Deck 4: Professional Legal Liability

Question 1

Claims against auditors based on the deep pocket theory are most likely to occur in courts where damages are based on proportionate liability.

Answer 1

False

Question 2

A foreseeable user of audited financial statements is a member of a limited class of users for a particular transaction.

Answer 2

False

Question 3

Gross negligence is a failure to use even minimal care,a reckless disregard for the truth,or reckless behavior.

Answer 3

True

Question 4

Ordinary negligence is the failure to exercise minimal care.

Question 5

A tort is a civil wrong,other than a breach of contract,based on ordinary negligence,gross negligence,or fraud.

Question 6

An identified user is a specific third party named in the audit engagement letter as a user of the audited financial statements.

Question 7

The expectations gap represents a misunderstanding whereby shareholders mistakenly believe that they are entitled to recover losses on investments for which the auditor provided an unqualified opinion on the financial statements.

Question 8

Failing to provide the audit report on time is a potential cause of action against the auditor for breach of contract.

Question 9

Under joint and several liability,users who experience losses from reliance on materially misstated financial statements may recover full damages from any defendant,including the audit firm,regardless of the level of fault for that defendant.

Question 10

Auditors can be held liable to third parties for fraud,but not for ordinary or gross negligence.

Question 11

Professional auditing standards and financial accounting principles are used by courts as criteria for determining an auditor's duty not to be negligent.

Question 12

Contingent fees for lawyers serve as a deterrent to lawsuits filed against audit firms.

Question 13

Class action lawsuits are designed to encourage multiple lawsuits arising from the same claim.

Question 14

Liability concepts developed through court decisions are referred to as statutory law.

Question 15

Under the Securities Act of 1933,the accuracy of the registration statement is determined as of the date normal audit work is completed,which may be several months before the effective date of the registration statement.

Question 16

The occurrence of an important event,such as a change in auditors,is reported to the SEC by filing Form 8-K.

Question 17

Under common law,liability concepts are developed through court decisions based on ordinary negligence,gross negligence,or fraud.

Question 18

An audit failure occurs when an audit firm issues an inaccurate audit opinion and fails to comply with auditing standards.

Question 19

Both the 1933 and 1934 Securities Acts and the Sarbanes-Oxley Act of 2002 provide for criminal actions against auditors.

Question 20

Fraud occurs when there is an intentional concealment or an unintentional misrepresentation of a material fact that causes damage to those deceived.

Question 21

Which of the following has contributed to a decrease in federal class actions involving audit firms as co-defendants over the last decade?

A)Supreme Court decisions in Janus Capital Group,Inc. ,and Stoneridge Investment Partners.
B)Federal restrictions on contingent fees for lawyers in lawsuits filed under the Securities Act of 1934.
C)A growing expectations gap causing investors to view audit reports as insurance against losses.
D)All of the above.

Question 22

Which of the following may an auditor use as a defense under the Securities Act of 1933?

A)Contributory negligence.
B)Scienter.
C)Due care.
D)Immaterial loss.

Question 23

Compliance with GAAP was an unsuccessful defense in which of the following court cases?

A)Credit Alliance v.Arthur Andersen & Co.
B)Ultramares Corp.v.Touche.
C)Ernst and Ernst v.Hochfelder.
D)Herzfeld v.Laventhol,Krekstein,Horwath & Horwath.

Question 24

To win a lawsuit against an auditor,third parties generally have to prove which of the following?

A)The parties suffered a loss.
B)A loss occurred due to reliance on misleading financial statements.
C)The auditor knew,or should have known,financial statements were misleading.
D)All of the above.

Question 25

Types of Law Relevant to Auditors' Legal Liability What are the three types of law that are relevant to auditors' legal liability? Explain the causes of legal action under each type.

Question 26

Which of the following is not a potential cause for action against the auditor for breach of contract?

A)Withdrawing from an audit engagement due to unresolved disagreements with management.
B)Failing to discover a material error in the financial statements.
C)Violating client confidentiality.
D)Failing to provide the audit report on time.

Question 27

Which of the following documents must be filed with the SEC under the Securities Act of 1933 before a company can issue new securities to the public?

A)Form 10-K.
B)Form 10-Q.
C)Prospectus.
D)All of the above.

Question 28

Expectations Gap What is the expectations gap?

Question 29

Which of the following statements describes the expectations gap as it relates to audited financial statements?

A)Investors believe that an unqualified audit report guarantees that an investment in the audited company is risk- free.
B)Investors believe that an unqualified audit report is an insurance policy against losses from a risky investment.
C)Investors believe they are entitled to recover losses on investments for which the auditor provided an unqualified opinion on the financial statements.
D)All of the above.

Question 30

Which of the following is not a basis for a third-party lawsuit against an auditor?

A)Common law.
B)Breach of contract.
C)Gross negligence.
D)Fraud.

Question 31

Which of the following would be the first form filed with the SEC describing a major change in corporate governance?

A)8-K
B)8-Q
C)10-K
D)10-Q

Question 32

A jury has determined that Jason Pruitt,CPA,is 20% at fault for losses suffered by investors who relied on materially misstated financial statements.The jury found that Pruitt's co-defendants,the client company and the company's CEO,are each 40% at fault.The company is bankrupt,and only Pruitt and the CEO have adequate resources to pay damages.Under joint and several liability,what is the likely percentage of damages that Pruitt will pay?

A)20%.
B)20% plus a proportionate share of damages attributed to the company.
C)20% plus 50% of damages attributed to the company.
D)100% of damages.

Question 33

The concept of the third-party beneficiary test was established by which court case?

A)Credit Alliance Corp.v.Arthur Andersen & Co.
B)Ultramares Corp.v.Touche.
C)Citizens State Bank v.Timm,Schmidt,& Co.
D)Rosenblum v.Adler.

Question 34

Which is the best definition of scienter?

A)A wrongful state of mind when making a misrepresentation.
B)A causal connection between a misstatement and a material loss.
C)A material omission of facts.
D)Fraudulent conduct in the purchase of a security.

Question 35

Auditor Defenses to Breach of Contract Suits A client seeking to recover damages from an auditor for breach of contract in an action based on negligence must show that the auditor had a duty not to be negligent.Identify at least three defenses an auditor can use against a breach of contract lawsuit.

Question 36

Generally,auditors can be sued for breach of contract by which of the following parties?

A)Shareholders.
B)Third parties other than shareholders.
C)Clients.
D)All of the above.

Question 37

Under common law,which of the following is a basis for litigation against an auditor for failure to meet professional standards and responsibilities?

A)Ordinary negligence
B)Gross negligence
C)Fraud
D)All of the above.

Question 38

Which of the following is not an incentive for filing lawsuits against audit firms?

A)Class action lawsuits.
B)Increased complexity of accounting standards.
C)Contingent-fee-based compensation for law firms.
D)Joint and several liability doctrine.

Question 39

Which of the following statements regarding liability doctrines is not true?

A)Under proportionate liability,a defendant's share of damages depends on the degree of fault determined by the judge or jury.
B)Joint and several liability provides more protection to users who experience losses from relying on misstated financial statements.
C)Proportionate liability generally applies to lawsuits filed in federal court.
D)Joint and several liability cannot be applied in class-action lawsuits.

Question 40

Liability based on federal securities law is known as which type of law?

A)Common law.
B)Contract law.
C)Statutory law.
D)Commercial law.