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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5-3
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
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5-4
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
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5-5
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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5-7
Business Failure, Audit Failure,
and Audit Risk
Audit failure
Auditor issues an incorrect opinion from
a failure to follow GAAS.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5-8
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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5-9
Learning Objective 3
Use the primary legal concepts
and terms concerning accountants
liability as a basis for studying
legal liability of auditors.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 10
Legal Concepts Affecting
Liability
Prudent person concept
Liability for the acts of others
Lack of privileged communication
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 11
Legal Terms Affecting
CPAs Liability
Terms related to negligence and fraud:
Ordinary negligence
Gross negligence
Constructive fraud
Fraud
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 12
Legal Terms Affecting
CPAs Liability
Contract Law
Breach of
contract
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
Third party
beneficiary
5 - 13
Legal Terms Affecting
CPAs Liability
Other terms:
Common law
Statutory law
Joint and several liability
Separate and proportionate liability
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 14
Learning Objective 4
Describe accountants liability to
clients and related defenses.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 15
Four Major Sources of Auditors
Legal Liability
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 16
Liability to Clients
The most common source of lawsuits
against CPAs is from clients.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 17
Auditors Defenses Against
Client Suits
Lack of duty to perform
Nonnegligent performance
Contributory negligence
Absence of causal connection
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 18
Learning Objective 5
Describe accountants liability to
third parties under common law
and related defenses.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 19
Liability to Third Parties Under
Common Law
Ultramares
doctrine
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
Foreseen
users
5 - 20
Foreseen Users
Credit alliance
Restatement of torts
Foreseeable user
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 21
Auditor Defenses Against
Third-Party Suits
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 22
Learning Objective 6
Describe accountants civil liability
under the federal securities laws
and related defenses.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 24
Securities Exchange
Act of 1934
Auditor liability under this act often
centers on the audited financial statements
issued in annual reports
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 26
SEC Sanctions
SEC can sanction or suspend practitioners.
SEC has temporarily suspended a number of
individual CPAs from auditing SEC clients.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 27
Foreign Corrupt
Practices Act of 1977
Bribing a foreign official for the purpose
of exerting business related influence
is illegal.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 29
Learning Objective 7
Specify what constitutes criminal
liability for accountants.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 30
Criminal Liability
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 31
Sarbanes-Oxley Act
This act makes it a felony to destroy
or create documents to impede or
obstruct a federal investigation.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 32
Auditor Defenses
1933 & 1934 Acts
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 33
Learning Objective 8
Describe what the profession and
the individual CPA can do and
what is being done to reduce
the threat of litigation.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 34
The Professions Response
to Legal Liability
Research in auditing
Standard and rule setting
Set requirements to protect auditors
Establish peer review requirements
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
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
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 36
Protecting Individual CPAs
from Legal Liability
Honest Clients
Follow
Professional
Standards
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
Qualified
Personnel
Maintain
Independence
5 - 37
Protecting Individual CPAs
from Legal Liability
Understand the clients business
Perform quality audits
Document the work properly
Obtain an engagement and a representation letter
Maintain confidential relations
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 38
Protecting Individual CPAs
from Legal Liability
Carry adequate insurance
Seek legal counsel
Choose a form of organization with limited liability
Exercise professional skepticism
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 39
End of Chapter
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley
5 - 40
