- unintentional mistake in computations or application of principles
- unintentional incorrect estimates
intentional misrepresentation of transactions, records, accounting principles
Auditor's responsibility to detect errors and irregularities (E/I)
Auditor must ( on all engagements):
Design the audit to provide reasonable assurance of detecting E/I that are material to the financial statements
Failure to detect is not automatically evidence of auditor negligence ( e.g, irregularities such as forgery and collusion are difficult to detect)
What are some possible indicators of E/I?
- 1. poor internal controls.
- 2. management decisions dominated by single person
- 3. aggressive management
- 4. poor profitability of client
- 5. rapid growth
- 6. going concern problems
- 7. related party transactions - fictitious company
- 8. new client (easier to fool a new auditor)
If an irregularity is detected ( whistle blowing): what should you do?
Refer to a level of management at least one level above where fraud occurred
consider effect on f/s - revise f/s accordingly - if client refuses, qualified, adverse, or withdraw
communicated findings to audit committee
if client is public, may need to tell SEC if client does not.
what is client illegal acts?
- Illegal acts is violations of laws or government regulations (some relevant laws: RICO, FCPA)
- Whether an act is illegal is normally beyond the expertise of an auditor
Auditor's responsibility to detect illegal acts
Auditor must (on all engagements):
Design the audit to provide reasonable assurance of detecting illegal acts that have a direct, material effect on the f/s's (active responsibility to look for these) e.g tax laws
For illegal acts having an indirect effect on f/s, auditor's responsibility is ( if comes to auditor's attention)
What are possible client claims
- 1. breach of contract: engagement letter is a contract
- 2. tort law- negligence
Under the tort law, burden of proof is on client to prove:
- 1. damages
- 2. CPA was negligent (at least ordinary)
- Ordinary negligence- lack of reasonable care (failure to follow GAAS)
- Gross negligence- lack of even slight care
- Fraud- intentional deception.
Auditor's defenses under the tort law are
- 1. due care (not negligent, followed GAAS), also called due diligence
- 2. contributory or comparative negligence (share the blame with client)
- 3. clear engagement letter
What are the kinds of 3rd parties affected by audit in common law
- 1. 3rd party beneficiary (3B)= 3rd party that benefits from a contract between other persons
- 2. Primary Beneficiary (known users)= specifically named or known at time of contracting to do audit
- 3. Foreseen User= known, but not specifically (only as a group)
- 4. Foreseeable user= reasonably foreseeable that would rely on audit
When 3rd party sues CPA, burden of proof is on 3rd party to prove?
- 1. damage
- 2. reliance (and proximate cause)
- 3. cpa negligence- type of negligence required depends on what kind of 3B (and state)
- with PRIVITY of contract: at least ordinary negligence
- without PRIVITY: at least gross negligence (fraud)
NOTE: In most cases, only the audit client and any primary beneficiaries (3B) have privity of contract.
If 3B is what is the court case extending privity?
- Primary- Ultramares vs. Tourche
- Foreseen- Rusch factors vs. Levin
- Foreseeable- Rosenblum vs. Adler
Auditors' defenses against 3rd party suits?
- 1. due caare
- 2. lack of privity
SEC 1933 Act applies to?
- Applies to any person acquiring securities through a "public offering" (IPO vs. Seasoned PO)
- FIRST BUYER
Under the SEC 1933 person suing CPA needs to show
Person doesn't need to show reliance on f/s or that drop in prices was fault of misleading statements
- 1. F/s were "false or misleading" as to "material fact"
- 2. damages ( drop in stock price)
Under the SEC 1933 CPA has burden of proof to show?
CPA has to show he/she was not negligent- therefore CPA is essentially liable for any negligence. Therefore with ordinary negligence, CPA loses.
- 1. f/s not "false or misleading" or discrepancy was"immaterial"
- 2. Due Care (followed GAAS)
- 3. Another cause of damage ( general market drop)
SEC 1934 Act applies to ?
Applies to all "publicly traded" companies to file annual f/s (10K) and quarterly f/s (10Q) with the SEC -10k has to be audited, 10Q has to be reviewed. "Continuous Disclosure Act"
SEC 1934 has two section:
- section 18 = gross recklessness
- section 10 = scienter - rule 10-5b
Under the SEC 1934 the person suing CPA needs to show
- -be a buyer or seller of stock
- -show f/s false or misleading as to material fact
- -prove of damages
- -prove reliance on f/s
- -gross recklessness (18) or scienter (10)
Under the SEC 1934 CPA has burden of proof to show?
- -due care
- -f/s not false or misleading / immateriality
- -other causes of drop in stock prices.