Question

1.A company engaged a CPA to perform the annual audit of its financial statements. The audit failed to reveal an embezzlement scheme by one of the employees. Which of the following statements best describes the CPA's potential liability for this failure?

The CPA's adherence to generally accepted auditing standards (GAAS) may prevent liability.

The CPA will not be liable if care and skill of an ordinary reasonable person was exercised.

The CPA may be liable for punitive damages if due care was not exercised.

The CPA is liable for any embezzlement losses that occurred before the scheme should have been detected.

Answer 1

Explanation
Choice "a" is correct. A CPA will be liable in negligence if he or she fails
to exercise the care and prudence that an ordinary CPA would exercise
in performing an audit. An ordinary CPA would normally adhere to
GAAS. Thus, proof of adherence to GAAS may prevent liability.

Choice "b" is incorrect. A CPA must perform an audit with the care and
skill that an ordinary CPA would exercise; exercising the care and skill of
an ordinary, reasonable person is not enough.

Choice "c" is incorrect. A CPA may be liable for punitive damages for
willful fraud or recklessly performing an audit. While failure to exercise
due care is a sufficient basis to impose liability for negligence, it is not a
sufficient basis to impose liability for fraud.

Choice "d" is incorrect. This choice sets up a strict liability standard –
CPAs are liable for any embezzlement losses that should have been
detected. The law imposes no such liability. A CPA must at least be
negligent before liability will be imposed.