Chapter 27

Question 1

Who regulates public accounting firms?

Answer 1

Public Company Accounting Oversight Board

Question 2

Who must auditors report to under SOX?

Answer 2

The audit committee of the client’s board of directors, not to senior management

Question 3

What does SOX prohibit accounting firms from doing?

Answer 3

Firms that audit public companies cannot provide consulting services to clients on topics such as bookkeeping, financial information systems, human resources, and legal issues unrelated to the audit

Question 4

What conflicts of interest can an accounting firm have?

Answer 4

An accounting firm cannot audit a firm if one of the client’s top officers has worked for that accounting firm within the prior year and was involved in the firm’s audit

Question 5

What are term limits on audit partners?

Answer 5

• lead audit partner must rotate off an account for at least 5 years after 5 years with a client
• other partners must rotate off an account every 7 years for at least 2 years

Question 6

What is an auditor?

Answer 6

An independent evaluator of the financial statements issued by management to investors and creditors

Question 7

What is vouching?

Answer 7

An auditor chooses a transaction listed in a company’s books and checks backward for original data to support it

Question 8

What is tracing?

Answer 8

An auditor takes an item of original data and tracks it forward to ensure that it has been properly recorded throughout the bookkeeping process

Question 9

What is GAAP and what does it do?

Answer 9

Generally Accepted Accounting Principles
The rules for preparing financial statements

Question 10

What is GAAS and what does it do?

Answer 10

Generally Accepted Auditing Standards
The rules for conducting audits

Question 11

What is the IFRS?

Answer 11

International Financial Reporting Standards

Question 12

What is an opinion?

Answer 12

After the audit is complete, the accountant issues an opinion that indicates how accurately the financial statements reflect the company’s true financial condition

Question 13

What is an unqualified (clean) opinion?

Answer 13

The most favorable report an auditor can give

Question 14

What is a qualified opinion?

Answer 14

Indicates that although the statements are generally accurate, there is an unresolved issueW

Question 15

What is an adverse opinion?

Answer 15

Auditor believes the firm’s financial statements do not accurately reflect its financial position
Bad news

Question 16

What is a disclaimer of opinion?

Answer 16

Issued when auditor doesn’t have enough information to form an opinion
If an auditor shows that statements are inaccurate, she cannot hide behind a disclaimer opinion

Question 17

What is an engagement letter?

Answer 17

A written contract by which a client hires an accountant

Question 18

Negligence - an accountant is liable to a client who can prove:

Answer 18

1. the accountant breached his duty by failing to exercise the degree of skill and competence an ordinarily prudent accountant would under the circumstances
2. the accountant’s violation of duty caused foreseeable harm to the client

Question 19

Accountants are liable to their clients for fraud if:

Answer 19

1. They make a false statement of a material fact
2. They either know it is not true or recklessly disregard the truth
3. The client justifiably relies on the statement
4. The reliance results in damages

Question 20

Breach of trust - accountants have a legal obligation to:

Answer 20

1. Keep all client information confidential
2. Use client information only for the benefit of the client

Question 21

What is a fiduciary relationship?

Answer 21

One party has an obligation to:
1. Act in a trustworthy fashion for the benefit of the other person
2. To put that person’s interests first

Question 22

Negligence - What is the Ultramares Doctrine?

Answer 22

Accountants who fail to exercise care are liable to a third party only if they know that the third party:
1. Will see their work product
2. Will rely on the work product for a particular, known purpose
Accountants must know the identity of the 3rd party to be liable

Question 23

What is the foreseeable doctrine?

Answer 23

Courts have held that accountants are liable to any foreseeable users who suffer harm as a result of their carelessness
Court has held that an accountant who fails to exercise due care is liable to a third party if:
1. It was foreseeable that the third party would receive financial statements from the accountant’s client
The third party relied on these statements

Question 24

What is the restatement doctrine?

Answer 24

Accountants who fail to exercise due care are liable to:
1. Anyone they knew would rely on the information
2. Anyone else in the same class

Question 25

What is fraud?

Answer 25

An accountant who commits fraud is liable to any foreseeable user of the world product who justifiably relied on it

Question 26

What is liability for qualified opinions?

Answer 26

To avoid liability, the less than clean opinion must be issued for the right reasons

Question 27

What is the Securities Act of 1933?

Answer 27

Auditors are liable for any material misstatement or omission in the financial statements that they prepare for a registration statement

Question 28

What is due diligence?

Answer 28

An investigation of a registration document

Question 29

What is the Securities Exchange Act of 1934?

Answer 29

An auditor who makes a false or misleading statement in a required filing is liable to any buyer or seller of the stock who has acted in reliance upon the statement

Question 30

What is fraud under the Securities Exchange Act of 1934?

Answer 30

An auditor is liable for making: 1. A misstatement or omission of material fact 2. Knowingly or recklessly with the intent to deceive, manipulate, or defraud 3. That the plaintiff relies on in purchasing or selling a security

Question 31

What is scienter?

Answer 31

An action is done knowingly or recklessly with an intent to deceive, manipulate, or defraud

Question 32

What is aiding and abetting?

Answer 32

The SEC has the right to sue anyone who aids and abets others in making untrue statements in connection with the purchase or sale of a security

Question 33

Whistleblowing under the SEC

Answer 33

If the board fails to take appropriate action, the auditors must issue an official report to the board If the board receives such a report from its auditors, it must notify the SEC within one business day and send a copy of this notice to the auditors If the auditors do not receive this copy, they must notify the SEC themselves

Question 34

What is joint and several liability?

Answer 34

All members of a group are liable They can be sued as a group, or any of them can be sued individually for the full amount owing The plaintiff may not recover more than 100% of damages

Question 35

What is criminal liability?

Answer 35

The penalty for a civil offense is the payment of monetary damages Some offenses are criminal acts for which the punishment is a fine and imprisonment

Question 36

What is the Accountant-Client Relationship?

Answer 36

An auditor and her family must not maintain a financial or business relationship with a client

Question 37

What is Accountant-Client privilege?

Answer 37

Provides limited protection for confidential communications between accountants and clients

Question 38

What are working papers?

Answer 38

Accountants use the client's documents and also prepare working papers of their own The accountant: 1. Cannot show the working papers to anyone without the client's permission or a court order 2. Must allow the client access to the working papers