Chapter 4

  1. Scope of CPA Liability
    • Potential liability may exceed that of other profesions (such as physicians) because:
    • Number of parties suffering significant losses
    • Possibly millions of investors as well as firm creditors
    • Amount scan be excessive in some cases exceeding the limits of professional liability insurance
  2. Litigation Perspective
    • Cases from less than adequate performance
    • many estimates made in preparaion of FS are in hindsight, proven wrong
    • The ability of the CPA firm to pay (deep pockets)
  3. Primary Source of CPA Liability
    • 1. Breach of Contract
    • 2. Neligence-Tort
    • Ordinary
    • Gross
    • 3. Fraud
    • 4. Statutory
  4. Ordinary Negligence
    Violation of legal duty to exercise a degree of care that an ordinary prudent person would exercise under similar circumstances
  5. Gross Negligence
    Lack of even slight care, indicative of a reckless disregard for one's professional responsibilites
  6. Fraud
    Misrepresentation by a person of a material fact, known by the person to be untrue or made with reckless indifference as to whether the fact is true with the intention of deceiving the other party and with the reslut that the other party is injured
  7. Constructive Fraud
    does not involve a misrepresentation with intent to deceive (gross negligence)
  8. Statutory
    • Securites Act of 1933
    • Securities Act of 1934
  9. Statutory Sources of CPA Liability
    • Criminal Statues: Usually Class action lawsuits by investors.
    • RICO ACT :Rackateering
  10. Securites Acts-Pic
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  11. Securities Act 1933
    Auditor must prove due diligence
  12. Securities Exchange Act 1934- Section 10
    Third party must prove existence of scienter (auditors intent to deceive, manipulate, or defraud).
  13. Securities Exchange Act 1934- Section 18
    Auditor must prove good faith
  14. Elements of Proof by Client Under Common Law
    • Duty-CPA's accepted a duty of due professional care
    • Breach of duty-CPA's breached that duty
    • Losses-Suffered by plaintiff
    • Causation-(proximate cause)- Losses were caused by CPA's performance
  15. Third Parties
    • Must establish that losses resulted from CPA's performance
    • CPA breached a duty of due professional care
    • Third party seeks to establish that it sustained a loss caused by relying on misleading FS which included an audit report that was inadequate
  16. Common Law Liability to Third parties
    • Ultramares
    • Restatemtn of torts
    • Rosenblum
  17. Ultramares
    • Known User approach
    • Parties that may recover for Ordinary Negligence

    Third Party Beneficiary
  18. Restatement of Torts
    • Foreseen user approach
    • Parties that may recover for ordinary Negligence

    Limited class of know or intended Users
  19. Rosenblum
    • Foreseeable user approach
    • Parties that may recover for ordinary Negligence

    Any third party the auditors could reasonably foresee as user
  20. Legal Liability Plaintiff is Client
    • Must Prove:
    • Loss
    • Auditor negligence
    • Reliance
    • Proximate cause
  21. Legal Liability Plaintiff is Third-Party Beneficiary
    • Must Prove:
    • Loss
    • Auditor negligence
    • Reliance
    • Proximate cause
  22. Legal Liability Plaintiff is Limited Class of Foreseen Parties
    • Must Prove:
    • Loss
    • Auditor negligence or Gross Negligence
    • Reliance
    • Proximate Cause
  23. Unaudited Financial Statements of Nonpublic Companies
    • Compilation of financial statements
    • not intended to lend any assurance as to statents reliability
    • Review of financial statements
    • less in scope than an audit
    • provides limited asurance as to statements reliability
  24. CPA's who prepare unaudited financial statements should
    • Adhere closely to rules of conduct 102 and 202 of AICPA
    • Engagement letters are essential
    • Should be alert for unusual items, such as missing invoices
    • Report clearly and concisely using standardized language in SAS and SSARS
  25. Preventing Litigation
    • Place emphasis within the firm on complying with GAAS and professional ethics
    • Retain legal counsel that is familiar with CPA's legal liability
    • Maintain adequate professional liability insurance
    • Investigate prospective clients thoroughly
    • Obtain a thorough knowledge of the clients business
    • Use engagement letters to prevent misunderstandings with clients
    • Asses the risk of errors and irregularities, such as weakness in internal control
    • Exercise extreme care in audits of clients that have a high degree of business risk, as indicated by such factors as financial difficulties.
    • Carefully prepare and review working papers
Card Set
Chapter 4
Midterm 1