Assignment 2.4 - Auditor's Legal Liability to Third Parties
Chapter 20, Review Question 20-5
Distinguish among the four standards that have evolved for defining auditors' liability for ordinary negligence to third parties under common law. Why is this area of auditors' liability so complex?
Legal precedent differs by jurisdiction (state by state).
Third party must prove:
1. auditor had a duty to the plaintiff to exercise due care
2. auditor breached that duty by failing to act with due professional care
3. direct causal connection between auditor's negligence and third party's injury
4. third party suffered an actual loss as a result
If the auditor is found grossly negligent or has committed fraud, third parties may be able to successfully sue an auditor even if the third party does not have privity. If fraud or gross negligence has not been committed, four common-law standards exist for determining the types of third parties than can successfully sue auditors for ordinary negligence:
1. Privity (p. 699); Ultramares case
a. contract or specific agreement exists between the two parties
b. if using this standard, third parties generally cannot sue the auditor because they're usually not involved in the agreement, even if the auditor was negligent
2. Near privity
a. this approach has been followed by ID, IL, IN, MT, NY
b. third party relationship with the accountant approaches privity (p. 700)
i. accountant must be aware that the financial statements are to be used for a particular purposes or purposes ii. auditor is aware that a known party or parties will be relying on the financial statements iii. must be some conduct by the accountant which provides evidence of the accountants' understanding of intended reliance, and links them to the third party or parties
1. auditor has directly conveyed the audit report or acted to induce reliance on the report
3. Foreseen third parties (or Restatement Standard)
a. this approach is followed by the majority of states
b. expands the scope of who can potentially
Distinguish among the four standards that have evolved for defining auditors' liability for ordinary negligence to third parties under common law. Why is this area of auditors' liability so complex?
Legal precedent differs by jurisdiction (state by state).
Third party must prove:
1. auditor had a duty to the plaintiff to exercise due care
2. auditor breached that duty by failing to act with due professional care
3. direct causal connection between auditor's negligence and third party's injury
4. third party suffered an actual loss as a result
If the auditor is found grossly negligent or has committed fraud, third parties may be able to successfully sue an auditor even if the third party does not have privity. If fraud or gross negligence has not been committed, four common-law standards exist for determining the types of third parties than can successfully sue auditors for ordinary negligence:
1. Privity (p. 699); Ultramares case
a. contract or specific agreement exists between the two parties
b. if using this standard, third parties generally cannot sue the auditor because they're usually not involved in the agreement, even if the auditor was negligent
2. Near privity
a. this approach has been followed by ID, IL, IN, MT, NY
b. third party relationship with the accountant approaches privity (p. 700)
i. accountant must be aware that the financial statements are to be used for a particular purposes or purposes ii. auditor is aware that a known party or parties will be relying on the financial statements iii. must be some conduct by the accountant which provides evidence of the accountants' understanding of intended reliance, and links them to the third party or parties
1. auditor has directly conveyed the audit report or acted to induce reliance on the report
3. Foreseen third parties (or Restatement Standard)
a. this approach is followed by the majority of states
b. expands the scope of who can potentially