In the last decade, there has been significant growth in the number and size of legal actions against accounting firms. A study of several years' lawsuits suggests that auditors' legal problems arose from five major types of lawsuits, of which two, client fraud and fraud by the auditor, represented 20 percent of all litigation. The public's perception of the role of the independent auditor differs from that of the auditing profession. Many parties believe that the auditors should search diligently for material client errors, fraud, and illegal acts, that is, be the "guarantors" of external financial information, while many auditors contend that management has the responsibility for reported financial information. To clarify the auditor's role, the auditing profession has issued standards that (1) define the auditor's responsibility for detecting errors, fraud, and illegal acts by clients and (2) outline procedures to be followed when an audit suggests that one or more of these conditions may exist.

Required:

a. 1. Define "errors."

2. Define "fraud."

3. Outline the procedures that external auditors should follow when errors or fraud are suspected.

b. 1. Define "illegal acts."

2. Identify the circumstances that make "illegal acts" more difficult to detect than "errors" and "fraud."

c. Situational pressures on a company or an individual manager may lead to fraudulent financial reporting. Describe several situational pressures that the auditor should give attention to as potential indicators of fraudulent reporting.