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LEGAL LIABILITY

CHANGED LEGAL ENVIRONMENT

Audit professionals have a responsibility under


common law to fulfill implied or expressed
contracts with clients.

They are liable to their clients for negligence


and/or breach of contract should they fail to
provide the services or not exercise due care
in their performance.
BUSINESS FAILURE, AUDIT
FAILURE, AND AUDIT RISK

Audit
Business
Failure
Failure

Audit
Risk
BUSINESS FAILURE, AUDIT
FAILURE, AND AUDIT RISK

Business failure
It occurs when a business is unable to
repay its lenders or meet the
expectations of its investors because
of economic or business conditions.
BUSINESS FAILURE, AUDIT
FAILURE, AND AUDIT RISK

Audit failure
It occurs when the auditor issues an
erroneous audit opinion as the result
of an underlying failure to comply
with the requirements of generally
accepted auditing standards (GAAS).
BUSINESS FAILURE, AUDIT FAILURE, AND AUDIT RISK

Audit risk
It represents the risk that the auditor will
conclude that the financial statements
are fairly stated and an unqualified
opinion can be issued when, in fact,
they are materially misstated.
However, many users believe that auditors guarantee the
accuracy of financial statements, and some users even
believe that the auditor guarantees the financial viability
of the business.
The profession must continue to educate statement
users about the role of auditors and the differences between
business failure, audit failure, and audit risk. However,
auditors must recognize that, in part, the claims of audit failure
result from the hope of those who suffer a business loss to
recover from any source, regardless of who is at fault.
LEGAL CONCEPTS AFFECTING LIABILITY

Prudent
person
concept
Liability for
the acts
of others
Lack of
privileged
communication
FOUR MAJOR SOURCES OF AUDITOR’S LEGAL
LIABILITY

Civil liability under


Liability to clients the federal
securities laws

Liability to third parties


Criminal
under common law
liability
LIABILITY TO CLIENTS

The most common source of lawsuits against CPAs is from


clients.
AUDITOR’S DEFENSES AGAINST CLIENT SUITS
• The lack of duty to perform the service means that the CPA firm claims
that there was no implied or expressed contract.
• For nonnegligent performance in an audit, the CPA firm claims that
the audit was performed in accordance with auditing standards. Even
if there were undiscovered misstatements, the auditor is not
responsible if the audit was conducted properly.
• A defense of contributory negligence exists when the auditor
claims the client’s own actions either resulted in the loss that is the
basis for damages or interfered with the conduct of the audit in such a
way that prevented the auditor from discovering the cause of the loss.
• To succeed in an action against the auditor, the client must be able to
show that there is a close causal connection between the auditor’s
failure to follow auditing standards and the damages suffered by the
client.
CIVIL AND CRIMINAL LIABILITY UNDER THE FEDERAL SECURITIES
LAWS AND RELATED DEFENSES.
• 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
• Securities Exchange Act of 1934
The liability of auditors under this act often centers on the audited financial
statements issued to the public in annual reports or submitted to the SEC as a part
of annual Form 10-K reports.
• Auditor Defenses – 1934 Act
The lack of duty, nonnegligent performance , Absence of casual connection
• SEC and PCAOB Sanctions
The SEC has the power in certain circumstances to sanction or suspend
practitioners from doing audits for SEC companies.
• Foreign Corrupt Practices Act of 1977
The act makes it illegal to offer a bribe to an official of a foreign country for the
purpose of exerting influence and obtaining or retaining business.
• Sarbanes–Oxley Act of 2002
The Act requires the CEO and CFO to certify the annual and quarterly
CRIMINAL LIABILITY
CPAs can be held liable under criminal liability
for accountants. CPAs can be found guilty for
criminal action under both federal and state laws
THE PROFESSION’S RESPONSE
TO LEGAL LIABILITY

Standard and rule setting

Oppose law suits

Education of users

Sanction members for improper


conduct and performance

Lobby for changes in laws


PROTECTING INDIVIDUAL CPAS
FROM LEGAL LIABILITY EXAMPLE

Deal only with clients possessing integrity

Maintain independence

Understand the client’s business

Perform quality audits

Document the work properly

Exercise professional skepticism