Chapter 4 Legal Liability Considerations for Auditors

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Understand the litigious environment in which CPAs practice. Explain why the failure of financial statement users to differentiate among business failure, audit failure, and audit risk has resulted in lawsuits. Use the primary legal concepts and terms concerning accountants a basis for studying legal liability of auditors.
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Describe accountants liability to clients and related defenses. Describe accountants liability to third parties under common law and related defenses. Describe accountants civil liability under the federal securities laws and related defenses.

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Specify what constitutes criminal liability for accountants. Describe how the profession and individual CPAs can reduce the threat of litigation.

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Understand the litigious environment in which CPAs practice.

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Audit professionals have a contractual responsibility with clients. Auditors are liable for negligence.

The number of lawsuits and sizes of awards remain high.

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Major contributors:

Growing awareness by financial statement users

Increased consciousness of the SEC

Complexity in business drives complexity in auditing and accounting functions Litigious society
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Major contributors (cont.):

Global recession and tough economic times Large civil court judgments against CPA firms Willingness of CPA firms to settle out of court Judges and jurors difficulty in understanding technical accounting and auditing matters

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Explain why the failure of financial statement users to differentiate among business failure, audit failure, and audit risk has resulted in lawsuits.

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 Business failure

A business is unable to meet its obligations or investor expectations due to economic or business conditions.

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 Audit failure Auditor issues an incorrect opinion from a failure to follow GAAS.

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 Audit risk The risk that the auditor fails to find a material misstatement and issues an unqualified opinion.

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Use the primary legal concepts and terms concerning accountants liability as a basis for studying legal liability of auditors.

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Prudent person concept Liability for the acts of others Lack of privileged communication

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Terms related to negligence and fraud: Ordinary negligence

Gross negligence
Constructive fraud Fraud

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Contract Law

Breach of contract

Third party beneficiary

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Other terms: Common law Statutory law Joint and several liability Separate and proportionate liability

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Describe accountants liability to clients and related defenses.

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The most common source of lawsuits against CPAs is from clients.

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Lack of duty to perform Nonnegligent performance Contributory negligence

Absence of causal connection

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Describe accountants liability to third parties under common law and related defenses.

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Ultramares doctrine

Foreseen users

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 Credit alliance
Restatement of torts

Foreseeable user

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6
Describe accountants civil liability under the federal securities laws and related defenses.

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The Securities Act imposes an unusual burden on the auditor.

Section 11 of the 1933 act defines the rights of third parties and auditors.
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Auditor liability under this act often centers on the audited financial statements issued to the public in annual reports

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Section 10 and rule 10b-5 are often called the antifraud provisions of the 1934 act.

Scienter states that auditors must have the knowledge and intent to deceive in order to be liable for violation of Rule 10b-5.

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SEC and PCAOB can sanction or suspend practitioners.

SEC has temporarily suspended a number of individual CPAs from auditing SEC clients.

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Bribing a foreign official for the purpose of exerting business related influence is illegal.

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CEO and CFO are required to certify financial statements filed with the SEC. Management must report on the effectiveness of internal controls over financial reporting. Auditors must provide an opinion on internal controls over financial reporting.
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Specify what constitutes criminal liability for accountants.

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This act makes it a felony to destroy or create documents to impede or obstruct a federal investigation.

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8
Describe how the profession and individual CPAs can reduce the threat of litigation.

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 Seek protection from nonmeritorious litigation Improve auditing to better meet users needs

Educate users about the limits of auditing

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 Standard and rule setting

Oppose lawsuits Education of users Sanction members for improper conduct and performance Lobby for changes in laws
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Honest Clients

Qualified Personnel

Follow Professional Standards

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Maintain Independence

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 Deal only with clients possessing integrity Maintain independence Understand the clients business Perform quality audits

Document the work properly

Exercise professional skepticism
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 Carry adequate insurance Seek legal counsel Choose a form of organization with limited liability

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Copyright

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