Auditing and assurance services 14e by arens chapter 05

Legal Liability
Chapter 5
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©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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

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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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Legal Terms Affecting
CPAs’ Liability
Contract Law

Breach of
contract

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

Third party
beneficiary

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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

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

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

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Four Major Sources of Auditors’
Legal Liability

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

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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

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Auditor’s 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

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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

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Liability to Third Parties Under
Common Law
Ultramares
doctrine

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

Foreseen
users

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Foreseen Users
 Credit alliance
Restatement of torts
Foreseeable user

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

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Auditor Defenses Against
Third-Party Suits

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

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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

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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

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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

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