Chapter 4

• Potential liability may exceed that of other profesions (such as physicians) because:
• Number of parties suffering significant losses
• Possibly millions of investors as well as firm creditors
• Amount scan be excessive in some cases exceeding the limits of professional liability insurance

• Cases from less than adequate performance
• many estimates made in preparaion of FS are in hindsight, proven wrong
• The ability of the CPA firm to pay (deep pockets)

• 1. Breach of Contract
• 2. Neligence-Tort
• _Ordinary
• Gross
• 3. Fraud
• 4. Statutory

Violation of legal duty to exercise a degree of care that an ordinary prudent person would exercise under similar circumstances

Lack of even slight care, indicative of a reckless disregard for one's professional responsibilites

Misrepresentation by a person of a material fact, known by the person to be untrue or made with reckless indifference as to whether the fact is true with the intention of deceiving the other party and with the reslut that the other party is injured

does not involve a misrepresentation with intent to deceive (gross negligence)

• Securites Act of 1933
• Securities Act of 1934

• Criminal Statues: Usually Class action lawsuits by investors.
• RICO ACT :Rackateering

Auditor must prove due diligence

Third party must prove existence of scienter (auditors intent to deceive, manipulate, or defraud).

Auditor must prove good faith

• Duty-CPA's accepted a duty of due professional care
• Breach of duty-CPA's breached that duty
• Losses-Suffered by plaintiff
• Causation-(proximate cause)- Losses were caused by CPA's performance

• Must establish that losses resulted from CPA's performance
• CPA breached a duty of due professional care
• _{Third party seeks to establish that it sustained a loss caused by relying on misleading FS which included an audit report that was inadequate}

• Ultramares
• Restatemtn of torts
• Rosenblum

• Known User approach
• Parties that may recover for Ordinary Negligence

Third Party Beneficiary

• Foreseen user approach
• Parties that may recover for ordinary Negligence

Limited class of know or intended Users

• Foreseeable user approach
• Parties that may recover for ordinary Negligence

Any third party the auditors could reasonably foresee as user

• Must Prove:
• Loss
• Auditor negligence
• Reliance
• Proximate cause

• Must Prove:
• Loss
• Auditor negligence
• Reliance
• Proximate cause

• Must Prove:
• Loss
• Auditor negligence or Gross Negligence
• Reliance
• Proximate Cause

• Compilation of financial statements
• _{not intended to lend any assurance as to statents reliability}
• Review of financial statements
• _{less in scope than an audit}
• provides limited asurance as to statements reliability

• Adhere closely to rules of conduct 102 and 202 of AICPA
• Engagement letters are essential
• Should be alert for unusual items, such as missing invoices
• Report clearly and concisely using standardized language in SAS and SSARS

• Place emphasis within the firm on complying with GAAS and professional ethics
• Retain legal counsel that is familiar with CPA's legal liability
• Maintain adequate professional liability insurance
• Investigate prospective clients thoroughly
• Obtain a thorough knowledge of the clients business
• Use engagement letters to prevent misunderstandings with clients
• Asses the risk of errors and irregularities, such as weakness in internal control
• Exercise extreme care in audits of clients that have a high degree of business risk, as indicated by such factors as financial difficulties.
• Carefully prepare and review working papers