Deck 2: Ethics, Legal Liability and Client Acceptance

Question 1

The judgement in the Esanda case has made it far easier for third parties to establish that a duty of care is owed by the auditor.

Answer 1

False

Question 2

The fundamental ethical principles that apply to all members of the professional bodies are to act with integrity, objectivity, professional competence and due care, confidentiality and professional behaviour

Answer 2

True

Question 3

Being negligent means not exercising due care.

Answer 3

True

Question 4

A privity letter acknowledges that the third party intends to rely on the audited financial report.

Question 5

Ensuring compliance with auditing regulations will not assist auditors to avoid litigation.

Question 6

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

Question 7

A famous statement by Lord Justice Lopes in the Pacific Acceptance case was that an auditor "…is a watchdog, but not a bloodhound."

Question 8

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

Question 9

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 10

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

Question 11

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

Question 12

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

Question 13

Professional competence refers to the to the members of a professional body;

A) Maintain a level of commitment to their industry associations
B) Maintain a level of understanding of their clients business operations
C) Maintain their level of knowledge and skill required by the professional body
D) Maintain the knowledge to adequately operate in their clients industry

Question 14

An engagement letter sets out the terms of the engagement letter.

Question 15

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

Question 16

For an auditor to be truly independent they must possess independence of mind and independence of appearance.

Question 17

An engagement letter is prepared by the auditors and signed by the client at the conclusion of the audit process.

Question 18

The role of the Internal Auditors will enhance the work of the external auditors by further developing the findings of the external auditors between engagements

Question 19

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

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

Question 20

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

Question 21

Examples of board committees include the:

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

Question 22

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 23

According to the ASX Corporate Governance Council, an audit committee should:

A) not have a formal charter
B) consist of a majority of independent directors
C) be chaired by the chairman of the board of directors
D) have at least four members

Question 24

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 25

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 judgement
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 26

Under tort law, to prove that and 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 27

Threats to the independence of auditors include:

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

Question 28

It is the responsibility of the board of directors to:

A) ensure that the financial report is prepared so as to provide a true and fair view
B) provide an opinion on the truth and fairness of the financial statements
C) direct the auditors to audit specific financial statement accounts
D) none of the above

Question 29

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

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

Question 30

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 Corporations Act
C) the client's board of directors
D) None of the above

Question 31

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 32

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 33

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 holdings a senior position with the client

Question 34

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 35

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 judgement
D) ensure that they do not harm the reputation of the accounting profession

Question 36

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 37

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 38

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

A) the board of directors
B) the shareholders or members
C) the audit committee
D) the Australian Securities and Investments Commission

Question 39

Which of the following was an observation or recommendation by Justice Owen in the HIH Royal Commission Report?

A) boards of directors should establish an audit committee
B) auditor independence is not a critical element in establishing the credibility of an auditor's report
C) an independent and objective audit, conducted with an appropriate degree of professional scepticism, is required
D) audit reports should be addressed to shareholders

Question 40

Safeguards to independence are created by:

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

Question 41

Discuss the findings in the Esanda case as they relate to an auditor's liability to a third party.

Question 42

Explain the purpose and major contents of an engagement letter between the auditor and their client.

Question 43

Explain the five fundamental principles of professional ethics.

Question 44

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

Question 45

Which of these cases established the legal principle that auditors owe a duty of care to shareholders as a group and not to individual shareholders?

A) Esanda
B) Caparo
C) Scott Group
D) Pacific Acceptance

Question 46

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 47

The key difficulty for third parties in legal action against auditors has been establishing that a duty of care was owed to them by their auditor. Explain the development of the relevant legal principles relating to an auditor's duty of care to third parties with reference to specific case law.

Question 48

Audit committees have been widely recommended as being an important mechanism for enhancing the external auditor's independence. What are the important characteristics of audit committees and discuss why these characteristics are considered so important to a committee's effective and efficient operation.

Question 49

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

Question 50

Distinguish between independence of mind and independence in appearance.

Question 51

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 52

Independence is considered one of the key characteristics of auditors. Explain why auditor independence is so important to the effectiveness of an audit and explain the various threats to an auditor's independence.