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Unformatted text preview: 1 Chapter 5 Legal Liability Review Questions 5-3 Business failure is the risk that a business will fail financially and, as a result, will be unable to pay its financial obligations. Audit risk is the risk that the auditor will conclude that the financial statements are fairly stated and an unqualified opinion can therefore be issued when, in fact, they are materially misstated. When there has been a business failure, but not an audit failure, it is common for statement users to claim there was an audit failure, even if the most recently issued audited financial statements were fairly stated. Many auditors evaluate the potential for business failure in an engagement in determining the appropriate audit risk. 5-4 The prudent person concept states that a person is responsible for conducting a job in good faith and with integrity, but is not infallible. Therefore, the auditor is expected to conduct an audit using due care, but does not claim to be a guarantor or insurer of financial statements. 5-5 The difference between fraud and constructive fraud is that in fraud the wrongdoer intends to deceive another party whereas in constructive fraud there is a lack of intent to deceive or defraud. Constructive fraud is highly negligent performance. 5-7 An auditor's best defense for failure to detect a fraud is an audit properly conducted in accordance with auditing standards. SAS 99 states that the auditor should assess the risk of material misstatements of the financial statements due to fraud. Based on this assessment, the auditor should design the audit to provide reasonable assurance of detecting material misstatements due to fraud. SAS 99 also states that because of the nature of fraud (including defalcations), a properly designed and executed audit may not detect a material misstatement due to fraud. 5-8 Contributory negligence used in legal liability of auditors is a defense used by the auditor when he or she claims the client or user also had a responsibility in the legal case. An example is the claim by the auditor that management knew of the potential for fraud because of weaknesses in internal control, but refused to correct them. The auditor thereby claims that the client contributed to the fraud by not correcting material weaknesses in internal control. 5-9 1. An engagement letter from the auditor to the client specifies the responsibilities of both parties and states such matters as fee arrangements and deadlines for completion. 2. The auditor may also use the engagement letter as an opportunity to inform the client that the responsibility for the prevention of fraud is that of the client. 3. A well-written engagement letter can be useful evidence in the case of a lawsuit, given that the letter spells out the terms of the engagement agreed to by both parties. Without an engagement letter, the terms of the engagement are easily disputed....
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- Spring '11
- Auditor's report, U.S. Securities and Exchange Commission