Legal Liability
Learning Objective 1
Understand the litigious
environment in which
Changed Legal Environment
Audit professionals have a responsibility under common law to fulfill implied or expressed
contracts with clients.
They are liable to their clients for negligence and/or breach of contract should they fail to provide the services or not exercise due care
Learning Objective 2
Explain why the failure of financial
statement users to differentiate
among business failure, audit
failure, and audit risk has
resulted in lawsuits.
Explain why the failure of financial
statement users to differentiate
among business failure, audit
failure, and audit risk has
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
Business Failure, Audit
Failure, and Audit Risk
Audit failure
It occurs when the auditor issues an erroneous audit opinion as the result
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,
Learning Objective 3
Use the primary legal concepts
and the terms concerning
accountants’ liability as a
basis for studying legal
Lack of privileged
communication Liability for
the acts of others Prudent
person concept
Federal
securities laws
Third party Client
Major Sources of
Auditor’s Legal Liability
Learning Objective 4
Describe accountants’ liability
to clients and related defenses.
Liability to Clients
The most common source of lawsuits
against CPAs
Legal Terms Affecting
CPAs’ Liability
Terms related to negligence and fraud
Legal Terms Affecting
CPAs’ Liability
Terms related to contract law
Breach of contract
Legal Terms Affecting
CPAs’ Liability
Other terms
Common
Auditor’s Defenses
Against Client Suits
Lack of duty
Nonnegligent performance Contributory negligence
Learning Objective 5
Describe accountants’ liability
to third parties under common
law and related defenses.
Describe accountants’ liability
to third parties under common
Liability to Third Parties
Under Common Law
Ultramares doctrine
Foreseen Users
Credit alliance
Restatement of torts
Learning Objective 6
Describe accountants’ civil
liability under the federal
securities laws and
related defenses.
Describe accountants’ civil
liability under the federal
Securities Act of 1933
The Securities Act imposes an unusual burden on the auditor.
Securities Exchange
Act of 1934
The liability of auditors under this act often centers on the audited financial statements
issued to the public in annual reports or submitted to the SEC as a part of annual
Auditor Defenses – 1934 Act
Nonnegligent performance
Lack of duty
SEC Sanctions
The SEC has the power in certain circumstances to sanction or suspend practitioners from doing
audits for SEC companies.
SEC Sanctions
The commission may deny, the privilege of appearing or practicing before it in any way to any person who is found by the commission… (1) not to possess the requisite qualifications to represent others, or (2) to be lacking in character
or integrity or to have engaged in unethical or
Racketeer Influenced and
Corrupt Organization Act
This act allows an injured party to seek treble (triple) damages and recovery of legal fees
in cases where it can be demonstrated that the defendant was engaged in a
Foreign Corrupt
Practices Act of 1977
This act makes it illegal to offer a bribe to an official of a foreign country for the purpose of exerting influence and
Learning Objective 7
Specify what constitutes
criminal liability
for accountants.
Specify what constitutes
criminal liability
Criminal Liability
CPAs can be held liable under
criminal liability for accountants.
Learning Objective 8
Describe what the profession and
the individual CPA can do and
what is being done to reduce
the threat of litigation.
Describe what the profession and
the individual CPA can do and
The Profession’s Response
to Legal Liability
Research in auditing Standard and rule setting
The Profession’s Response
to Legal Liability
Oppose law suits Education of users
Sanction members for improper conduct and performance
Protecting Individual CPAs
from Legal Liability Example
Deal only with clients possessing integrity Hire qualified personnel
Protecting Individual CPAs
from Legal Liability Example
Understand the client’s business Perform quality audits
Document the work properly
Protecting Individual CPAs
from Legal Liability Example
Carry adequate insurance Seek legal counsel
