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Audits
• Conducting audits is a major role of
accountants.
• In the audit process, the accountant
verifies a sample of transactions.
• Verification is done in two ways:
– Vouching – beginning with a transaction in
the books, trace backwards to make sure the
original data supports it.
– Tracing – beginning with a data entry, trace it
forward to make sure it has been properly
recorded at each stage.
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Opinions
• After an audit, the accountant issues an
opinion.
– Unqualified Opinion – most favorable report; financial
statement matches true condition.
– Qualified Opinion -- financial statement is generally
accurate, but there is an unresolved issue.
– Adverse Opinion -- financial statement is not accurate;
places the company in a bad position
– Disclaimer of Opinion – issued when the auditor does
not have enough information to form an opinion.
Cannot be used when the auditor knows, but doesn’t
want to tell.
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Sarbanes-Oxley Act of 2002
• Public Company Accounting Oversight Board – ensures
investors receive accurate and complete financial
information.
• Reports to Audit Committee – Auditors must communicate
regularly with audit committees of its clients.
• Consulting Services -- prohibits accounting firms that audit
public companies from providing consulting services to
their audit clients on topics such as bookkeeping, financial
information systems, human resources, and legal issues
(unrelated to the audit).
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Sarbanes-Oxley Act of 2002
• Conflicts of Interest – Accounting firms
cannot audit a company whose officer has
worked for the firm in the past year.
• Term Limits on Audit Partners – A lead
audit partner cannot work for a client for
more than five years.
• Consolidation in the Accounting Profession
– Trends have led to fewer, but bigger
accounting firms. Congress has ordered a
study on the reasons, impact and possible
methods for reversal of this trend.
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Financial Statement Insurance
• A new approach to ensuring integrity in audits
has been proposed: insurance.
• Corporations would buy insurance from a
carrier, who would hire auditors to evaluate
the corporation’s risk.
• Auditors from the insurance company would
strive to correctly assess the firm’s financial
condition while the firm would strive to lower
its risk, and hence its insurance premiums.
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Negligence
• An accountant is liable for negligence to a
client who can prove both of the following
elements:
– The accountant breached his duty to his client
by failing to exercise the degree of skill and
competence that an ordinarily prudent
accountant would under the circumstances.
– The accountant’s violation of duty caused
harm to the client.
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Fraud and Breach of Trust
• An account is liable for fraud if:
– she makes a false statement of fact,
– she either knows it is not true or recklessly
disregards the truth, and
– the client justifiably relies on the statement.
• Accountants have a legal obligation to:
– keep all client information confidential, and
– use client information only for the benefit of the
client.
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Liability to Third Party
• Determined by state law:
– Ultramares Doctrine --accounts who fail to exercise
due care are liable to a third party only if they know
that the third party (1) will see their work produce
and (2) will rely on the work product for a particular
known purpose.
– Foreseeable Doctrine --The court held that an
accountant who fails to exercise due care is liable to
a third party if (1) it was foreseeable that the third
party would receive financial statements from the
accountant’s client, and (2) the third party relied on
these statements.
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Liability to Third Party (cont’d)
– Restatement Doctrine -- accountants who
fail to exercise due care are liable to (1)
anyone they knew would rely on the
information and (2) anyone else in the
same class.
• An accountant who commits fraud is
liable to any foreseeable user of the
work product who justifiably relied on
it.
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Securities Act of 1933
• Under §11 of the 1933 Act, auditors are liable
for any material misstatement or admission in
the financial statements that they prepare for
a registration statement.
• To prevail under §11, the plaintiff must prove
only that (1) the registration statement
contained a material misstatement or
omission and (2) she lost money.
• Auditors can avoid liability if they show that
they made a reasonable investigation (due
diligence).
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Securities Act of 1934
• Liability for Inaccurate Disclosure in a
Required Filing
– Under §18, an auditor who makes a false or
misleading statement in a required filing is liable
to any buyer or seller of the stock who has acted
in reliance on the statement
• Fraud
– Under §10(b), an auditor is liable for making (1) a
misstatement or omission of a material fact, (2)
knowingly or recklessly (3) that the plaintiff relies
on in purchasing or selling security.
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Aiding and Abetting
• The SEC can prosecute those who aid and
abet others in making untrue statements in
connection with the purchase or sale of a
security.
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Whistleblowing
• Under §10A of the 1934 Act, auditors
who suspect that a client has
committed an illegal act must ensure
that the client’s board of directors is
notified.
• If the board does not take appropriate
action, the auditors must notify the SEC
themselves.
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Joint and Several Liability
• Congress recently amended the 1934 Act
to provide that accountants are liable
jointly and severally only if they knowingly
violate the law. Otherwise, the defendants
are proportionally liable.
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Criminal Liability
• Offenses which may be criminal offenses
include willful violations of the 1933 or
1934 Acts, wrongdoing in the preparation
of income tax returns, violations of state
securities statutes.
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The Accountant-Client
Relationship
• An accountant’s relationship with his client
may create difficult situations, as the
accountant would lose a client if the business
fails. Yet, an accountant who practices
unethical or improper conduct (such as not
reporting found problems) may be banned
from practice.
• SEC rules prohibit accountants from owning
stock in a company that their firm audits; this
rule is widely broken.
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Accountant-Client Privilege
• Means that in some cases, information
shared between an accountant and client
may be protected from disclosure.
• Working Papers – Accountants own the
draft materials they are preparing for a
client, but the client controls who sees
them.
– Under the Sarbanes-Oxley Act, accountants
for public companies must keep audit work
papers for 7 years.
COPYRIGHT © 2010 South-Western/Cengage Learning.
“Over the past decade, accountants
have been shocked at the large
number of liability suits against
members of their profession. Now,
more than ever, accountants need to
be aware of their potential legal
liability.”
COPYRIGHT © 2010 South-Western/Cengage Learning.