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CHAPTER 20 - -4 The elements required for establishing an...

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CHAPTER 20 20-4 The elements required for establishing an auditor's liability for negligence to clients are (1) the duty to conform to a required standard of care, (2) failure to act in accordance with that duty, (3) a causal connection between the auditor's negligence and the client's damage, and (4) actual loss or damage to the client. 20-5 The four standards that have evolved for defining the extent of the auditor's liability to third parties are (1) privity, (2) near privity, (3) foreseen persons or classes, and (4) reasonably foreseeable third parties. The traditional view held that auditors had no liability under common law to third parties who did not have a privity relationship with the auditor. Privity here means that the obligations that exist under a contract are between the original parties to the contract, and failure to perform with due care results in a breach of that duty only to those parties. Near privity does not require strict privity of contract, but that the third party be known to the auditor and that the auditor has directly conveyed the audit report or acted to induce reliance on the audit report. Many courts have reexamined the privity notion and substituted the concept of public responsibility. Under the foreseen persons or classes approach, Section 522 of the Restatement (Second) of the Law of Torts is applied to an accountant's third-party liability suit. The Restatement is a compendium of common law prepared by legal scholars and presents an alternative view to the traditional Ultramares doctrine or rule. Finally, a small number of states have adopted a more expansive view of auditors' liability to third parties: the reasonably foreseeable third parties approach. The reasons cited for extending auditors' liability beyond privity include auditors' ability to spread the risk through the use of liability insurance.
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