Overview of External Auditors' Legal Liability Issue with Contract Law, Tort Law, State and Federal Criminal Law. Common issues and examples , over view powerpoint for class TCO#D

1. EXTERNAL AUDITING 555EXTERNAL AUDITING 555
TCO # DTCO # D
LITIGIOUS ENVIRONMENTLITIGIOUS ENVIRONMENT
ISSUES, LAWS, LEGAL SITUATIONS.ISSUES, LAWS, LEGAL SITUATIONS.

2. Business Failure, Audit Failure,Business Failure, Audit Failure,
and Audit Riskand Audit Risk
Business failureBusiness failure
It occurs when a business is unable toIt occurs when a business is unable to
repay its lenders or meet therepay its lenders or meet the
expectations of its investors becauseexpectations of its investors because
of economic or business conditions.of economic or business conditions.

3. Business Failure, Audit Failure,Business Failure, Audit Failure,
and Audit Riskand Audit Risk
Audit failureAudit failure
It occurs when the auditor issues anIt occurs when the auditor issues an
erroneous audit opinion as the resulterroneous audit opinion as the result
of an underlying failure to complyof an underlying failure to comply
with the requirements of generallywith the requirements of generally
accepted auditing standards (GAAS).accepted auditing standards (GAAS).

4. Business Failure, Audit Failure,Business Failure, Audit Failure,
and Audit Riskand Audit Risk
Audit riskAudit risk
It represents the risk that the auditor willIt represents the risk that the auditor will
conclude that the financial statementsconclude that the financial statements
are fairly stated and an unqualifiedare fairly stated and an unqualified
opinion can be issued when, in fact,opinion can be issued when, in fact,
they are materially misstated.they are materially misstated.

5. Business Failure, Audit Failure,Business Failure, Audit Failure,
and Audit Riskand Audit Risk
BusinessBusiness
failurefailure
AuditAudit
failurefailure
AuditAudit
riskrisk

6. Four Major Sources of Auditors’Four Major Sources of Auditors’
Legal LiabilityLegal Liability
Third partyThird party
FederalFederal
securities lawssecurities laws
ClientClient
CriminalCriminal
liabilityliability

7. Liability From ClientsLiability From Clients
The most common source of lawsuitsThe most common source of lawsuits
against CPAs is from clientsagainst CPAs is from clients..

8. Liability to Clients:Liability to Clients:
Under contract law - for breach of contractUnder contract law - for breach of contract
Under tort law** for:Under tort law** for:
Ordinary negligenceOrdinary negligence – failure to exercise care– failure to exercise care
aa reasonable person would under the samereasonable person would under the same
circumstancescircumstances
Gross negligenceGross negligence – failure to use even slight– failure to use even slight
care in circumstancescare in circumstances
FraudFraud -- intentional deceptionintentional deception
** Tort = wrongful act that injures another person’s property, body, or** Tort = wrongful act that injures another person’s property, body, or
reputation.reputation.
Liability Under the Common LawLiability Under the Common Law

9. Auditor’s Defenses AgainstAuditor’s Defenses Against
Client SuitsClient Suits
Lack of duty to performLack of duty to perform
Nonnegligent performanceNonnegligent performance
Contributory negligenceContributory negligence
Absence of causal connectionAbsence of causal connection

10. Liability Third Parties Under theLiability Third Parties Under the
Common LawCommon Law
Ultramares:Ultramares: upheld the privity of contractupheld the privity of contract
doctrine: third parties cannot sue auditors fordoctrine: third parties cannot sue auditors for
ordinary negligence.ordinary negligence.
Foreseen users – A limited group of persons forForeseen users – A limited group of persons for
whom the auditor is aware will rely on thewhom the auditor is aware will rely on the
financial statements.financial statements.

11. Securities Exchange Act of 1934Securities Exchange Act of 1934
1934 Act – requires ongoing filing of quarterly and
annual reports, and other information to keep the
registration statement current. Certain information,
including financial statements must be audited.
The liability of auditors under this act oftenThe liability of auditors under this act often
centers on Rule 10b-5, p. 118.centers on Rule 10b-5, p. 118.
• It may apply to accountants if they intentionallyIt may apply to accountants if they intentionally
or recklessly misrepresent information intended foror recklessly misrepresent information intended for
33rdrd
party use.party use.

12. Auditor Defenses – 1934 ActAuditor Defenses – 1934 Act
Nonnegligent performanceNonnegligent performance
Lack of dutyLack of duty
Absence of causal connectionAbsence of causal connection

13. Criminal LiabilityCriminal Liability
CPAs can be found guilty for criminalCPAs can be found guilty for criminal
action under both federal and state laws.action under both federal and state laws.
• Most laws make it a criminal offense toMost laws make it a criminal offense to
defraud another person throughdefraud another person through knowinglyknowingly
being involved with falsifications in financialbeing involved with falsifications in financial
statements.statements.
The Sarbanes-Oxley Act makes it a felonyThe Sarbanes-Oxley Act makes it a felony
to destroy or create documents to impedeto destroy or create documents to impede
Or obstruct a federal investigation.Or obstruct a federal investigation.

14. Protecting Individual CPAsProtecting Individual CPAs
from Legal Liabilityfrom Legal Liability
Deal only with clients possessing integrityDeal only with clients possessing integrity
Hire qualified personnelHire qualified personnel
Follow the standards of the professionFollow the standards of the profession
Maintain independenceMaintain independence

15. Protecting Individual CPAsProtecting Individual CPAs
from Legal Liabilityfrom Legal Liability
Understand the client’s businessUnderstand the client’s business
Perform quality auditsPerform quality audits
Document the work properlyDocument the work properly
Obtain an engagement and a representation letterObtain an engagement and a representation letter
Maintain confidential relationsMaintain confidential relations