CH 5a Flashcards
Name eight major contributors of changed legal environment?
1) Growing awareness by financial statement users
2) Increased consciousness of SEC
3) Complexity in business drive complexity in auditing and ACCT functions
4) Litigious society
5) Global recession and tough economic times
6) Large civil court judgements against CPA firms
7) WIllingness of CPA firms to settle out of court
8) Judges and jurors difficulty in understanding technical ACCT and auditing matters.
What is changed legal environment? How are audits responsible?
1) Audit professionals have a contractual responsibility with clients.
2) Auditors are liable for negligence
As a result: The number of lawsuits and sizes of awards remain high
Define Business failure
A business is unable to meet its obligations or investor expectations due to economic or business conditions.
What are two major causes of lawsuits against CPA firms?
1) The difference between a business failure and an audit failure
2) The difference between an audit failure and audit risk
Define audit risk
the auditor fails to find a material misstatement and issues an unqualified opinion
What are three legal concepts affecting liability?
1) liability for the acts of others ( partners, etc are joint liable for civil actions against any owner)
2) Lack of privileged communication ( CPAs cannot withhold information)
3) Prudent person concept ( auditor only expected through due care not perfection)
What are legal terms affecting CPAs’ liability?
1) ordinary negligence ( absence of reasonable care that can expected of a person in a set circumstances)
2) Gross negligence ( Lack of even slight care)
3) Constructive fraud ( Existence of extreme or unusual negligence)
4) Fraud ( intent to deceive)
What are two breaches of contract law
1) Breach of contract- failure of both parties in contract to fulfill the requirements of the contract.
2) Third party beneficiary -A third party who does not have privity of contract and is intended to have certain rights and benefits under the contract.
Define Common Law
Laws that have been developed through court decisions rather than government statutes
Statutory law
Laws that have been passed by the US congress and other government units
Joint and several liability
The assessment against a defendant of the full loss suffered by a plaintiff
Separate and proportionate liability
The assessment against a defendant of that portion of the damage caused by the defendant’s negligence.
What are major sources of auditors’ legal liability? What is most common suit against CPAs?
1) liability to clients ( clients sues auditor for material fraud)
2) Liability to third parties under common law ( bank sues auditor for not discovering that borrower’s FS have materiality.
3) Civil liability under federal securities laws ( combined group of stockholders sues auditor for not discovering materiality in FS)
4) Criminal liability ( federal government prosecutes auditor for knowingly issuing an incorrect audit report)
Most common source of lawsuits against CPAs is from clients
What are four auditor’s defense against suits?
1) Lack of duty to perform ( no implied or expressed contract)
2) Nonnegligent Performance ( claims that audit was performed in accordance with auditing standards)
3) Contributory Negligence ( claims the client’s own actions either resulted in the loss that is basis for damages or interfered with the conduct of the audit in such a way)
4) Absence of causal connection ( there is no connection between auditor’s actions that caused suit)
What are two liability for third party under common law?
1) Ultramare doctrine ( accountants were not liable because creditors were not a primary beneficiary or third party.
2) Foreseen Users ( reasonably limted and identiable group of users)
Credit alliance( lender brought suit against the auditor of one of its borrowers)
Restatement of torts ( foreseen users must be members of a reasonably limited and identifiable group of users who have relied on the CPA’s work)
Foreseeable user ( any users who the auditor should have reasonably been able to foresee as likely users of the client’s FS have the same rights as those with privity of contract)
