
D) All of the above

Question 40

Which of the following is a defence an auditor may argue to reduce a damages claim from an audit client?

A) Negligent performance by the auditor
B) Contributory negligence by management
C) A duty of care was owed
D) Plaintiff suffered losses

Question 41

In the Esanda Finance Corporation Ltd v Peat Hungerfords case, the court:

A) confirmed the auditors' duties as stated in the Pacific Acceptance case.
B) stated the auditors were aware of the intention of the third party's reliance on the audit report.
C) stated auditors must undertake the audit with reasonable skill and care.
D) all of the above

Question 42

Which one of the following was NOT a finding in the Pacific Acceptance case?

A) The auditors were entitled to rely on management representations.
B) Certain discoveries should have been communicated by the auditors to the board of directors.
C) Audit programs should be updated each year.
D) The auditors failed to use appropriate vouching procedures.

Question 43

An auditor's examination performed in accordance with Australian auditing standard ASA 240 generally should:

A) be relied upon to disclose violations of client confidentiality.
B) ensure a review of conditions and events that increase the risk of irregularity.
C) encompass a plan to search actively for illegalities which relate to environmental reporting.
D) guarantee that illegal acts will be detected.

Question 44

The notion of proximity:

A) is separate from consideration of reasonable reliance.
B) is not separate from foreseeability.
C) can relate to nonspecific third parties.
D) has a precise legal definition.

Question 45

The auditor's duty to inform management about irregularities regardless of materiality was established in which one of the following cases?

A) WA Chip and Pulp Co
B) Kingston Cotton Mills
C) AWA
D) Pacific Acceptance

Question 46

In third- party suits, which of the auditor's defences contends lack of privity of contract?

A) Lack of duty
B) Absence of causal connections
C) Non- negligent performance
D) Contributory negligence

Question 47

The activities and duties of auditors may be subject to considerable statutory direction or influences, including: 1. Crimes Act 1914
2) Trade Practices Act 1974
3) Corporations Act 2001
4) Auditor Independence Act 2004

A) 1, 2, & 4
B) 1, 2, & 3
C) 1, 3, & 4
D) 1, 2, 3, & 4

Question 48

Which one of the following is a NOT a method to reduce auditors' legal liability?

A) Perform quality audits
B) Employ qualified personnel
C) Include a disclaimer paragraph in the audit report
D) Exercise professional scepticism

Question 49

The Pacific Acceptance case was significant because it:

A) dealt with auditors' liability to shareholders
B) allowed contributory negligence as a defence for audit failure.
C) dealt with aspects related to auditors' duties.
D) established that liability might exist to third parties.

Question 50

A 'negligence calculus' has four components. Which of the following is NOT a component?

A) Taking precautions to avoid the harm
B) Taking out insurance against causing harm
C) Probability of harm occurring
D) Likely seriousness of harm

Question 51

Which of the following is an illustration of auditor's liability to a client?

A) Bank sues auditor for not discovering that borrower's financial statements are misstated.
B) Federal government prosecutes auditor for knowingly issuing an incorrect audit report.
C) Client sues auditor for not discovering a theft of assets by an employee.
D) Combined group of stockholders sue auditor for not discovering materially misstated financial statements.

Question 52

The monitoring of auditors is the primary legal function of:

A) the Financial Reporting Council (FRC).
B) each individual firm (for its own staff).
C) the professional bodies.
D) all of the above

Question 53

Which of the following is an illustration of criminal liability?

A) Auditors fail to report to ASIC a contravention of the Corporations Act by a client.
B) Client sues auditor for not discovering a theft of assets by an employee.
C) Bank sues auditor for not discovering that borrower's financial statements are misstated.
D) Combined group of stockholders sue auditor for not discovering materially misstated financial statements.

Question 54

A common way for a public accounting firm to ensure the respective obligations of the client and auditor are understood is by use of:

A) a letter of recommendation.
B) an engagement letter.
C) a confirmation letter.
D) an expert witness' testimony.

Question 55

In the AGC case, the court held the view that communication between AGC and the auditor:

A) was evidence of a necessary special relationship.
B) established proximity.
C) indicated that reliance was reasonable.
D) did not bring about a relationship giving rise to a duty of care.

Question 56

The Financial Reporting Council's functions include monitoring the adequacy of systems to ensure the adequacy of:

A) professional bodies disciplinary procedures.
B) auditor independence.
C) professional bodies quality assurance reviews.
D) all of the above

Question 57

Which one of the following statements is correct about criminal actions brought against auditors in Australia?

A) They have often failed due to lack of causation.
B) They have resulted in substantial damages being awarded when they have been successful.
C) None has resulted in prison sentences.
D) They have been few in number.

Question 58

A function of the Financial Reporting Council (FRC) is to:

A) require information from a professional body about reviews of a particular audit of disciplinary actions against any particular person.
B) monitor individual audits and auditors.
C) review particular audits.
D) all of the above

Question 59

The statutory requirements for independence mean an auditor is prohibited from engaging in audit activity if:

A) there is a conflict of interest situation in relation to the client of which the auditor is not aware and doesn't take all reasonable steps to resolve.
B) there is a breach of the ethical requirements.
C) there is a conflict of interest situation in relation to the client of which the auditor is aware but doesn't take all reasonable steps to resolve.
D) there is a breach of the auditor registration requirements.

Question 60

Auditors are affected by laws that have been developed by passage through governmental agencies. These are referred to as:

A) federal law.
B) common law.
C) statutory law.
D) judicial law.

Question 61

What is the role of the FRC in monitoring the audit profession?

Question 62

If an auditor's suspicion of fraud is aroused, investigations should be extended.

Question 63

Proportionate liability is the risk an auditor takes that an entity will fail, and he or she is liable for all losses incurred by the entity.

Question 64

It is clear from s. 199A of the Corporations Act that auditors:

A) have the defence of contributory negligence available to them.
B) can design clauses in letters of engagement to exempt or indemnify an auditor from or against any legal liability that would otherwise attach are valid.
C) cannot contract out of their duty to client companies.
D) all of the above

Question 65

An example of auditor legal liability to third parties under common law would be the federal government prosecuting an auditor for knowingly issuing an incorrect audit report.

Question 66

In Al Saudi Banque, a duty of care was found not to be owed to prospective lenders.

Question 67

Explain how an auditor might be able to use a disclaimer of liability.

Question 68

When the auditors have followed Australian auditing standards yet still fail to discover immaterial fraud, courts will find them liable.

Question 69

Common law generally allows auditors to withhold information from the courts by claiming such information is privileged.

Question 70

Which one of the following statements is correct about Candler v Crane, Christmas & Co?

A) There was no liability for financial loss.
B) A special relationship did not exist.
C) Losses were not foreseeable.
D) All of the above

Question 71

The standard of due care to which the auditor is expected to be held is referred to as the reasonable person concept.

Question 72

Identify the four tests that a plaintiff must satisfy in order to recover damages against the auditor.

Question 73

An auditor holds office for a period of twelve months, with reappointment required annually.

Question 74

A tort is a civil wrong, of which negligence is a good example.

Question 75

Contributory negligence:

A) has been interpreted very widely by Australian courts.
B) cannot be used in cases involving a breach of statutory duty.
C) failed as a defence in the AWA case.
D) was successfully argued in the Pacific Acceptance case.

Question 76

Does the auditing profession in Australia register public company auditors?

Question 77

There are four common sources of auditor's legal liability. One source is liability to the audit client under common law. Briefly summarise the other three sources.

Question 78

Liability to third parties is a contentious issue in auditing.

Question 79

Legal liability of auditors in Australia, particularly in relation to third parties, was expanded by the
Esanda case in 1997.

Question 80

A contributory negligence defence succeeded in the AWA Ltd v Daniels case.