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©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 1 Legal Liability Chapter 5.

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Presentation on theme: "©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 1 Legal Liability Chapter 5."— Presentation transcript:

1 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 1 Legal Liability Chapter 5

2 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 2 Learning Objective 1 Understand the litigious environment in which CPAs practice.

3 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 3 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.

4 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 4 Changed Legal Environment  Growing awareness by financial statement users  Increased consciousness of the SEC  Complexity in business drives complexity in auditing and accounting functions  Litigious society Major contributors:

5 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 5 Changed Legal Environment  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 Major contributors (cont.):

6 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 6 Learning Objective 2 Explain why the failure of financial statement users to differentiate among business failure, audit failure, and audit risk hasresulted in lawsuits.

7 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 7 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.

8 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 8 Business Failure, Audit Failure, and Audit Risk  Audit failure Auditor issues an incorrect opinion from a failure to follow GAAS.

9 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 9 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.

10 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 10 Learning Objective 3 Use the primary legal concepts and terms concerning accountants’ liability as a basis for studying legal liability of auditors.

11 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 11  Prudent person concept  Liability for the acts of others  Lack of privileged communication Legal Concepts Affecting Liability

12 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 12 Legal Terms Affecting CPAs’ Liability Terms related to negligence and fraud:  Ordinary negligence  Gross negligence  Constructive fraud  Fraud

13 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 13 Legal Terms Affecting CPAs’ Liability Breach of contract Contract Law Third party beneficiary

14 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 14 Legal Terms Affecting CPAs’ Liability Other terms:  Common law  Joint and several liability  Statutory law  Separate and proportionate liability

15 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 15 Learning Objective 4 Describe accountants’ liability to clients and related defenses.

16 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 16 Four Major Sources of Auditors’ Legal Liability

17 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 17 Liability to Clients The most common source of lawsuits against CPAs is from clients.

18 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 18 Auditor’s Defenses Against Client Suits  Lack of duty to perform  Nonnegligent performance  Contributory negligence  Absence of causal connection

19 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 19 Learning Objective 5 Describe accountants’ liability to third parties under common law and related defenses.

20 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 20 Liability to Third Parties Under Common Law Ultramares doctrine Foreseen users

21 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 21 Foreseen Users  Credit alliance  Restatement of torts  Foreseeable user

22 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 22 Auditor Defenses Against Third-Party Suits

23 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 23 Learning Objective 6 Describe accountants’ civil liability under the federal securities laws and related defenses.

24 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 24 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.

25 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 25 Securities Exchange Act of 1934 Auditor liability under this act often centers on the audited financial statements issued in annual reports

26 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 26 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.

27 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 27 SEC Sanctions SEC can sanction or suspend practitioners. SEC has temporarily suspended a number of individual CPAs from auditing SEC clients.

28 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 28 Foreign Corrupt Practices Act of 1977 Bribing a foreign official for the purpose of exerting business related influence is illegal.

29 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 29 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.

30 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 30 Learning Objective 7 Specify what constitutes criminal liability for accountants.

31 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 31 Criminal Liability

32 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 32 Sarbanes-Oxley Act This act makes it a felony to destroy or create documents to impede or obstruct a federal investigation.

33 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 33 Auditor Defenses – 1933 & 1934 Acts

34 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 34 Learning Objective 8 Describe what the profession and the individual CPA can do and what is being done to reduce the threat of litigation.

35 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 35 The Profession’s Response to Legal Liability  Research in auditing  Standard and rule setting  Set requirements to protect auditors  Establish peer review requirements

36 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 36 The Profession’s Response to Legal Liability  Oppose lawsuits  Education of users  Sanction members for improper conduct and performance  Lobby for changes in laws

37 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 37 Protecting Individual CPAs from Legal Liability Follow Professional Standards Honest Clients Maintain Independence Qualified Personnel

38 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 38 Protecting Individual CPAs from Legal Liability  Understand the client’s business  Perform quality audits  Document the work properly  Obtain an engagement and a representation letter  Maintain confidential relations

39 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 39 Protecting Individual CPAs from Legal Liability  Carry adequate insurance  Seek legal counsel  Choose a form of organization with limited liability  Exercise professional skepticism

40 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 40 End of Chapter 5

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