Presentation on theme: "It Takes the Net Profit From Many Audits to Offset the"— Presentation transcript:
1It Takes the Net Profit From Many Audits to Offset the 5It Takes the Net Profit FromMany Audits to Offset theCost of One Lawsuit
2CHANGED LEGAL ENVIRONMENT Understand the litigious environmentin which CPAs practice.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.
3DISTINCTION AMONG BUSINESS FAILURE, AUDIT FAILURE, AUDIT RISK Explain why the failure of financial statement users todifferentiate among business failure, audit failure, andaudit risk has resulted in lawsuits.Business Failure - occurs when a business is unable to repayits lenders or meet the expectations of its investors because of economicor business conditions.Audit Failure - occurs when the auditor issues an erroneous auditopinion as the result of an underlying failure to comply with the requirementsof generally accepted auditing standards (GAAS).Audit Risk - represents the risk that the auditor will conclude that thefinancial statements are fairly stated and an unqualified opinion can beissued when, in fact, they are materially misstated. EVEN THOUGH IT WASA WELL-CONDUCTED GAAS AUDIT!
5LEGAL CONCEPTS AFFECTING LIABILITY Prudent Person Concept (not perfection)Liability for the Acts of Others (LLP)Lack of Privileged Communication (w/p’s)Use the primary legal concepts andthe terms concerning accountants’liability as a basis for studying legalliability of auditors.Four Major Sources of Auditors’ Legal Liability1. Client - liability to client under common law2. Third party - liability to third parties under common law3. Liability under federal securities laws – SH suit4. Criminal liability – Intent to deceive
6LIABILITY TO CLIENTS Legal Terms Affecting CPAs’ Liability The mostcommon sourceof lawsuitsagainst CPAsis fromclients.Describe accountants’ liability toclients and related defenses.Legal Terms Affecting CPAs’ LiabilityTerms Relatedto Negligenceand FraudOrdinary NegligenceGross NegligenceConstructive FraudFraudTerms Relatedto Contract LawBreach of ContractThird-Party BeneficiaryCommon LawStatutory LawJoint and Several LiabilitySeparate and Proportionate LiabilityOther Terms
7Lack of Duty - means that the CPA claims that there was no implied or expressed contract to perform.Nonnegligent Performance - in an audit, the CPA firmclaims that the audit was performed in accordance with GAAS.Contributory Negligence - exists when the client’s own actionprevents the auditor from discovering the cause of the loss.Absence of Causal Connection - to succeed in an action against theauditor, the client must be able to show that there is a close causal connectionbetween the auditor’s breach of the standard of due care and the damagessuffered by the client.
8LIABILITY TO THIRD PARTIES UNDER COMMON LAW Describe accountants’ liability tothird parties under common lawand related defenses.LIABILITY TO THIRD PARTIESUNDER COMMON LAWUltramares Doctrine - A case that summarized the Liability toThird Parties.Foreseen Users - The broadest interpretation of the rights of third-partybeneficiaries is to use the concept of foreseeable users.Credit Alliance - Was a case in New York in which a lender broughtsuit against the auditor of one of its borrowers, alleging that it relied onthe financial statements of the borrower, who was in default, in grantingthe loan. TO BE LIABLE, THE AUDITOR MUST KNOW WHO WILLRELY ON HIS REPORT AND WHY.Restatement of Torts - foreseen users may be members of aReasonably limited and identifiable group of users (eg, creditors)
9CIVIL LIABILITY UNDERTHE FEDERAL SECURITIES LAWSDescribe accountants’ civil liability under the federal securities laws and related defenses.Securities Act of 1933The Securities Act imposes an unusual burden on the auditor. Section 11 of the1933 act defines the rights of third partiesand auditors. Involves new security issues -Securities Exchange Act of The liability of auditorsunder this act often centers on the audited financial statementsissued to the public in annual reports or submitted to the SEC asa part of annual Form 10-K reports. Fraud=Rule 10b-5
10The SEC has the power in certain circumstances to sanction or suspend practitioners from doing auditsfor SEC companies. Rule 2 (e) of the SEC’s Rules ofPractice states.The commission may deny, temporarily or permanently, the privilegeof appearing or practicing before it in any way to any person who isfound by the commission…..(1) not to possess the requisite qualificationsto represent others, or (2) to be lacking in character or integrity or to haveengaged in unethical or improper professional conduct.
11Racketeer Influenced and Corrupt Organization Act (RICO) This act allows an injured party to seek treble (triple) damagesand recovery of legal fees in cases where it can be demonstratedthat the defendant was engaged in a “pattern of racketeeringactivity.”
12THE PROFESSION’S RESPONSE TO LEGAL LIABILITY Research in auditing Describe what the profession and the individual CPA can do and what is being done to reduce the threat of litigation.Research in auditingStandard and rule settingSet requirements to protect auditorsEstablish peer review requirementsOppose lawsuitsEducation of usersSanction members for improper conduct and performanceLobby for changes in laws