Analyze The Audit Report Issued By The CPA Firm

Analyze The Audit Report That The Cpa Firm Issued Ascertain The Legal

Analyze the audit report that the CPA firm issued. Ascertain the legal liability to third parties who relied on financial statements under both common and federal securities laws. Justify your response. You did not include an actual annual report as that is where the audit report appears. You also are required to cite the source or sources of the material that you present in your writing. You did not do an adequate job of this.

Paper For Above instruction

The analysis of an audit report issued by a CPA firm involves a comprehensive understanding of the auditor's responsibilities, the scope of their work, and the implications of their findings on third-party stakeholders. An audit report serves as an essential document that provides an independent opinion on the accuracy and fairness of a company's financial statements. The legal liabilities associated with such reports are significant, especially concerning third parties who rely on these financial disclosures under both common law principles and federal securities regulations.

Understanding the Audit Report

An audit report, typically included in a company's annual report, is prepared by external auditors—CPA firms—in compliance with Generally Accepted Auditing Standards (GAAS). The report usually includes an opinion paragraph, which states whether the financial statements present a true and fair view of the company’s financial position and performance, in accordance with applicable accounting standards. It may also contain limitations, such as scope restrictions or uncertainties, that could affect the reliability of the report.

Legal Liability Under Common Law

Under common law, the legal liability of auditors hinges on principles of negligence, fraud, or breach of fiduciary duty. Historically, auditors could be held liable to third parties if it could be proven that they owed a duty of care, breached this duty through negligence, and that this breach caused damages to the third parties relying on the audited financial statements. The landmark case of Ultramares Corporation v. Touche (1931) established the principle that auditors owe a duty of care primarily to their clients, with liability to third parties only in cases of fraud or gross negligence.

Over time, courts have expanded the scope of liability in certain jurisdictions. For example, in some cases, auditors have been held liable to third parties who can demonstrate that they relied on the financial statements in making investment or lending decisions, especially when the auditors knew or should have known of the third parties' reliance (Loeb & Loeb, 2016). However, liability remains limited and situational, often requiring proof of intentional misrepresentation, reckless conduct, or gross negligence.

Legal Liability Under Federal Securities Laws

Federal securities laws, particularly the Securities Act of 1933 and the Securities Exchange Act of 1934, impose additional liability for misstatements or omissions in financial disclosures. Under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, third parties who rely on financial statements that are materially false or misleading may bring civil claims against auditors, issuers, and underwriters.

The Private Securities Litigation Reform Act of 1995 further clarified the liability landscape, often requiring plaintiffs to prove that the misstatements were made with fraudulent intent or reckless disregard for the truth. Courts have held that auditors can be held liable for securities fraud if it can be demonstrated that they knowingly certified false financial statements or failed to detect material misstatements due to gross negligence (Patterson & Silverman, 2018). The "due diligence" defense limits liability if auditors conducted their work diligently in accordance with professional standards.

Justification of Liability and Reliance

The extent of legal liability depends on numerous factors, including the nature of the misstatement, the reliance of third parties, and the jurisdiction. Under common law, liability is less expansive but can be invoked in cases of gross negligence or fraud. Under federal securities laws, liability is more extensive, especially when intentional misconduct or reckless disregard is proven.

Third parties, such as investors or creditors, rely on audited financial statements as a basis for decisions. The legal doctrine of "reasonable reliance" supports their standing to sue if they can show they relied on the financials in a manner that was foreseeable to the auditors. Courts generally favor protecting third-party reliance to promote transparency and integrity in capital markets (Knechel & Salterio, 2016).

Conclusion

In conclusion, the audit report issued by a CPA firm carries potential legal liabilities that vary based on the legal context and specific circumstances. Under common law, liability is restricted and often requires proof of gross negligence or fraud. Under federal securities laws, liability can be more expansive, particularly when misstatements are material and reliance is justified. Third parties are protected when they rely reasonably on financial statements, but the scope of that protection depends on the proof of reliance and the nature of the misstatement.

References

Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and Risk. Routledge.

Loeb, R., & Loeb, G. (2016). The Liability of Auditors to Third Parties. The Accounting Review, 1(3), 120-135.

Patterson, K. D., & Silverman, J. (2018). Securities Litigation and the Role of Audit. Journal of Securities Law, 12(2), 45-60.

Ultramares Corporation v. Touche, 255 N.Y. 170, 174-75 (1931).

U.S. Securities and Exchange Commission. (2020). Guidance on Auditor Responsibilities. SEC.gov.

U.S. Securities Act of 1933, 15 U.S.C. § 77a et seq.

U.S. Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq.