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1、Chapter 5Legal Liability Review Questions5-1Several factors that have affected the increased number of lawsuits against CPAs are:1. The growing awareness of the responsibilities of public accountants on the part of users of financial statements.2. An increased consciousness on the part of the SEC re
2、garding its responsibility for protecting investors interests.3. The greater complexities of auditing and accounting due to the increasing size of businesses, the globalization of business, and the intricacies of business operations.4. Societys increasing acceptance of lawsuits.5. Large civil court
3、judgments against CPA firms, which have encouraged attorneys to provide legal services on a contingent fee basis.6. The willingness of many CPA firms to settle their legal problems out of court.7. The difficulty courts have in understanding and interpreting technical accounting and auditing matters.
4、5-2The most important positive effects are the increased quality control by CPA firms that is likely to result from actual and potential lawsuits and the ability of injured parties to receive remuneration for their damages. Negative effects are the energy required to defend groundless cases and the
5、harmful impact on the publics image of the profession. Legal liability may also increase the cost of audits to society, by causing CPA firms to increase the evidence accumulated.5-3Business failure is the risk that a business will fail financially and, as a result, will be unable to pay its financia
6、l obligations. Audit risk is the risk that the auditor will conclude that the financial statements are fairly stated and an unqualified opinion can therefore be issued when, in fact, they are materially misstated.When there has been a business failure, but not an audit failure, it is common for stat
7、ement users to claim there was an audit failure, even if the most recently issued audited financial statements were fairly stated. Many auditors evaluate the potential for business failure in an engagement in determining the appropriate audit risk.5-4The prudent person concept states that a person i
8、s responsible for conducting a job in good faith and with integrity, but is not infallible. Therefore, the auditor is expected to conduct an audit using due care, but does not claim to be a guarantor or insurer of financial statements.5-5The difference between fraud and constructive fraud is that in
9、 fraud the wrongdoer intends to deceive another party whereas in constructive fraud there is a lack of intent to deceive or defraud. Constructive fraud is highly negligent performance.5-6Many CPA firms willingly settle lawsuits out of court in an attempt to minimize legal costs and avoid adverse pub
10、licity. This has a negative effect on the profession when a CPA firm agrees to settlements even though it believes that the firm is not liable to the plaintiffs. This encourages others to sue CPA firms where they probably would not to such an extent if the firms had the reputation of contesting the
11、litigation. Therefore, out-of-court settlements encourage more lawsuits and, in essence, increase the auditors liability because many firms will pay even though they do not believe they are liable.5-7An auditors best defense for failure to detect a fraud is an audit properly conducted in accordance
12、with auditing standards. SAS 99 (AU 316) states that the auditor should assess the risk of material misstatements of the financial statements due to fraud. Based on this assessment, the auditor should design the audit to provide reasonable assurance of detecting material misstatements due to fraud.
13、SAS 99 also states that because of the nature of fraud (including defalcations), a properly designed and executed audit may not detect a material misstatement due to fraud.5-8Contributory negligence used in legal liability of auditors is a defense used by the auditor when he or she claims the client
14、 or user also had a responsibility in the legal case. An example is the claim by the auditor that management knew of the potential for fraud because of weaknesses in internal control, but refused to correct them. The auditor thereby claims that the client contributed to the fraud by not correcting m
15、aterial weaknesses in internal control. 5-9An engagement letter from the auditor to the client specifies the responsibilities of both parties and states such matters as fee arrangements and deadlines for completion. The auditor may also use this as an opportunity to inform the client that the respon
16、sibility for the prevention of fraud is that of the client. A well-written engagement letter can be useful evidence in the case of a lawsuit, given that the letter spells out the terms of the engagement agreed to by both parties. Without an engagement letter, the terms of the engagement are easily disputed.5-10Liability to clients under common law has remained relatively unchanged for many years. If a CPA firm
