Homework

Chapter 5

Legal Liability

Key objectives:

1. Appreciate the litigious environment in which CPAs operate.

2. Understand the difference between business failure, audit failure and audit risk.

4. Describe accountant's liability to clients and related defenses.

5. Describe accountant's liability to third parties under common law and related defenses.

6. Describe accountant's civil liability under federal securities laws and related defenses.

1. Current Legal Environment

The legal environment is one of the most important issues facing the profession today. KPMG recently agreed to a $456 million fine from the federal government. Several Big 5 firms paid large settlements in the 1990s to the federal government in connection with the audits of savings and loans. Andersen effectively ceased operations in 2002 due to a Justice Department suit against the firm. Laventhol and Horwath (at the time the 7th largest firm) entered bankruptcy in 1990, partially due to legal liability concerns. The firms report that they spend over 10% of practice revenues on insurance and related defense costs. Many smaller CPA firms have stopped providing audit services, and firms have become much more selective about their clients.

What are some fairly recent changes in the area of legal liability? (Discussion)

1. Proportionate versus joint and several liability. Proportionate liability applies to securities litigation as a result of the Private Securities Litigation Reform Act of 1995.

2. Operation of practice as limited liability corporations (LLC) and limited liability partnerships (LLP) - this is currently allowed in most states, and most of the Big 4 operate as LLPs.

2. Business Failure, Audit Failure and Audit Risk - One reason that CPAs face so much litigation is the inability of financial statement users to distinguish among these terms.

A. Business Failure - Defining...