when a business is unable to pay lenders or meet expectations of stockholders
usually because of unexpected competition, poor management, or economic conditions.
when an auditor issues an incorrect opinion because they failed to comply with GAAS
the possibility that after conducting an adequate audit, they determine that the financial statements are fairly stated, when they are actually misstated.
*unavoidable - because of test basis, concealed fraud
Difference between what auditors do, and what users of financial information think they do.
The wider the gap, the more liability the auditors have.
conducted audit with due care
1. AICPA Ethics
3. Professional Standards (look up recording)
4. Quality Control
*Must be expressed at the point of communication
Absence of resonable care that can be expected of a person in a set of circumstances - for auditors it is generally in terms of what other auditors would have done. - lack of reasonable care
Lack of even slight care that can be expected of a person. - lack of minimal care
existence of extreme, or unusual, negligence even through there was NO INTENT to deceive or do harm.
when a misstatement is made and there is both the KNOWLEDGE of its falsity and the INTENT to deceive.
Breach of Contract
Failure of one or both parties in a contract to fulfill the requirements of the contract.
Privity of Contract
Parties who have a relationship that is established by a contract.
*must have privity before litigation.
A third party who does not have privity of contract but is known to the contracting parties and is intended to have certain rights and benefits under the contract.
*i.e. a bank that has a large loan outstanding at the balance sheet date and requires an audit as a part of its loan ageement.
Laws developed through court decisions rather than through government statutes.
Laws that have been passed by US congress and other governmental units. SOX, SEC act of 1934
Joint and Several Liability
the assessment against a defendant of the full loss suffered by a plaintiff, regardless of the extent to which other parties shared in the wrongdoing.
i.e. management intentionally falsifies financial statements, an auditor can be assessed the entire loss to shareholders if the company is bankrupt and management is unable to pay.
Separate and proportionate liability
the assessment against a defendant of that portion of the damage caused by the defendant's negligence.
i.e. courts determine that an auditor's negligence in conducting an audit was the cause of 30%of a loss to a defendant, only 30% of the aggregate damage will be assessed to the CPA firm.+
Obligation based on failure to exercise appropriate level of professional care.
person who posesses the intent to deceive with fraud - must be proven
T or F: The distinction between constructive fraud and fraud is that fraud has a greater degree of recklessness
False: Fraud needs intent
failure of one or both parties to fulfill the requirements of a contract. (legal term)
Breach of Contract
Recklessness (legal term)
Gross Negligence OR Constructive Fraud
Parties who share a contractual relationship (legal term)
Laws passed by Congress or Governmental Units (legal term)
The assessment of a full loss suffered by a plaintiff irrespective of shared wrongdoing (legal term)
joint sever loss
knowledge of a material misstatement with intent to deceive (legal term)
The concept that the audtitor is expected to conduct the audit with due care and is not expected to be perfect
prudent person concept
Elements to be proven by plaintiff for conviction of common law negligence (4)
1. Duty of care existed
2. Breach of that Duty
3. Injury to Plaintiff
4. proximate cause of injury was the breach (2)
Elements to be proven by plaintiff for conviction of common law fraud
1. Material misrepresentation of fact
2. knowledge and intent to deceive - scienter
Elements to be proven by plaintiff for conviction of constructive fraud
Proof and Defenses: liable for ordinary negligence, gross negligence constructive fraud and fraud
Lack of duty - never in contract
causation - auditor didn't cause injury
contributory negligence - clients partially responsible
___ is not a viable defense in a suit against the CPA by the client.
If a stockholder sues a CPA for common law fraud based on false statements contained in the financial statements audited by the CPA, which of the following would be the best defense?
a. Stockholder's lack of privity
b. the false statements are immaterial (answer)
c. the cpa did not financially benefit from the alleged fraud.
d. the contributory negligence of the client
ordinary negligence is insufficient for liabilities to third parties, because of lack of privity
If a CPA recklessly departs from standards of due care when conducting an audit, the CPA will be liable to third parties who are unknown to the CPA based on _______.
Gross Negligence/Constructive Fraud
Under Common Law, which of the following statements most accurately reflects the liability of a CPA who fraudulently gives an opinion on an audit client's financial statements?
The CPA probably is liable to any person who suffered a loss as a result of the fraud
What is the best defense a CPA firm can assert in a suit for common law fraud based on its unqualified opinion on materially false financial statements?
Lack of scienter
Securities act of 1933
regulates initial issuance of securities by registrants to investing public
registration statment must include f/s
Section 11 of 1933
plaintiff must prove
1. material missrepresentation or omission in registration statement.
2. prove loss suffered
BURDEN OF PROOF ON DEFENDANT
Under section 10b and 10b5 of the sec 1934 act - what must be proven by a stock purchaser in a suit against a CPA?
1. Intentional conduct by the cpa designed to deceive investors
distinction between Sec 1934 Act. 10b and Sec act 1933 section 11?
sec act 1934 requires intent to deceive, section 11 burden of proof lies on defendant
sources of legal liability for auditors
third party under common law