11-Common Law Duties and Liabilities to Clients and Third Parties Flashcards
A company engaged a CPA to perform the annual audit of its financial statements. The audit failed to reveal an embezzlement scheme by one of the employees. Which of the following statements best describes the CPA’s potential liability for this failure?
The CPA’s adherence to generally accepted auditing standards (GAAS) may prevent liability.
CPAs doing audits are held to professional standards and must obviously do a better job than the “ordinary reasonable person” off the street.
When performing an audit, a CPA
Must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.
A CPA may be held liable for doing less than being grossly negligent. The standard that CPAs are held to is one of due care. They need not perform perfect work in every audit to live up to this standard. They must simply act as a reasonably prudent CPA would in the same circumstances.
Under the position taken by a majority of the courts, to which third parties will an accountant who negligently prepares a client’s financial report be liable?
Any foreseen or known third party who relied on the report.
Although the AICPA lists this as the correct answer, it is poorly worded. The majority view is the Restatement “limited class” approach, which generally allows recovery by third parties where the CPA had prior knowledge of the existence of a limited class of potential users (but not necessarily of their individual identities) and of the general purpose of their use of the audit. Prior knowledge is the key, so mere foresee ability is not enough, although this answer implies the contrary.
Mix and Associates, CPAs, issued an unqualified opinion on the financial statements of Glass Corp. for the year ended December 31, 2005.
It was determined later that Glass’s treasurer had embezzled $300,000 from Glass during 2005. Glass sued Mix because of Mix’s failure to discover the embezzlement. Mix was unaware of the embezzlement.
Which of the following is Mix’s best defense?
The audit was performed in accordance with GAAS.
To defend such a case, a CPA must show not that she acted perfectly, but that she acted as a reasonable CPA in the circumstances. By showing that she conformed with GAAS, she makes a strong argument that she acted reasonably.
Phillips, CPA, was engaged by Veda, Inc. to audit Veda’s financial statements. Phillips was told that the financial statements and the audit report were to be shown to Ryan, a potential investor. As a result of the audit, Phillips issued an audit report containing an unqualified opinion on Veda’s financial statements. Ryan, after seeing the financial statements and audit report made a substantial investment in Veda shares. Although Phillips exercised reasonable care in performing the audit, inaccuracies in the financial statements were later discovered causing Veda share prices to fall. Ryan claimed that had Ryan known of the inaccuracies, Ryan would not have purchased the shares. Will Ryan succeed in a suit against Phillips for negligence?
No, because Phillips exercised reasonable care in performing the audit.
Phillips owed Ryan a duty of care, but did not breach it. Phillips exercised reasonable care in performing the audit. Therefore, Phillips did not act negligently and is not liable to Ryan. Perfection is not the standard of care for auditors.
