Chapter 4 Preparatory Multiple Choice 11th Ed

4-1 Litigation costs are the largest single cost faced by audit firms. (T / F) F

4-2 The expectations gap includes a misperception by shareholders that they are entitled to recover losses on investments for which the auditor provided an unqualified opinion on the financial statements. (T / F) T

4-3Which of the following factors is not a reason that audit firms experience litigation for business failures, rather than audit failures? C

a.Joint and several liability statutes.

b.Class action lawsuits.

c.Contingent-fee compensation for audit firms.

d.A misunderstanding by some users that an unqualified audit opinion represents an insurance policy against investment losses.

4-4 The shareholders of a bank sue Karen Frank, CPA, for malpractice due to an audit failure that preceded the bank’s financial failure. The jury determines that Frank is 60% at fault and that management is 40% at fault. The bank has no financial resources, nor does its management. Under joint and several liability, what is the likely percentage of damages that Frank will? C

a. 100%.

b. 50%.

c. 40%.

d. None of the above.

4-5 The three laws most relevant to auditor liability include common law, contract law, and statutory law. (T / F) T

4-6 Negligence occurs when a person fails to perform a contractual duty. (T / F) F

4-7 Which of the following statements is false? A

a. Breach of contract occurs when a person competently performs a contractual duty.

b. Negligence is the failure to exercise reasonable care, thereby causing harm to another person or to property.

c. Gross negligence is operating with a reckless disregard for the truth, or the failure to use even minimal care.

d. Fraud is an intentional concealment or misrepresentation of a material fact with the intent to deceive another person, causing damage to the deceived person.

4-8 An audit client can sue the auditor under contract law for which of the following?

a. Breach of contract.

b. Negligence.

c. Gross negligence.

d. Fraud.

e. All of the above.

4-9 Examples of breach of contract include violating client confidentiality, failing to provide the audit report on time, and failing to discover material error or material employee fraud. (T / F) T

4-10 To win a claim against the auditor, third parties suing under common law must generally prove that they suffered a loss, that the loss was due to lack of reliance on misleading financial statements, and that the auditor knowingly participated in the financial misrepresentation. (T / F) F

4-11 The remedies for breach of contract include which of the following? D

a. Requiring specific performance of the contract agreement.

b. Granting an injunction to prohibit the auditor from doing certain acts, such as disclosing confidential information.

c. Providing for recovery of amounts lost as a result of the breach.

d. All of the above.

4-12 Which of the following scenarios includes an example of a foreseen user? B

a. The auditor knows that the First National Bank wants audited financial statements as part of the client’s application for a loan.

b. The auditor knows that the client needs audited financial statements because it wants to obtain a loan from one of several possible banks.

c. Current and prospective creditors and stockholders are likely to use the audited financial statements.

d. None of the above.