Addthis Arens Chapter05

(1)

Legal Liability

(2)

Learning Objective 1

Understand the litigious

environment in which

CPAs practice.

(3)

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 in their performance.

(4)

Changed Legal Environment

o Growing awareness of responsibilities of public accountants by users of financial statements

o Increased consciousness of the Securities and Exchange Commission (SEC) for its responsibility for protecting investors’ interests

o Complexity of auditing and accounting functions caused by increasing size of businesses, globalization of business, and complexities of business operations

oTendency of society to accept lawsuits by injured parties against anyone who might be able to provide compensation, regardless of fault (“deep-pocket” concept of

liability)

o Large civil court judgments against CPA firms awarded in a few cases encourage attorneys to provide legal services on a contingent-fee basis – offers the injured party a potential gain when the suit is successful, but minimal losses when it is not

o Willingness of many CPA firms to settle legal problems out of court in an attempt to avoid costly legal fees and adverse publicity, rather than resolution through judicial process

o Judges’ and jurors’ difficulty in understanding and interpreting technical accounting and auditing matters

(5)

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.

(6)

Business Failure, Audit Failure,

and Audit Risk

_{Business failure}

It occurs when a business is unable to repay its lenders or meet the

(7)

Business Failure, Audit Failure,

and Audit Risk

_{Audit failure}

It occurs when the auditor issues an incorrect audit opinion because it

(8)

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

(9)

Learning Objective 3

Use the primary legal concepts

and terms concerning accountants’

liability as a basis for studying

legal liability of auditors.

(10)

_{Lack of privileged communication} _{Liability for the acts of others}

_{Prudent person concept}

Legal Concepts Affecting

(11)

Legal Terms Affecting

CPAs’ Liability

Terms related to negligence and fraud:

_{Ordinary negligence}

_{Constructive fraud} _{Gross negligence}

(12)

Legal Terms Affecting

CPAs’ Liability

Terms related to contract law:

_{Breach of contract}

(13)

Legal Terms Affecting

CPAs’ Liability

Other terms:

_{Common law}

_{Joint and several liability} _{Statutory law}

(14)

Four Major Sources of Auditors’

Legal Liability

_{Liability to third parties}

_{Federal securities laws} _{Liability to clients}

(15)

Learning Objective 4

Describe accountants’ liability to

clients and related defenses.

(16)

Liability to Clients

(17)

Auditor’s Defenses Against

Client Suits

_{Lack of duty to perform}

_{Nonnegligent performance}

_{Contributory negligence}

(18)

Learning Objective 5

Describe accountants’ liability to

third parties under common law

and related defenses.

(19)

Liability to Third Parties Under

Common Law

_Ultramares_doctrine

(20)

Foreseen Users

_{Credit alliance}

_{Restatement of torts}

(21)

Auditor Defenses Against

Third-Party Suits

The preferred defense is

(22)

Learning Objective 6

Describe accountants’ civil liability

under the federal securities laws

and related defenses.

(23)

Securities Act of 1933

The Securities Act imposes an unusual burden on the auditor.

(24)

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

(25)

Rule 10b-5 of the Securities

Exchange Act of 1934

(26)

Auditor Defenses – 1934 Act

_{Non negligent performance}

_{Lack of duty}

(27)

SEC Sanctions

The SEC has the power in certain circumstances to sanction or suspend practitioners from

doing audits for SEC companies.

(28)

Foreign Corrupt

Practices Act of 1977

This act makes it illegal to offer a bribe to an official of a foreign country for

(29)

Sarbanes-Oxley Act of 2002

This act requires the CEO and CFO to certify the annual and quarterly financial statements filed with the SEC.

Management must report its assessment of the effectiveness of internal control

over financial reporting.

(30)

Learning Objective 7

Specify what constitutes criminal

liability for accountants.

(31)

Criminal Liability

CPAs can be held liable under

criminal liability for accountants.

CPAs can be found guilty for criminal

(32)

Sarbanes-Oxley Act

(33)

Learning Objective 8

Describe what the profession and

the individual CPA can do and

what is being done to reduce

the threat of litigation.

(34)

The Profession’s Response

to Legal Liability

_{Research in auditing}

_{Standard and rule setting}

_{Set requirements to protect auditors}

(35)

The Profession’s Response

to Legal Liability

_{Oppose lawsuits}

_{Education of users}

_{Sanction members for improper conduct}

and performance

(36)

Protecting Individual CPAs

from Legal Liability

_{Deal only with clients possessing integrity}

_{Hire qualified personnel}

_{Follow the standards of the profession}

(37)

Protecting Individual CPAs

from Legal Liability

_{Understand the client’s business}

_{Perform quality audits}

_{Document the work properly}

(38)

Protecting Individual CPAs

from Legal Liability

_{Carry adequate insurance}

_{Seek legal counsel}

_{Choose a form of organization with limited liability}

(39)