Deck 2: Ethics, Legal Liability and Client Acceptance

Question 1

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

Answer 1

True

Question 2

An engagement letter sets out the terms of the engagement.

Answer 2

True

Question 3

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

Answer 3

True

Question 4

All members of professional bodies must be straightforward and honest. To which fundamental principle of the Code of Ethics for Professional Accountants does this refer?

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

Question 5

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

Question 6

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

Question 7

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

Question 8

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

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

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

Question 11

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

Question 12

Being negligent means not exercising due care.

Question 13

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

Question 14

Which of the following is not one of the fundamental principles of the Code of Ethics for Professional Accountants?

A) confidentiality
B) objectivity
C) integrity
D) intelligence

Question 15

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

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

Question 16

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

Question 17

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 18

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

Question 19

The obligation is that all members of the professional bodies are not allowed to let their personal feelings influence their judgment. To which fundamental principle of the Code of Ethics for Professional Accountants does this refer?

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

Question 20

Members must attain a level of competence and keep up to date with changes in regulations. To which fundamental principle of the Code of Ethics for Professional Accountants does this refer?

A) objectivity
B) professional competence and due care
C) professional behaviour
D) integrity

Question 21

The firm of McMaster and Martin, CPA'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 22

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 23

When Jonathon Gerinum, CPA 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 the above

Question 24

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 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 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 26

The key groups the external auditor has a professional link with are

A) client's board of directors and audit committee.
B) client's shareholders, the board of directors, audit committee and the internal audit team.
C) client's shareholders and prospective shareholders and board of directors.
D) client's shareholders only.

Question 27

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 28

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 29

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 30

Threats to the independence of auditors include

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

Question 31

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 32

Safeguards to independence are created by

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

Question 33

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 34

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 35

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 36

Cliff Marsden has been an audit manager at Copeland & Cahoon, CPA'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 37

Joanna Whittaker, CPA 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 38

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 39

When the external auditors perform work they are responsible for auditing the financial statements. Which users are the auditors least likely to deal with in fulfilling their duties?

A) executive directors of the board
B) audit committee of the board
C) shareholders
D) internal auditors

Question 40

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 41

The audit committee

A) communicates with the auditor regarding any disagreements with management regarding accounting policies and the financial statements.
B) has the responsibility to ensure that the financial statements are presented fairly.
C) makes decisions regarding the appointment and/or removal of auditors.
D) none of the above

Question 42

Which of the following statements regarding the auditor's responsibility to third parties is correct?

A) The auditor has no legal responsibility to third parties.
B) Third parties can sue the auditor under contract for any losses suffered.
C) The auditor owed the third party a duty of care, was negligent in the conduct of the audit and suffered a loss.
D) Third parties must establish that the auditor owed them a duty of care and the auditor was negligent.

Question 43

An auditor can avoid litigation by

A) preparing engagement letters.
B) complying with ethical principles and pronouncements.
C) ensuring all audit staff have the required skills and competence to conduct the audit.
D) all of the above

Question 44

Which of the following statements is not true regarding engagement letters?

A) Engagement letters are prepared by the client and acknowledged by the auditor before commencement of each audit.
B) Engagement letters are a form of contract between the auditor and the client.
C) Engagement letters are prepared before commencing every audit engagement.
D) Engagement letters set out the terms of the audit engagement.

Question 45

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 46

The relationship between the external and internal auditor can be described as

A) the internal audit function is separate and independent of the external audit.
B) the external auditor can review the effectiveness of the internal audit function to modify the nature and timing of audit testing.
C) the external auditor relies solely on the internal auditor's reports.
D) none of the above

Question 47

The Pacific Acceptance case set the standards of reasonable care and skill required for the conduct of an audit. Which one of the following was not one of the recommendations?

A) closely supervise and review the work of junior staff
B) properly document procedures used
C) duty to use reasonable care and skill
D) promptly report material fraud

Question 48

The audit committee

A) consists of non-executive directors of the Board of Directors.
B) consists of major shareholders of the client company.
C) reports to the shareholders at the annual general meeting.
D) none of the above

Question 49

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) both a and b
D) no liability

Question 50

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 51

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 52

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) both a and c

Question 53

Examples of board committees include the

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

Question 54

If a prospective new audit client does not allow the auditor to contact its existing auditor,

A) the auditor should contact the existing auditor anyway because it is the duty.
B) the auditor should refuse to take on the prospective new client.
C) the existing auditor should contact the new auditor to tell them all about the client.
D) the auditor should respect the prospective client's right to privacy.

Question 55

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) both a and b

Question 56

The Kingston Cotton Mill case states that the duty of the auditor is to

A) assume that the clients' statements are not materially misstated.
B) approach the audit with professional scepticism.
C) approach the audit with suspicion.
D) none of the above

Question 57

Contributory negligence means

A) the actions of the client as well as the actions of the auditor lead to losses suffered.
B) actions by the client and shareholders led to losses suffered.
C) actions of the client lead to the losses suffered.
D) none of the above

Question 58

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 59

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 60

Brenda Beauchamp withdrew from a client engagement. The client sued her for not fulfilling the understanding in the engagement letter and can establish that Brenda owed him a
Duty of due care. How can this be done using legal means?

A) the client can sue the auditor for breach of contract
B) the client can claim that the auditor failed to take reasonable care in the performance of the audit
C) both a and b
D) none of the above

Question 61

Explain the five fundamental principles of professional ethics.

Question 62

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.

Question 63

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 64

Distinguish between independence of mind and independence in appearance.

Question 65

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 66

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 67

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

Question 68

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 69

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

Question 70

The CPL Audit Committee has a policy of changing audit firms every five years to ensure that they receive fresh approaches from different audit firms. Accordingly, the CPL Board has asked Ginger & Paprika LLP to replace its previous audit firm.
CPL is a manufacturer and distributor of wire ropes, industrial cables, and rigging cables and has a reputation for its ability to fill special orders and to ship across Canada from its Thunder Bay facility on time and at competitive prices. They have a reputation among their customers for going the extra mile and have kept a loyal customer base for over a century.
Curtis Sanza, a new partner at Ginger & Paprika LLP, a growing CPA firm in northern Ontario, is excited about CPL becoming a potential new client. The previous week he met with the Canadian President of CPL, Jinyi Gu.
Curtis Sanza quickly decided that Jinyi Gu was a man of integrity and his frank and open opinions would make it a pleasure to deal with him. He also appeared to have a competent management team in place.
Curtis also wanted to make an impression on his new firm by bringing in several new clients in the next year or two, as a good portion of his future compensation will be derived from new business.
He is also aware that any negligence on his part during the client acceptance phase would reflect on his professional judgment and open the firm to possible litigation.
The senior partner, Walter Peters, has invited Curtis Sanza to join him in his office to discuss CPL.
Required:
a) You are Walter Peters, the Senior Partner at Ginger & Paprika LLP. What would be on your "checklist" of client acceptance questions? Prepare an exhaustive inventory of all the questions you would ask Jack before deciding to accept or reject CPL.
b) The firm recently lost a lawsuit and has parted ways with the partner-in-charge of the aggrieved client. What can Walter Peters do to avoid litigation?

Question 71

For each of the following, indicate if there is a threat to independence. If so, state the threat and a possible safeguard.
a) J.P. Schultz, CPA is unaware that his audit client, Cold Creek Spa Co. makes up 20% of J.P. Schultz firms revenues.
b) Luca Lobo goes to his assurance client, Joe's Auto Mart to buy a used car for his daughter. Due to their business relationship, Joe offers James a vehicle below cost.
c) Leslie Jacko has been auditing Joe's Pool and Spa Limited for many years. Joe'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. Joe's now owes Leslie Jacko $50,000 in assurance fees.
d) Peter Razo has three review engagements. One of the review engagements is done for Hugo's Meatshop Ltd., which is 80% owned by Peter's father-in-law, Igor Slovlog. The remaining 20% of the Meatshop is owned by Igor's four children.

Question 72

Simean & Co, a firm of CPA's, issued an unqualified audit report for its client, Xiing Manufacturing Corporation, a footwear manufacturer in Asia. Xiing Manufacturing, listed its head office in Toronto, Ontario, and its shares were traded on a Canadian Stock Exchange. Besides the shareholders, Simean & Co. knew the company was in the process of refinancing a significant bank loan coming due, and the bank was anxious to see the year end results. After an unqualified audit report was issued, the regulator of the stock exchange halted the trading of the shares after allegations of management fraud came to light. As a result, the share price plummeted and the company went out of business.
Required:
(a) To whom did Simean & Co. owe a duty of care?
(b) What must the bank demonstrate to establish negligence?
(c) What are the defences available to Simean & Co?

Question 73

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 74

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.