ACCY 6802 Final Exam

auditors’ concerns about errors/misstatements/omissions should include

how does it effect the company and its many stakeholders

how can this problem be fixed and prevent future harm

how did it happen, how was it detected, and how do we prevent similar problems in the future

legal and professional obligations regarding changes to previous f/s depend on if the change is due to

a change in accounting principle used

a change in an estimate used

an error correct

change in accounting principle

change from one accounting principle to another when both principles are generally accepted or when the former principle no longer is generally accepted

it is an error

if the principle used in the earlier period violated GAAP

a change in accounting principle creates a risk that the f/s are not

comparable over time

and that the company is manipulating earnings

companies should change to a new GAAP principle only when

it is required by a new rule

the change is done voluntarily on the basis that the new principle is preferable

if a change is done voluntarily a public company must

file a preferability letter from its auditor

change all prior years under new principle for comparability\

auditor must discuss change in explanatory paragraph

in preferability letter auditor must conclude

the change is preferable

change in accounting estimate

change that results from new information that requires adjusting the carrying amount of an existing asset or liability

change in accounting estimate is immaterial

company makes the change in the ordinary course of accounting

does not need to make disclosures

change in accounting estimate is material

company must disclose the effect of the change on earnings

if the data was available in the previous period but was not used

error correction

if the data for previous period is new

change in accounting estimate

error in earlier f/s

an error in recognition, measurement, presentation, or disclosure in f/s resulting from mathematical mistakes, mistakes in application of GAAP, or the overlook or misuse of facts existing at the time the f/s were prepared

when an error is discovered what happens next depends on

materiality to f/s

materiality of an error depends on

both quantitative and qualitative factors

out of period adjustment

used when the error is clearly immaterial to the current and prior periods’ f/s

make the correct on the current f/s only

normally no disclosure required

revision restatement (little R)

used when the error is immaterial to the prior period f/s but correcting it in the current period could materially misstate the current period f/s

little r restatement is done by

correcting the error in current year comparative f/s for the year being reported

because little r restatements have immaterial errors you do not need to

reissue prior f/s

notify users that they cannot rely on old f/s

amend form 10-k or 10-q

re-issuance restatement (big r restatement)

used when error is material to prior periof f/s

in big r restatement you must

restate and reissue prior periods’ f/s to correct the error

corrections made by filing amended 10-k and 10-q

sec requires that within 4 days of determination that prior period f/s cannot be relied on

company must disclose this fact on 8-k

stealth restatements

little r restatements that simply disclose the prior period error on their periodic report (10-k/q) without filing 8-k

problem with stealth restatements

can create ethical problem if done intentionally to hide material misstatements

should have made a big r restatement

if company’s corporate governance model gives priority to shareholders interests and little corner to other stakeholders

this can lead to earnings management and other financial reporting issues

corporate governance systems also can fail due to

not setting ethical tone at top

management override of i/c

creating excessive pressure to achieve financial targets

lack of an independent audit committe

lack of ethical leadership

leadership is

motivating collective efforts to accomplish shared objectives

transactional leadership

high degree of structure, organization, and top-down direction that uses short term planning and clearly defined goals

performance is monitored and controlled with rewards and punishment

ethical leadership

places weight on communicating values, openness, and trust

more effective in achieving long-term success

transactional leadership creates more

pressure and less motivation

a company is less likely to have ethical problems

with it has ethical leadership

social learning theory

within organizations, individuals look to role models and imitate their behavior

social learning theory suggest thats

leaders should model ethical behavior

authentic leadership is reflected in this definition

ethical leadership is knowing your core values and having the courage to live them in all parts of your life in the service of the common good

transformational leadership

brings about change to improve systems or to cause followers to support higher organizational goals

servant leadership

puts the needs, growth, and wellbeing of their organization, employees, and community above their own needs

focuses on getting employees what they need to succeed

liable

being held responsible (civil case)

guilty

convicted of a crime (criminal case)

illegal

violates criminal law

3 bases (theories of recovery) for auditor legal liability

contract

tort

securities laws

contract

breach of a promise

tort

negligence - carelessness

fraud - intent

securities law

civil

criminal

liability is based on a contract (exchange of promises) between

the auditor and the audit client

even if not stated auditors can be held liable for

breach of an implied promise of due care

implied promise

confidentiality

due care

reasonable competence

reasonable competence requires

knowledge, skill, and judgment of a reasonable auditor but not a guarantee of perfection

professional auditing standards are set by

GAAS

AICPA code of ethics

federal & state regulations

privity of contract

says only parties to the contract can enforce the contract

torts are

wrongful acts other than a broken promise

two torts can arise in a failed audit

negligence

fraud

negligence

failure to use the required amount of due care

for negligence plaintiff must prove

auditor owed the plaintiff a duty of care

auditor breach its duty

breach of duty caused the plaintiff’s injury

ultramares rule

the auditor’s duty extends only to the client (based on the privity of contract)

ultramares rule was modified to

include parties in near privity relationship

near privity relationship

someone to whom the auditor directly provided the audit report

who uses ultramares rule

new york

foreseen user rule

an auditor is liable for negligence only to its client and third parties who are foreseen

or members of a limited class of third parties foreseen relying on the f/s

most states

use foreseen user rule

foreseeable user rule

all whose injuries are foreseeable consequences of negligence

very small amount of states

use foreseeable user rule

foreseeable standard applies for negligence by

everyone except auditors

once the plaintiff meets its burden of proof

the burden shifts to the defendant to prove a defense

alternative defenses in negligence cases

contributory negligence

comparative fault

contributory negligence

the defendant has no liability if the plaintiff’s carelessness contributed to its injury

comparative fault

plaintiff’s fault is compared to the defendant’s fault, and the plaintiff can only recover the proportion of its loss that was the proportion share of the total fault

alternative rules when multiple defendants at fault

joint and several liability

proportionate liability

joint and several liability

where there are multiple defendants at fault the plaintiff can recover from all of them jointly or recover the full amount from any one or more of the severally

proportionate liability

each defendant is liable for the share of the loss that is their share of the total fault

elements of fraud

defendant made a material false statement of omission

with knowledge it was false (scienter)

reliance by the plaintiff

and injury as a result

scienter

intent to decieve

scienter is proven by showing the defendant either

knew statements were false

recklessly disregarded the truth

an auditor that commits fraud can be sued by

all whose injuries are a foreseeable consequence to the fraud

(usual scope of liability for all torts)

an auditor’s liability for fraud

extends to all those who were hurt by relying on false statements

(not the rule when auditors are sued for negligence)

securities act of 1933

regulates the issuance of a security to the public

purpose is to ensure investors have the information they need to make intelligent investment decisions

under 1933 issuers must file with a SEC a

registration statement containing audited f/s

1933 section 11 liability

if the registration materials are false investors can sue the issuer and everyone who signs the registration statement

under 1933 section 11 plaintiffs must prove

they lost money investing in the security and

the registration materials contained material false statement or omission

under 1933 section 11 investors do not need to prove

fraud

negligence

reliance

privity of contract

under 1933 section 11 must important defense is to prove

due diligence (no negligence)

under 1933 section 11 defendant must prove

it made a reasonable investigation and based on that

reasonably believed the statement was true

securities exchange act of 1934

public companies must file an annual report on form 10-k including audited f/s

exposes auditors to potential liability

1934 section 10b and rule 10b-5

it is a crime to commit any fraud in any securities transaction

1934 requires both

scienter = fraudulent intent

reliance by the plaintiff

2 premises of fraud on the market theory

most investor don’t make their own calculations on a fair price before investing

efficient market hypothesis

efficient market hypothesis

markets for securities are highly efficient

price of a security at any moment reflects all info at any moment

liability under federal securities laws is

proportionate and joint and several except where there was intentional wrongdoing

both 33 and 34 have

criminal provisions for intentional violations

sec can sanction professionals under rule of practice 102(e) for

lacking qualifications to do sec work

willingly violating or aiding in violating securities law

engaging in improper professional conduct

improper professional conduct

an intentional violation, or multiple careless violations of professional standards

sanctions

civil penalties up to $500,000 and bar or suspension from sec practice

when an auditing firm violates auditing standards

it can be penalized by the pcaob

associated person liability

individual auditors can also be liable for the firm’s violation of audit standards

2024 pcaob modified apl to

make individual auditors secondarily liable for the firm’s violation of audit standards when the individual acted negligently

shift from recklessness to negligence is

bad for auditors because recklessness is an extreme form of negligence

associated person liability only applies to

people in a position to directly and substantially contribution to the firm’s violation

foreign corrupt practices act 2 provisions

anti-bribery

accouting

fcpa anti-bribery provision

it is illegal for any US person to pay or offer to pay a bribe to a foreign politician, political party, or government official to influence government decision