Deck 2: Ethics, Legal Liability and Client Acceptance

Question 1

An effective audit committee will enhance the independence of the external audit function.

Answer 1

True

Question 2

An engagement letter sets out the terms of the engagement.

Answer 2

True

Question 3

Objectivity refers to the obligation that all members of the professional bodies be
straightforward and honest.

Answer 3

False

Question 4

Joanna Whittaker, CPA, CA lives in the same neighbourhood as one of her major clients. She and her children are involved in the Lower Thames Yacht Club, as are many of her client's
Management employees. How would her independence threat best be described?

A) self-interest threat
B) self-review threat
C) advocacy threat
D) none of these

Question 5

Being negligent means not exercising due care.

Question 6

When auditors divest themselves of shares owned in a client company, they are eliminating
their self-review threat to independence.

Question 7

Luanne Phong just joined the firm of Moses, Denson, and Etchevery (MDE). She found out that she owns shares in a client company of MDE. She is going to divest herself of these
Shares. Which threat to her independence will she be eliminating?

A) self-interest threat
B) self-review threat
C) familiarity threat
D) advocacy threat

Question 8

The key difficulty for third parties in successfully claiming against the auditor is establishing
that the client's management contributed to the third party's loss.

Question 9

Phillip Montain wrote up an advertisement for his firm. In his draft to the local newspaper he indicated that the firm was able to provide services that he knew it could not deliver. Which part
Of the profession's standards or codes of conduct was Phillip breaking?

A) objectivity
B) professional behaviour
C) confidentiality
D) communication

Question 10

Auditors can avoid litigation by implementing policies and procedures that ensure all work is
fully documented.

Question 11

When Jonathon Gerinum, CPA, CA tried to collect last year's audit fees, he was told that he would receive the fees for the previous year and the current year upon finishing this year's work
And issuing a "clean" audit opinion. This was non-negotiable and he was told that if he did not
Want to go along with it, the client would get another auditor. When he decided to leave his
Client, what threat to his independence did he mitigate?

A) self-interest threat
B) self-review threat
C) advocacy threat
D) none of these

Question 12

An engagement letter does not include an overview of the client's responsibility for the preparation of the financial statements.

Question 13

Third parties are anyone other than the client and its shareholders that use the financial
statements to make a decision.

Question 14

Independence in appearance is the ability to act with integrity, objectivity and professional
scepticism.

Question 15

Shayna Kirschfield audits a company that has market capitalization of $20,000,000. There is also a requirement that the partners in her firm be rotated every seven years and the audit
Committee must pre-approve all services provided to the client by Shayna's firm. What kind of
Client is this?

A) small business
B) diversified
C) reporting issuer
D) partnership

Question 16

An example of an advocacy threat is encouraging others to buy shares or bonds being sold
by the client.

Question 17

Ensuring compliance with auditing regulations will not assist auditors in avoiding litigation.

Question 18

Cliff Marsden has been an audit manager at Copeland & Cahoon, CA's the past ten years. Two years ago he performed human resources and internal audit functions for 9 months while
His client underwent a major restructuring. His firm has a policy of changing audit partners and
Managers every five to seven years. He is reluctant to take on the audit because he believes
There is an independence threat. Which threat is in play?

A) integrity threat
B) familiarity threat
C) self-review threat
D) advocacy threat

Question 19

Compliance with the fundamental ethical principles is mandatory for all members of the
accounting profession.

Question 20

When assessing client integrity, the auditor will consider the appropriateness of the client's
interpretation of accounting rules.

Question 21

Rob Wood has reviewed the engagement letter his firm has prepared for a client. Which of these elements would he be surprised to find?

A) unrestricted access to persons within the entity in order to obtain audit evidence
B) references to Canadian generally accepted auditing standards
C) management's responsibilities
D) previous year's internal control issues

Question 22

Executive directors are:

A) part of the company's management team.
B) full-time employees of the company.
C) not members of the company's board of directors.
D) a and b.

Question 23

Intimidation threats to independence include:

A) the threat that that the client will use a different assurance firm next year.
B) a close business relationship with the client.
C) representing the client in a legal dispute.
D) preparing information for the client that is then assured.

Question 24

What type of threat to independence arises when an accounting firm acts on behalf of its assurance client?

A) advocacy threat
B) self-interest threat
C) intimidation threat
D) self-review threat

Question 25

Objectivity refers to the obligation that all members of the professional bodies:

A) be straightforward and honest.
B) refrain from disclosing information to people outside of their workplace that is learned as a result of their employment.
C) not allow their personal feelings or prejudices to influence their professional judgment.
D) ensure that they do not harm the reputation of the accounting profession.

Question 26

Threats to the independence of auditors include:

A) familiarity threats.
B) self-interest threats. c.) advocacy threats.
D) all of the above.

Question 27

Having policies and procedures to ensure the quality of an accounting firm's service is an example of a safeguard to independence created by:

A) the client's audit committee.
B) the Canada Business Corporations Act.
C) the client's board of directors.
D) None of the above.

Question 28

Auditor independence is:

A) defined as acting with integrity, objectivity and professional scepticism.
B) essential when complying with the ethical principles to act with integrity and objectivity.
C) both a and b.
D) not fundamental to every audit.

Question 29

Safeguards to independence are created by:

A) accounting firms.
B) the profession, legislation or regulation.
C) clients.
D) all of the above.

Question 30

An example of a safeguard to independence created by accounting firms is:

A) the establishment of a code of ethics.
B) legislation that requires that an auditor be independent.
C) the existence of client acceptance and continuation procedures.
D) the establishment of an audit committee.

Question 31

Independence in appearance is:

A) the ability to act with integrity, objectivity and professional scepticism.
B) the belief that independence of mind has been achieved.
C) the ability to make a decision that is free from bias, personal beliefs and client pressures.
D) also referred to as actual independence.

Question 32

Professional behaviour refers to the obligation that all members of the professional bodies:

A) ensure that they do not harm the reputation of the accounting profession.
B) not allow their personal feelings or prejudices to influence their professional judgment.
C) refrain from disclosing information to people outside of their workplace that is learned as a result of their employment.
D) be straightforward and honest.

Question 33

The firm of McMaster and Martin, CPA, CA's is concerned that its client's current corporate culture may have an impact on the firm's independence. What kinds of safeguards can the
Client introduce or create to reduce the threat to independence?

A) introduce appropriate corporate governance mechanisms such as the establishment of an audit committee
B) ensure that the responsibility for the appointment and removal of an auditor rests with independent directors on the audit committee or the board
C) both a and b
D) none of the above

Question 34

It is the responsibility of the board of directors to:

A) ensure that the financial statements are fairly presented.
B) provide an opinion on the fair presentation of the financial statements.
C) direct the auditors to audit specific financial statement accounts.
D) none of the above.

Question 35

Examples of board committees include the:

A) risk committee.
B) nomination committee.
C) compensation committee.
D) all of the above.

Question 36

A self-interest threat refers to the threat that can occur when an accounting firm or its staff:

A) is threatened by the client's staff or directors.
B) has a financial interest in an audit client.
C) needs to form an opinion on their own work or work performed by others in the firm.
D) acts on behalf of its assurance client.

Question 37

The main recipients of the financial statements and the attached audit report are acknowledged as:

A) the board of directors.
B) the shareholders or members.
C) the audit committee.
D) the provincial stock exchanges.

Question 38

Which of the following is an example of a familiarity threat to independence?

A) a bank account held with the client
B) performing services for the client that are then assured
C) both a and b
D) a former partner of the assurance firm holding a senior position with the client

Question 39

Management failed to put in a system of adequate internal controls. The public accounting firm uncovered the weakness, but did not report it to the Board members of the company. What
Kind of liability, if any, would the auditors be exposed to?

A) breach of contract
B) contributory negligence
C) a and b
D) no liability

Question 40

Which of the following is a fundamental principle of professional ethics?

A) confidentiality
B) objectivity
C) integrity
D) all of the above

Question 41

An auditor's assessment of their client's integrity would not include:

A) whether the auditor has sufficiently competent staff to complete the audit.
B) the client's attitude to audit fees and its willingness to pay a fair amount.
C) the client's attitude to risk exposure and management.
D) the reputation of the client and its management.

Question 42

Distinguish between independence of mind and independence in appearance.

Question 43

Under tort law, to prove that an auditor has been negligent the plaintiff must establish:

A) there was a breach of the duty of care.
B) a loss was suffered as a result of the breach of duty of care.
C) a duty of care was owed by the auditor.
D) all of the above.

Question 44

Describe the three categories of safeguards to an auditor's independence.

Question 45

The principles established by Justice Moffitt in the Pacific Acceptance case do not include:

A) auditors are watchdogs but not bloodhounds.
B) auditors must properly document procedures used.
C) auditors have a duty to use reasonable skills and care.
D) auditors must audit the whole year.

Question 46

The final stage in the client acceptance and continuance decision process involves:

A) the auditor obtaining a management representation letter from the client.
B) the auditor preparing an independence declaration statement.
C) the client's audit committee meeting with the auditor.
D) the preparation of an engagement letter. ANSWERS TO
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Question 47

Indicate whether you agree or disagree with the following statements and explain your reasoning.
a) To ensure that it is independent of prospective and continuing clients, an audit firm must review the threats to independence, and make certain that safeguards are put in place to limit or remove those threats.
b) The final stage in the client acceptance and continuance decision process involves assessing independence threats.
c) By signing the engagement letter, management is not necessarily considered to be responsible for the financial statements.
d) To successfully sue an auditor, a plaintiff must only prove that a duty of care was owed by the auditor.

Question 48

Explain the five fundamental principles of professional ethics.

Question 49

Auditors can avoid litigation by:

A) ensuring compliance with ethical regulations.
B) meeting with the client's nomination committee to discuss any significant audit issues.
C) training their staff and regularly updating their knowledge.
D) a and c.

Question 50

For each of the following, indicate if there is a threat to independence. If so, state the threat and a possible safeguard.
(a) John Schmidt, CPA, CA, is unaware that his audit client, Franks Spa and Pool Co. makes up 20% of John Schmidt firms revenues.
(b) James Para goes to his assurance client, Bob's Autosales to buy a used car for his daughter. Due to their business relationship, Bob offers James a vehicle below cost.
(c) Jack Jacobs has been auditing Bob's Pool and Spa Limited for many years. Bob's Pool and Spa Limited has been experiencing financial difficulties and has not been able to pay its audit fees for the last three years. Bob's now owes Jack Jacobs $50,000 in assurance fees.
(d) Frank Fargo has three review engagements. One of the review engagements is done for Sangha Meatshop Ltd., which is 80% owned by his father-in-law, Sanchez Sangha. The remaining 20% of the Meatshop is owned by Sanchez's four children.

Question 51

For the following scenarios, state the violation(s) to the Rules of Professional Conduct:
(a)Bill Williams, CPA, began a telephone campaign to grow his client base. He began calling companies listed in the telephone directly within a twenty mile radius advising them of his accounting services. After making several phone calls, Bill finally landed a new audit client, Big Bob's Autosales and Leasing Ltd. In order to secure this new business, Bill entered into an agreement with Big Bob whereby Bill would receive a flat fee every time he referred one of his clients to Big Bob's. He would also earn a 1% percent commission on any vehicle sale or lease that resulted from the referral. As their business relationship grew overtime, Bill asked Big Bob for a loan claiming he wanted to expand his accounting practice. He in fact took the funds for his own personal use without advising his client.
(b)Paul Lee, CPA, was the CFO of ABC Incorporated. In his role as CFO, he became aware of a material error in the company's inventory for the annual financial statements in the amount of approximately $1.5 million. Paul brought the matters to the attention of senior management, who casually indicated that year end was already completed and thus they did not want to harm investor confidence by reissuing the financial statements, but Paul did not seek assistance or guidance from either the professional body or the securities commission.
(c)David Collier, CPA, obtained his designation in 2000. Since that time, he has built up a significant tax practice. In late 2015, a new client approached David and asked him to perform an audit engagement. Believing this could lead to a substantial amount of tax work in the future, David agreed, even though he had not taken any accounting or assurance courses for many years. In performing the audit engagement, David obtained an engagement letter, put the financial statements together based on the clients trial balance, and attached a review engagement report. The financial statements contained a material error.