Module C: Legal Liability

Question 1

breach of contract

Answer 1

A claim that accounting or auditing services were not performed in the manner described in the contract.

Question 2

causation defense

Answer 2

An argument available to auditors who can show that a plaintiff’s economic loss was caused by a factor other than the auditors’ failure to exercise the appropriate level of professional care or breach of contract.

Question 3

class action

Answer 3

A situation in which a group of plaintiffs comes together in a legal action against another party.

Question 4

comfort letter

Answer 4

A letter issued by auditors to underwriters of securities that provides an opinion on the fairness of the issuers’ financial statements.

Question 5

common law

Answer 5

The liability for injuries that is based on reasons other than violation of a written law or statute. Under common law, legal precedent is used in assessing the degree of responsibility or fault of the parties; auditors have common law liability to clients and non shareholder third parties.

Question 6

constructive fraud

Answer 6

A failure to provide any care in fulfilling a duty owed to another including a reckless disregard for the truth (similar to gross negligence).

Question 7

contributory negligence

Answer 7

A legal defense theory in which the plaintiff’s own failure to perform with the appropriate level of professional care bars recovery from auditors.

Question 8

“deep pockets” theory

Answer 8

The concept that lawsuits may be brought against auditors not because they are necessarily at fault but because they are the only party with resources against which recovery can be made.

Question 9

expectation gap

Answer 9

The difference between the actual work and assurance required by GAAS and the expectation of that work by the general public.

Question 10

Financial Reporting Releases (FRRs)

Answer 10

Reports prepared by SEC staff that express new rules and policies about disclosure.

Question 11

foreseeable party

Answer 11

The individuals or organizations whose decisions normally rely on audited financial statements and opinions on whose financial statements.

Question 12

foreseen party

Answer 12

A limited class of individuals or organizations that could be reasonably expected to rely on auditors’ work.

Question 13

Form 8-K

Answer 13

The “current events” report filed periodically at the occurrence of major events, such as earnings releases, major asset sales, acquisitions, and auditor changes.

Question 14

Form 10-K

Answer 14

The form to use for annual filing of financial statements and related disclosures by public companies with the SEC.

Question 15

Form 10-Q

Answer 15

The form to use for quarterly filing of financial statements and related disclosures by public companies with the SEC.

Question 16

fraud

Answer 16

The misrepresentation of facts that the individual knows to be false with the intention of deceive.

Question 17

gross negligence

Answer 17

The breach of duty owed to another party because of. lack of minimal care (similar to constructive fraud).

Question 18

initial public offering (IPO)

Answer 18

The initial issuance of securities by a registrant entity to the investing public through a market that is subject to the provisions of the Securities Act of 1933.

Question 19

joint and several liability

Answer 19

The legal doctrine that when multiple defendants are named, the full amount of a damage award may be collected from any of the defendants named in the lawsuit even though they may be only partially at fault.

Question 20

limited liability partnership

Answer 20

A form of organization adopted by most large accounting firms that combines the advantages of a traditional partnership with the liability protection afforded to corporations.

Question 21

ordinary negligence

Answer 21

The unintentional breach of duty owed to another as a result of a lack of reasonable care.

Question 22

plaintiff

Answer 22

The person or organization that initiates a lawsuit (client or their-party user of financial statements).

Question 23

primary beneficiary

Answer 23

A person known by name to the auditor for whose primary benefit the audit or other accounting service is performed.

Question 24

privity of contract

Answer 24

A situation in which parties have a contractual relationship.

Question 25

proportionate liability

Answer 25

The legal doctrine that payment of a share of the court’s damage award be based on the extent (or proportion) of fault exhibited by a convicted defendant.

Question 26

prospectus

Answer 26

A legal document offering securities for sale; includes significant information about the issuing entity, including its historical financial statements and other necessary disclosures.

Question 27

registration statement

Answer 27

A set of documents, including a prospectus, that a company files with the SEC prior to an initial public offering.

Question 28

Regulation S-K

Answer 28

The SEC requirements relating to all business, analytical, and supplementary financial disclosures other than financial statements themselves.

Question 29

Regulation S-X

Answer 29

The SEC accounting requirements for annual and interim financial statements filed under both the Securities Act and the Securities Exchange Act.

Question 30

scienter

Answer 30

A mental state embracing the intent to deceive, manipulate, or defraud prior to committing those actions (for example, auditors’ knowledge of a misstatement in the financial statements and the intentional failure to disclose this misstatement in their report).

Question 31

Staff Accounting Bulletins (SABs)

Answer 31

The unofficial but important interpretations of Regulation S-X and Regulation S-K by SEC staff.

Question 32

statutory law

Answer 32

The legal rules affecting liability based on violations of written laws or statutes. Auditors have statutory liability to third-part investors under the securities acts.

Question 33

tort

Answer 33

A civil complaint charging that the action of one person caused injury (personal or financial) to another; such action against auditors is normally initiated by users of financial statements.