Audit Legal Liabilities

Legal Liability
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5-1
Learning Objective 1
Understand the litigious environment in
which CPAs practice.
5-2
Changed Legal Environment

Audit professionals have a
contractual responsibility with clients.
Auditors are liable for negligence.
The number of lawsuits and sizes of
awards remain high.
5-3

Major contributors:
Growing awareness by financial statement

users
Increased consciousness of the SEC
Complexity in business drives complexity in
auditing and accounting functions
Litigious society
5-4

Major contributors (cont.):
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
5-5
Explain why the failure of financial
statement users to differentiate among
business failure, audit failure, and audit
risk has resulted in lawsuits.
5-6
Business Failure, Audit Failure,

and Audit Risk
Business failure
A business is unable to meet its
obligations or investor expectations due
to economic or business conditions.
5-7

and Audit Risk
Audit failure
Auditor issues an incorrect opinion from

a failure to follow GAAS.
5-8

and Audit Risk
Audit risk
The risk that the auditor fails to find a

material misstatement and issues an
unqualified opinion.
5-9
Use the primary legal concepts
and terms concerning accountants
liability as a basis for studying
legal liability of auditors.
5 - 10
Legal Concepts Affecting

Liability
Prudent person concept
Liability for the acts of others
Lack of privileged communication
5 - 11
Legal Terms Affecting

CPAs Liability
Terms related to negligence and fraud:
Ordinary negligence
Gross negligence
Constructive fraud
Fraud
5 - 12

CPAs Liability
Contract Law
Breach of
contract
Third party
beneficiary
5 - 13

CPAs Liability
Other terms:
Common law
Statutory law
Joint and several liability
Separate and proportionate liability
5 - 14
Describe accountants liability to
clients and related defenses.
5 - 15
Four Major Sources of Auditors

Legal Liability
5 - 16
Liability to Clients
The most common source of lawsuits
against CPAs is from clients.
5 - 17
Auditors Defenses Against

Client Suits
Lack of duty to perform
Nonnegligent performance
Contributory negligence
Absence of causal connection
5 - 18
Describe accountants liability to
third parties under common law
and related defenses.
5 - 19
Liability to Third Parties Under

Common Law
Ultramares
doctrine
Foreseen
users
5 - 20
Foreseen Users
Credit alliance
Restatement of torts
Foreseeable user
5 - 21
Auditor Defenses Against

Third-Party Suits
5 - 22
Describe accountants civil liability
under the federal securities laws
and related defenses.
5 - 23
Securities Act of 1933

The Securities Act imposes an
unusual burden on the auditor.
Section 11 of the 1933 act defines the

rights of third parties and auditors.
5 - 24
Securities Exchange
Act of 1934
Auditor liability under this act often
centers on the audited financial statements
issued in annual reports
5 - 25
Rule 10b-5 of the Securities

Exchange Act of 1934
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 of
Rule 10b-5.
5 - 26
SEC Sanctions
SEC can sanction or suspend practitioners.
SEC has temporarily suspended a number of

individual CPAs from auditing SEC clients.
5 - 27
Foreign Corrupt
Practices Act of 1977
Bribing a foreign official for the purpose
of exerting business related influence
is illegal.
5 - 28
Sarbanes-Oxley Act of 2002

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 opine on internal controls
over financial reporting.
5 - 29
Specify what constitutes criminal
liability for accountants.
5 - 30
Criminal Liability
5 - 31
Sarbanes-Oxley Act
This act makes it a felony to destroy
or create documents to impede or
obstruct a federal investigation.
5 - 32
Auditor Defenses
1933 & 1934 Acts
5 - 33
Describe what the profession and
the individual CPA can do and
what is being done to reduce
the threat of litigation.
5 - 34
The Professions Response

to Legal Liability
Research in auditing
Standard and rule setting
Set requirements to protect auditors
Establish peer review requirements
5 - 35
The Professions Response

to Legal Liability
Oppose lawsuits
Education of users
Sanction members for improper conduct
and performance
Lobby for changes in laws
5 - 36
Protecting Individual CPAs

from Legal Liability
Honest Clients
Follow
Professional
Standards
Qualified
Personnel
Maintain
Independence
5 - 37

Understand the clients business
Perform quality audits
Document the work properly
Obtain an engagement and a representation letter
Maintain confidential relations
5 - 38

Carry adequate insurance
Seek legal counsel
Choose a form of organization with limited liability
Exercise professional skepticism
5 - 39
End of Chapter
5 - 40

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Legal Liability

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Changed Legal Environment

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Changed Legal Environment

Growing awareness by financial statement

Changed Legal Environment

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Business Failure, Audit Failure,

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Business Failure, Audit Failure,

Auditor issues an incorrect opinion from

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Business Failure, Audit Failure,

The risk that the auditor fails to find a

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Legal Concepts Affecting

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Legal Terms Affecting

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Legal Terms Affecting

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Legal Terms Affecting

Separate and proportionate liability

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Four Major Sources of Auditors

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Auditors Defenses Against

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Liability to Third Parties Under

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Auditor Defenses Against

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Securities Act of 1933

Section 11 of the 1933 act defines the

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Rule 10b-5 of the Securities

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

SEC has temporarily suspended a number of

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Sarbanes-Oxley Act of 2002

Management must report on the

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

The Professions Response

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

The Professions Response

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley