CHAPTER C

Question 1

sources of auditor liabilities

Answer 1

common law and statutory liability

Question 2

Types of third parties

Answer 2

• primary beneficiaries
• foreseen third parties
• foreseeable third parties

Question 3

Primary beneficiaries

Answer 3

Third parties that are known by name to the auditor
- The auditor knows that a certain company is going to rely on the financial statements and the auditor’s opinion

Question 4

foreseen third parties

Answer 4

Auditors know about the third party but without a specific name
- They know the bank is going to use the financial statements to make a lending decision but u don’t know which bank it is

Question 5

foreseeable third parties

Answer 5

Anybody who would normally rely on the financial statements
- They just assume that banks rely on financial statements as do investors

Question 6

gross negligence

Answer 6

Lack of minimum care, the auditor doesn’t even try to do it right

Extreme case of negligence, or there’s participation in the fraud by auditors.

• If this happens, they are reliable to all third parties.

Question 7

common law

Answer 7

Law that comes from court cases over the years

Question 8

components of common law

Answer 8

breach of contract

tort liability

Question 9

statutory law

Answer 9

Liability that comes from statutes or laws that are passed

Question 10

two statutes for public clients in statutory law

Answer 10

Securities act of 1933

Securities exchange act of 1934

Question 11

Securities act

Answer 11

Regulates initial issuance of securities and requires registrants to provide registration statement (including financial statements)

Question 12

Securities exchange act

Answer 12

Regulates daily trading of securities and requires periodic financial statements and information to be filed with the SEC.

Question 13

Under the ______, auditors are liable for ordinary negligence.
- They are also liable for gross negligence and fraud.
- Burden of proof is on the auditors.

Answer 13

Securities Act

Question 14

Under the __________, auditors are liable for gross negligence and fraud.
- NOT ordinary negligence.
- Burden of proof is on the plaintiffs (party who initiated lawsuit),
they have to show a loss and that the financial statements contained a misstatement, and that the auditors were aware of the misstatement or exercised gross negligence (which is very hard to do)

Answer 14

Securities Exchange Act

Question 15

Under the _______, auditors defend themselves by proving they did a good audit or that the plaintiff’s loss was caused by something else.

Answer 15

Securities Act

Question 16

Under the ________, auditors defend themselves by showing that they acted in good faith, which means they did a good audit and they were not aware of the misstatement.

Answer 16

Securities Exchange Act

Question 17

this act:
- Expanded liability
- Increased the statute of limitations and increased penalties

Answer 17

Sarbanes Oxley Act

Question 18

this act:
- Reduced liability
- Established a standard of proportionate liability instead of joint and several liability.
- The way this works is that the judge will assign blame during the lawsuit.

Answer 18

Private securities litigation reform act

Question 19

this act:
- Reduced liability
- Moved lawsuits from states to the federal courts where there are more resources and less local favoritism.

Answer 19

Securities litigation uniform standard &
Class action fairness act

Question 20

ordinary negligence

Answer 20

a lack of reasonable care

auditors making a mistake or trying to follow auditing standards but falling short

Question 21

fraud

Answer 21

exists when the auditor knows the financial statements are incorrect but gives an Unqualified opinion anyways

Question 22

why do auditors prefer proportionate liability standards to joint and several liability standards?

Answer 22

the maximum payout for auditors is generally much lower under proportionate standards

auditors stand a greater chance of going bankrupt under joint and several standards

joint and several standards may require auditors to pay the liabilities of all other parties