1. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 1 Legal Liability المسوؤلية او الالتزام القانونية Chapter 5

2. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 2 Changed Legal Environment Audit professionals have a responsibility under common law to fulfill implied or expressed contracts with clients. They are liable to their clients for negligence and/or breach of contract should they fail to provide the services or not exercise due care in their performance.

3. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 3 Many accountants and professionals believe that a major Cause of lawsuits against CPA firm is financial statements Users’ lack of understanding of two concepts: 1. The deference between a business failure and an audit failure. 2. The difference between audit failure and audit risk.

4. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 4 Business Failure, Audit Failure, and Audit Risk  Business failure فشل العمل It occurs when a business is unable to repay its lenders or meet the expectations of its investors because of economic or business conditions.

5. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 5 Business Failure, Audit Failure, and Audit Risk  Audit failure فشل التدقيق It occurs when the auditor issues an incorrect audit opinion because it failed to comply with the requirements of auditing standards.

6. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 6 Business Failure, Audit Failure, and Audit Risk  Audit risk خطر التدقيق It represents the risk that the auditor will conclude that the financial statements are fairly stated and an unqualified opinion can be issued when, in fact, they are materially misstated.

7. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 7 Legal Terms Affecting CPAs’ Liability Terms related to negligence and fraud:  Ordinary negligence الاهمال المألوف  Constructive fraud احتيال منظم او محكم  Gross negligence اهمال جسيم, كبير  Fraud

8. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 8 Legal Terms Affecting CPAs’ Liability Terms related to contract law:  Breach of contract  Third-party beneficiary

9. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 9 Four Major Sources of Auditors’ Legal Liability  Liability to third parties  Federal securities laws  Liability to clients  Criminal liability

10. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 10 Liability to Clients The most common source of lawsuits against CPAs is from clients.

11. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 11 Auditor’s Defenses Against Client Suits  Lack of duty to perform  Nonnegligent performance  Contributory negligence  Absence of causal connection

12. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 12 Auditor Defenses Against Third-Party Suits The preferred defense is nonnegligent performance.

13. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 13 Auditor Defenses – 1934 Act  Nonnegligent performance  Lack of duty  Absence of causal connection

14. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 14 SEC Sanctions The SEC has the power in certain circumstances to sanction or suspend practitioners from doing audits for SEC companies. In recent years, the SEC has temporarily suspended a number of individual CPAs from doing any audits on SEC clients.

15. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 15 Sarbanes-Oxley Act of 2002 This act requires the CEO and CFO to certify the annual and quarterly financial statements filed with the SEC. Management must report its assessment of the effectiveness of internal control over financial reporting. The auditor must provide an opinion on management’s assessment.

16. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 16 Criminal Liability المسوؤلية الجنائية CPAs can be held liable under criminal liability for accountants. CPAs can be found guilty for criminal action under both federal and state laws.

17. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 17 Sarbanes-Oxley Act This act makes it a felony to destroy or create documents to impede or obstruct a federal investigation.

18. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 18 The Profession’s Response to Legal Liability  Research in auditing  Standard and rule setting  Set requirements to protect auditors  Establish peer review requirements

19. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 19 The Profession’s Response to Legal Liability  Oppose lawsuits  Education of users  Sanction members for improper conduct and performance  Lobby for changes in laws

20. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 20 Protecting Individual CPAs from Legal Liability  Deal only with clients possessing integrity  Hire qualified personnel  Follow the standards of the profession  Maintain independence

21. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 21 Protecting Individual CPAs from Legal Liability  Understand the client’s business  Perform quality audits  Document the work properly  Obtain an engagement and a representation letter  Maintain confidential relations

22. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 22 Protecting Individual CPAs from Legal Liability  Carry adequate insurance  Seek legal counsel  Choose a form of organization with limited liability  Exercise professional skepticism

23. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 5 - 23 End of Chapter 5