Acct 402 Cont.

  1. Define Error
    • unintentional mistake in computations or application of principles
    • unintentional incorrect estimates
  2. define irregularity
    intentional misrepresentation of transactions, records, accounting principles
  3. Auditor's responsibility to detect errors and irregularities (E/I)
    Auditor must ( on all engagements):
    Design the audit to provide reasonable assurance of detecting E/I that are material to the financial statements

    Failure to detect is not automatically evidence of auditor negligence ( e.g, irregularities such as forgery and collusion are difficult to detect)
  4. What are some possible indicators of E/I?
    • 1. poor internal controls.
    • 2. management decisions dominated by single person
    • 3. aggressive management
    • 4. poor profitability of client
    • 5. rapid growth
    • 6. going concern problems
    • 7. related party transactions - fictitious company
    • 8. new client (easier to fool a new auditor)
  5. If an irregularity is detected ( whistle blowing): what should you do?
    Refer to a level of management at least one level above where fraud occurred

    consider effect on f/s - revise f/s accordingly - if client refuses, qualified, adverse, or withdraw

    communicated findings to audit committee

    if client is public, may need to tell SEC if client does not.
  6. what is client illegal acts?
    • Illegal acts is violations of laws or government regulations (some relevant laws: RICO, FCPA)
    • Whether an act is illegal is normally beyond the expertise of an auditor
  7. Auditor's responsibility to detect illegal acts
    Auditor must (on all engagements):
    Design the audit to provide reasonable assurance of detecting illegal acts that have a direct, material effect on the f/s's (active responsibility to look for these) e.g tax laws
  8. For illegal acts having an indirect effect on f/s, auditor's responsibility is ( if comes to auditor's attention)
  9. What are possible client claims
    • 1. breach of contract: engagement letter is a contract
    • 2. tort law- negligence
  10. Under the tort law, burden of proof is on client to prove:
    • 1. damages
    • 2. CPA was negligent (at least ordinary)

    • Ordinary negligence- lack of reasonable care (failure to follow GAAS)
    • Gross negligence- lack of even slight care
    • Fraud- intentional deception.
  11. Auditor's defenses under the tort law are
    • 1. due care (not negligent, followed GAAS), also called due diligence
    • 2. contributory or comparative negligence (share the blame with client)
    • 3. clear engagement letter
  12. What are the kinds of 3rd parties affected by audit in common law
    • 1. 3rd party beneficiary (3B)= 3rd party that benefits from a contract between other persons
    • 2. Primary Beneficiary (known users)= specifically named or known at time of contracting to do audit
    • 3. Foreseen User= known, but not specifically (only as a group)
    • 4. Foreseeable user= reasonably foreseeable that would rely on audit
  13. When 3rd party sues CPA, burden of proof is on 3rd party to prove?
    • 1. damage
    • 2. reliance (and proximate cause)
    • 3. cpa negligence- type of negligence required depends on what kind of 3B (and state)
    • with PRIVITY of contract: at least ordinary negligence
    • without PRIVITY: at least gross negligence (fraud)
  14. NOTE: In most cases, only the audit client and any primary beneficiaries (3B) have privity of contract.
  15. If 3B is what is the court case extending privity?
    • Primary- Ultramares vs. Tourche
    • Foreseen- Rusch factors vs. Levin
    • Foreseeable- Rosenblum vs. Adler
  16. Auditors' defenses against 3rd party suits?
    • 1. due caare
    • 2. lack of privity
  17. SEC 1933 Act applies to?
    • Applies to any person acquiring securities through a "public offering" (IPO vs. Seasoned PO)
  18. Under the SEC 1933 person suing CPA needs to show
    • 1. F/s were "false or misleading" as to "material fact"
    • 2. damages ( drop in stock price)

    Person doesn't need to show reliance on f/s or that drop in prices was fault of misleading statements
  19. Under the SEC 1933 CPA has burden of proof to show?
    • 1. f/s not "false or misleading" or discrepancy was"immaterial"
    • 2. Due Care (followed GAAS)
    • 3. Another cause of damage ( general market drop)

    CPA has to show he/she was not negligent- therefore CPA is essentially liable for any negligence. Therefore with ordinary negligence, CPA loses.
  20. SEC 1934 Act applies to ?
    Applies to all "publicly traded" companies to file annual f/s (10K) and quarterly f/s (10Q) with the SEC -10k has to be audited, 10Q has to be reviewed. "Continuous Disclosure Act"
  21. SEC 1934 has two section:
    • section 18 = gross recklessness
    • section 10 = scienter - rule 10-5b
  22. Under the SEC 1934 the person suing CPA needs to show
    • -be a buyer or seller of stock
    • -show f/s false or misleading as to material fact
    • -prove of damages
    • -prove reliance on f/s
    • -gross recklessness (18) or scienter (10)
  23. Under the SEC 1934 CPA has burden of proof to show?
    • -due care
    • -f/s not false or misleading / immateriality
    • -other causes of drop in stock prices.
Card Set
Acct 402 Cont.
Acct 402 Cont. Exam #1