Audit Chapter 5

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kirkgg
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Audit Chapter 5
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2014-02-11 17:21:03
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Audit Chapter 5
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  1. What is the year of the Securities Act? What does this act do?
    1933 - Makes it so IPOs must be preceded by an audit.
  2. Who bears the burden of proof under 1933 Securities Act lawsuits?
    The auditors/CPA firm bears burden of proof. i.e. - the investors must only prove they suffered a loss and the CPA firm must prove it was not at fault.
  3. What year is the Securities Exchange Act? What does it say?
    1934 - Publicly traded companies must be audited every year.
  4. Name this case:

    Management , including top management, was involved in a massive fraud that increased the value of inventory - allowing the client to borrow at a lower interest rate and obtain higher fire insurance. When an employee of the client discovered and reported the fraud, stockholders won in a class action lawsuit. 

    Years later, the client sued the CPA firm for breach of contract, professional negligence, and fraud. The CPA firm's main defense was that the auditors attempted to follow up on indications of fraud, management's tactics to cover it up prevented the firm from discovering the fraud. The CPA firm won on the basis that management's wrongdoing was a valid defense against the charges.
    Cenco Inc. v Seidman & Seidman (1982)
  5. What does the Cenco Inc. v Seidman & Seidman (1982) case entail?
    Seidman and Seidman failed to uncover a massive fraud that was done by Cenco's management. Cenco sued Seidman & Seidman for negligence, but Seidman & Seidman won on the basis that the management's wrongdoings prevented Seidman & Seidman from uncovering the fraud.
  6. Name this case:

    A CPA firm was engaged by a real estate management agent to prepare financial statements, a tax return, and some other accounting services for a client. There was no engagement to perform an audit. It turns out that the manager of the firm embezzled significant funds from the tenants. The accountants did not uncover the fraud.

    The court ruled that the CPA firm actually was engaged to perform an audit because "some audit procedures" were performed by the firm, including preparation of a "missing invoices" worksheet. The court held the CPA firm liable because the CPAs had a responsibility to follow up on those missing invoices, but they did not.
    1136 Tenants v. Max Rothenberg and Company (1967)
  7. Explain what happened during this case: 1136 Tenants v. Max Rothenburg and Company
    Max Rothenburg and Company was engaged by a real estate management agent to prepare financial statements, a tax return, and some other accounting services for a client. There was no engagement to perform an audit.

    It turns out that the manager of the firm embezzled significant funds from the tenants. The accountants did not uncover the fraud.The court ruled that the CPA firm actually was engaged to perform an audit because "some audit procedures" were performed by the firm, including preparation of a "missing invoices" worksheet.

    The court held the CPA firm liable because the CPAs had a responsibility to follow up on those missing invoices, but they did not. From this case we learn that specific Engagement letters are important.
  8. Name this case: The creditors of an insolvent corporation sued the auditing CPA firm, claiming that the firm should have been able to discover the $50,000 discrepancy in Accounts Receivable. 

    The Court ruled that 3rd parties can only sue in cases due to fraud, not honest blunders.
    Ultramares Corporation v. Touche (1931)
  9. What does the Ultramares Corporation v. Touche (1931) case entail?
    The creditors of Ultramares sued the auditing CPA firm, claiming that the firm should have been able to discover the $50,000 discrepancy in Accounts Receivable. 

    The Court ruled that 3rd parties can only sue in cases due to fraud, not honest blunders.
  10. Name this case: A New York lendor brought suit against the auditors of one of its borrowers, claiming that it relied on the financial statements of the borrower, who defaulted, in granting the loan.

    The court ruled that accountants must know and intend their products to be used by a specific 3rd party.
    Credit Alliance v. Arthur Andersen (1986)
  11. What does this case entail? Credit Alliance v. Arthur Andersen (1986)
    A New York lender brought suit against the auditors of one of its borrowers, claiming that it relied on the financial statements of the borrower, who defaulted, in granting the loan.The court ruled that accountants must know and intend their products to be used by a specific 3rd party.
  12. Name this case: The third parties to this case won. The court ruled that CPAs are liable to any foreseeable user of financial statements.
    Rosemblum, Inc. v. Adler (1983)
  13. What does Rosenblum v. Adler (1983) entail?
    The third parties to this case won. The court ruled that CPAs are liable to any foreseeable user of financial statements.
  14. Name this case: A lender asked a CPA firm to audit the financial statements of a potential borrower. The auditors issued a report indicating the company was solvent, but it was insolvent. The court relied on the Restatement of Torts principle to find the CPA guilty.
    Rusch Factors v. Levin (1968)
  15. What is the restatement of torts principle?
    This principle says that professionals are liable to a reasonably limited and identifiable group of users who have relied on the CPA's work, such as creditors.
  16. What is the Rusch Factors v. Levin (1968) case?
    Rusch Factors asked a CPA firm to audit the financial statements of a potential borrower, Levin. The auditors issued a report indicating Levin was solvent, but it was insolvent. The court relied on the Restatement of Torts principle to find the CPAs guilty.
  17. Name this case: A construction company made an IPO, but went bankrupt 17 months later. The court found that the firm's audit program was in compliance with auditing standards. However, the court was critical of the accountants for accepting "glib answers" to questions, instead of following up.

    The CPA firm was found liable because it had not established due diligence.
    Escott et al. v. BarChris Construction Corporation (1968) - Securities Act of 1933
  18. What is the history of the Escott et al. v. BarChris Construction Corporation (1968) case?
    A construction company made an IPO, but went bankrupt 17 months later. The court found that the firm's audit program was in compliance with auditing standards. However, the court was critical of the accountants for accepting "glib answers" to questions, instead of following up.The CPA firm was found liable because it had not established due diligence.
  19. What is rule 10b-5?
    A rule by the SEC that says it is illegal to commit fraud through the use of mail or any national securities system.

    It is also illegal to be an aider or abettor to someone breaking rule 10b-5.
  20. Name this case: 

    The President of the client, Nay, devised a mail rule that made it so checks written to his company must be made out to him. Nay never placed investors funds in any company account.

    In the subsequent litigation, plaintiffs claimed that the CPAs should have uncovered the "mail rule" and the fraud. They claimed the CPAs acted as "aiders and abettors" under section 10b-5.

    The supreme court ruled that the language of 10b-5 requires scienter or recklessness. Neither was present in this case - only negligence.
    Hochfelder v. Ernst & Ernst (1976)
  21. What is the Hochfelder v. Ernst & Ernst (1976) case about?
    The President of the client, Nay, devised a mail rule that made it so checks written to his company must be made out to him. Nay never placed investors funds in any company account.In the subsequent litigation, plaintiffs claimed that the CPAs should have uncovered the "mail rule" and the fraud. They claimed the CPAs acted as "aiders and abettors" under section 10b-5.The supreme court ruled that the language of 10b-5 requires scienter or recklessness. Neither was present in this case - only negligence.
  22. Name this case:

    A manufacturer of electronic devices overstated inventory by 30% in order to help itself acquire new companies. 

    Concerning the auditors, the court ruled that sufficient recklessness could be a basis of a 10b-5 ruling, but since the auditors had knowledge of the act, there was no reason to prove sufficient recklessness.
    Howard Sirota v. Solitron Devices, Inc (1982)
  23. What is the Howard Sirota v. Solitron Devices, Inc (1982) case about?
    A manufacturer of electronic devices overstated inventory by 30% in order to help itself acquire new companies. Concerning the auditors, the court ruled that sufficient recklessness could be a basis of a 10b-5 ruling, but since the auditors had knowledge of the act, there was no reason to prove sufficient recklessness.
  24. What is the foreign corrupt practices act of 1977?
    This act makes it illegal to bribe a foreign country official in order to exert influence and obtain/retain business.
  25. Name this case:

    The auditor found out that its large client was being investigated by the SEC. The SEC served the CPA firm a subpoena in connection with its client, and the firm subsequently shredded extensive physical documentation and deleted computer files. 

    The firm was convicted of one count of obstruction of justice, based on the alteration of a memo. This firm was no longer able to audit publicly traded U.S. companies. 

    The conviction was actually overturned by the U.S. Supreme Court in 2005, but the victory was largely symbolic since the firm ceased operations after the original conviction.
    United States v. Andersen (2002)
  26. Talk about what happened in the United States v. Anderson (2002) case.
    The auditor found out that its large client was being investigated by the SEC. The SEC served the CPA firm a subpoena in connection with its client, and the firm subsequently shredded extensive physical documentation and deleted computer files. The firm was convicted of one count of obstruction of justice, based on the alteration of a memo. This firm was no longer able to audit publicly traded U.S. companies. The conviction was actually overturned by the U.S. Supreme Court in 2005, but the victory was largely symbolic since the firm ceased operations after the original conviction.
  27. What happened in United States v. Natelli (1975)?
    Two auditors were convicted of criminal liability under the 1934 act for certifying financial statements of National Student Marketing Corporation that contained inadequate disclosure.
  28. What happened in United States v. Weiner (1975)?
    Three auditors were convicted of securities fraud in their audit of Equity Funding Corporation of America. The audit work was so poor that the court ruled the auditors must have been aware of the fraud and were therefore guilty of knowing complicity.
  29. ESM Government Securities v. Alexander Grant & Co. (1986)
    Management revealed to an audit partner that last year's audited statements had a material misstatement. Rather than comply with auditing standards, the partner agreed to say nothing in hopes that management would work its way out of the problem in the current year. The partner was convicted of criminal charges for sustaining fraud.

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