Auditing Ch 5 Legal Liability

Front 1

Business failure

Back 1

business is unable to repay lenders or meet expectations ot its investorsbecuase of econ or business conditions like recession, bad mgmt or competiton

Front 2

Audit failure

Back 2

auditor issues an incorrect audit opinion because it failed to comply with requirements of auditing standards

Front 3

Audit risk

Back 3

possibility that the auditor concldes after conducting an adequate audit, that the FS were fairly stated when, in fact, they were materially misstated. This is unavoidable due to testing auditor does which aren't foolproof

Front 4

Prudent person concept

Back 4

A person has a duty to exercise reasonable care and diligence in th performance of obligations of another.

Front 5

Ordinary negligence

Back 5

What other competent auditors would have done in the same situation.
Absence of reasonable care

Front 6

Gross negligence

Back 6

Lack of even slight care, reckless behaviour

Front 7

Constructive fraud

Back 7

Extreme or unusual negligence even though there was no intent to deceive or do hard. also referred to as recklessness

Front 8

Fraud

Back 8

Misstatement is made and there is both the knowledge of its falsity and the intent to deceive

Front 9

Four major sources of auditor's legal liability

Back 9

1. to clients (client sues for not discovering material fraud)
2. to third parties under common law (bank sues auditor)
3. civil liability under federal securities law (stockholders sue for not discovering material misstmt)
4. criminal liability

Front 10

Auditor's defense against clients suits (4)

Back 10

1. Lack of duty to perform (no impled or expressed contract)
2. Nonneglient Performance (auditor claims audit done in accordance w/ GAAS even if MMS found)
3. Contributory negligence (client's actions resulted in loss)
4. Absence of Causal Connection (no connection between auditor failure and damages suffered by client)

Front 11

Ultramares doctrine

Back 11

common-law approach to 3rd party liability, est in 1931, in which ordinary negligence is insufficient for liability to 3rd parties because of a lack of privity of contract between 3rd party and auditor, unless the 3rd party is a primary beneficiary

Front 12

Restatement of Torts

Back 12

Approach followed by most states.
forseen users must be members of a reasonably limited and identifiable group of users who relied on the CPA's report

Front 13

Foreseeable user

Back 13

Members of a limited class of users whom the auditor is aware will rely on the fin stmts

Front 14

Securities Act of 1933

Back 14

-Deals with the reporting requirements for companies issuing new securities.
-only parties who can recover from auditor's are original purchasers of securites

Front 15

Rights of Third Parties under Securities Act of 1933

Back 15

1. any 3rd party who purchased securities can sue auditor for material misreps or ommissions in stmts
2. 3rd party users don't have burden of proof they relied on FS or auditor was neg or fraud. only have to prove FS contained MMS
3. auditor has to show a) adequate adit was conducted b) all or a portion of plaintiff's loss caused by some other factor

Front 16

Securities Exchange Act of 1934 and Rule 10b-5

Back 16

-deals w/ audited financials of public companies (annual reports and 10-k's)
-Rule 10b-5 says accountants can be held liable if they intentionally or recklessly misrepresent info intended for third party use

Front 17

Auditor defenses for 1934 Act

Back 17

1. nonnegligent performance
2. lack of duty to perform
3. absence of causal connection

Front 18

AICPA's ways to reduce practioner's exposure to lawsuits (3)

Back 18

1. seek protection form nonmeritorious litigation
2. imporve auditing to better meet users' needs
3. educate users on limits of auditing

Front 19

Protecting individual CPA's from legal liablity

Back 19

-deal only with clients w/ integrity
-hire qualified people and train em
-follow standards
-be independent
-understand client's biz
-perform quality audits
-document work properly
-obtain engagement letter and rep letter
-maintain confidential relations
-carry adequate insurance
-seek legal counsel
-choose organizational form with limited liability
-exercise professional skepticism

Front 20

Breach of Contract

Back 20

Failure of one or both parties in a contract to the fulfill the requirements of the contract. (ex failure to deliver by the agreed upon date)

Front 21

Third Party Beneficiary

Back 21

A third party who does not have privity of contract but is known to the contracting partners and is intended to have certain rights and benefits under the contract. (ex bank that requires the annual audit as part of its loan agreement)

Front 22

Nonnegligent Performance

Back 22

An auditor's legal defense under which the auditor claims that the audit was performed in accordance with auditing standards.