Chapter 4: Legal Liability

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audit failure

issuing an incorrect opinion because it failed to comply with the requirements of auditing standards

audit risk

risk of giving the wrong opinion

prudent person concept

the auditor is only expected to conduct the audit with due care and not expected to be perfect nor be the guarantor of financial statements

Terms related to Negligence and Fraud

1. ordinary negligence
2. Gross negligence
3. Constructive Fraud
4. Fraud

Ordinary negligence

absence of reasonable care that can be expected of a person in a set of circumstances. What other competent auditors would have done in the same situation

Gross negligence

lack of even slight care, reckless behavior

Constructive fraud

not intentional, BUT SO BAD, deemed to be bad. Recklessness. Adequate audit not done, but still issued an opinion

Fraud

intent to deceive

Breach of Contract

failure of one or both parties to fulfill contract

3rd party beneficiary

does not have privity to contract, but is known to the contracting parties and has certain rights and benefits under contracts

Common law

developed through court decisions rather than govt statutes

Statutory law

laws on the books. passed by govt unit

Joint and several liability

no petitioning of liability (no percentage divyed up)

Separate and proportional liability

petitioned liability. able to make down in percentage of responsibility

4 Sources of Legal Liability

1. Clients
2. 3rd parties under common law
3. civil liability under Securities laws
4. Criminal liability

1136 Tenants (1967)

if what you do should have uncovered fraud you could be held liable

Ultramares (1931)

Parties: forseen (ordinary negligence) and unforseen (gross negligence) -> higher standard
Only primary beneficiary can sue if those services are rendered negligently. Not held liable for honest blunders beyond their control to 3rd parties

Auditor's Defense Against Suits

1. Lack of Duty
2.Nonnegligent Performance
3. Contributory Negligence
4. Absence of casual connection

Lack of Duty

CPA firm claims that there was no implied or expressed contract to perform duty

Nonnegligent Performance

we followed all auditing standards. BEST DEFENSE

Contributory Negligence

Auditor claims the client own actions resulted in the loss

Absence of Causal Connection

took a loss, but cant connect it to me. i wasnt the reason

3 Auditor's Defense against 3rd parties

1. lack of duty to persorm
2. nonnegligent performance
3.absence of casual connection

Securities Act 1933

reporting requirements for companies issuing NEW SECURITIES. Must only prove that the audited financial statements contained material misstatement or omission. Auditor has the burden of defense; adequate audit done and all of portion of loss was caused by factors other than misleading financial statements. Defines rights of 3rd parties. Only ppl can sue are original purchasers.

Securities Act 1934

Extended to everyone who buys stock.Prohibits any fraudulent activities related to the sale and or purchase of securites

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