Chapter 4 Audit

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Chapter 4 Legal Liability for auditors

4-1. Understand litigious environment, which CPAs practice

According to Google dictionary, litigious environment means a controversial environment. Where a simple mishaps can end up in a heavy lawsuit. Under common law, audit professionals have the responsibility to their client to fulfill their agreed on contracts. However, if one audit fails to fulfill their contract, not only they have to take responsibility to their clients but in some circumstances, to parties other than their clients.

These parties of those who rely on audit reports, therefore auditors also have the responsibility to them as professionals. In addition to common law, auditors may be held to third parties under statutory law (hkum undang2). Although this happens only in rare cases, criminal conviction is charged to an auditor when the plaintiff demonstrates that the auditor intend to deceive or harm others.

Slide-3..Despite the efforts to address legal liability of CPAs, the lawsuit and sizes of awards to plaintiffs are very high. Including cases of those in third parties under both common law and federal securities acts. 7 major reasons why this happens is because of:

* Growing awareness of users of the financial statement upon the responsibility of the accountants * Increased consciousness of the SEC of the investors’ interest * Complexity of auditing and accounting functions (caused by globalization, expansion, and complexities of the business) * Deep Pocket Liability : Regardless of who is at fault, often the targeted defendant, even when the true (moral) culpability(whose to blame) is with another party because the deep pocket has money to pay a verdict. For example:

* a lawyer may comment that he or she sued the manufacturer of a product rather than the seller because it is the deep pocket, meaning it has more money than the seller with which to compensate the victim. * Judgments by the large civil court against CPA firms cases, encourage attorneys to provide legal services on contingent-fee basis (meaning, no win no fee basis). Which offered the injured party a potential gain when the suit is successful and minimum loss when it is not. * Many CPA firms like to settle legal problems out of court (to avoid costly legal fees and adverse publicity) rather than pursuing resolution through judicial process * The difficulty of judges and jurors of having to interpret technical auditing matters.

4-2 Distinguishing between business audit failure, and audit risk

Users’ lack of understanding in distinguishing between these 2 concepts is the reasons of lawsuits towards CPAs:
-The difference between a business failure and an audit failure
-The difference between an audit failure and an audit risk
1. Business Failure:
is when the business is unable to repay its lenders/meet the expectations of its investors because of economic or business conditions. (e.g. recession, poor management decisions, or unexpected competition)

2. Audit failure :
When auditor issues incorrect audit opinion because it fails to comply (follow) with the requirements of the accounting standard.
e.g. case: When a firm assigns an unqualified assistants to perform certain audit tasks where they failed to notice material misstatements, in which a qualified assistant would. That is considered an audit failure cause by the unqualified assistant

3. Audit risk :
Represents the possibility that the auditor commits a mistake in stating the materials regarding the information stated in the financial statement.
It is unavoidable because the auditors gather evidence only on test basis and because a well-concealed frauds are extremely difficult to detect. An auditor may fully follow the accounting standards and still fail to uncover the misstatement due to fraud.

In cases of an audit failure, the law often allows parties who suffered losses to recover some or all of the losses caused by...
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