audit legal liabilities

7/23/2019 Audit Legal Liabilities

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©2012 Prentice Hall Business Publishing,

Auditing 14/e,

Arens/Elder/Beasley 5

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1

Legal Liability




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Learning Objective 1

Understand the

litigious environment

inwhich CPAs

practice.




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Changed Legal Environment

Audit professionals have acontractual responsibility with clients.

Auditors are liable for negligence.

The number of lawsuits and sizes ofawards remain high.




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Growing awareness by financial statementusers

Increased consciousness of the SEC

Complexity in business drives complexity inauditing and accounting functions

Litigious society

Major contributors:




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Large civil court judgments against CPA firms

Willingness of CPA firms to settle out of court

Judges’ and jurors’ difficulty in understanding

technical accounting and auditing matters

Major contributors (cont.):




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Explain why the failure of financial

statement

users to

differentiate among

business failure,

audit failure

, and auditrisk

has

resulted

in lawsuits.



©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 7

Business Failure, Audit Failure,and Audit Risk

Business failure

A business is unable to meet itsobligations or investor expectations dueto economic or business conditions.





Audit failure

Auditor issues an incorrect opinion froma failure to follow GAAS.





Audit risk

The risk that the auditor fails to find amaterial misstatement and issues anunqualified opinion.





Use the primary legal concepts

and terms concerning accountants’

liability as a basis for studying

legal liability of auditors.




Prudent person concept

Liability for the acts of others

Lack of privileged communication

Legal Concepts AffectingLiability




Legal Terms AffectingCPAs’ Liability

Terms related to negligence and fraud:Ordinary negligence

Gross negligence

Constructive fraud

Fraud





Breach of

contract

Contract Law

Third party

beneficiary





Other terms:

Common law

Joint and several liability

Statutory law

Separate and proportionate liability





Describe accountants’ liability to

clients and related defenses.




Four Major Sources of Auditors’Legal Liability




Liability to Clients

The most common source of lawsuitsagainst CPAs is from clients.




Auditor’s Defenses AgainstClient Suits

Lack of duty to perform

Nonnegligent performance

Contributory negligence

Absence of causal connection





Describe accountants’ liability to

third parties under common law

and related defenses.




Liability to Third Parties UnderCommon Law

Ultramares doctrine Foreseen

users




Foreseen Users

Credit alliance

Restatement of torts

Foreseeable user




Auditor Defenses AgainstThird-Party Suits





Describe accountants’ civil liability

under the federal securities laws

and related defenses.




Securities Act of 1933

The Securities Act imposes anunusual burden on the auditor.

Section 11 of the 1933 act defines therights of third parties and auditors.




Securities Exchange Act of 1934

Auditor liability under this act oftencenters on the audited financial statements

issued in annual reports




Rule 10b-5 of the SecuritiesExchange Act of 1934

Section 10 and rule 10b-5 are often calledthe antifraud provisions of the 1934 act.

“Scienter” states that auditors must havethe knowledge and intent to deceive in

order to be liable for violation ofRule 10b-5.




SEC Sanctions

SEC can sanction or suspend practitioners.

SEC has temporarily suspended a number of

individual CPAs from auditing SEC clients.




Foreign CorruptPractices Act of 1977

Bribing a foreign official for the purposeof exerting business related influence

is illegal.




Sarbanes-Oxley Act of 2002

CEO and CFO are required to certifyfinancial statements filed with the SEC.

Management must report on theeffectiveness of internal controls overfinancial reporting.

Auditors must opine on internal controlsover financial reporting.





Specify what constitutes criminal

liability for accountants.




Criminal Liability




Sarbanes-Oxley Act

This act makes it a felony to destroyor create documents to impede or

obstruct a federal investigation.




Auditor Defenses –1933 & 1934 Acts





Describe what the profession and

the individual CPA can do and

what is being done to reducethe threat of litigation.




The Profession’s Responseto Legal Liability

Research in auditing

Standard and rule setting

Set requirements to protect auditors

Establish peer review requirements




The Profession’s Responseto Legal Liability

Oppose lawsuits

Education of users

Sanction members for improper conductand performance

Lobby for changes in laws




Protecting Individual CPAsfrom Legal Liability

FollowProfessional

Standards

Honest Clients

MaintainIndependence

QualifiedPersonnel





Understand the client’s business

Perform quality audits

Document the work properly

Obtain an engagement and a representation letter

Maintain confidential relations

d d l





Carry adequate insurance

Seek legal counsel

Choose a form of organization with limited liability

Exercise professional skepticism

audit legal liabilities

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