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Copyright 2014 Pearson Education
Chapter 4
Legal Liability
Considerations for
Auditors
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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.