Chapters 5 - 7 Flashcards Preview

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Flashcards in Chapters 5 - 7 Deck (152):
1

Audit professionals have a responsibility under _______________ to fulfill implied or expressed contracts with clients

Common law

2

Auditors are liable to their clients for _____________ and/or ____________________ should they fail to provide the services or not exercise _____________ in their performance.

Negligence; breach of contract; due care

3

True or false?

The number of lawsuits and sizes of awards to plaintiffs have dropped due to efforts by the profession to address the legal liability of CPAs.

False - Numbers and sizes remain high despite efforts

4

Factors contributing to the increase in legal liability:

- Growing awareness of responsibilities of public accountants by users of financial statements
- Increased consciousness of the SEC for its responsibility for protecting investors' interests
- Complexity of auditing and accounting functions caused by increasing size of businesses, globalization of business, and complexities of business operations
- Tendency of society to accept lawsuits by injured parties against anyone who might be able to provide compensation, regardless of fault
- Large civil court judgments against CPA firms awarded in a few cases encourage attorneys to provide legal services on a contingent-fee basis
- Willingness of many CPA firms to settle legal problems out of court in an attempt to avoid costly legal fees and adverse publicity, rather than resolution through judicial process
- Judges' and juror's difficulty in understanding and interpreting technical accounting and auditing matters

5

Occurs when a business is unable to repay its lenders or meet the expectations of its investors because of economic or business conditions, such as a recession, poor management decisions, or unexpected competition in the industry

Business failure

6

Occurs when the auditor issues an incorrect audit opinion because it failed to comply with the requirements of auditing standards

Audit failure

7

Represents the possibility that the auditor concludes after conducting an adequate audit that the financial statements were fairly stated when, in fact, they were materially misstated

Audit risk

8

The auditor is expected only to conduct the audit with due care, and is not expected to be perfect

Prudent person concept

9

True or false?

Under an LLP and an LLC, the liability for one owner's actions does not extend to another owner's personal assets, unless the other owner was directly involved in the actions of the owner causing the liability

True

10

The three groups an auditor is most likely to rely on are:

Employees
Other CPA firms engaged to do part of the work
Specialists called upon to provide technical information

11

The partners of an LLP or LLC may be liable for the work of others on whom they rely

Laws of agency

12

True or false?

CPAs do not have the right to withhold information from the courts on the grounds that the information is privileged

True

13

Provides that a contract cannot confer rights or impose obligations arising under it on any person or agent except the parties to it

The doctrine of privity in the common law of contract

14

Absence of reasonable care that can be expected of a person in a set of circumstances

Ordinary negligence

15

Lack of even slight care, tantamount to reckless behavior, that can be expected of a person

Gross negligence

16

Existence of extreme or unusual negligence even though there was no intent to deceive or do harm. Also termed recklessness.

Constructive fraud

17

Occurs when a misstatement is made and there is both the knowledge of its falsity and the intent to deceive

Fraud

18

Failure of one or both parties in a contract to fulfill the requirements of the contract

Breach of contract

19

A third party who does not have privity of contract but is known to the contracting parties and is intended to have certain rights and benefits under the contract

Third-party beneficiary

20

The assessment against a defendant of the full loss suffered by a plaintiff, regardless of the extent to which other parties shared in the wrongdoing

Joint and several liability

21

Four sources of auditor's legal liability

Liability to clients
Liability to third parties under common law
Civil liability under the federal securities laws
Criminal liability

22

The most common source of lawsuits against CPAs is from:

Clients

23

A lawsuit can be for:

Breach of contract
A tort action for negligence
Both

24

____________ are more common lawsuits because the amounts recoverable under them are normally larger

Tort actions

25

The principal issue in cases involving alleged negligence is usually:

Level of care required

26

______________ can exist without a written agreement, but an engagement letter defines the contract more clearly

Privity of contract

27

Four defenses when there are legal claims by clients:

Lack of duty to perform
Non-negligent performance
Contributory negligence
Absence of causal connection

28

Means that the CPA firm claims that there was no implied or expressed contract

Lack of duty to perform

29

Means that the CPA firm claims that the audit was performed in accordance with auditing standards

Non-negligent performance

30

Exists when the auditor claims the client's own actions either resulted in the loss that is the basis for damages or interfered with the conduct of the audit in such a way that prevented the auditor from discovering the cause of the loss

Contributory negligence

31

To succeed in an action against the auditor, the client must be able to show that there is a close causal connection between the auditor's failure to follow auditing standards and the damages suffered by the client

Absence of causal connection

32

Third parties include:

Actual and potential stockholders
Vendors
Bankers
Other creditors
Employees
Customers

33

CPA may be liable if a loss was incurred by the claimant due to:

Reliance on misleading financial statements

34

Precedent that ordinary negligence is insufficient for liability to third parties because of the lack of privity of contract between the third party and the auditor, unless the third party is a primary beneficiary

Ultramares doctrine

35

Members of a limited class of users that the auditor knows will rely on the financial statements

Foreseen users

36

Auditor knows and intends that user will use audit report

Primary beneficiary/identified user

37

An unlimited class of users that the auditor should have reasonably been able to foresee as being likely users of the financial statements

Foreseeable user

38

Three of the four defenses available to auditors in suits by clients are also available in third-party lawsuits:

Lack of duty to perform
Non-negligent performance
Absence of causal connection

39

Why is contributory negligence not ordinarily available in auditor defenses against third-party suits?

A third party is not in a position to contribute to misstated financial statements

40

Which defense is preferable in third-party suits?

Non-negligent performance

41

Although there has been some growth in actions brought against accountants by clients and third parties under common law, the greatest growth in CPA liability litigation has been under:

Federal securities laws

42

Why do litigants commonly seek federal remedies?

Availability of class action litigation
Can obtain significant damages
Strict liability standards

43

Fairly recent ___________ legislation may result in a reduction of negative outcomes for CPA firms in federal courts

Tort reform

44

Specific activities the AICPA and the profession as a whole can do to reduce practitioners' exposure to lawsuits:

Standard and rule setting
Oppose lawsuits
Education of users
Sanction members for improper conduct and performance
Lobby for changes in laws

45

Practicing auditors may also take specific action to minimize their liability. Some of the more common actions are as follows:

Deal only with clients possessing integrity
Maintain independence
Understand the client's business
Perform quality audits
Document the work properly
Exercise professional skepticism
Hire qualified personnel
Carry adequate insurance
Choose business form that provides limited liability

46

Steps to develop audit objectives

1) Understand objectives and responsibilities for the audit
2) Divide financial statements into cycles
3) Know management assertions about financial statements
4) Know general audit objectives for classes of transactions, accounts, and disclosures
5) Know specific audit objectives for classes of transactions, accounts, and disclosures

47

Responsibilities of management:

Adopting sound accounting policies
Maintaining adequate internal control
Making fair representations in the financial statements

48

The Sarbanes-Oxley Act requires the ______ and the _____ of public companies to certify the quarterly and annual financial statements submitted to the SEC

CEO; CFO

49

Why do the CEO and CFO need to certify their financial statements?

To say that the statements fully comply with the requirements of the Securities Exchange Act of 1934 and that the information contained in the financial statements fairly present, in all material respects, the financial condition and results of operations.

50

What are the penalties for certified financial statements not being fairly presented or fully complying with the Securities Exchange Act?

Criminal penalties including significant monetary fines or imprisonment up to 20 years

51

The overall objectives of the auditor, in conducting an audit of financial statements, are to:

Obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, and
Report on the financial statements

52

Misstatements are usually considered material if:

The combined uncorrected errors and fraud in the financial statements would likely have changed or influenced the decisions of a reasonable person using the statements

53

Indicates that the auditor is not an insurer or guarantor of the correctness of the financial statements

Reasonable assurance

54

Why do auditors use reasonable assurance instead of perfect assurance?

Most audit evidence results from testing a sample of a population
Accounting presentations contain complex estimates
Fraudulently prepared financial statements are often extremely difficult, if not impossible, for the auditor to detect

55

An unintentional misstatement of the financial statements

Error

56

Intentional misstatement of the financial statements

Fraud

57

Two types of fraud:

Misappropriation of assets
Fraudulent financial reporting

58

Auditing standards require that an audit be designed to provide reasonable assurance of detecting both material errors and fraud in the financial statements. To accomplish this, the audit must be planned and performed with:

An attitude of professional skepticism

59

Six characteristics of professional skepticism:

Questioning mindset
Suspension of judgment
Search for knowledge
Interpersonal understanding
Autonomy
Self-esteem

60

A common way to divide an audit by keeping closely related types (or classes) of transactions and account balances in the same segment

Cycle approach

61

Auditors have found that, generally, the most efficient and effective way to conduct audits is to:

Obtain some combination of assurance for each class of transactions and for the ending balance in the related accounts

62

Several audit objectives that must be met for any given class of transactions

Transaction-related audit objectives

63

Several audit objectives that must be met for any given account balance

Balance-related audit objectives

64

Several audit objectives that must be met relating to the presentation and disclosure of information in the financial statements

Presentation and disclosure-related audit objectives

65

International auditing standards and AICPA auditing standards classify assertions into three categories:

Assertions about classes of transactions and events for the period under audit
Assertions about account balances at period end
Assertions about presentation and disclosure

66

Transactions and events that have been recorded have occurred and pertain to the entity

Occurrence

67

All transactions and events that should have been recorded have been recorded

Completeness

68

Amounts and other data relating to recorded transactions and events have been recorded appropriately

Accurace

69

Transactions and events have been recorded in the proper accounts

Classification

70

Transactions and events have been recorded in the correct accounting period

Cutoff

71

Assets, liabilities, and equity interests exist

Existence

72

All assets, liabilities, and equity interests that should have been recorded have been recorded

Completeness

73

Assets, liabilities, and equity interest are included in the financial statements at appropriate amounts and any resulting valuation adjustments are appropriate recorded

Valuation and allocation

74

The entity holds or controls the rights to assets, and liabilities are the obligation of the entity

Rights and obligations

75

Disclosed events and transactions have occurred and pertain to the entity

Occurrence and rights and obligations

76

All disclosures that should have been included in the financial statements have been included

Completeness

77

Financial and other information are disclosed appropriately and at appropriate amounts

Accuracy and valuation

78

Financial and other information is appropriately presented and described and disclosures are clearly expressed

Classification and understandability

79

Four phases of a financial statement audit:

1) Plan and design an audit approach based on risk assessment procedures
2) Perform tests of controls and substantive tests of transactions
3) Perform analytical procedures and tests of details of balances
4) Complete the audit and issue an audit report

80

Any information used by the auditor to determine whether the information being audited is stated in accordance with the established criteria

Evidence

81

Auditors must determine the appropriate type and quantity of evidence. They answer 4 questions:

1) Which audit procedures to use
2) What sample size to select for a given procedure
3) Which items to select from the population
4) When to perform the procedures

82

The detailed instruction that explains the audit evidence to be obtained during the audit

Audit procedure

83

The list of audit procedures for an audit area or an entire audit

Audit program

84

The audit program ALWAYS includes:

List of audit procedures

85

The audit program USUALLY includes:

Sample size
Items to select
Timing

86

Two determinants of persuasiveness (both must be met):

Appropriateness
Sufficiency

87

A measure of the quality of evidence, meaning its relevance and reliability in meeting audit objectives for classes of transactions, account balances, and related disclosures

Appropriateness of evidence

88

Evidence must ________________ the audit objective that the auditor is testing before it can be appropriate

Pertain to or be relevant to

89

Refers to the degree to which evidence can be believable or worthy of trust

Reliability of evidence

90

Reliability, and therefore appropriateness, depends on the following six characteristics of reliable evidence:

Independence of provider
Effectiveness of client's internal controls
Auditor's direct knowledge
Qualifications of individuals providing the information
Degree of objectivity
Timeliness

91

The quantity of evidence obtained determines its:

Sufficiency

92

Measure primarily by the sample size the auditor selects

Sufficiency of evidence

93

Two factors that influence sufficiency of evidence:

Adequate sample size
Selection of proper population items

94

Two main determinants of sample size

Auditor's expectation of misstatement
Auditor's evaluation of internal control

95

The persuasiveness and cost of all alternatives should be considered before selecting the best type or types of evidence. The auditor's goal is to:

Obtain a sufficient amount of appropriate evidence at the lowest possible total cost

96

Eight types of evidence:

Physical examination
Confirmation
Inspection
Analytical procedures
Inquiries of the client
Recalculation
Reperformance
Observation

97

The inspection or county by the auditor of a tangible asset. Most often associated with inventory or cash. Also applies to the verification of securities, notes receivable, and tangible fixed assets.

Physical examination

98

The receipt of a direct written response from a third party verifying the accuracy of information that was requested by the auditor.

Confirmation

99

When practical and reasonable, US auditing standards require:

The confirmation of a sample of accounts receivable

100

To be reliable, confirmations must be:

Controlled by the auditor from the time prepared until returned

101

The auditor's examination of the client's documents and records to substantiate the information that is, or should be, included in the financial statements

Inspection

102

An __________ document has been prepared and used within the client's organization and is retained without ever going to an outside party

Internal

103

An __________ document has been handled by someone outside the client's organization who is a party to the transaction being documented, but which is either currently held by the client or readily accessible

External

104

Internal documents require:

Good internal control

105

Which is better? Internal documents? Or external documents?

External documents

106

When auditors use documentation to support recorded transactions or amounts, the process if often called:

Vouching

107

If the auditor traces from one report to another to satisfy the completeness objective, it is called:

Tracing

108

Evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data

Analytical procedures

109

Analytical procedures are required during the _________ and _________ phases on all audits

Planning; completion

110

Purposes of analytical procedures:

Understand the client's industry and business
Assess the entity's ability to continue as a going concern
Indicate the presence of possible misstatements
Reduce detailed audit tests

111

The obtaining of written or oral information from the client in response to questions from the auditor

Inquiry

112

When an auditor obtains evidence through inquiry, it is normally necessary to obtain:

Corroborating evidence

113

Additional evidence to support the original evidence

Corroborating evidence

114

Rechecking a sample of calculations (often done by computer-assisted software)

Recalculation

115

Independent tests of client accounting procedures or controls that were originally done as a part of an entity's accounting and internal control system

Reperformance

116

Consists of looking at a process or procedure being performed by others. Requires corroborative evidence

Observation

117

Conclusions about evidence:

Internal control has a significant influence on the reliability of most kinds of evidence
Two different types of evidence can be equally reliable
A specific type of evidence is rarely sufficient by itself

118

The two most expensive types of evidence:

Physical examination
Confirmation

119

The three least expensive types of evidence:

Observation
Inquiries of the client
Recalculation

120

If two different kinds of evidence are equally reliable, choose:

The cheapest

121

A reasonably detailed study of a document or record to determine specific facts about it

Examine

122

A less-detailed examination of a document or record to determine whether there is something unusual warranting further investigation

Scan

123

An examination of written information to determine facts pertinent to the audit

Read

124

A calculation done by the auditor independent of the client

Compute

125

A calculation done to determine whether a client's calculation is correct

Recompute

126

Addition of a column of numbers to determine whether the total is the same as the client's

Foot

127

An instruction normally associated with inspection or reperformance

Trace

128

A comparison of information in two different locations

Compare

129

A determination of assets on hand at a given time

Count

130

The act of observation should be associated with the types of evidence defined as observation

Observe

131

The act of inquiry should be associated with the type of evidence defined as inquiry

Inquiry

132

The use of documents to verify recorded transactions or amounts

Vouch

133

The record of audit procedures performed, relevant audit evidence, and conclusions the auditor reached

Audit documentation

134

Audit documentation is often referred to as:

Working papers, or work papers

135

When is audit documentation usually complete?

Within 60 days after the audit report release date (last day of field work)

136

Auditing standards require that records for audits of private companies be retained for a minimum of:

5 years

137

The Sarbanes-Oxley Act requires auditors of public companies to prepare and maintain audit files and other information related to any audit report in sufficient detail to support the auditor's conclusions, for a period of not less than:

7 years

138

True or false:

The auditor should not document any changes after the file completion date

False - should

139

The overall objective of audit documentation is to:

Aid the auditor in providing reasonable assurance that an adequate audit was performed in accordance with auditing standards

140

Audit documentation provides:

A basis for planning the audit
A record of the evidence accumulated and the results of the tests
Data for determining the proper type of audit report
A basis for review by supervisors and partners

141

Who owns audit files?

They are the property of the auditor. The only time another party, including the client, has the right to see them is when subpoenaed.

142

A member shall not disclose any confidential information obtained in the course of a professional engagement except with the consent of the client

Rule 301 Code of Professional Conduct

143

The SEC requires the following documentation for public company auditors:

Working papers
Memos
Correspondence
Communications
Other documents and records
Electronic records

144

Contain data of a historical or continuing nature pertinent to the current audit file

Permanent files

145

Permanent files typically include:

Articles of incorporation
Bylaws
Bond indentures
Contracts
Analyses from previous years of accounts
Information related to assessing internal control and assessing control risk
Results of analytical procedures from previous year's audits

146

Includes all documentation applicable to the year under audit

Current Files

147

Current files typically include:

Audit program
General information
Working trial balance
Adjusting and reclassification entries
Supporting schedules

148

Auditing standards require a ________ audit program

Written

149

The detailed accounts from the general ledger making up the line item

Lead schedule

150

The largest portion of audit documentation includes the detailed ____________________ prepared by the client or the auditors in support of specific amounts on the financial statements

Supporting schedules

151

Symbols used on an audit schedule that provide additional information or details of audit procedures performed

Tick marks

152

Significant unexpected differences indicated by analytical procedures between the current year's unaudited financial data and other data used in comparisons

Unusual fluctuations