Question 1

The Credit Alliance approach to the concept of foreseen users states that to be liable to third parties, an auditor (1) must know and intend that the work product would be used by the third-party for a specific purpose, and (2) the knowledge and intent must be evidenced by the auditor's conduct.

Accepted Answer

The Credit Alliance approach does state that these two conditions must be met to establish liability to third parties.

Question 2

The partnership of Booth & Haynes, CPAs, has been engaged to examine the financial statements of Paul, Inc., in connection with the registration of Paul's securities with the Securities and Exchange Commission. Under these circumstances, which of the following statements is true?

Accepted Answer

When performing audits of publicly traded companies, CPAs assume greater liability under the Securities Act of 1933 than under common law. This act imposes strict liability on CPAs for material misstatements in financial statements. Therefore, Booth & Haynes is assuming much greater third-party liability on this engagement than it assumes on engagements under common law.

B, C, and D are incorrect because they are not applicable or accurate in this scenario. Booth & Haynes cannot issue a disclaimer to avoid liability, they do not need to incorporate to practice before the SEC, and there is no requirement for them to be a large interstate firm.

Question 3

The basic legal concept which was affirmed in the 1985 New York case, Credit Alliance, was that:

Accepted Answer

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Question 4

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 has a duty to adhere to generally accepted auditing standards, which includes the detection of any material errors or fraud in financial statements. Harrison's failure to detect the embezzlement during his examination of the Lamp Corp. would be considered a breach of his duty of care, which makes him liable for any losses that are attributable to his negligence. Privity of contract is not a requirement for liability in cases of professional negligence.

Question 5

In an action against a CPA in a jurisdiction that follows the Ultramares doctrine, lack of privity is a viable defense provided the plaintiff:

Accepted Answer

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Question 6

A broad interpretation of the rights of third-party beneficiaries holds that users that 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 being described is that of foreseeable users, meaning users of financial statements who the auditor should have been able to reasonably anticipate would rely on the statements. This idea extends the rights normally afforded to only those with privity of contract to a wider range of users. The other answer choices do not accurately describe this concept.

Question 7

The major conclusion of the 1931 Ultramares case was that:

Accepted Answer

The Ultramares case established that auditors are not liable to third parties for ordinary negligence, only for fraud or gross negligence.

Question 8

Which of the following required an adequate system of internal control for SEC registrants?

Accepted Answer

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Question 9

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

Accepted Answer

The option A is the correct one as it provides a unique identifier, whereas the other options are randomly generated numbers and do not provide any relevant information. Additionally, "third parties" typically refers to individuals or entities that are not part of a legal transaction or dispute but may be affected by it.

Question 10

Of the three approaches to applying the concept of foreseen users (Credit Alliance approach, restatement of torts approach, and foreseeable user approach), the approach followed by the most states is the Credit Alliance approach.

Accepted Answer

The Restatement of Torts approach is followed by the most states, as it provides a more balanced framework for determining liability to third parties.

Question 11

Under the Securities Act of 1933, the auditor's responsibility for making sure the financial statements were fairly stated extends to:

Accepted Answer

Under the Securities Act of 1933, the auditor's responsibility for making sure the financial statements were fairly stated extends to the date the registration statement becomes effective, which is typically a few months after the date of the financial statements. The auditor's responsibility does not extend to the date of the audit report or one year beyond the date of the financial statements.

Question 12

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

Accepted Answer

The Restatement of Torts establishes that a defendant owes a duty of care to all foreseeable plaintiffs, who must be members of a reasonably limited and identifiable user group. This means that not all potential users are necessarily foreseeable and protected by the duty of care. Additionally, the users must be identifiable and limited in order to allow the defendant to predict and anticipate the risks involved with the use of their product or service. Therefore, the correct choice is C.

Question 13

The increased litigation under the federal securities laws has resulted from:

Accepted Answer

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Question 14

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

Accepted Answer

Contributory negligence is a defense that places partial blame on the plaintiff for their own damages or losses. However, this defense is typically not available when lawsuits are filed by third parties because the auditor did not have a direct relationship with the third party and therefore cannot argue that the third party's own actions contributed to their losses. The other defenses listed (absence of causal connections, non-negligent performance, lack of duty) may still be available to the auditor in third-party lawsuits.

Question 15

The restatement of torts approach to the concept of foreseen users states that any users that the auditor should have reasonably been able to foresee as being likely users of financial statements have the same rights as those with privity of contract.

Accepted Answer

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Question 16

Three approaches to the application of the foreseen users' concept are (1) the Credit Alliance approach, (2) the restatement of torts approach, and (3) the foreseeable user approach. Summarize each of these three approaches.

Accepted Answer

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Question 17

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

Under common law, known as the privity doctrine, third parties without a contract with an auditor have generally been unable to bring a lawsuit against an auditor for professional negligence. However, with the development of statutory law and court cases, third parties have been given the same rights as a client if the auditor knew their report would be used by the third party and if there was reasonable reliance on the report. Therefore, the third party in the given situation would have the same rights as a client against the auditor.

Question 18

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 scenario describes a situation where a third party (the financial institution) is suing the audit firm for failure to detect material misstatements in the borrower's financial statements. This falls under the concept of liability to third parties under common law.

Question 19

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

Accepted Answer

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Question 20

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

Accepted Answer

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Quiz 5: Legal Liability