Question 1

A group typically included as "third parties" in common law is

Accepted Answer

The answer of A group typically included as "third parties"...

Question 2

Under the Ultramares doctrine, ordinary negligence is insufficient for liability to third parties unless the third party is

Accepted Answer

The Ultramares doctrine holds that an accountant is only liable for negligence to third parties who are primary beneficiaries, meaning they were specifically intended to benefit from the accountant's work.

Question 3

A financial institution sues the audit firm for failure to discover that a borrower's financial statements are materially misstated. This is an example of which of the following legal liability concepts?

Accepted Answer

This situation is an example of liability to third parties under common law. The financial institution, as a third party to the audit engagement, is suing the audit firm for not discovering the borrower's misstated financial statements, which has caused them harm. This type of liability is recognized under common law, which allows third parties to sue a professional service provider for negligence if they suffer damages as a result of the provider's failure to exercise reasonable care.

Question 4

Assume that an auditor failed to complete an audit for a client on an agreed-upon date. The client files a lawsuit against the auditor, claiming that this delay caused the client to delay a public offering of common stock. A potential defense for the auditor is that the public offering was delayed by the underwriters due to the weakening financial condition of the client.

Accepted Answer

The auditor's potential defense is valid, as the delay in the public offering could have been caused by factors beyond the auditor's control, such as a weakening financial condition or the underwriters' decisions. Therefore, the lawsuit may not be solely attributable to the auditor's failure to complete the audit on time.

Question 5

A broad interpretation of the rights of third-party beneficiaries holds that users whom 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

Accepted Answer

The concept of foreseeable users holds that users whom 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 interpretation broadens the scope of the auditor's responsibility beyond only those in direct contractual relationship with the auditor.

Question 6

Which of the following auditor's defenses usually means nonreliance on the financial statements by the user?

Accepted Answer

Absence of causal connections means that the user's loss was not caused by reliance on the financial statements, indicating nonreliance.

Question 7

Even if the auditor conducts an audit properly, the auditor can be held legally responsible if subsequently there are undiscovered misstatements in the financial statements.

Accepted Answer

An auditor is not held legally responsible for undiscovered misstatements if they conducted the audit in accordance with auditing standards and exercised due professional care.

Question 8

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:

Accepted Answer

According to common law, third-party beneficiaries have the same rights as the client in accordance with the terms of the engagement letter. The three conditions mentioned in the question indicate that the third party would reasonably rely on the auditor's report, and therefore, have a right to seek legal action if the report is found to be misleading or incorrect. Therefore, the correct choice is D.

Question 9

Discuss each of the four defenses a CPA firm can normally use when facing legal claims by clients.

Accepted Answer

The answer of Discuss each of the four defenses a...

Question 10

A CPA firm is sued after performing a review of a client's financial statements for not uncovering a material misstatement. The CPA firm in this situation can claim lack of duty as a legal defense.

Accepted Answer

A CPA firm can claim lack of duty as a defense if they were only engaged to perform a review, which provides limited assurance and is not designed to uncover all material misstatements like an audit would.

Question 11

Under common law, a foreseen user would be treated the same as

Accepted Answer

The question appears to have missing information, but under common law, a "foreseeable" user would be treated the same as any other user. Therefore, the answer is A.

Question 12

Which of the auditor's defenses is ordinarily not available when lawsuits are filed by a third party?

Accepted Answer

Contributory negligence is not a defense available when lawsuits are filed by a third party. This is because third parties are not directly responsible for their actions and cannot be charged with contributory negligence. The other defenses, such as absence of causal connections, nonnegligent performance, and lack of duty, may be applicable in certain situations regardless of who files the lawsuit.

Question 13

A CPA firm notifies their audit client of a material weakness in internal controls in the warehouse storing inventories. Subsequently, the client discovers a large theft of inventory in the warehouse. In this case, the CPA firm would have the defense of contributor negligence.

Accepted Answer

Contributor negligence can be a defense if the client was informed of the weakness and failed to take corrective action, contributing to the loss.

Question 14

There are four major sources of an auditor's legal liability. One source is liability to the audit client. List the other three sources.

Accepted Answer

The answer of There are four major sources of an...

Question 15

In audits, failure of the auditor to meet auditing standards are not, by themselves, conclusive evidence of negligence.

Accepted Answer

The answer of In audits, failure of the auditor to...

Question 16

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?

Accepted Answer

As a CPA, Harrison had a duty to adhere to generally accepted auditing standards, which include understanding the client's internal controls and assessing the risk of fraud. By failing to detect the embezzlement, Harrison breached this duty and was negligent. Lamp Corp. can therefore seek damages from Harrison for their losses attributable to the embezzlement. Privity of contract is not a requirement for liability in cases of professional negligence. While gross negligence may increase the damages awarded, it is not necessary to prove in order for Harrison to be liable.

Question 17

According to the principle established by the Restatement of Torts, foreseen users must be members of

Accepted Answer

The principle established by the Restatement of Torts is that a manufacturer owes a duty of care to all foreseeable users and consumers of its products. Foreseeable users must be a reasonably limited and identifiable user group. This means that the manufacturer must reasonably anticipate that its product will be used by a certain group of people and take reasonable precautions to ensure that the product is safe for that group. The user group must be identifiable in that the manufacturer must have some knowledge or awareness of the group's existence or potential use of the product. Therefore, choice C, a reasonably limited and identifiable user group, is the best answer.

Question 18

The major conclusion of the 1931 Ultramares case was that

Accepted Answer

The Ultramares case concluded that auditors are not liable to third parties for ordinary negligence, but they may be liable for fraud or gross negligence.

Question 19

The question of level of care is similar where the auditor is involved in a compilation or a review of financial statements.

Accepted Answer

In a compilation, the auditor does not provide any assurance on the accuracy or completeness of the financial statements, whereas in a review, the auditor performs limited assurance procedures to ensure there are no material modifications that should be made to the financial statements for them to be in conformity with the applicable financial reporting framework.

Question 20

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

Accepted Answer

The answer of If an auditor is unsuccessful in using...

Quiz 5: Legal Liability