Chapter 5 Legal Liability in Auditing & Assurance

Lack of Duty to Perform

An auditor's legal defense under which the auditor claims that no contract existed with the client; therefore, no duty existed to perform the disputed service.

Non-negligent Performance

An auditor's legal defense under which the auditor claims that the audit was performed in accordance with auditing standards.

Ultramares Doctrine

A common-law approach to third-party liability, established in 1931 in the case of Ultramares Corporation v. Touche, in which ordinary negligence is insufficient for liability to third parties because of the lack of privity of contract between the third party and the auditor, unless the third party is a primary beneficiary. The doctrine that allowed 3rd party users to sue.

Securities Act of 1933

A federal statute dealing with companies that register and sell securities to the public; under the statue, third parties who are original purchasers of securities may recover damages from the auditor if the financial statements are misstated, unless the auditor proves that the audit was adequate or that the third party's loss was caused by factors other than misleading financial statements.

Securities Exchange Act of 1934

A federal statute dealing with companies that trade securities on national and over-the-counter exchanges; auditors are involved because the annual reporting requirements include audited financial statements.

Audit Failure

A situation in which the auditor issues an incorrect audit opinion as the result of an underlying failure to comply with the requirements of auditing standards.

Contributory Negligence

An auditor's legal defense under which the auditor claims that the client failed to perform certain obligations and that it is the client's failure to perform those obligations that brought about the claimed damages.

Absence of Causal Connection

An auditor's legal defense under which the auditor contends that the damages claimed by the client were not brought about by any act of the auditor.

Restatement of Torts

An authoritative set of legal principles, that states that foreseen users must members of a reasonably limited and identifiable group of users who have relied on the CPS's work, such as creditors, even though those persons were nonspecifically known the CPA at the time the work was done.

Foreseeable Users

An unlimited class of users that the auditor should reasonably been able to foresee as being likely users of financial statements.

Scienter

Commission of an act with knowledge or intent to deceive.

Foreseen Users

Members of a limited class of users who the auditor is aware will rely on the financial statements.

Credit Alliance

One of three interpretations generated by the courts about foreseen users, Credit Alliance grasps the basic concept of privity established by Ultramares, stating that to be liable, (1) an auditor must know and intend that the work product would be used by the third party for a specific purpose, and (2) the knowledge and intent must be evidenced by the auditor's conduct.

Prudent Person Concept

The legal concept that a person has a duty to exercise reasonable care and diligence in the performance of obligation to another. "He undertakes for good faith and integrity, but not for infallibility."

Legal Liability

The professional's obligation under the law to provide a reasonable level of care while performing work those served.

Audit Risk

The risk that the auditor will conclude after conducting an adequate audit that the financial statements are fairly stated and an unmodified opinion can therefore be issued when, in fact, they are materially misstated.

Business Failure

The situation when a business is unable to repay its lenders or meet the expectations of its investors because of economic or business conditions, such as a recession, poor management decisions, or unexpected competition in the industry

In a common law action against an accountant, lack of privity is a viable defense if the plaintiff:

is the client's creditor who sues the accountant for negligence.

The 1136 Tenants case was important chiefly because of its emphasis on the legal liability of the CPA when associated with:

unaudited financial statements.