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Legal & Regulatory Aspects of FP > Chapter 24 - Accountants' Liability > Flashcards

Chapter 24 - Accountants' Liability Flashcards

1
Q

What is Vouching?

A

Auditors choose a transaction listed in the company’s books and check backwards for original data to support it.

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2
Q

What is Tracing?

A

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

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3
Q

What is GAAP?

A

“Generally accepted accounting principals” are the rules for preparing financial statements.

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4
Q

What is GAAS?

A

“Generally accepted auditing standards” are rules for conducting audits.

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5
Q

What is IFRS?

A

“International Financial Reporting Standards” are a set of international accounting principals that U.S companies may ultimately be required to follow in preparing financial statements.

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6
Q

What two masters do accountants serve?

A

Company management - hires the accountants

Investing public - rely upon them to offer an independent evaluation of the financial statements that mangement issues.

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7
Q

How do accountants attempt to verify correctness in place of verifying every transaction?

A

They verify a sample of various types of transactions. If these are accurate, they aassume all are.

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8
Q

What two processes do accountants use to verify transactions?

A
  • Vouching

- Tracing

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9
Q

What two sets of rules must accountants follow?

A
  • GAAP

- GAAS

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10
Q

If the SEC’s proposed set of rules become law, what would replace GAAP? Why?

A
  • The International Finacial Reporting Standards.
  • As businesses become more global, there is something to be said for a worldwide, consistent set of accounting rules. If everyone used IFRS, cross-country comparisons would be easier.
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11
Q

What is downside of the IFRS rules?

A

The generally offer greater flexibility and there is worry that cross-company comparisons will be more difficult because observers will not know how each company interpreted the guidelines. Companies would have to report financial information to places other than the SEC - to parites with home they have contracted, banks, and other regulators.

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12
Q

What does an account do after completing an audit?

A

Issue an opinion on the financial statements that indicates how accurately those statements reflect the company’s true financial condition.

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13
Q

What choices of opinions to issue does an auditor have?

A
  • Unqualified opinion (Clean opinion)
  • Qualified opinion
  • Adverse opinion
  • Disclaimer of opinion.
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14
Q

What is an Unqualified Opinion?

A

This indiciates that the company’s financial statements fairly present its financial condition in accordance with GAAP.

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15
Q

What is a Qualified Opinion?

A

Indicates that although the financial statements are generally accurate, there is nonetheless an outstanding, unresolved issue.

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16
Q

What is an Adverse Opinion?

A

In the auditor’s view, the company’s financial statements do not accurately reflect its financial position. The company is being less than truthful about its finances.

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17
Q

What is a Disclaimer of Opinon?

A

Although not as damning as an adverse opinion, a disclaimrer is still not good news. It is issued when an auditor does not have enought information to form an opinion.

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18
Q

What does a less-than-clean opinion do?

A

Warn potential investors and creditors something may be wrong.

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19
Q

What are the major provisions of the Sarbanes-Oxley Act of 2002 that relate to auditors? 5

A
  • The Public Company Accounting Oversight Board
  • Reports to the Audit Committee
  • Consulting Services
  • Conflicts of Interest
  • Term Limits of Audit Partners
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20
Q

Why did congress establish the The Public Company Accounting Oversight Board?

A

Ti ensure that investors receive accurate and complete financial information

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21
Q

What does The Public Company Accounting Oversight Board have the authority to do?

A

Regulate public accounting firms, establishing everything from audit rules to eithics guidelines

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22
Q

Who must register with The Public Company Accounting Oversight Board? Why

A
  • All accounting firms that audit public companies
  • So that the board can inspect them regularly. The board has the authority to revoke an accounting firm’s registration or prohibit it from auditing public companies.
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23
Q

What does the statute do to keep The Public Company Accounting Oversight Board free from corruption?

A

Say that nom ore than two of the five board members may ber CPAs.

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24
Q

What was the goal of establishing The Public Company Accounting Oversight Board?

A

To allow it to revise lax accounting rules, including those that contributed to Enron.

25
Q

Who did auditors traditionally report to during an audit? Why was this a problem? How was it addressed?

A
  • The senior management of a client.
  • They could be reporting problems to the people causing, or at least benefiting from the problems.
  • Under SOX, auditors must report to the audit committee of the client’s board of directors, not senior management.
26
Q

What must the accountants inform the audit committee?

A

Of any:

1) Significant flaws they find in the company’s internal controls
2) Alternative options that the firm considered in preparing the financial statements, and
3) Accounting disagreements with management

27
Q

What does SOX do regarding consulting?

A
  • It prohibits accounting firms that audit public companies from providing consulting services to their audit clients on topics such as bookkeeping, financial information systems, human resources, and legal issues (unrelated to the audit).
  • Any consulting agereements must be approved by a client’s audit committee.
  • Auditing firms cannot base their employee’s compensation on sales of consulting services to clients.
28
Q

Where do the SOX rules apply?

A

In the US.

29
Q

What does SOX say about conflicts of interest?

A

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

30
Q

What does SOX say about term limits on audit partners?

A

After five years with a client, the lead audit partner must rotate off the account for at least five years. Other partners must rotate off an account every seven years for at least two years.

31
Q

What is an Engagement Letter?

A

A written contract by which a client hires an accountant.

32
Q

What are the express terms in an enagement letter?

A

Promises to perform a particular project by a given date.

33
Q

What are the implied terms in an engagement letter?

A

That they will work as carefully as an ordinary prudent accountant would under the circumstances.

34
Q

How does an accountant breach their contract?

A

If they fail to do both the express and implied terms outlined in the contract.

35
Q

What must a client prove in order to hold an account liable for negligence?

A
  • The accountant breached his duty to his client by failing to excercise the degree of skill and competence that an ordinarily prudent account would under the circumstances
  • The accountant’s violation of duty caused harm to the client.
36
Q

When can an account be liable for fraud? What can be won in doing so?

A

If:

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

If the client wins they may ask for punitive damages, which can be substantially higher that a compensatory claim.

37
Q

What is an accounts legal duty in regards to trust?

A

They have an obligation to:

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

38
Q

What are the obligations in a fiduciary relationship?

A

One party has an oblgation to:

1) Act as a trustworth fashion for the benefit of the other person
2) To put that person’s interests first.

39
Q

Do accountants have a fiduciary duty to their clients?

A

Generally no.
If yes it may be because that the accountant takes on responsibilities (like take on the role of financial advisor) that extend the typical scope of an accountant-client relationship.

40
Q

What is an accounts liability to a third party regarding negligence?

A

Accounts who fail to excercise due care are liable to

1) Anyone they know would rely on the information, and
2) anyone else in the same class. (banks are in the same class as banks, etc)

41
Q

Why do courts consider fraud worse than negligence?

A

Because it is intentional.

42
Q

Who is an accountant whom commits fraud liable to?

A

Any forseeable user of the work product who justifiably relied on it.

43
Q

What is an auditors liability regarding the audited financial statements used when a company registers with the SEC before an IPO?

A

Auditors are liable for any important misstatement or omission in the financial statements that they prepare for a registration statement if the investors lose money.

44
Q

What is Due Dilligence in regards to an IPO?

A

An investigation of the registration statement

45
Q

What must a plaintiff prove to hold an auditor liable for errors on a company’s registration statement?

A

1) The registration statement contained an important misstatement or omission
2) They lost money

46
Q

How can auditors avoid liability regarding registration statements?

A

That they made a reasonable investigation of the finanicial statements in a registration statement. Typically they will not be liable if they can show that they complied with GAAP and GAAS.

47
Q

Under the 1934 Act regarding a company’s annual and quarterly reports, when is an auditor liable?

A

An auditor is liable for making
1) a mistatement or omission of an important fact
2) knowingly or recklessly
3) that the plaintiff relies on in purchasing or selling a security.
Note - accountants are liable only if they know their statement is wrong or they are reckless in checking the accuracy of their reports.

48
Q

What is Scienter? What is it required for?

A

Intent to deceive, manipulate, or defraud.

-Liability under the 1934 Act.

49
Q

What is an auditors duty regarding whistleblowing? What happens?

A
  • Auditors who suspect that a client has commited an illegal act must notify the client’s board of directors.
  • 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 auditor, it must notify the SEC within one business day (and send a copy of this notice to its accountants)
  • If the auditors don not receive this copy, they must notify the SEC themselves.
50
Q

When are accountants held liable jointly and severally under the 1934 Act? What about when that doesn’t happen?

A

Only if they knowingly violate the law. Otherwise the defendants are held proportionately liable.

51
Q

What is Proportionate Liability?

A

They are liable only for the share of damages that they themselves caused.

52
Q

What are some violations be accounts that are criminal acts for which the punishment mayb be a fine and imprisonment?

A
  • The Justice Department has the right to prosecute WILFUL VIOLATIONS under either the 1933 Act of the 1934 Act.
  • The Internal Revenue Code imposes various criminal penalities on accountants for WRONGDOING N THE PREPERATION OF TAX RETURNS.
  • Many states prosecute violations of their sercurity laws.
53
Q

What are two SEC rules regarding an accountant’s independence with the companies they audit?

A
  • An auditor or their fmaily must not maintain a finanical or business relationship with the client.
  • SEC rules on independence specially prohibit accounts or their families from owning stock in a company that their firm audits.
54
Q

What is the purpose of the IRS Restructuring and Reform Act?

A

To reduce IRS abuse of taxpayers.

55
Q

What protection for tax advice that clients give their clients are granded under the IRS Restructuring and Reform Act? What does that protection not cover?

A

Limited liability
This attorney client privilege applies only in civil cases involving the IRS or the US Government.

It does NOT apply to

  • Criminal Cases
  • Civil case not involving the US Government, or
  • cases with other federal agencies such as the SEC
  • Nor does it apply to advice about tax shelters.
56
Q

What are working papers?

A

The papers the accountant prepares when working with a client including notes, memoranda, and research.

57
Q

What is the law regarding an accountants’ working papers?

A

The account

1) Cannot show the working papers to anyone without the client’s permission (or a valid court order), and
2) Must allow the client access to the working papers.

58
Q

Under SOX, how long must accountant for public companies keep all their audit work papers?

A

At least seven years.

Legal & Regulatory Aspects of FP (26 decks)

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