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Lecture Notes Ch. 5 (ACCT-422)

Lecture Notes Ch. 5 (ACCT-422) - Chapter 5 Legal Liability...

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Chapter 5 Legal Liability This chapter deals with the legal environment in which CPAs practice, focusing on liability under both common law and statutory law. Both civil and criminal liability is discussed. A good place to start is to familiarize yourself with the legal terms listed in Table 5-1 on page 117. There are 4 possible sources of liability for auditors: 1. liability to clients under common law, 2. liability to third parties under common law, 3. liability to third parties under federal securities laws (or state securities laws), and 4. criminal liability. Common Law Common law is law that has developed over the years through court decisions. Under common law, a CPA may be liable either to its clients (auditee) or to third parties. Liability to clients Lawsuits brought by clients is the most common source of lawsuits faced by CPAs. CPAs may be liable to clients under a theory of breach of contract and/or one of the tort theories: negligence, gross negligence, constructive fraud, or fraud. There exists a contractual relationship between the CPA and its client. As parties to the contractual relationship, the CPA and client are said to have privity of contract. The contract may be oral or written; however, it is preferable, and recommended by the AICPA, that the contract be in writing. Written contracts in the accounting field are often called engagement letters . Liability under the theory of breach of contract arises when it is shown that the CPA has breached (or failed to comply with) a contractual obligation owed to the client, the client suffered damages or harm, and the breach was the cause of the harm or damages. An example of a breach of contract may involve a CPA not delivering an audit report on the date promised in the engagement letter. A CPA may also be liable to clients under one of four tort theories: 1. Negligence is the absence of reasonable care that can be expected of a person in a set of circumstances. In determining whether an auditor has acted in a negligent manner, you look to what other competent auditors would have done in similar situations. An example of negligence may involve a failure to adequately follow a specific GAAS such as not effectively supervising staff.
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