Legal Liability Considerations for

Auditors
Chapter 4

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4-1

 Learning Objective 1

Understand the litigious environment in

which CPAs practice.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4-2

 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.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4-3

 Changed Legal Environment

Major contributors:

Growing awareness by financial statement

users
 Increased consciousness of the SEC
 Complexity in business drives complexity in
auditing and accounting functions
 Litigious society
©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4-4
 Changed Legal Environment

Major contributors (cont.):

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

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4-5

 Learning Objective 2

Explain why the failure of financial

statement users to differentiate among
business failure, audit failure, and audit
risk has resulted in lawsuits.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4-6

 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.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4-7

 Business Failure, Audit Failure,
and Audit Risk
 Audit failure

Auditor issues an incorrect opinion from

a failure to follow GAAS.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4-8

 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.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4-9

 Learning Objective 3

Use the primary legal concepts

and terms concerning accountants’
liability as a basis for studying
legal liability of auditors.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 10

 Legal Concepts Affecting
Liability

Prudent person concept

Liability for the acts of others

Lack of privileged communication

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 11

 Legal Terms Affecting
CPAs’ Liability
Terms related to negligence and fraud:
Ordinary negligence

Gross negligence

Constructive fraud

Fraud

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 12

 Legal Terms Affecting
CPAs’ Liability

Contract Law

Breach of Third party

contract beneficiary

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 13

 Legal Terms Affecting
CPAs’ Liability
Other terms:

 Common law

 Statutory law

 Joint and several liability

 Separate and proportionate liability

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 14

 Learning Objective 4

Describe accountants’ liability to

clients and related defenses.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 15

 Four Major Sources of Auditors’
Legal Liability

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 16

 Liability to Clients

The most common source of lawsuits

against CPAs is from clients.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 17

 Auditor’s Defenses Against
Client Suits
Lack of duty to perform

Nonnegligent performance

Contributory negligence

Absence of causal connection

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 18

 Learning Objective 5

Describe accountants’ liability to

third parties under common law
and related defenses.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 19

 Liability to Third Parties Under
Common Law

Ultramares Foreseen
doctrine users

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 20

 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.
©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 21
 Sarbanes-Oxley Act

This act makes it a felony to destroy

or create documents to impede or
obstruct a federal investigation.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 22

 Protecting Individual CPAs
from Legal Liability

Qualified
Honest Clients
Personnel

Follow
Maintain
Professional
Independence
Standards

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 23

 End of Chapter 4

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 4 - 24