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    CH 5

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    Mohammed Fouad
    The chapter discusses the legal liability of CPAs. It notes that CPAs now practice in a more litigious environment due to factors such as increased complexity, economic downturns, and contingent-fee attorneys. The failure of financial statement users to differentiate between business failure, audit failure, and audit risk has led to more lawsuits against auditors. The chapter outlines key legal concepts in determining CPA liability, including liability to clients and third parties. It also discusses common defenses auditors use against client claims, such as lack of duty, non-negligent performance, contributory negligence, and absence of causal connection.

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    CH 5

    Uploaded by

    Mohammed Fouad
    48 views15 pages
    The chapter discusses the legal liability of CPAs. It notes that CPAs now practice in a more litigious environment due to factors such as increased complexity, economic downturns, and contingent-fee attorneys. The failure of financial statement users to differentiate between business failure, audit failure, and audit risk has led to more lawsuits against auditors. The chapter outlines key legal concepts in determining CPA liability, including liability to clients and third parties. It also discusses common defenses auditors use against client claims, such as lack of duty, non-negligent performance, contributory negligence, and absence of causal connection.

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    Ch5

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    The chapter discusses the legal liability of CPAs. It notes that CPAs now practice in a more litigious environment due to factors such as increased complexity, economic downturns, and contingent-fee attorneys. The failure of financial statement users to differentiate between business failure, audit failure, and audit risk has led to more lawsuits against auditors. The chapter outlines key legal concepts in determining CPA liability, including liability to clients and third parties. It also discusses common defenses auditors use against client claims, such as lack of duty, non-negligent performance, contributory negligence, and absence of causal connection.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    48 views15 pages

    CH 5

    Uploaded by

    Mohammed Fouad
    The chapter discusses the legal liability of CPAs. It notes that CPAs now practice in a more litigious environment due to factors such as increased complexity, economic downturns, and contingent-fee attorneys. The failure of financial statement users to differentiate between business failure, audit failure, and audit risk has led to more lawsuits against auditors. The chapter outlines key legal concepts in determining CPA liability, including liability to clients and third parties. It also discusses common defenses auditors use against client claims, such as lack of duty, non-negligent performance, contributory negligence, and absence of causal connection.

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    LEGAL

    LIABILITY
    CHAPTER 5

    Copyright ©2017 Pearson Education, Inc. 5-1


    CHAPTER 5 LEARNING OBJECTIVES
    5-1 Understand the litigious environment in which CPAs practice.
    5-2 Explain why the failure of financial statement users to
    differentiate among business failure, audit failure, and audit risk
    has resulted in lawsuits.
    5-3 Use the primary legal concepts and terms concerning
    accountants’ liability as a basis for studying legal liability of
    auditors.
    5-4 Describe accountants’ liability to clients and related defenses.
    5-5 Describe accountants’ liability to third parties under common
    law and related defenses.

    Copyright © 2017 Pearson Education, Inc. 5-2


    OBJECTIVE 5-1
    Understand the litigious
    environment in which CPAs
    practice.

    Copyright © 2017 Pearson Education, Inc. 5-3


    CHANGED LEGAL ENVIRONMENT

    • Professionals, including CPAs, are held to a high level of


    performance.
    • Under common law, auditors must fulfill contracts with
    clients and may also be held liable to third parties.
    • Auditors may also be held liable to third parties based
    on statute, including the Securities Act of 1933, the
    Securities Exchange Act of 1934, and the Sarbanes-
    Oxley Act.

    Copyright © 2017 Pearson Education, Inc. 5-4


    CHANGED LEGAL ENVIRONMENT (CONT.)
    Increase in the number of lawsuits and the sizes of the awards to
    plaintiffs
    Reasons for this trend include:
    • Growing awareness of the responsibilities of CPAs
    • Increased effort by the SEC to protect investors’ interests
    • Increased complexity of auditing and accounting
    • Litigious society

    Copyright © 2017 Pearson Education, Inc. 5-5


    CHANGED LEGAL ENVIRONMENT (CONT.)
    Reasons for increased litigation against CPAs (cont):
    • Recession and tough economic times resulting in business failures
    • Attorneys often provide legal services on a contingent-fee basis
    • CPA firms willing to settle legal cases out of court
    • Difficulties of judges and juries understanding technical accounting
    and auditing matters

    Copyright © 2017 Pearson Education, Inc. 5-6


    OBJECTIVE 5-2
    Explain why the failure of financial
    statement users to differentiate among
    business failure, audit failure, and audit
    risk has resulted in lawsuits.

    Copyright © 2017 Pearson Education, Inc. 5-7


    DISTINGUISHING BUSINESS FAILURE,
    AUDIT FAILURE, AND AUDIT RISK

    Important distinctions:
    1. The difference between a business failure and an audit failure
    2. The difference between an audit failure and audit risk

    • A business failure occurs when a business is unable to repay its


    lenders or meet the expectations of investors

    Copyright © 2017 Pearson Education, Inc. 5-8


    DISTINGUISHING BUSINESS FAILURE,
    AUDIT FAILURE, AND AUDIT RISK
    • Audit failure occurs when the auditor issues an incorrect audit
    opinion because the auditor did not comply with auditing
    standards
    • Audit risk represents the possibility that the auditor concludes,
    after conducting an adequate audit, that the financial statements
    were fairly stated when, in fact, they were materially misstated
    In cases when an audit failed to uncover material misstatements
    and the wrong type of opinion was issued, it is appropriate to
    question whether the auditor exercised due care in performing the
    audit.
    If the auditor did not exercise due care, the auditor can be held
    liable for the incorrect opinion.

    Copyright © 2017 Pearson Education, Inc. 5-9


    DISTINGUISHING BUSINESS FAILURE,
    AUDIT FAILURE, AND AUDIT RISK
    The “expectation gap” contributes to the amount of
    litigation against auditors.
    The “expectation gap” refers to the difference between what an
    auditor’s responsibilities are and what the user expects from the
    auditor.
    • Auditor’s responsibility: to perform the audit in accordance with
    auditing standards
    • User expectation: is often that the auditor guarantees the accuracy
    of the financial statements, and even guarantees the viability of
    the business

    Copyright © 2017 Pearson Education, Inc. 5-10


    OBJECTIVE 5-3
    Use the primary legal concepts and terms
    concerning accountants’ liability as a basis
    for studying legal liability of auditors.

    Copyright © 2017 Pearson Education, Inc. 5-11


    LEGAL CONCEPTS AFFECTING LIABILITY
    Some basic legal concepts involved in determining liability:
    • Prudent person concept
    • Liability for the acts of others
    • Lack of privileged communication
    • Legal terms affecting CPAs liability
    • Sources of legal liability:
    1. Liability to clients
    2. Liability to third parties under common law
    3. Civil liability under federal securities laws
    4. Criminal liability
    Some examples of these classifications of liability are included in Figure 5-1.

    Copyright © 2017 Pearson Education, Inc. 5-12


    Copyright ©2017 Pearson Education, Inc. 5-13
    OBJECTIVE 5-4
    Describe accountants’ liability to clients
    and related defenses.

    Copyright © 2017 Pearson Education, Inc. 5-14


    LIABILITY TO CLIENTS

    The most common source of lawsuits against CPAs is from


    clients regarding negligent acts.
    Auditors normally use one, or a combination of,
    the following four defenses with claims filed by
    clients:
    • Lack of duty to perform service
    • Nonnegligent performance
    • Contributory negligence
    • Absence of causal connection

    Copyright © 2017 Pearson Education, Inc. 5-15

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