Far Eastern University

ACCOUNTING 1.1

Chapter 4: PROFESSIONAL LIABILITY AND THE NEED FOR QUALITY AUDITOR JUDGMENTS AND ETHICAL DECISIONS

1)In which of the following statements about a public accounting firm’s action is scienter or its equivalent absent?

1. 1. 1. Reckless disregard for the truth
      2. Actual knowledge of fraud
      3. Intent to gain monetarily by concealing fraud
      4. Performance of substandard auditing procedures

1. 2. The leading precedent-setting auditing case in the third party liability is
      1. Escott et al. v Bar Chris Construction Corp
      2. Hochfelder Ernst & Ernst
      3. Ultramares Corporation v Touche
      4. United States v Simon

1. 3. Mead Corp. orally engaged Dex & Co., CPAs, to audit its financial statements. The management of Mead informed Dex that it suspected that the accounts receivable were materially overstated. Although the financial statements audited by Dex did, in fact, include a materially overstated accounts receivable balance, Dex issued an unqualified opinion. Mead relied on the financial statements in deciding to obtain a loan from City Bank to expand its operations. City relied on the financial statements in making the loan to Mead. As a result of the overstated accounts receivable balance, Mead has defaulted on the loan and has incurred a substantial loss. If Mead sues Dex for negligence in failing to discover the overstatement, Dex's best defense would be that
      1. No engagement letter had been signed by Dex.
      2. The audit was performed by Dex in accordance with generally accepted auditing standards.
      3. Dex was not in privity of contract with Mead.
      4. Dex did not perform the audit recklessly or with an intent to deceive.

1. 4. As a consequence of failure to adhere to generally accepted auditing standards in the course of an audit 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?
      1. No liability since the ordinary examination cannot be relied on to detect defalcations.
      2. No liability because privity of contract is lacking.
      3. Liable for losses attributable to her or his negligence.
      4. Liable only if it could be proved that he or she was grossly negligent.

1. 5. Martin Corporation orally engaged Humm & Dawson to audit its year-end financial statements. The engagement was to be completed within two months after the close of

Martin's fiscal year for a fixed fee of P250,000. Under these circumstances, what obligation is assumed by Humm & Dawson?

1. 1. 1. None. The contract is unenforceable since it is not in writing.
      2. An implied promise to exercise reasonable standards of competence and care.
      3. An implied obligation to take extraordinary steps to discover all defalcations.
      4. The obligation of an insurer of its work, which is liable without fault.

1. 6. The role of persons entrusted with the supervision, control and direction of an entity
      1. Governance                                                  c. Government
      2. Board of directors                                      d. Management

1. 7. Which statement is correct regarding “audit matters of governance interest”?
      1. These are matters that arise from the audit of financial statements and, in the opinion of the auditor, are either important or relevant to those charged with governance in overseeing the financial reporting and disclosure process.
      2. These include only those matters that have come to the attention of the auditor as a

result of the performance of the audit.

1. 1. 3. The auditor is required, in an audit in accordance with PSAs, to design procedures for the specific purpose of identifying these matters.
      4. The auditor is not required to communicate these matters with those charged with

governance of an entity.

1. 8. An auditor’s overall objective in a financial statement audit is to
      1. Determine that all individual accounts and footnotes are fairly presented.
      2. Employ the audit risk model.
      3. Express an opinion on the fair presentation of the financial statements in accordance with generally accepted accounting principles.
      4. Detect all errors and fraud.

1. 9. The primary responsibility for the adequacy of disclosure in the financial statements of a publicly held company rests with the
      1. Partner assigned to the audit engagement. c. Auditor in-charge of field work.
      2. Management of the company.                             d. Securities and Exchange Commission.

1. 10. Reasonable assurance means:
       1. Gathering of all available corroborating evidence for the auditor to conclude that there are no material misstatements in the financial statements, taken as a whole.
       2. Gathering of the audit evidence necessary for the auditor to conclude that there are no

material misstatements in the financial statements, taken as a whole.

1. 1. 3. Gathering of the audit evidence necessary for the auditor to conclude that the financial statements, taken as a whole, are free from any misstatements.

1. 1. 4. Gathering of the audit evidence necessary for the auditor to conclude that the financial statements are free of material unintentional misstatements.

1. 11. Which of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the expression of an opinion?
       1. the audit program.                                     c. generally accepted auditing standards.
       2. the auditor’s judgment.                          d. the auditor’s working papers.

1. 12. If the auditor suspects that members of senior management, including members of the board of directors, are involved in noncompliance to laws as regulations, and he believes his report may not be acted upon, he would:
       1. Do nothing.
       2. Issue a disclaimer of opinion.
       3. Consider seeking legal advice.
       4. Make special investigation in order to fully determine the extent of client’s noncompliance.

1. 13. Which of the following best describes a trend in litigation involving CPAs?
       1. A CPA cannot render an opinion on a company unless the CPA has audited all affiliates of that company.
       2. A CPA may successfully assert as a defense that the CPA had no motive to be part of a

fraud.

1. 13. 3. A CPA may be exposed to criminal as well as civil liability.
       4. A CPA is primarily responsible for a client’s footnotes in an annual report filed with the SEC.
   14. Which one of the following, if present, would support a finding of constructive fraud on the part of a CPA?
       1. Privity of contract.                                      c. Intent to deceive.
       2. Reckless disregard.                                    d. Ordinary negligence.

1. 15. The limitation of auditor liability under contract law is known as
       1. Privity of contract.                      c. Contributory liability.
       2. Statutory liability.                       d. Common law liability

1. 16. The auditor's defense of contributory negligence is most likely to prevail when
       1. Third party injury has been minimal.
       2. The auditor fails to detect fraud resulting from management override of the control structure.
       3. The client is privately held as contrasted with a public company.
       4. Undetected errors have resulted in materially misleading financial statements.

1. 17. The factor that distinguishes constructive fraud from actual fraud is
       1. Materiality                                                     c. Quality of internal control.