1. 19 - 1 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Chapter 51: Liability of Accountants Chapter 51: Liability of Accountants Business Law Legal, E-Commerce, Ethical, and International Environments

2. 19 - 2 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Certified Public Accountant (CPA) CPA – an accountant who has: –met certain educational requirements –passed the CPA examination –had a certain number of years of audit experience Public Accountant – a person who is not certified.

3. 19 - 3 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Primary Functions of Accountants Primary functions: –Auditing financial statements –Rendering opinions about those audits Other functions: –Rendering tax advice and tax preparation –Preparing unaudited financial statements –Consulting services

4. 19 - 4 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Accounting Standards and Principles Generally Accepted Accounting Principles (GAAP) –Standards for the preparation and presentation of financial statements. Generally Accepted Accounting Principles (GAAP) –Standards for the preparation and presentation of financial statements. Generally Accepted Auditing Standards (GAAS ) –Standards for the methods and procedures that must be used to conduct audits. Generally Accepted Auditing Standards (GAAS ) –Standards for the methods and procedures that must be used to conduct audits.

5. 19 - 5 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Audits The verification of a company’s books and records pursuant to: –Federal securities laws –State laws –Stock exchange rules The audit must be performed by an independent CPA. –Must conduct sampling –Verify information from third parties

6. 19 - 6 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Auditor’s Opinions After the audit is complete, the auditor must render an opinion about how fairly the financial statements present: –the company’s financial position, –result of operations, and –change in financial position

7. 19 - 7 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Auditor’s Opinions (continued) The auditor’s opinion may be: –Unqualified –Qualified –Adverse Disclaimer of Opinion expresses the auditor’s inability to draw a conclusion as to the accuracy of the company’s financial records.

8. 19 - 8 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Limited Liability Partnership (LLP) A special for of partnership where all partners are limited partners. Only loss incurred is capital contributions. Most public accounting firms operate as an LLP.

9. 19 - 9 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Liability of Accountants to Their Clients Breach of Contract Fraud Negligence

10. 19 - 10 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Breach of Contract Terms of engagement are specified when accountant and client enter into contract. If accountant fails to perform, he is liable for breach. Damages include: –Expenses incurred in securing new accountant –Fines and penalties owed because of delay

11. 19 - 11 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Fraud When accountant is liable for actual or constructive fraud, client can recover proximate damages. Punitive damages may be awarded in cases of actual fraud.

12. 19 - 12 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Negligence Accountants owe duty to use reasonable care, knowledge, skill, and judgment. Measured against those actions of a reasonable accountant. May be sued for damages if fails to meet standards.

13. 19 - 13 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Liability of Accountants to Third Parties There are three major rules of liability that a state may adopt in determining whether an accountant is liable in negligence to third parties: 1. The Ultramares Doctrine 2. Section 552 of the Restatement (Second) of Torts 3. The foreseeability standard

14. 19 - 14 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Ultramares Doctrine A rule that an accountant is liable only for negligence to third parties who are in privity of contract or a privity-like relationship with the accountant. Provides the narrowest standard for holding accountants liable to third parties for negligence.

15. 19 - 15 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Section 552 of the Restatement (Second) of Torts A rule that an accountant is liable only for negligence to third parties who are members of a limited class of intended users of the client’s financial statements. Provides a broader standard for holding accountants liable to third parties for negligence than the Ultramares doctrine.

16. 19 - 16 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman The Foreseeability Standard A rule that an accountant is liable for negligence to third parties who are foreseeable users of the client’s financial statements. Provides the broadest standard for holding accountants liable to third parties for negligence.

17. 19 - 17 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Fraud If an accountant engages in actual or constructive fraud, a third party who relies on the accountant’s fraud and is injured may bring tort action to recover damages.

18. 19 - 18 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Breach of Contract Third parties usually cannot sue accountants for breach of contract. –Third parties are merely incidental beneficiaries who do not acquire any rights under the accountant-client contract. –They are not in privity of contract with the accountants.

19. 19 - 19 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Statutory Liability of Accountants The Securities Act of 1933 –Section 11(a) The Securities Exchange Act of 1934 –Section 10(b) and Rule 10b-5 –Section 18(a) Private Securities Litigation Reform Act of 1995

20. 19 - 20 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Criminal Liability of Accountants Criminal Violations of the Securities Act of 1933 –Section 24 Criminal Violations of the Securities Exchange Act of 1934 –Section 32(a) 1976 Tax Reform Act Racketeer Influenced and Corrupt Organizations Act

21. 19 - 21 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Accountant-Client Privilege Accountant cannot be called as a witness against a client in a court action. An accountant can be a plaintiff in a lawsuit.

22. 19 - 22 © 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Sarbanes-Oxley Act of 2002 Major Provisions: Establishment of the Public Company Accounting Oversight Board. Public accounting firms must register with the board. Separation of audit and nonaudit services. Audit reports sign-offs Prohibited employment.