AUDITING AND ASSURANCE SERVICES - QUESTION 7 - PLEASE AND THANK YOU! (BOTH QUESTION ANSWERS MUST BE 100-200 WORDS LONG)

QUESTION 7. You are a CPA practicing audit in the state of Mississippi. You committed ordinary negligence today in 2021. You are sued by a third party. How would your legal responsibilities today be different from those in the Ultramares case? (100-200 WORDS)

PICTURE OF SLIDE REGARDING THE CASE:

LECTURE NOTES REGARDING SLIDE:

If your client company sued you under common law, the first defense you can use is "lack of duty" or "lack of privity." The latter is a legal term meaning that there is no contract for you to perform the duty. The audit contract is in the form of an "audit engagement letter," which describes what job and responsibilities the auditor is contracted to perform and under what terms. No contract, no liability. Note that the US contract law recognizes both oral and written contracts.

The second defense is "non-negligent performance." With this you argue that you performed a GAAS audit.

The third defense is "contributory negligence." With this you argue that the client contributed to your failure to detect the misstatement. For example, there were client imposed scope limitations.

The fourth defense is "absence of causal connection." Let me give you an example of how to use this defense. Lets say there were two things happened: one was that the auditor failed to complete the audit on time, and the other was that the bank denied a loan to the company. The company sued the auditor for causing the bank to deny the loan. The auditor then may argue that the banks loan decision had nothing to do with the delay of the audit, and that the loan decision was based purely on the ongoing relationship between the bank and the company.

Now, if a third party sued you under common law, the situation is a little complicated. The key issue here is whether or not the auditor is liable for the third party if the auditor committed ordinary negligence. The common law has evolved quite significantly on this. There are a lot of complicated court rulings concerning audit. The good news is that in this class you are only required to know just one court ruling, a very important and a very old one. You need to learn this grandfather court ruling because you need to know how much has changed -- how the law today is different from the famous old one.

It was the "Ultramares" case in 1931. On p. 122, there is a brief description of the case in Fig. 5-4. According to the court ruling of this case, auditors are liable for a third party for committing ordinary negligence if the third party is a primary beneficiary of whom the auditor was informed before conducting the audit. Today, in contrast, a third party is able to sue the auditor for committing ordinary negligence and win the case if the third party is a "foreseen user" -- which means that the suing third party now does not have to be known to the auditor.

The broadest concept of the eligible third party is that of "foreseeable user," which is found in the court rulings in a couple of states. The state of Mississippi is one of them. Under this concept, almost any third party can sue the auditor for committing ordinary negligence.

If you get sued by a third party, you can use defenses 1, 2 and 4, but not 3, because you are now dealing with a third party, not your client company.

CHAPTER 5 CONCEPTS FROM BOOK REFERRING TO CASE:

thank you all for giving the time to help with my questions!

Auditor's Defense Against lawsuits by clients under common law 1. lack of duty (engagement letter) 2. nonnegligent performance 3. contributory negligence (the client contributed to the failure of detecting the misstatement) 4. absence of causal connection Against lawsuits by 3rd parties for the auditor's ordinary negligence under common law: 1, 2, 4 -Court decisions: Ultramares (1931)/known third party -foreseen users -foreseeable users LIABILITY TO THIRD PARTIES UNDER COMMON LAW OBJECTIVE 5.5 In addition to being sued by clients, CPAs may be liable to third parties under common Deserbe contato law. Third parties include actual and potential stockholders, vendors hankers and card parties under con lo other creditors, employees, and customers. A CPA firm may be liable to third parties it android de a boss was incurred by the claimant due to reliance on misleading financial statements. A typical suit occurs when a bank is unable to collect a major loan from an inscent customer and the bank then claims that misleading audited financial statements were relied on in making the loan and that the CPA firm should be held responsible because it failed to perform the audit with due care. The leading precedent setting auditing case in third-party liability was Liltramane Ultramares Doctrine Corporation Touche (1931), which established the Ultramares doctrine. Take a moment to read the summary of the case in Figure 5-4 In this case, the court led that although the accountants were negligent, they were not liable to the creditors because the creditors were not a primary beneficiary. In this context, a pritary beneficiary is one about whom the auditor was informed before conducting the audit (a known third party). This case established a precedent. commonly called the Ultramures doctrine, that ordinary negligence is insufficient for liability to third parties because of the lack of privity of contract between the third party and the auditor, unless the third party is a primary beneficiary. However, in a subsequent trial of the Ultramares case, the court pointed out that had there been fraud or grass negligence on the part of the auditor the auditor could be held liable to third parties who are not primary beneficiaries. Foreseen Users In subsequent decisions courts have broadened the Ultramares doctrine to allow recov cry by third parties in more circumstances by introducing the concept of foreseen users, who are members of a limited class of users that the auditer knows will rely on the financial statements. For example, a bank that has lisans outstanding to a client at the balance sheet date may be a foreseen user. Under this concepLa foreseen user is treated the same as a knowo third party FIGURE 54 Ultramares Corporation. Touche (1991) - Liability to Third Parties The role of corporate ( Urred on the waters and subsequently ed the accountant le chat chey were alle de and fraudulene arapresentation. The as receivable had noted to SASA ODS ter of over $700.00. The credonged that are region would be shown the $700.000 berent. The la contar discrepancies The court held at the contents had been betrued that it would not be able to end wie Borhes anders beyond the love of the original contrat e they were bencana. The court held that only one who are contract with curtant for rica three ruderanduty Sourceh4NEMINY.1991 122 Part 1 THE AUDITING PROFESSION FIGURE 5-5 Rusch factors v. Levin (1960) ---Liability to Third Parties The pict, Rachers, alundersked the defendatud ter s udt the ancient of comowy salon Thermopon on the winners Indicating that the company was solver when in fact I want. The plained the company weg teda halok, and with or for racey The auditor's defense in the case was based on the bence of print on the part of Rasch Factors. The court found in for of the plant Although the court could be found in two of Rouch Pacar ander trenere in the was a primary bensary, it has to rely on the comment of Tarte string that the should be le for ardeary neglice in die where the fronciertoves are ched on by by fand red choice of Penn Sawie Rose SCRIIW Although the concept of foreseen users may appear straightforward. courts have generated several different interpretations. At present, the three leading approaches taken by the courts that have emerged are described as follows: Credit Alliance In Credit Alliance v. Arthur Andersen & C (1986) in New York, a lender brought suit against the auditor of one of its borrowers claiming that it relied on the financial statements of the borrower, who was in default, in granting the kan. The New York State Court of Appeals upheld the basic concept of privity established by Uitmares and stated that to he liable (1) an auditor must know and intend that the work product would be used by the third party for a specific purpose, and (3) the knowledge and intent must be evidenced by the auditor's conduct. Restatement of Torts The approach followed by most states is to apply the rule cited in the Restatement of Tots, an authoritative ser of legal principles. The Restatomers Ruk is that foreseen users must be members of a reseably limited and identifiable group of te who have relied on the CPA's work, such as creditors, even though those persons were not specifically known to the CPA at the time the work was done. A leading case sup- porting the application of this rule is Ruch Factors v. Lavin, as presented in Figure 5.5. Foreseeable User The broadest interpretation of the rights of third party beneficia ries is to use the concept of foreseeable users. Under this concept, any users who the auditor should have reasonably been able to foreseeas likely users of the client's finan- cial statements have the same rights as those with privity of contract. These users are often called an unlimited class. Although a significant mumber of states followed this approach in the past, it is now used in only a minority of States Table 52 summarizes the three approaches to third party liability taken by the courts under con law. There is confusion caused by these differing views of Bability to third parties under common law, but the movement is clearly away from the TABLE 5-2 ample Interpretation Narro Approaches Courts Take to Assign Third-Party Liability Under Common Law Approaches by Courts and Example Chies Definition at Third-Party User Primary bencidente e Auditor www und went Aaltor is real see Uhe Corpo Toucher it report more that repares foros Cadiz Antu Andero ( 16 . Forester Restory and think Bank or trade creditor with Harmowe group who were wao wanachar on the who's work provided audied soil 10 Forever Alte dissols the the Aracreditor that is not previously Rosenblume, inc. Al 1981) Tornby condens with the der fursas of the Thar de nos furia firas its traderen in the past. Bread