Accountant Common Law Liabilities

An accountant’s liability describes the legal liability assumed while performing professional duties. An accountant is liable for a client’s accounting misstatements. This risk of being responsible for fraud or misstatement forces accountants to be knowledgeable and employ all applicable accounting standards.

An accountant who is negligible in their examination of a company can face legal charges from either the company, investors, or creditors that rely on the accountant’s work. The accountant could also be responsible for the financial losses incurred from any incorrect representation of a company’s books. This possible negative scenario often leads to accountants taking out professional liability insurance.

Whether providing services as an accountant or auditor, a certified public accountant (CPA) owes a duty of care to the client and third parties who foreseeably rely on the accountant’s work. Accountants can be sued for negligence or malpractice in the performance of their duties, and for fraud.

Liability to clients

CPAs have an obligation to their clients to exercise due professional care. With an engagement letter, it provides the client and other third parties with rights of recovery. Therefore, if the CPAs are not performing within the agreement set forth in the contract this will be considered a breach of contract. The clients may also claim negligence against the CPAs if the work was performed but contained errors or was not done professionally. This is considered a tort action.

In order to recover from an auditor under common law negligence theory, the client must prove:

• Duty of care
• Breach of Duty
• Losses
• Causation

CPAs may defend against a breach of contract if they can prove that the client’s loss occurred because of factors other than negligence by the auditors. If the auditor proves the loss resulted from causes other than the auditor’s negligence, a client may be accused of contributory negligence. If a state follows the doctrine of contributory negligence, the auditor may eliminate their liability to the client based on contributory negligence by the client. Many states do not follow this doctrine. Most states permit a jury to assess the fault and apply the correct percentage of fault to the parties involved. This is called comparative negligence.

Rosenblum (foreseeable user) approach

The “reasonably foreseeable” approach which was created due to Rosenblum v. Adler. This method is very liberal and broad in terms of scope, unlike the privity approach. This system holds an auditor liable to all third parties that rely on financial statements.

Restatement of Torts (foreseen user) approach

The “foreseen” or “Restatement Standard” approach was established by the American Law Institute’s (ALI) Second Restatement of Law of Torts. With this approach the auditor is liable to all third parties in which their reliance is foreseen even if the auditor doesn’t know the third party. This approach came about due to Rusch Factors, Inc. v. Levin. In this case, the CPA was found accountable for ordinary negligence to the third party who had not been specifically identified but the CPA was aware that the financial statements were to be used by this party.

Ultramares (known user) approach

In order for the court to decide if the auditor’s duty actually extended to the third party, for ordinary negligence, there are four legal approaches each state could follow. First is the Privity approach, which states the auditor is liable to a third party if an existence of a contract is in existence. This approach was established in Ultramares Corporation v. Touche and is the most limiting approach in respect to scope. Ultramares occurred in 1933 where the defendant CPA distributed an unqualified opinion on the balance sheet of a company. In addition to the CPAs estimations, Ultramares wrote out several loans to the company shortly before the company declared bankruptcy. Ultramares sued the CPA for ordinary negligence. The New York Court of Appeals ruled that CPAs are held accountable for ordinary negligence to their clients and third parties who identify themselves as users of the CPAs reports.

Liability to third parties

Not all suits brought to an auditor are from a direct client. Third parties can also sue an auditor for fraud, in which case a contract (privity) is necessary. In order for a third party to prevail in a case, there are a number of things they must prove. First, the third party must prove that the auditor had a duty to exercise due care. Second, the third party must prove that the auditor breached that duty knowingly. Third, the third party must prove that the auditor’s breach was the direct reason for the loss. Finally, the third party must prove that they suffered an actual loss.

Statutory liability

Statutory law consists of written laws created by legislative bodies. Lawsuits brought against auditors based on statutory provisions differ from those under common law. Common law theories of liability may evolve or change over time, and interpretation and application may differ between jurisdictions, while statutory law is constrained to a greater degree by the text of the underlying statute.