1. Copyright © 2004 by Prentice-Hall. All rights reserved. PowerPoint Slides to Accompany BUSINESS LAW E-Commerce and Digital Law International Law and Ethics 5 th Edition by Henry R. Cheeseman Slides developed by Les Wiletzky Wiletzky and Associates, Puyallup, WA Chapter 43 Liability of Accountants Chapter 43 Liability of Accountants

2. 43 - 2Copyright © 2004 by Prentice-Hall. All rights reserved. Certified Public Accountant (CPA)  CPA – an accountant who has: met certain educational requirements met certain educational requirements passed the CPA examination passed the CPA examination had a certain number of years of audit experience had a certain number of years of audit experience  Public Accountant – a person who is not certified.

3. 43 - 3Copyright © 2004 by Prentice-Hall. All rights reserved. Primary Functions of Accountants  Primary functions: Auditing financial statements Auditing financial statements Rendering opinions about those audits Rendering opinions about those audits  Other functions: Rendering tax advice and tax preparation Rendering tax advice and tax preparation Preparing unaudited financial statements Preparing unaudited financial statements Consulting services Consulting services

4. 43 - 4Copyright © 2004 by Prentice-Hall. All rights reserved. Generally Accepted Accounting Standards  Generally Accepted Accounting Principles (GAAP) Standards for the preparation and presentation of financial statements. Standards for the preparation and presentation of financial statements.  Generally Accepted Accounting Principles (GAAP) Standards for the preparation and presentation of financial statements. 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. 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. Standards for the methods and procedures that must be used to conduct audits.

5. 43 - 5Copyright © 2004 by Prentice-Hall. All rights reserved. Audit  The verification of a company’s books and records pursuant to: Federal securities laws Federal securities laws State laws State laws Stock exchange rules Stock exchange rules  The audit must be performed by an independent CPA.

6. 43 - 6Copyright © 2004 by Prentice-Hall. All rights reserved. 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, the company’s financial position, result of operations, and result of operations, and change in financial position change in financial position

7. 43 - 7Copyright © 2004 by Prentice-Hall. All rights reserved. Auditor’s Opinions (continued)  The auditor’s opinion may be: Unqualified Unqualified Qualified Qualified Adverse Adverse  Disclaimer of Opinion – expresses the auditor’s inability to draw a conclusion as to the accuracy of the company’s financial records.

8. 43 - 8Copyright © 2004 by Prentice-Hall. All rights reserved. Common Law Liability of Accountants to Their Clients Breach of Contract Fraud Negligence

9. 43 - 9Copyright © 2004 by Prentice-Hall. All rights reserved. Accountant Malpractice  Occurs when the accountant breaches the duty of reasonable care, knowledge, skill, and judgment that he or she owes to a client when providing auditing and other accounting services to the client.

10. 43 - 10Copyright © 2004 by Prentice-Hall. All rights reserved. Negligence 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

11. 43 - 11Copyright © 2004 by Prentice-Hall. All rights reserved. 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.

12. 43 - 12Copyright © 2004 by Prentice-Hall. All rights reserved. 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.

13. 43 - 13Copyright © 2004 by Prentice-Hall. All rights reserved. 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.

14. 43 - 14Copyright © 2004 by Prentice-Hall. All rights reserved. Other Common Law Doctrines That Impose Liability on Accountants to Third Parties  Breach of Contract Third parties usually cannot sue accountants for breach of contract. Third parties usually cannot sue accountants for breach of contract. That is because the third parties are merely incidental beneficiaries who do not acquire any rights under the accountant-client contract. That is because the 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. They are not in privity of contract with the accountants.

15. 43 - 15Copyright © 2004 by Prentice-Hall. All rights reserved. Other Common Law Doctrines That Impose Liability on Accountants to Third Parties (continued)  Fraud If an accountant engages in actual or constructive fraud, a third party who relies on the accountant’s fraud and is injured thereby may bring tort action against the accountant to recover damages. If an accountant engages in actual or constructive fraud, a third party who relies on the accountant’s fraud and is injured thereby may bring tort action against the accountant to recover damages.

16. 43 - 16Copyright © 2004 by Prentice-Hall. All rights reserved. Statutory Liability of Accountants  The Securities Act of 1933 Section 11(a) Section 11(a)  The Securities Exchange Act of 1934 Section 10(b) and Rule 10b-5 Section 10(b) and Rule 10b-5 Section 18(a) Section 18(a)  Private Securities Litigation Reform Act of 1995

17. 43 - 17Copyright © 2004 by Prentice-Hall. All rights reserved. Criminal Liability of Accountants  Criminal Violations of the Securities Act of 1933 Section 24 Section 24  Criminal Violations of the Securities Exchange Act of 1934 Section 32(a) Section 32(a)  Racketeer Influenced and Corrupt Organizations (RICO) Act

18. 43 - 18Copyright © 2004 by Prentice-Hall. All rights reserved. Criminal Liability of Accountants (continued)  Criminal Liability Regarding Tax Preparation Tax Reform Act of 1976 Tax Reform Act of 1976  State Securities Laws  Uniform Securities Act  Accountants’ Work Papers  Ownership of Work Papers

19. 43 - 19Copyright © 2004 by Prentice-Hall. All rights reserved. Lawsuits by Accountants  An accountant can be a plaintiff in a lawsuit.  The accountant can bring an action against a client to recover damages if a client, Does not perform under the terms of a contract Does not perform under the terms of a contract Fails to pay the accountant for services provided Fails to pay the accountant for services provided Otherwise breaches the contract Otherwise breaches the contract Commits fraud Commits fraud