Exam 2 Notes ACC 477

Chapter 5: Legal Liability

Business Failure-The situation when a business is unable to repay its

lenders or meet the expectations of investors because of economi, or business conditions,
Audit risk- The risk that the auditor will conclude after conducting an
adequate audit that the nancial statements are fairly stated and an unmodi ed
Opinion can therefore be issued when, in fact they are molevially misstated.
Audit failure - a situation in which the auditor issues an incorrect audit
opinion as the result of an underlying failure to comply with the requirements
of auditing standards,
Prudent person concept - the legal concept that a personhosa duty to
exercise reasonable care and diligence in the performans of obligations to another,
Joint and Several Liability-The assessment against a defendent for the full
loss suffered by the plantiff, regardless to which ofter portion shaved in wrongdoing
Seperate and Proportional Liability - The assesment against a defendend caused by
the defendant's liability.
common law - Unwritten or case-made law that evolves from prior or precedent cases
Suit in contract-based on privity and the auditors alleged breach of the agreement
Suit infort- based on negligene grosspas ligone, or front
Negligence absence of reasonable cave
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Gross negligence- lack of even slight core or ratbesiness
Froud - intent to deceive on the part of the CPA or twould be of mongdoing
Ultramares doctrine - a common-law approach to third party liability, eathliked
in 1931 in the case of Ultrowhores corporation ✓. Tout he in which ondiery nezligace
is insuf cient for liability to third parties because the lack of privity of contrat
between the third party and the auditor, unless the third party is a pi may
bene ciory.
Ordinary Negligence- Albsense of reasonable care that com
be expected of a person in a set of circumstances.
Constructive fraud - Existence of extreme or unusual negligenca even
Though there was no intent to decieve or do harm. Also reckless
Breach of contract - Failure of one or both parties in a contract to
ful ll the requirements of the contract
Third party benefwory -bes not have privity of contract but is known
to the contracting parties and is intended to have certain bene ts and ghts
Under the contract.
Securities Act of 1933-a federal statute dealing with companies that
register and sell securities to the publis under the statute third parties who
one original purchasers of securities may recover damages from the
auditor if the nancial statements pre misstated, unless the duditor proves
that the audit was adequate or that the third party's loss was caused by
factors other than misleading nancial statements
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Securities Exchange Act of 1934-a federal statute deding with compones
that trade securities on national and over-the-counter exchanges; auditors
gro. involved because the annual reporting requirements include audited
nancial statements
Foreign Corrupt Practices. Act of 1977-A federal statute that
makes it illegal to offer a bribe to an of cial of a foreign country to event
in uence for obtaining or retaining business and that requires Vis componies
to maintain reasonably complete and accurate records and an adequate
System of internal control.
Criminal liability- liability for defrauding a person through knowing
involving with false nancial statements
Chapter 6: Audit Responsibilities and Objectives
Management's responsibility is to adopt sound accounting policies,
maintain adequate internal control, and make fair representations in the
nancial statements
Reasonable assurine -(See DQ #2) cost to obtain evidence
and most importantly suf ciency,
Two forms of fraud:
• Miss appropriation of fraud- a fraud involving the theft of an entity's
assets; often called defabortion.
•Fondulent nancial reporting-intentional misstatements or ommissions of
amounts or disclopes in nancial statements to deceive users; often
called management fraud
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Professional skepticism- an attitude of the auditor that includes
a questioning mind that is alert to condition, that may indicate possible
misstatement due to fraud or error, and a criticy assessment of and t
evidence. Elements include
• Questioning mindset
• Suspension of judgement
Search for toowledg
• Interpersonal understanding
• Autonomy
• Self-esteem
Table 6-1
Con rmation: The tendency to put more weight on information that is
consistent with initial beliefs or preferences
Overgon dence: The tendency to overestimate one's own abilities to
perform tasks or to make accurate assessments of rists or other judgements
and decisions
Anchoring: Tendency to make assessment by starting from an initial
value and then adjusting insuf ciently away from that initial value.
Availability: The tendency to consider information that is easily retrievable
or easily accessible as being more likely or more relevanta
Management assertions- implied or expressed representation by management,
about classes of transactions, related account balones, and presentation
and disclosung in the nancial statements
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Existence or occurrence - Assets or liabilities exist at a given date, and
recorded transactions have occured during the period
Completenes-All transactions and accounts that should be presented in
in the nancial statements are so included.
Accuracy, Valuation, and allocation Assets, liabilities, and equity interests
have been included in the nancial statements at appropriate amounts, any
resulting valuation adjustments have been appropriolely recoded, and related
disclosungs have been appropriately measured and described.
Classi cation- Assets, liabilities, and equity interests have been
recorded in the proper accounts.
Rights and Obligations- The company holds or controls rights to
the assets, and liabilities are obligations of the company at a given dak
Presentation - The components of the nancial Statements are profely
Classi ed, described and disclosed.
Chapter 7. Audit Evidence
Audit procedungs- Detailed instruction for the collection of a
type of audit evidence.
And it Prayan-List of audit procedures for an audit area or an entire
audit; the audit program always includes audit procedures and may also
include sample sizes, items to select, and timing of the tests
Persuasiveness of evidence- the degree to which the auditor is
convinced that the evidence supports the audit opinion; the two determments
of persuasiveness are the approproteas and suf ciency of evidence
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Appropriateness of evidence - a measure of the quality of evidence; appropriate
evidence is relevant and reliable in meeting audit objectives for classes
of transactions account balances, and related disclosures.
Reliability of evidence- the extent to which evidence is believable or
Worthy of trust; evidence is reliable when it is obtained (1) from an independent
provider (2) from a client with effective internal controls, (3) from the
audito's direct knowledge, (4) from quali al providers suchos law rms
and bonts, (5) from objective souxe), and (6) in a timely manner.
Suf ciery. the quantity of evidence; proper simplesize
Physical examination - The quditors inspection or count of a tangible asset
Con rmation- The auditor's receipt of a direct written or electionis response
from a third party verifying the accurney of information requested.
Inspection - the auditors examination of the client's documents and
records to substanite the information that is or should be included in
the nancial statements-
Analytical Paradores - evaluations of nancial information through analysis of
Plansable relationshines amony noncity and non nancial dotel.
Irguines-He obtaining of written or pral information from the client in
response to speci c question during the dudit
Recalculation-recheciting a sample of the computation mode by the client,
including mathematical accuracy of individual transactions and amounts and
the adding of gamals and subsidiary records
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Reperformance the auditors independendent tests of dient accounting
procedures or controls that were originally done as part of the entities of daunting
and internal control system.
Observation-looking at a process of procedure being performed by others
Rahos:
Shartterm Debt-Raying Ability
Cash ratio = cash + martelable secunties/current liabiliting
Quick ratio= tret A/R
cument ratio= cument assets/cument liabilities
Liquidity:
Accounts receivable turnover = net sales/quergegress receivables
Days to collect receivable = 365 days/queants receivable turnover
Inventory trnover = LOG's covers the inventory
Dans to sell inventory = 365 days/ Inventory tumover
Ability fomeethang-Tem Delt- Obligation:
Debt to equity = total licbilities / total equity
Times interes camede openting inwone, interest expense
Pro tability:
Eoming per share = net income /overage common shores outstanding
Gross pro t percent = Net-sales 20065/retsales
Pro t margin = O pecting income
Return on assets = income before taxes/ average tautol assels
return on commonequity= income before taxes 2 & ofered dividends
Average stockholders
Audit documentation record of the audit praeues performed, relevant dudition, the
obtained, and conclusions the auditor reached.
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Chapter 3: Auht Planing and molentily,
to
Acceptable qulit risk - A measure of how willing the duditor is
accept that the nancial statement may be matercolliby misstated after
the and it is completed and an unmodi ed audit opinion has been issued;
Ilient continuance and exceptie.
The successoris required to communicate with the predecessor,
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