Chapter 5

Auditing I Assignment 03 (Chapter 05)

* Multiple Choice Questions From CPA Examinations

5-16 a. (2) b. (1) c. (4)

5-17 a. (3) b. (4) c. (2) d. (2)

* Case

5-27 PART 1

a. In order for Thaxton to hold Mitchell & Moss liable for his losses under the Securities Exchange Act of 1934, he must rely upon the antifraud provisions of Section 10(b) of the act. In order to prevail, Thaxton must establish that:

1. There was an omission or misstatement of a material fact in the financial statements used in connection with his purchase of the Whitlow & Company shares of stock.

2. He sustained a loss as a result of his purchase of the shares of stock.

3. His loss was caused by reliance on the misleading financial statements.

4. Mitchell & Moss acted with scienter (knowledge of the misstatement).

Based on the stated facts, Thaxton can probably prove the first three requirements cited above. To prove the fourth requirement, Thaxton must show that Mitchell & Moss had knowledge of the fraud or recklessly disregarded the truth. The facts clearly indicate that Mitchell & Moss did not have knowledge of the fraud and did not recklessly disregard the truth.

b. The customers and shareholders of Whitlow & Company would attempt to recover on a negligence theory based on Mitchell & Moss’ failure to comply with auditing standards. Even if Mitchell & Moss were negligent, Whitlow & Company’s customers and shareholders must also establish either that:

5-27 PART 1 (continued)

1. They were third-party beneficiaries of Mitchell & Moss’ contract to audit Whitlow & Company, or

2. Mitchell & Moss owed the customers and shareholders a legal duty to act without negligence.

Although many cases have expanded a CPA’s legal responsibilities to a third party for negligence, the facts of this case may fall within...