Chapter 20 Terms

Question 1

What are the four general stages in the initiation and disposition of audit-related disputes?

Answer 1

1) The occurrence of events that result in losses for users of the financial statements,
2) The investigation by plaintiff attorneys before filing suit to link the user losses with allegations of material omissions or misstatements of financial statements.
3) The legal process that commences with the filing of the suit and
4) The final resolution of the dispute.

Question 2

Common Law

Answer 2

Case law developed over time by judges who issue legal opinions when deciding a case (the legal principles announced in these cases become precedent for judges deciding similar cases in the future).

Question 3

Statutory Law

Answer 3

Written law enacted by the legislative branch of federal and state governments. Tort. A wrongful act other than a breach of contract for which civil action may be taken.

Question 4

Breach of Contract

Answer 4

Occurs when the client or auditor fails to meet the terms and obligations established in the contract (either expressly or implied), which is normally finalized in the engagement letter. Third parties may have privity or near privity of contract.

Question 5

Civil Law

Answer 5

A law that does not relate to criminal matters.

Question 6

Class Action

Answer 6

Lawsuit filed by one or more individuals on behalf of all persons who may have invested on the basis of the same false and misleading information.

Question 7

Criminal Law

Answer 7

Statutory law that defines the duties citizens owe to society and prescribes penalties for violations.

Question 8

Fraud

Answer 8

Actions taken with the knowledge and intent to deceive.

Question 9

Gross Negligence

Answer 9

An extreme, flagrant, or reckless departure from professional standards of due care. This is also referred to as constructive fraud.

Question 10

Ordinary Negligence

Answer 10

an absence of reasonable or due care in the conduct of an engagement. Due care is evaluated in terms of what other professional accountants would have done under similar circumstances.

Question 11

Privity

Answer 11

A contract or specific agreement exists between two parties. Absent a contractual fiduciary relationship, the accountant does not owe a duty of care to an injured party.

Question 12

Scienter

Answer 12

Acting with intent to deceive, defraud, or with knowledge of a false representation.

Question 13

Tort

Answer 13

A wrongful act, other than a breach of contract, for which civil action may be taken.

Question 14

Due Professional Care

Answer 14

A legal standard requiring that the auditor perform his or her professional services with the same degree of skill, knowledge, and judgment possessed by other members of the profession.

Question 15

Engagement Letter

Answer 15

A letter that formalizes the contract between the auditor and the entity and outlines the responsibilities of both parties.

Question 16

To recover against an auditor in a negligence case, the client must prove the following:

Answer 16

1) The auditor had the duty to the client to conform to a required standard of care.
2) The auditor breached that duty by failing to act with due professional care.
3) There was a direct causal connection between the auditor’s negligence and the client’s damage.
4) The client suffered actual losses or damages as a result.

Question 17

To prevail in a suit alleging negligence, the THIRD party must prove all of the following:

Answer 17

1) The auditor had the duty to the client to conform to a required standard of care.
2) The auditor breached that duty by failing to act with due professional care.
3) There was a direct causal connection between the auditor’s negligence and the third party’s injury (e.g., the financial statements were misleading and the third party relied on the financial statements).
4) The third party suffered an actual loss as a result.

Question 18

What are the common law doctrines for third parties suing auditors for ordinary negligence?

Answer 18

This continuum goes from left to right, from narrowest to broadest definition of eligible third parties. It is divided into four equal parts (left to right): Privy (Ultramares), near privity (Credit Alliance), foreseen or Restatement standard (Rusch Factors), to reasonable foreseeable (Rosenblum). The foreseen third party, Restatement Standards, or Rusch Factors doctrine is the legal doctrine followed by most states.

Question 19

Joint and Several Liability

Answer 19

The auditor can be responsible for the entire loss even if other parties contributed to the loss.

Question 20

Proportionate Liability

Answer 20

Each defendant is liable solely for the portion of the damages that corresponds to the percentage of responsibility of that defendant.

Question 21

Foreign Corrupt Practices Act (FCPA)

Answer 21

Passed by Congress in 1977 in response to the discovery of bribery and other misconduct on the part of more than 300 American Companies. It prohibits corporate officers from knowingly participating in bribing foreign officials to obtain or retain business. It also imposes record-keeping and internal control requirements on public companies.

Question 22

Racketeer Influenced and Corrupt Organizations Act (RICO)

Answer 22

Enacted by Congress in 1970 to combat the infiltration of legitimate businesses by organized crime. It provides civil and criminal sanctions for certain types of illegal acts.