Chapter 4

Question 1

business failure

Answer 1

when a business is unable to repay its lenders or meet the expectations of its investors because of economic or business conditions

Question 2

audit failure

Answer 2

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

Question 3

audit risk

Answer 3

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

Question 4

prudent person concept

Answer 4

people have to act with reasonable care and diligence

Question 5

ordinary negligence

Answer 5

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

Question 6

gross negligence

Answer 6

lack of even slight care, tantamount to reckless behavior, than can be expected in a person

Question 7

constructive fraud

Answer 7

existence of extreme or unusual negligence even though there was no intent to deceive or do harm

Question 8

fraud

Answer 8

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

Question 9

breach of contract

Answer 9

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

Question 10

third party beneficiary

Answer 10

a third party who does not have privity of contract but is known to the contracting parties and is intended to have certain right

Question 11

four sources of auditors legal liability

Answer 11

liability to clients
liability to third parties under common law
civil liability under the federal securities law
criminal liability

Question 12

lack of duty to perform

Answer 12

when a cpa firm claims that there was no implied or express contract

Question 13

non-negligent performance

Answer 13

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

Question 14

contributory negligence

Answer 14

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 that prevented the auditor from discovering the mistakes

Question 15

absence of causal connection

Answer 15

when an auditor claims that there was another source or party that caused the damages

Question 16

ultramares doctrine

Answer 16

where auditors are not liable to creditors for negligence

Question 17

forseen users

Answer 17

members of a limited class of users the auditor knows will rely on the financial statements, this is used in the broadening of the ultramares doctrine

Question 18

foreseeable users

Answer 18

where any user the auditor could have reasonably seen would use the financial statements, gets privity of contract

Question 19

Securities Act of 1933

Answer 19

imposes the burden of proof on the auditor to third parties for material misstatements, the auditor must prove

1) an adequate audit was conducted
2) all or a portion of the plaintiff’s loss was caused by factors other than misleading financial statements

Question 20

Securities Act of 1934

Answer 20

required that each public company submit financial statements each year

Question 21

scienter

Answer 21

knowledge and intent to deceive, ruled in Hochfelder v Ernst & Ernst that in order to be sued for negligence there must be this

Question 22

Foreign Corrupt Practices Act of 1977

Answer 22

makes it illegal to offer a bribe to an official of a foreign country for purpose of exerting influence and obtaining or retaining business

Question 23

criminal liability for accountants

Answer 23

CPA’s can be found guilty for criminal action under both federal and state laws