Chapter 3 - Professional Ethics and Legal Liability Flashcards
1
Q
What is a professional according to the Center for Study of Professional Ethics?
A
A member of an occupation group who:
- Sees other members, including those employed elsewhere, as peers / colleagues.
- Exercises judgement when performing specialized tasks and following relevant professional standards.
- Accepts the professions agreement to work in a morally permissible way (set out in the professions code of conduct) as an obligation of their role.
2
Q
What are ethics?
A
A set of moral principles or values that guide us on how we should act in certain situations.
3
Q
What are professional ethics?
A
Morally acceptable standards of conduct that apply to members of a particular profession.
4
Q
What are the five fundamental principles that guide the ethical behaviour of Professional Accountants?
A
- Professional Behavior
- Professional competence and due care
- Confidentiality
- Objectivity
- Integrity.
5
Q
What is professional behaviour?
A
To comply with relevant laws and regulations. Avoid conduct that a public accountant knows or should know could discredit the profession.
6
Q
What is integrity?
A
To be straightforward, honest, and fair in all professional relationships.
7
Q
What is objectivity?
A
Do not compromise professional judgement or business judgement due to bias, conflict of interest, or undue influence of others.
8
Q
What is professional competence?
A
To maintain professional skill and competence to provide professional services in accordance with current technical and professional standards.
9
Q
What is due care?
A
Act diligently, in accordance with technical and professional standards, when providing professional services.
10
Q
What is confidentiality?
A
To respect the information acquired through business relationships, employment, or professional and to not disclose to any third party without specific authority or caused, such to avoid the exploitation of information for personal use or third parties.
11
Q
What is an Ethical Dilemma?
A
A situation where a decision must be made about the appropriate behaviour. They are rarely black and white.
12
Q
What does it mean to behave ethically?
A
- Avoid harm to people, organizations, or other stakeholders.
- Be viewed as right or good.
13
Q
What are the steps in the ethical decision making framework?
A
- Gather relevant facts and identify the problem.
- Identify fundamental principles involved.
- Identify the ethical issues involved.
- Identify the relevant parties.
- Consider and evaluate courses of action
- Determine the course of action to take.
14
Q
What steps should be taken if the dilemma cannot be resolved?
A
Consult with other appropriate persons within the firm in obtaining a resolution.
15
Q
What are the three key questions when resolving an ethical dilemma?
A
- What fundamental principles are affected?
- What would be your key consideration in your approach to resolving the dilemma?
- What course of action would you take to resolve the dilemma.
16
Q
What three things makes ethical decisions challenging?
A
- Recognizing you are faced with an ethical issue.
- Deciding which values matter the most to you.
- Putting the ethical decision into action, called moral courage.
17
Q
What must the ethical reasoning process consist of for CPA’s?
A
- Professions values and standards
- Stakeholder focus
- Adheres to laws
- Firms policies
18
Q
What are constraints to evaluating alternatives?
A
- Ethical constraints
- Organizational policies.
- Applicable laws and regulations
- Rules of professional conduct.
- Universal values and principles.
19
Q
Describe considering the consequences of each alternative.
A
It is essential to evaluate both eh long term and short term effects, and while the long term effects may be difficult to visualize, it should be considered in a broad context from time perspective and various stakeholder perspectives. There is a tendency to hyper focus on the short term consequences, as the consequences will happen quickly.
20
Q
Describe potential rationalizations.
A
While there are many different ways to resolve an ethical dilemma, one must attempt to avoid rationalizing unethical behaviour. DO not attempt to justify it and ignore the ethical issue.
21
Q
What are the two tests that assess the appropriateness of a course of action. What do these two tests mean?
A
- Universal test - Would a similar action be taken in a similar situation?
- Peer Test - Would the action stand up to the scrutiny of people?
22
Q
What is the harms test?
A
Would this option do less harm than any other alternative?
23
Q
What is the rights test?
A
Would this option violate anyone’s rights, especially a human right.
24
Q
What is the publicity test?
A
Would I want my choice published in the newspaper?
25
What is the defensibility test?
Could I defend my choice of this option before a judge, a committee of my peers, or my parents.
26
What is a virtue test?
What does this say about my character if I choose this option often?
27
What is the professional test?
What would my provincial accounting body's disciplinary committee say about this option?
28
What is the colleague test?
What would my colleagues say when I describe my problem and suggest this option as my solution.
29
What is the firm test
- What would the firms quality control partner or legal counsel say about this
30
What is ethical blind spot?
unconscious judgemental tendencies that can hinder the ethical decision making process or cause the decision maker to fail to recognize the ethical dimension of a choice.
31
Why are ethical blindspots worse than rationalizations?
The decision maker is unaware of the blind spot and it can stop them from recognizing an ethical dilemma to begin with.
32
According to Max Bozeman and Ann Tenbrunsel, why does unethical behaviour occur?
People are unconsciously fooling themselves, which is an ethical blindspot.
33
What is ethical fading? Describe.
Eliminates ethics from the decision. For example, if we frame an issue as law vs financial costs, the concerns of other are higher than others. Therefore it is no longer an ethical dilemma, but a legal or economic issue.
34
What is motivated blindness? Why do many audits fails?
Fail to see our ethical blindspots because we are self interested not to see it. Failures arise due to the auditors having a strong bias to their clients interest, thus not seeing an ethical dilemma.
35
Who determines the rules of professional conduct? What have the provincial bodies done with regard to these rules?
The provincial accounting bodies determine the rules of professional conduct for members and students. Harmonize them such that the rules applies to all public accountants in Canada.
36
What is the professional code of conduct based on? Explain
Compliance and principles. The code will indicate to follow the ethical decision making framework to resolve a conflict by applying the fundamental ethical principles or if there is a specific rule abide by the code.
37
What is the advantage of compliance based approach?
Accounting body can enforce minimum behaviour and performance standards,.
38
What are the disadvantages of the compliance based approach? What does the code emphasize?
1. The tendency of some practitioners to define the rules as a maximum rather than a minimum.
2. Practitioners may view the code as the law and conclude that if some action is not prohibited, it must be legal.
The broader principles and values of the profession must be considered when deciding on whether a particular action is acceptable or not.
39
What is section 200 of the code of professional conduct?
The standards of conduct that ensure the protection of the public interest and maintenance of the professions reputation.
40
What is rule 201 of the code of conduct? What are three some aspects of the rule?
Maintenance of good reputation of the profession.
1. Members behave in the best interest of their profession and the public interest, do not take advantage.
2. An accountant should not be publicly critical of a colleague (to the body or client) without allowing them to explain their actions first.
3. Do not resign from an engagement underway without good reason
41
What are some reasons that an auditor may resign from an engagement while it is underway?
1. Auditor losses confidence in the client.
2. Situations where the auditors independence or objectivity could be reasonably question
3. Client pressures auditor to perform illegal, unjust, or fraudulent acts.
42
What is section 202 of the professional code of conduct?
Integrity, due care, and objectivity.
43
In accordance to the code, what is the difference between objectivity and independence?
Objectivity is a state of mind, whereas independence is a state of mind and the appearance of independence
44
What is a reasonable observer?
A hypothetical individual who has the knowledge of the facts which the member of the firm knew or ought to have known, and who applies judgement objectively with integrity and care.
45
What is rule 203?
Professional competence
46
Describe professional competence?
1. The need to have adequate training and technical competence
2. Keep up with the latest techniques and methodologies
3. Attend a certain number of courses for continuing professional education
4. Knowledge of the business, industry, and technical aspects.
47
What is rule 204? What does it mean?
Independence. Any public accountant who engages in an audit engagement must be free of bias, interest, influence, or relationships that can impede professional judgement and objectivity.
48
What is independence? What are the two dimensions of independence?
Impartiality in performing professional services. Independence in fact and appearance.
49
What is independence in fact?
The auditors ability to take an unbiased viewpoint in the performance of professional services.
50
What is independence in appearance? Why is this important?
The auditors appearance of being unbiased from the viewpoint of others. If they have an unbiased attitude when performing it, but the client does not see them as unbiased, than the audit function fails.
51
What is rule 205? What does this mean?
False and misleading documents and oral representations. No members can sign off or associate with documents that mislead or fail to reveal material omissions. Public accountants may lose faith if info is withheld, and users of the statement must have all available information.
52
What is rule 206? What does it mean?
Compliance with the professional standards. Comply with the professional standards when auditing financial statements. Particularly the GAAS and accounting standards.
53
What is rule 208? Describe it.
Confidentiality of information. Management provides auditors with lots of confidential information like salaries, product costing, advertising, etc. Thus you must speak of any financial data to outsiders or client employees who are not permitted to have this info, as it can cause harm.
54
What is rule 208.1?
It explains the disclosure of confidential information. Under normal circumstances, this data must not be shared with anyone, both past and present clients.
55
What situations under rule 208.1 can information be disclosed?
1. Carrying out their professional duties.
2. Lawfully required or allowed to do so.
3. Defendant in a legal proceeding, defending against professional misconduct complaints, and plaintiff to recover professional fees.
4. Past or current client / employer provides permission.
56
Describe the treatment of confidentiality rules with working paper.
The working paper may only be provided to some else if the client permits it. Even if one firms gets bought out by another, or a successor auditor takes place, the client must permit the new individual to look at it.
57
When can confidentiality rules of working papers be broken?
They are subpoenaed by a court, used as part of a practice inspection, or in connection with a disciplinary hearing. However, you must inform the client immediately if it is a subpoena.
58
What is rule 208.2?
Concerns the use of confidential information, both of past and current clients without their consent, for the advantage of the auditor, a third party, or to disadvantage the client of the employer.
59
What is rule 208.3?
Requires the members to take appropriate measures to protect the confidential information of present and former clients and employers. Protect the confidential information such that it is only accessible to those for a legitimate purpose. If using the cloud ensure that the standards are set and can protect the information.
60
What is confidential or inside information?
Client information that may not be disclosed without the specific consent of the client except under authoritative professional or legal investigation.
61
What is rule 210? Describe.
Conflict of interest rule. If an auditor must provide assurance services to two clients who are competitors, there must be explicit consent from both parties and use lots of procedures to safeguard the information.
62
What is rule 211? Describe.
Duty to report breaches of the CPA code. If a member is aware that another member has breached the rules, the member must first inform the member of the intent to report, and then bring it to the professional committee.
63
What is rule 214? Describe
Fee quotations and billings. Members must obtain adequate information before providing a fee quotation.
64
What is rule 215? Describe
Contingent fees. Charging a fee based on the outcome of the audit can impair the auditor's independence. These are prohibited for audits, reviews, compilations, and other assurance engagements.
65
What is rule 217? Describe.
Advertising, soliciting, and endorsements. The profession is not enhanced by soliciting one another's clients, advertising aggressively or being critical of other members. Soliciting and advertising is not prohibited if these are in effect. When endorsing a product or service, one must avoid conflict of interest or impairing objectivity.
66
What is rule 218? Describe.
Rule 218 is the retention of documentation and working papers. Retain documents for a reasonable period of time in case of litigation, hearings, or practice inspections.
67
What is a permanent file?
Documentation that is retained indefinitely.
68
What are collegial relationships?
Relationships, where client interests are placed ahead of the interest of the member or firm and that professional courtesy and cooperation, are expected at all times.
69
What is rule 302? Describe. Why is this rule important?
Communication with the predecessor. In any situation where a potential auditor successor may take over a file, the successor auditor must ask the incumbent about any circumstances that may stop the successor from taking the file. The successor asks the client, and if there is hesitation, there may be an indication of hiding something.
It is important because it protects the successor from unknowingly picking up an engagement where the client is engaging in malicious activities with undesirable clients.
70
What is rule 303? Describe.
Predecessor provide sufficient information about the client to the next auditor, information typically provided is the prior year financial statements and the tax returns.
71
What is professional courtesy? Why is this important?
Predecessors should cooperate and allow the successor to review the working papers, and to answer the successor's questions. Smooth transitions and meets the CPA requirement of the auditor having opening balance information.
72
What is rule 204.1 to 204.10? What do these rules seek to provide?
A systematic principles-based framework to assess the independence for assurance engagements. Provide a way to evaluate the significance of economic, financial, and other relationships in light of what a reasonable observer would conclude to be acceptable in maintaining independence.
73
What does rule 204 assist in identifying?
1. Threats to independence
2. Safeguards to minimize or eliminate threats to an acceptable level.
74
What must be assessed prior to the conceptual framework being applied?
Assess whether the circumstances or the relationship are prohibited.
75
What does rule 204.4 describe?
Circumstances and activities in which members and firms must avoid performing assurance engagements because adequate safeguards will not exist to eliminate the threat or reduce it to an acceptable level.
76
What are prohibitions? Who does prohibitions apply to?
The requirement that allow an individual or the firm to partake in an audit engagement. It can apply to the firm, but more commonly it applies to the specific individual who does not possess the requirements to engage.
77
What are the examples of prohibitions applicable to all assurance engagements? - Part 1
- Material Interest
- Loans
- Relationships
- Family Members
1. Members of the engagement team cannot have a direct or indirect material interest in the entity subject.
2. Firm or members of the engagement team have a loan from, or guaranteed by the entity.
3. Firm and members cannot have a close business relationship with the entity, related entity, or management.
4. Members of the engagement ream cannot have an immediate family member who is an officer or a director of the client, someone who can exercise significant influence, or has an accounting / financial reporting oversight role.
78
What are the examples of the prohibitions applicable to all assurance engagements? - Part 2
- Managerial positions
- Managerial functions
- Client Approval
- Gifts
5. Members of the engagement team must not serve as a director or officer during the period of the assurance report.
6. Members and firms are prohibited from performing management functions - Unless the entity management directs and supervises their work.
7. Engagement team members met obtain client approval for making journal entries and accounting classifications. Creating original source documents like cheques and invoices are prohibited.
8. Members must not accept any gifts unless they are insignificant or hospitality from assurance clients.
79
What are the examples of prohibitions applicable to all assurance engagements? - Part 3
- Key audit partners
- Fees
9. Key audit partners cannot be evaluated or compensated based on selling non assurance services.
10. A member of the firm cannot charge a fee that is significantly lower than the market, unless it can be demonstrated that all applicable standards are followed.
80
What are the five prohibitions for listed entities?
- Members engaged in audit
- CEO engaged in audit
- Key Audit Partners
- Revenue Threshold
- Non assurance services
1. Member or a firm cannot perform an audit if a person who would participate in the audit is an officer or director or is in a financial reporting oversight role of the entity.
2. Firm cannot perform an audit if the CEO of the audit firm is an officer, director, or is in financial reporting oversight role of the entity.
3. Key audit partners must leave the audit team after seven years.
4. Firms are prohibited from performing the financial statement audit if 15% of the firms total revenue comes from a listed entity for two consecutive years, unless specific safeguards are in play.
5. It it prohibited to provide actuarial, Human Resources, and tax calculations for preparing audit entries.
81
What are listed entities?
Entities whose debts or shares are listed on a recognized stock exchange, and have market capitalization and total assets greater than 10 million.
82
What are threats to independence? What are the 5 types of threats to independence?
Relationships or circumstances that could impair the public accountant's independence. These include self interest, self review, advocacy, familiarity, and intimidation.
83
What is the self interest threat?
When the public accountant could receive a benefit because of a financial interest in the client or in the financial results of the client or due to a conflict of interest.
84
What is the self review threat?
When the public accountant has made judgements in previous engagements that need to be evaluated in making conclusions on the assurance engagement. (The public accountant is placed in the position of having to audit their own work or systems during the audit)
85
What is the advocacy threat?
When the firm or public accountant is perceived too promote (or actually does promote) the clients position. That is, the clients judgement is perceived to direct the actions of the public accountant.
86
What is the familiarity threat?
Occurs when it is difficult to behave with professional skepticism during the engagement due to a belief that one knows the client well.
87
What is the intimidation threat?
The client personnel intimidate the firm or its staff, with respect to the content of the financial statements, or with respect to the conduct of the audit, preventing objective completion of field work.
88
Describe evaluating the significant of a threat?
Even if a threat exists, it does not mean they are in violation of the independence rule, but they should evaluate the significance and determine if it is at an acceptable level.
89
What is an acceptable level of a threat mean? What do we do if the threat is not at an acceptable level?
A reasonable observer would likely conclude that independence is not compromised.Identify and apply safeguards that eliminate or deuce the threat to an acceptable level.
90
What are the three safeguard categories?
1. Created by the profession, legislation, or securities regulation.
2. Provided by the client
3. Available within the firms systems and procedures.
91
What are safeguards by the profession, legislation, and regulators?
1. Rules regarding partner rotation and compensation
2. Limits on the percentage of a firms revenue from one client, and prohibited services.
3. Educating and training provided by the professional accounting body
4. Practice review conducted by the professional accounting body or the CPAB.
92
What are safeguards at the client level?
1. Competent accounting staff
2. A qualified, independent audit committee.
3. Corporate governance policies that restrict services with the external auditors.
4. Corporate policies or ethical codes that stress ethical behaviour and provide channels to discuss ethical issues.
93
What is an audit committee?
A committee of the board of directors that is responsible for auditor oversight both internally and externally. It is an objective and independent liaison between auditors, management, and the board of directors.
94
What is an indicator of a healthy corporate governance structure? What is required to incorporate acts?
Access to an active audit committee by internal and external auditors.The auditors must be independent outside directors.
95
What are the 2 requirements and rules for an audit committee listed on Canadian or American stock exchanges? What is the rules for private companies?
1. Three independent directors who are financially literate.
2. All public companies must have an audit committee.
- Private companies do not necessarily need one, but the large private firms have one.
96
What do audit committees decide on?
- What do typical audit committees discuss with the public accounting firms?
1. Which public accounting firm to retain and the scope of the services the the public accounting firm is going to perform.
- Progress and findings of the audit, and resolve conflicts between public accounting firms and management.
97
What do auditors self report on? How frequently should auditors report to the audit committee?
1. The levels of the auditors independence
2. Relationships between the auditor and their related business or practice and the entity and its related entities.
3. Total fees charged.
- They should report annually.
98
What are safeguards available within a firms systems and procedures?
1. Tone at the top encouraging high quality audits and professional skepticism.
2. Firms policies and procedures that promote awareness and ensure compliance of independence.
3. Rotation of senior personnel on client engagements
4. Required consultation.
99
Describe step 4 of evaluating the effectiveness of safeguards if there are adequate safeguards and there are not adequate safeguards.
If there are safeguards and it has brought the threat to an acceptable level, then they are permitted to continue with the assurance engagement. If there are no adequate safeguards to reduce it to an acceptable level, simply terminate the engagement.
100
What is the independence threat analysis?
An assessment of independence for an assurance engagement.
101
Describe step 5 - Documenting threats and safeguards. What information should be included in the documentation process?
For each new and ongoing audit engagement,ent, management like the partner and manager in the audit, must evaluate in writing the independence of the firm and the staff assigned in the engagements.
1. Outline of the threat
2. Description of the safeguard to eliminate or reduce the threat to an acceptable level
3. How the safeguard actually works to eliminate or reduce the threat to an acceptable level.
102
How are the rules of conduct for CPA established and administered?
Provincially, in which the professional bodies have the power to impose penalties from public censure in the news letter or courses to upgrade skills, to fines and expulsion from the CPA
103
What are 9 examples of sanctions that could be imposed against PA's or firms?
1. Publication of the nae of the offender and the nature
2. Sanctions from the CPAB, OSC, and SEC.
3. Refusal to renew licenses.
4. Increased frequency of peer review.
5. Appointment of external monitor
6. Fines and / or payments of legal fees
7. Mandated change to quality control procedures.
8. Mandatory education
9. Suspension of designation and expulsion from the CPA.
104
What is the issue with the profession being self regulating and public notice?
There is a danger that the public will perceive the discipline as not strict enough. It is dealt with by including laypersons on disciplinary committees and being transparent regarding the disciplinary committee proceedings.
105
What is the expectations gap?
The difference between what the public expects from the auditor and the financial statement audit and what the auditing profession actually provides.
106
What are the three components of the expectations gap?
1. The knowledge gap
2. Performance gap
3. Evolution gap.
107
What is the knowledge gap?
It is the difference between what the public thinks auditors do and what auditors actually do.
108
What is the performance gap? What are the three causes of the performance gap?
Where auditors do not do what auditing standards or regulations require.
Caused by
1. insufficient focus on the audit quality,
2. complexity of the standards, and the
3. differences in interpretation of auditing standards or regulatory requirements between practitioners and regulators.
109
What is the evolution gap?
It is the areas of audit that need an evolution, taking into consideration the general publics demand, technological advances, and how the overall audit process could be enhanced to add more value.
110
What is the common debate between the public and the auditor when there is a serious case of fraud?
The public scrutinizes the auditors for not doing enough and failing to meet the expectations. Auditors reply by stating that it is not reasonable and not in the personal and performance responsibilities.
111
How can we reduce the knowledge gap?
1. Standard setting - Revise and develop new standards to address users needs and expectations.
2. Educate society about the role of an auditor - Educate investors and others who read financial statements about the meaning of an auditors opinion, and the extent and nature of the auditors work.
112
How can we reduce the performance gap?
1. Standard setting - IAASB and CPA strive to set and revise standards
2. External monitoring - Inspections by the CPA and CPAB ensure public companies follow the audit standards and help improve their level of performance, and sanctions where warranted.
3. Firms system of quality management - Even if the other two items are presented the quality management systems are critical to the success of the firm.
113
How do we reduce the evolution gap?
Address the knowledge and performance gap components, as it will allow the public to determine how they want audit to evolve.
Engage in meaningful discussions with stakeholders like, auditing standard setters, regulators, professional accounting bodies, audit firms, audit committee members, investors, governments, and the public.
114
What is the truth regarding the misconception of auditors should accept the primary responsibility for the financial statements?
The managers of the firms hold the responsibility for ensuring that the statements are prepared in accordance with the GAAP and GAAS standards.
115
What is the truth regarding the misconception of auditors certify the financial statements?
Auditors express opinions on the financial statements of their audit work, not certify.
116
What is the truth regarding the misconception of a clean opinion guarantees the accuracy of financial statements.
The auditors has obtained reasonable assurance that the financial statements are free of material misstatements but it does not mean that it is 100% accurate.
117
What is the truth regarding the misconception of auditors perform a 100% verification
The auditor gathers evidence on a test basis. The procedures selected vary according to the auditors professional judgement.
118
What is the truth regarding the misconception of auditors should give an early warning about the possibility of possible business failure
It is managements responsibility to assess and disclose details regarding entity's ability to continue as a going concern. When the auditor has a significant doubt regarding going concern, the auditor is required to assess the managements plan and to highlight in the audit report the going concern note ion the financial statements.
119
What is the truth regarding the misconception of auditors are supposed to detect fraud?
The auditor is required to identify the risks that exist due to error and fraud (that could give rise to the risk of material misstatement) and to adjust the audit strategy.
120
What is audit failure?
A situation in which the auditor issues an erroneous audit opinion as the result of an underlying failure to comply with the requirements of GAAS.
121
What is a business failure?
The situation when a business is unable to pay its lenders or meet the expectations of its investors because of economic or business conditions.
122
What is audit risk? How is it reduced?
The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. The auditor must obtain sufficient appropriate evidence to reduce audit risk to an acceptably low level.
123
Is audit risk avoidable?
No it is not, since auditors gather evidence on a test basis and because well concealed fraud is very difficult to detect.
124
What is legal liability?
The professionals obligation under the law to provide a reasonable level of care when performing work for those they serve.
125
When can auditors be held to legal liability?
1. Negligence and / or breach of contract - Either failing to provide it or failing to exercise due care in the performance.
2. Common law tort of negligence
3. provincial securities acts.
126
What is common law liability to the client?
Client sues auditor for not discovering a defalcation during the audit
127
What is common law liability to third parties
Bank sues auditor for not discovering materially misstated financial statements.
128
What is liability under provincial securities act?
Purchaser of shares issued by a company sues auditor for not discovering materially misstated financial statements in a prospectus (primary market).
Purchaser of shares on the secondary market sues auditor for not alerting the purchaser of material misstatements.
129
What is criminal liability?
Court prosecutes auditor under the Criminal Code of Canada for knowingly issuing an incorrect auditors report.
130
In the auditing environment, what is a strong piece of evidence for negligence? Under tort law, what must be proved by the prosecutor to state negligence.
- Failing to abide by the GAAS
1. The auditor owed a duty of care to the plaintiff.
2. The auditor breached the duty of care
3. Plaintiff suffered a loss
4. Plaintiff loss resulted, in part or wholly, from the auditors breach of duty.
131
What is the most common source of lawsuits against CPA's? Is duty of care an issue in these lawsuits?
Liability to clients. No duty of care is not an issue as it is typically under a contractual relationship, however duty of care can exist if the client thought it was meant to be an audit procedure and it was only a review engagement.
132
What are common lawsuits issued by the clients? What are the outcomes of these typical lawsuits?
1. Failure to complete a non audit engagement by the agreed upon date
2. Inappropriate withdrawal from an audit
3. Failure to discover an embezzlement (theft of assets)
4. Breach of confidentiality requirements.
- The monetary amounts to be paid are relatively small, and they do not receive the same publicity as third parties or public companies.
133
Describe the liability to third parties under common law.
A public accounting firm may be liable to third parties if there is a failure on the side of the company, and since there is no contract, they must rely on tort law, and the hardest part is establishing a duty of care is required by the auditor.
134
What is the Ultramares doctrine in 1931
Auditors are not liable for ordinary negligence to parties with whom they do not have a privity (contractural) relationship. it is important to limiting the auditors liability.
135
What did the case of Hedley Byrne and Co v Heller and Partners Ltd establish in 1964?
It expanded the definitions for which the auditor could be sued. Auditors are liable to the third parties if it is reasonable for the auditors to know that specific third parties will be relying upon their audit report.
136
What was the importance of the Gordon T.Haig v Ralph L Bamford (1977)
Confirmed the privity of contract is not a valid defence. The auditors could see that the report was going to be used, and thus they had a knowledge of identifiable class of limited third parties, thus they held a duty of care though they did not know them specifically.
137
What was the importance of the Hercules Management v Ernest and young in 1997
It established the scope of the auditors duty of care and limits to the indeterminate liability. Auditors only owed a duty of care if:
1. The auditor had knowledge of the specific third party or a narrow class of third parties
2. The specific third party or limit class of third parties relied upon the financial statements for the specific purpose of the transaction for which they were prepared.
In this case the judge ruled that they made that audit report for the statutory requirements and not for person investment decisions.
138
What was the implications of the Castor Holdings case in 2011?
While the judge followed the same principles as the Hercules case, indeterminate liability should also include the fact that:
"Auditors could take steps to protect themselves when they saw the broad purpose for which their work product was being used"
139
Describe liabilities to third parties under securities law.
Amendments to provincial securities legislation have made it easier for shareholders to pursue securities class action lawsuits. It allows investors to sue auditors for misrepresentations. Investors do not have to prove they relied upon the representation, and thus Hercules law rulings do not apply.
140
What is the deep pockets theory?
When a company is no longer solvent, the auditors become the target for the class action lawsuits.
141
What are situations where auditors can face criminal and quasi criminal liability trials?
1. Breaches of securities legislation, where security regulators make the allegations.
2. Criminal charges relating to fraud / fraudulent financial statements.
142
What are ways to minimize litigation risk?
1. Deal only with clients possessing integrity
2. Maintain independence
3. Understand the clients business
4. Perform quality audits
5. Document the work properly
6. Exercise and maintain professional skepticism.
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What does it mean to deal only with clients that have integrity
When you deal with a client that lacks integrity, there is a higher chance of having legal problems as they did bot conduct their relationships with customers, employees, and governments accurately. Thus disassociate from those that lack integrity
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What does it mean to maintain independence
Maintain an attitude of responsibility away from client interest. When you fall into client pressure or representations, risks go up. They require healthy professional skepticism.
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What does it mean to understand the clients business
If you do not understand the nature of the client than you can miss accounting standards leading to misstatements and fraud.
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What does it mean to perform quality audits
Obtain appropriate evidence and make appropriate judgements about the evidence. Understand the internal controls and modify the evidence to reflect the findings. It reduces misstatements and lawsuits.
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What does it mean to document the work properly.
Documenting evidence and findings properly helps auditors to perform quality audits. If they must defend themselves in court, having quality audit documentation, an engagement and representation letter helps to define the respective obligations of the parties involved.
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What does it mean to exercise and maintain professional judgements
Auditors become liable when they are presented with information that indicate they have failed to recognize a problem. They need professional skepticism to keep them alert on the potential misstatements.
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What happens if there is a business failure and the financial statements were misstated?
Users may claim that the auditor was negligent and lacked competence / independent, even if the audit was conducted in accordance with GAAS.
