Chapter 5
Legal Liability
1) While performing services for their clients, professionals have a duty to provide a
level of care which is:
A) reasonable. B) superior.
C) free from judgment errors. D) greater than average.
2) Auditors who fail to exercise due care in their performance of professional services may
be liable for:
A) criminal charges. B) excess liability.
C) punitive liability. D) breach of contract.
3) A(n) ________ failure occurs when an auditor issues an erroneous opinion as the result of
an underlying failure to comply with auditing standards.
A) process B) audit C) business D) ethics
4) Under the laws of agency, partners of an audit firm may be liable for the work of
others on whom they rely. This would not include:
A) other audit firms engaged to do part of the audit work.
B) employees of the audit client.
C) specialists employed by the audit firm to provide technical advice on the audit.
D) employees of the audit firm.
5) An example of a breach of contract would likely include:
A) an auditor’s claim that the client staff is unqualified.
B) a bank’s claim that an auditor had a duty to uncover material errors in financial
statements that had been relied on in making a loan.
C) an audit firm’s failure to complete an audit on the agreed-upon date because the
firm had a backlog of other work which was more lucrative.
D) an auditor’s refusal to return the client’s general ledger book until the client paid
last year’s audit fees.
6) Which of the following factors does not contribute to the number of lawsuits
against auditors?
A) large civil court judgments against CPA firms awarded in a few cases
B) growing awareness of the responsibilities of public accountants by users of
financial statements
C) the simplicity of auditing and accounting functions
D) an increased consciousness by the SEC for its responsibility for protecting
investors' interests
7) Which of the following is an accurate statement regarding audit risk, audit failure,
and business failure?
A) Audit risk is always avoidable if the audit is conducted in accordance with
generally accepted auditing standards.
B) Because auditors gather evidence on a test basis, and because well-concealed
frauds are difficult to detect, audit risk is unavoidable.
C) Legal precedent makes it easy to determine who has the right to recover losses in
the event of an audit failure.
D) A business failure will always result in an audit failure.
8) Privity of contract exists between:
A) auditor and the government. B) auditor and client attorney.
C) auditor and client. D) auditor and third parties.
9) An individual who is not party to the contract between an auditor and the client,
but who is known by both and is intended to receive certain benefits from the
contract is known as:
A) a third-party beneficiary. B) a tort.
C) a third party. D) a common law inheritor.
10) A common way for an audit firm to demonstrate its lack of duty to perform is by
use of a(n):
A) confirmation letter. B) management representation letter.
C) expert witness’ testimony. D) audit contract, or engagement letter.
11) Under common law, a foreseen user would be treated the same as:
A) Yes No
B) No No
C) No Yes
D) Yes Yes
12) 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 is called
A) separate and proportionate liability.
B) shared liability.
C) unitary liability.
D) joint and several liability.
13) The assessment against a defendant of that portion of the damage caused by the
defendant's negligence is called
A) separate and proportionate liability.
B) joint and several liability.
C) shared liability.
D) unitary liability.
14) Which of the following is not likely a factor in the increase in the number of
lawsuits and sizes of awards to plaintiffs related to auditor behavior?
A) Auditing firms are more willing to settle lawsuits.
B) Increased awareness of auditor responsibilities by users of financial statements.
C) Difficulty judges and jurors have in understanding legal matters.
D) Increased consciousness on the part of capital market authorities for their
responsibility to protect investors.
15) Under the Securities Act of 1933, the auditor's responsibility for making sure the
financial statements were fairly stated extends to
A) the date of the financial statements.
B) the date the registration statement becomes effective.
C) the date of the audit report.
D) one year beyond the date of the financial statements.
16) The Securities and Exchange Commission can impose all but which of the
following sanctions?
A) suspend a CPA from auditing SEC clients
B) prohibit a CPA from accepting new SEC clients for a period of time
C) require a CPA to participate in continuing-education programs and make changes
in their practice
D) revoke a CPA license
17) Hussain & Shah, a medium-sized audit firm, employed Sonya as a staff
accountant. Sonya was negligent while auditing several of the firm’s clients. Under
these circumstances, which of the following statements is true?
A) Hussain & Shah can recover against its insurer on its malpractice policy even if
one of the partners was also negligent in reviewing Sonya’s work.
B) Sonya would have no personal liability for negligence.
C) Hussain & Shah is not liable for Sonya’s negligence because auditors are
generally considered to be independent contractors.
D) Hussain & Shah would not be liable for Sonya’s negligence if she disobeyed
specific instructions in the performance of the audits.
18) Which of the following statements about the Securities Act of 1933 is not true?
A) A third party that purchased securities described in the registration statement
may sue the auditor for material misrepresentations or omissions in the audited
financial statements.
B) A third party user does not have the burden of proof that he/she relied on the
financial statements.
C) A third party user has the burden of proof that the auditor was either negligent or
fraudulent in doing the audit.
D) A third party user does not have the burden of proof that the loss was caused by
the misleading statements.
19) Under the Securities Act of 1933,
A) any party who relies on the company's audited financial statements can recover
from the auditors.
B) third-party users must prove that the auditor was negligent.
C) the burden of proof is on the defendant.
D) auditors face potential legal exposure for information contained in the Form 10-Q.
20) In order to protect themselves from legal liability, it is important that CPAs
A) are organized as sole-proprietors.
B) accept client representations.
C) understand the client's business.
D) use engagement letters, not representation letters.
21) 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:
A) no rights against an auditor.
B) no rights unless an auditor is grossly negligent.
C) no rights unless an auditor is fraudulent.
D) the same rights against an auditor as a client.
22) A CPA is subject to criminal liability if the CPA
A) refuses to turn over requested audit documentation to a client.
B) performs an audit in a negligent manner.
C) is knowingly involved with false financial statements.
D) willfully breaches a contract with a client.