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Legal Liability. Chapter 5. Key Topics in Chapter 5. Legal liability for auditors Liability to clients, and defenses Liability to third parties, and defenses Liability from Federal securities law: Securities acts of 1933 and 1934 Criminal liability.

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Legal liability

Legal Liability

Chapter 5


Key topics in chapter 5

Key Topics in Chapter 5

  • Legal liability for auditors

    • Liability to clients, and defenses

    • Liability to third parties, and defenses

    • Liability from Federal securities law: Securities acts of 1933 and 1934

    • Criminal liability


Business failure audit failure and audit risk

Business Failure, Audit Failure, and Audit Risk

Business failure

It occurs when a business is unable to

repay its lenders or meet the

expectations of its investors because

of economic or business conditions.


Business failure audit failure and audit risk1

Business Failure, Audit Failure, and Audit Risk

Audit failure

It occurs when the auditor issues an

erroneous audit opinion as the result

of an underlying failure to comply

with the requirements of generally

accepted auditing standards (GAAS).


Business failure audit failure and audit risk2

Business Failure, Audit Failure, and Audit Risk

Audit risk

It represents the risk that the auditor will

conclude that the financial statements

are fairly stated and an unqualified

opinion can be issued when, in fact,

they are materially misstated.


Business failure audit failure and audit risk3

Business Failure, Audit Failure, and Audit Risk

Audit

failure

Business

failure

Audit

risk


Four major sources of auditors legal liability

Four Major Sources of Auditors’ Legal Liability

Client

Third party

Federal

securities laws

Criminal

liability


Liability from clients

Liability From Clients

The most common source of lawsuits

against CPAs is from clients.


Liability under the common law

Liability Under the Common Law

  • Liability to Clients:

    • Under contract law - for breach of contract

    • Under tort law** for:

      • Ordinary negligence – failure to exercise care a reasonable person would under the same circumstances

      • Gross negligence – failure to use even slight care in circumstances

      • Fraud- intentional deception

  • ** Tort = wrongful act that injures another person’s property, body, or reputation.


Auditor s defenses against client suits

Auditor’s Defenses AgainstClient Suits

Lack of duty to perform

Nonnegligent performance

Contributory negligence

Absence of causal connection


Liability to third parties under common law

Liability to Third Parties Under Common Law

Ultramares doctrine

Foreseen users


Liability third parties under the common law

Liability Third Parties Under the Common Law

  • Ultramares:upheld the privity of contract doctrine: third parties cannot sue auditors for ordinary negligence.

  • Foreseen users – A limited group of persons for whom the auditor is aware will rely on the financial statements.


Auditor defenses against third party suits

Auditor Defenses AgainstThird-Party Suits

The preferred defense is

nonnegligent performance.


Securities act of 1933

Securities Act of 1933

The Securities Act imposes an unusual

burden on the auditor – see p. 117.

  • 1933 Act :

  • Deals only with new securities.

  • Only original purchasers of securities

  • may recover from auditors.


Securities exchange act of 1934

Securities Exchange Act of 1934

1934 Act – requires ongoing filing of quarterly and

annual reports, and other information to keep the

registration statement current. Certain information,

including financial statements must be audited.

  • The liability of auditors under this act often

  • centers on Rule 10b-5, p. 118.

    • It may apply to accountants if they intentionally

    • or recklessly misrepresent information intended for

    • 3rd party use.


Auditor defenses 1934 act

Auditor Defenses – 1934 Act

Nonnegligent performance

Lack of duty

Absence of causal connection


Criminal liability

Criminal Liability

  • CPAs can be found guilty for criminal

  • action under both federal and state laws.

    • Most laws make it a criminal offense to

    • defraud another person through knowingly

    • being involved with falsifications in financial

    • statements.

The Sarbanes-Oxley Act makes it a felony

to destroy or create documents to impede

Or obstruct a federal investigation.


Protecting individual cpas from legal liability

Protecting Individual CPAsfrom Legal Liability

Deal only with clients possessing integrity

Hire qualified personnel

Follow the standards of the profession

Maintain independence


Protecting individual cpas from legal liability1

Protecting Individual CPAsfrom Legal Liability

Understand the client’s business

Perform quality audits

Document the work properly

Obtain an engagement and a representation letter

Maintain confidential relations


Protecting individual cpas from legal liability2

Protecting Individual CPAsfrom Legal Liability

Carry adequate insurance

Seek legal counsel

Choose a form of organization with limited liability

Exercise professional skepticism


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