Chapter 23 Practice Exam
Matching Questions
Match the following terms with their definitions:
(5) B. Tracing
(1) D. GAAP
(3) F. Unqualified opinion
1. Rules for preparing financial statements.
3. Clean opinion.
5. Accountants check a transaction forward to ensure it has been properly recorded.
True/False Questions
Circle true or false:
1. T F Auditors are only liable under the 1933 Act if they intentionally misrepresent financial statements.
3. T F Accountants are prohibited under federal law from disclosing a client’s confidential information.
5. T F Under federal law, accounting firms may not provide any consulting services to companies that they audit.
Multiple-Choice Questions
7. An accountant is liable to a client for conducting an audit negligently if the accountant:
(a) Acted with intent.
(b) Was a fiduciary of the client.
(c) Failed to exercise due care.
(d) Executed an engagement letter.
9. For a client to prove a case of fraud against an accountant, the following element is not required:
(a) The client lost money.
(b) The accountant made a false statement of fact.
(c) The client relied on the false statement.
(d) The accountant knew the statement was false.
(e) The accountant was reckless.
11. Ted prepared fraudulent financial statements for the Arbor Corp. Lacy read these statements before purchasing stock in the company. When Arbor goes bankrupt, Lacy sues Ted.
(a) Lacy will win because it was foreseeable that she would rely on these statements.
(b) Lacy will win because Ted was negligent.
(c) Lacy will lose because she did not rely on these statements.
(d) Lacy will lose because it was not foreseeable and she did not rely on these statements.
(e) Lacy will lose because it is not foreseeable that she would rely on these statements.
Short-Answer Questions
13. James and Penelope Monroe purchased securities offered by Hughes Homes, Inc., a retailer of manufactured housing in Tacoma, Washington. During its audit, Deloitte & Touche found that Hughes Homes’ internal controls had flaws. As a result, the accounting firm adjusted the scope of its audit to perform independent testing to verify the accuracy of the company’s financial records. Satisfied that the internal controls were functional, Deloitte issued a clean opinion. After Hughes Homes went bankrupt, the Monroes sued Deloitte for violating the 1933 Act. They alleged that Deloitte’s failure to disclose that it had found flaws in Hughes’s internal control system was a material omission. GAAS did not require disclosure. Is Deloitte liable?
Answer: Deloitte was not liable because GAAS did not require it to disclose the flaws. Furthermore, the internal controls functioned adequately at the time of the audit. Monroe v. Hughes, 31 F.2d 772, 1994 U.S. App. LEXIS 18003 (9th Cir. 1994).
15. Medtrans, an ambulance company, was unable to pay its bills. In need of cash, it signed an engagement letter with Deloitte & Touche to perform an audit that could be used to attract investors. Unfortunately, the audit had the opposite effect. The unaudited statements showed earnings of $1.9 million, but the accountants calculated that the company had actually lost about $500,000. While in the process of negotiating adjustments to the financials, Deloitte resigned. Some time passed before Medtrans found another auditor, and, in that interim, a potential investor withdrew its $10 million offer. Is Deloitte liable for breach of contract?
Answer: Although a jury found for the plaintiffs, the court of appeals overruled, holding that an auditor does not breach the engagement letter if he resigns for good cause. National Medical Transportation Network v. Deloitte & Touche, 62 Cal. App. 4th 412, 1998 Cal. App. LEXIS 228.