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Copyright 2014 Pearson Education

Chapter 4

Legal Liability

Considerations for

Auditors

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Copyright 2014 Pearson Education4-2

Understand the litigious environment in whichCPAs 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 termsconcerning accountants a basis for studying

legal liability of auditors.

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Describe accountants liability to clients andrelated 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 foraccountants.

Describe how the profession and individual

CPAs can reduce the threat of litigation.

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Understand the litigious environment in whichCPAs 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 statementusers

Increased consciousness of the SEC

Complexity in business drives complexity in

auditing and accounting functions

Litigious society

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Explain why the failure of financial statementusers 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 itsobligations 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 termsconcerning 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 toclients andrelated 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 tothird partiesunder common law and related defenses.

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Describe accountants civil liability under thefederal 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 ofRule 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 criminalliability 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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Describe how the profession and individualCPAs 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 ofauditing

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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 ClientsQualified

Personnel

Follow

Professional

Standards

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

All rights reserved. No part of this publication may be reproduced,

stored in a retrieval system, or transmitted, in any form or by anymeans, electronic, mechanical, photocopying, recording, or

otherwise, without the prior written permission of the publisher.

Printed in the United States of America.

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