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Legal Liability

Legal Liability. Chapter 5. Learning Objective 1. Understand the litigious environment in which CPAs practice. Changed Legal Environment. Audit professionals have a contractual responsibility with clients. Auditors are liable for negligence.

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Legal Liability

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  1. Legal Liability Chapter 5

  2. Learning Objective 1 Understand the litigious environment in which CPAs practice.

  3. 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.

  4. Changed Legal Environment 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. Changed Legal Environment 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

  6. Learning Objective 2 Explain why the failure of financial statement users to differentiate among business failure, audit failure, and audit risk has resulted in lawsuits.

  7. 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.

  8. Business Failure, Audit Failure, and Audit Risk • Audit failure Auditor issues an incorrect opinion from a failure to follow GAAS.

  9. Business Failure, Audit Failure, and Audit Risk • Audit risk The risk that the auditor fails to find a material misstatement and issues an unqualified opinion.

  10. Learning Objective 3 Use the primary legal concepts and terms concerning accountants’ liability as a basis for studying legal liability of auditors.

  11. Legal Concepts Affecting Liability • Prudent person concept • Liability for the acts of others • Lack of privileged communication

  12. Legal Terms AffectingCPAs’ Liability • Terms related to negligence and fraud: • Ordinary negligence • Gross negligence • Constructive fraud • Fraud

  13. Legal Terms AffectingCPAs’ Liability Contract Law Breach of contract Third party beneficiary

  14. Legal Terms AffectingCPAs’ Liability Other terms: • Common law • Statutory law • Joint and several liability • Separate and proportionate liability

  15. Learning Objective 4 Describe accountants’ liability to clients and related defenses.

  16. Four Major Sources of Auditors’ Legal Liability

  17. Liability to Clients The most common source of lawsuits against CPAs is from clients.

  18. Auditor’s Defenses AgainstClient Suits • Lack of duty to perform • Nonnegligent performance • Contributory negligence • Absence of causal connection

  19. Learning Objective 5 Describe accountants’ liability to third parties under common law and related defenses.

  20. Liability to Third Parties Under Common Law Ultramares doctrine Foreseen users

  21. Foreseen Users • Credit alliance • Restatement of torts • Foreseeable user

  22. Auditor Defenses AgainstThird-Party Suits

  23. Learning Objective 6 Describe accountants’ civil liability under the federal securities laws and related defenses.

  24. 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.

  25. Securities ExchangeAct of 1934 Auditor liability under this act often centers on the audited financial statements issued in annual reports

  26. 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.

  27. SEC Sanctions SEC can sanction or suspend practitioners. SEC has temporarily suspended a number of individual CPAs from auditing SEC clients.

  28. Foreign CorruptPractices Act of 1977 Bribing a foreign official for the purpose of exerting business related influence is illegal.

  29. 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.

  30. Learning Objective 7 Specify what constitutes criminal liability for accountants.

  31. Criminal Liability

  32. Sarbanes-Oxley Act This act makes it a felony to destroy or create documents to impede or obstruct a federal investigation.

  33. Auditor Defenses – 1933 & 1934 Acts

  34. Learning Objective 8 Describe what the profession and the individual CPA can do and what is being done to reduce the threat of litigation.

  35. The Profession’s Responseto Legal Liability • Research in auditing • Standard and rule setting • Set requirements to protect auditors • Establish peer review requirements

  36. The Profession’s Responseto Legal Liability • Oppose lawsuits • Education of users • Sanction members for improper conduct and performance • Lobby for changes in laws

  37. Protecting Individual CPAsfrom Legal Liability Honest Clients Qualified Personnel Maintain Independence Follow Professional Standards

  38. Protecting Individual CPAsfrom Legal Liability • Understand the client’s business • Perform quality audits • Document the work properly • Obtain an engagement and a representation letter • Maintain confidential relations

  39. Protecting Individual CPAsfrom Legal Liability • Carry adequate insurance • Seek legal counsel • Choose a form of organization with limited liability • Exercise professional skepticism

  40. End of Chapter 5

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