full version Liability Of Certified Public Accounts Essay

Liability Of Certified Public Accounts

Category: Business

Autor: i_like_essay 29 March 2010

Words: 1317 | Pages: 6

Liability of Certified Public Accounts

An accountant is someone who prepares and analyzes financial records for a company, a government, or an individual. Decision makers to interpret financial information to plan then use these financial records. A certified public account (C.P.A.) is an accountant who takes and passes a uniform state test and then obtains a special license to practice.
Accountants are professionals whose expertise and knowledge the clients that hire them count on. Because of this expertise, the reports and financial statements that an accountant produces for his clients are considered a fair and accurate reporting of their clients' financial situation.
Clients and third parties use these reports and financial statements to make important decisions. Because of how these reports and financial statements are used, an accountant has a liability to his clients and sometimes to third parties. There is potential liability under:
(1) Common law
(2) Securities Laws
(3) Internal Revenue Code

An Accountant’s Liability to his Clients under Common Law

An accountant’s common law liability to his client can include:
(1) Breach of contract
(2) Negligence
(3) Fraud
Breach of contract is the failure, without legal excuse, of an account to perform the obligation of the contract between the client and the accountant. The accountant owes a duty to his client to honor the terms of the contract that they entered into.
If the contract is breached the accountant can be held liable for expenses incurred by the client in finding and hiring another accountant as well as any penalties imposed on the client and any other monetary losses that are foreseeable.
Negligence is the failure to exercise the standard of care that a reasonable person would exercise in similar circumstances. To show negligence, four elements must be proved.
The elements of Negligence:
(1) A duty of care existed
(2) The duty of care was breached
(3) The plaintiff (client) suffered an injury
(4) The injury was proximately caused by the defendants (accountants) breach of duty of care.
An accountant has the standard of care to conform to generally accepted accounting
practices (GAAP) and to generally accepted auditing standards (GAAS). Any violation to these standards is considered evidence of negligence on the part of the accountant, although compliance to these standards does not necessarily relieve them of the potential for legal liability.
Fraud is any misrepresentation, by either misstatement or omission of material fact, knowingly made with the intention of deceiving another and on which a reasonable person would and does rely to his detriment.
There are four elements to fraud. They are:
(1) A misrepresentation of material fact has occurred
(2) There exists an intent to deceive
(3) The innocent party has justifiably relied on the misrepresentation
(4) For damages, the innocent party must have been injured
An accountant can be liable for two different types of fraud, actual fraud or constructive
Actual fraud is when an accountant intentionally misstates a material fact to mislead his client and the client justifiable relies on the misstated fact to his injury.
Constructive fraud may be found if an accountant is grossly negligent in the performance of his duties. An accountant can be liable for constructive fraud whether or not he acted with fraudulent intent.

An Accountant’s Liability to Third Parties

An accountant may be held liable to third parties. There are three views on this liability, they are:
(1) The Ultramares Rule
(2) The Restatement Rule
(3) The Reasonable Foreseeable User Rule
The Ultramares Rule states that privity of contract is required, and that accountants owe a
duty of care only to those persons whose primary benefit the reports or financial statements are intended. Privity of contract is the relationship that exists between the accountant and the contract he has with his client.
The Restatement Rule states that accountants are subject to liability for negligence not only to their clients, but also to foreseen or known users of their reports or financial statements. For example if an accountant knows that the client will submit the reports or financial statements to a bank to secure a loan, the accountant may be held liable to the bank for negligent misstatements or omissions because the bank relied on the work the accountant produced.
Small minorities of courts hold accountants liable to any users whose reliance on an accountant’s reports or financial statements was reasonable foreseeable.
The Reasonable Foreseeable User Rule states that accountants should be liable to those whose use of their reports or financial statements is reasonably foreseeable. This rule elaborates further on the Restatement Rule. It states that an accountant should be aware that other people besides his client will use the information in the reports and financial statements to make decisions concerning the client.
In all fairness, an accountant should not be held liable in circumstances where they are unaware of the use to which their opinions will be put. The restatement approach to third party liability it the more reasonable approach since it allows an accountant to control their exposure to liability.

An Accountant’s Liability under Securities Laws

Both civil and criminal liability may be imposed on accountants under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995.
The Securities Act of 1933, Section 11 imposes civil liability for misstatements and omissions of material facts in registration statements. An accountant may be liable to anyone who acquires a security covered by the registration statement that he made. It imposes the duty of due diligence, this places the burden on the accountant to verify the information that is given to him by the company’s officers. Failure to follow GAAP and GAAS are proof of a lack of due diligence.
An accountant can raise the following defenses to Section 11 liability:
(1) There were no misstatements or omissions
(2) The misstatements or omissions were not of material fact
(3) The misstatements or omissions had no casual connection to the plaintiff’s loss
(4) The plaintiff purchaser invested in the securities knowing of the misstatements or omissions
(5) The alleged misstatement or omission was not part of the financial statements that he prepared or certified
Liability under Section 12(2) imposes civil liability for fraud.
The Securities Exchange Act of 1934 imposes liability for fraud. An accountant can be
relieved of liability if he acted in good faith.
Section 18 imposes civil liability on an accountant who makes or causes to be made in any application report, or document a statement that is false or misleading in respect to material fact. This liability is narrow.
Section 10(b) imposes legal liability.
The Private Securities Litigation Reform Act of 1995 made some changes to potential liability to security fraud. An accountant must use adequate procedures to uncover illegal acts of the company he is auditing, and he must disclose it to the proper authorities.

An accountant may be held criminally liable for violations of any of these Securities Laws. He may be subject to criminal penalties for will violation and imprisoned up to five years and/or fined up to $10,000 under the Act of 1933 and $100,000 under the Act of 1934

An Accountant’s Liability under the Internal Revenue Code

The Internal Revenue Code makes it a felony for an accountant to falsify tax documents or any information included in a tax document. There are also monetary penalties placed on an accountant who willfully understates or misstates a clients tax liability.
Criminal penalties may also be imposed on an accountant who fails to sign a client’s tax return, fails to give his client a copy of the tax return or does not use proper tax identification numbers.


Accountants are required to keep all work papers that were used to prepare reports or financial statements. This way they will have all the documentation needed to show how they came to the conclusions of their reports and statements.
The accountant must allow his client access to these work papers if the client needs them to transact his business, and may not transfer them to another accountant without the client’s permission.
An accountant must also keep all information concerning a client confidential.

*All definitions and element description are from West’s Business Law, 8th Ed