CHAPTER 39

1. Click your mouse anywhere on the screen to advance the text in each slide. After the starburst appears, click a blue triangle to move to the next slide or previous slide. CHAPTER 39 Accountants: Liability and Professional Responsibility

2. Quote of the Day “You can’t blame money for what it does to people. The evil is within the people, and the money is the peg they hang it on. They go wild for money when they’ve lost their other values.” Ross MacDonald, American novelist writing in The Moving Target

3. Introduction • The accounting profession is in a crisis for several reasons, including: • Savings and Loan Crisis • Unrealistic Expectations • Competition

4. Audits • Conducting audits is a major role of accountants. • In the audit process, the accountant verifies a sample of transactions. • Verification is done in two ways: • Vouching – beginning with a transaction in the books, trace backwards to make sure the original data supports it. • Tracing – beginning with a data entry, trace it forward to make sure it has been properly recorded at each stage.

5. Opinions • After an audit, the accountant issues an opinion. • Unqualified Opinion – most favorable report; financial statement matches true condition. • Qualified Opinion -- financial statement is generally accurate, but there is an unresolved issue. • Adverse Opinion -- financial statement is not accurate; places the company in a bad position • Disclaimer of Opinion – issued when the auditor does not have enough information to form an opinion. Cannot be used when the auditor knows, but doesn’t want to tell.

6. Negligence • An accountant is liable for negligence to a client who can prove both of the following elements: • The accountant breached his duty to his client by failing to exercise the degree of skill and competence that an ordinarily prudent accountant would under the circumstances. • The accountant’s violation of duty caused harm to the client.

7. Fraud and Breach of Trust • An account is liable for fraud if: • she makes a false statement of fact, • she either knows it is not true or recklessly disregards the truth, and • the client justifiably relies on the statement. • Accountants have a legal obligation to: • keep all client information confidential, and • use client information only for the benefit of the client.

8. Liability to Third Party • Determined by state law: • Ultramares Doctrine --accounts who fail to exercise due care are liable to a third party only if they know that the third party (1) will see their work produce and (2) will rely on the work product for a particular known purpose. • Foreseeable Doctrine --The court held that an accountant who fails to exercise due care is liable to a third party if (1) it was foreseeable that the third party would receive financial statements from the accountant’s client, and (2) the third party relied on these statements.

9. Liability to Third Party (cont’d) • Restatement Doctrine -- accountants who fail to exercise due care are liable to (1) anyone they knew would rely on the information and (2) anyone else in the same class. • An accountant who commits fraud is liable to any foreseeable user of the work product who justifiably relied on it.

10. Securities Act of 1933 • Under §11 of the 1933 Act, auditors are liable for any material misstatement or admission in the financial statements that they prepare for a registration statement. • Auditors can avoid liability if they show that they made a reasonable investigation (due diligence).

11. Securities Act of 1934 • Liability for Inaccurate Disclosure in a Required Filing • Under §18, an auditor who makes a false or misleading statement in a required filing is liable to any buyer or seller of the stock who has acted in reliance on the statement • Fraud • Under §10(b), an auditor is liable for making (1) a misstatement or omission of a material fact, (2) knowingly or recklessly (3) that the plaintiff relies on in purchasing or selling security.

12. Aiding and Abetting • The SEC can prosecute those who aid and abet others in making untrue statements in connection with the purchase or sale of a security. • Under §10(a), auditors who suspect that a client has committed an illegal act must ensure that the client’s board of directors is notified.

13. Type of Liability • Joint and Several Liability • Congress recently amended the 1934 Act to provide that accountants are liable jointly and severally only if they knowingly violate the law. Otherwise, the defendants are proportionally liable. • Criminal Liability • Offenses which may be criminal offenses include willful violations of the 1933 or 1934 Acts, wrongdoing in the preparation of income tax returns, violations of state securities statutes.

14. The Accountant-Client Relationship • An accountant’s relationship with his client may create difficult situations, as the accountant would lose a client if the business fails. Yet, an accountant who practices unethical or improper conduct (such as not reporting found problems) may be banned from practice.

15. Accountant-Client Privilege • Means that in some cases, information shared between an accountant and client may be protected from disclosure. • Working Papers – Accountants own the draft materials they are preparing for a client, but the client controls who sees them.

16. “Over the past decade, accountants have been shocked at the large number of liability suits against members of their profession. Now, more than ever, accountants need to be aware of their potential legal liability.”