Accountant’s Liability to Third Party
Table Of Contents
The Ultramares Doctrine3
Auditors Defenses against Third Party Suits8
The Impact of the Doctrine10
This purpose of this research paper is to provide information about the importance of accountant’s liability to third party. In 1931, the case of Ultramares Corporation v. Touche brought about a very crucial segment of accountants liability to their clients. In this case, accountants were found negligent to the creditors. At this time, accountants were not liable to creditors because they were not primary beneficiaries and “ordinary negligence is insufficient for liability to third party because of lack of privity of contract between the third party and the auditor, unless the third party is primary beneficiary” (Arens et. 2012). As a result of this case, Common Law states that certified public accountants (CPAs) are now liable to third parties and named this law ‘Ultramares Doctrine’. Third parties consist of stockholders (current and future), bankers, vendors, customers, employees and other creditors. In addition, this doctrine introduces the concept of foreseen users as individuals who auditors know, who would depend heavily on the financial statements. Accountants can now be I incurred by the due to the reliance of misleading financial statements if there was a loss to the third party. This research paper will discuss the importance of the Ultramares Doctrine, foreseen users, auditors’ defense against the third party suit and the impact this doctrine has towards the accounting profession.
The Ultramares Doctrine
Fred Stern and Co., a company engaged in the importation and sale of rubber, sought a loan from Ultramares to finance its rubber imports. After reviewing Fred Stern and Co.’s application, Ultramares decided to approve the loan subject to Fred Stern and Co. submitting an audited balance sheet. In January of 1924, Fred, Stern and Co. employed Touche, Niven and Co. auditing firm to prepare and certify its balance sheet as of December 31, 1923. However, never being told exactly who the users of these financial statements were, the auditors of Touche, Niven and Co. only could assume that there were a number of potential users. Accordingly, on February 26, 1924, Touche, Niven and Co. completed the audit, certified and submitted thirty - two copies of the balance sheet with serial numbers as counterpart originals but nothing was ever said as to who would be viewing these counterparts or to what extent they might be used. The balance sheet of Fred, Stern and Co. certified by Touche stated assets in the sum of $2 million plus and liabilities other than capital and surplus, in the sum of $1 million plus thus showing a net worth of some $1,070,715.26. Touche further certified that in their opinion, the financial statements presented a true and correct view of the financial position of Fred, Stern and Co. as at December 31, 1923. On this basis, Ultramares loaned the money to Stern. In hind sight, Fred, Stern and Co. was insolvent as management had falsified the books. Accounts receivable had been falsified by the addition of approximately $650,000 and some $700,000 to another item. The accounts payable contained similar discrepancies as well. Had the auditors followed paper trails leading to “off the books’ transactions, that if properly analyzed, they would have revealed that Stern was insolvent as the company failed to repay their loans. Ultramares then sued Touche alleging that the accountants were guilty of negligence and fraudulent misrepresentation. The NYC court of appeal refuses to impose liability on the accountant and concluded that the accountants had been negligent but would not be held liable to third parties for honest blunders beyond the bounds of the original contract unless they were...