Chapter Two

THE AUDITING PROFESSION

This unit covers the basic codes of professional conduct, which the auditors need to bear
in mind in carrying out their duties. The main source of material for code of professional
conduct in this unit is the AICPA’s code of professional ethics. Standards are established to
measure the quality and performance of individuals and organizations. Standards relating to the
auditing profession concern themselves both with the CPA’s professional qualities and with the
judgment exercised by CPA’s in the performance of their professional engagement. Our purpose
in this topic is to make clear the nature of generally accepted auditing standards (GAAS). In our
discussion of GAAS, we consider mainly on the nature of the independent auditor’s report.
2.1 Generally Accepted Auditing Standards (GAAS)
The existence of GAAS is evidence that auditors are very concerned with the maintenance of
a uniformly high quality of audit work by all independent public accountants.
What are the standards developed for the public accounting profession? The AICPA has set forth
the basic framework in the following 10 generally accepted auditing standards.
General Standards

1. The audit is to be performed by a person or persons having adequate technical training

and proficiency as an auditor.

2. In all matters relating to the assignment independence in mental attitude is to be

maintained by the auditor or auditors.

3. Due professional care is to be exercised in the performance of the audit and the
preparation of the report.

Standard of field Work

1. The work is to be adequately planned and assistants, if any, are to be properly supervised.

2. A sufficient understanding of the internal control structure is to be obtained to plan the

audit and to determine the nature, timing, and extent of test to be performed.

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 3. A sufficient competent evidential matter is to be obtained through inspection,
observation, inquiries, and confirmation to afford reasonable bias for an opinion
regarding the financial statements under audit.

Standard of Reporting

1. The report shall state whether the financial statements are presented in accordance with
GAAP.

2. The report shall identify those circumstances in which such principle have not been
consistently observed in the current period in relation to the preceding periods.

3. Informative disclosures in the financial statements are to be regarded as reasonably

adequate unless otherwise stated in the report.

4. The report shall either contain an expression of opinion regarding the financial
statements, taken as a whole, or an assertion to the effect that an opinion can not be
expended.

Brief explanation of the above 10 GAAS standards

1. Training and Proficiency: - How does the independent auditors achieve “adequate training
and proficiency” required by the first general standard? This requirement is usually
interpreted to mean college and University education in accounting and auditing,
participation in continuing education programs, and substantial public accounting experience.
It fallows that a CPA firm must not accept an audit engagement without first determining that
members of its staff have the technical training and proficiency needed to function
effectively in the particular industry.
2. Independence: - It states an opinion by an independent public accountant as to the fairness
of the campaigns financial statements should be independent from other parties’ influence. If
auditors owned share of stock in a company that they audited, or if they served as members
of the board of directors, they might subconsciously be biased in the performance of auditing
duties. A CPA should therefore avoid any relationship with a client that would cause an
outsider who had knowledge of all the facts to doubt the CPA’S independence.

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3. Due professional Care: - The third general standard requires due professional care in the
conduct of the audit and in the preparation of the audit report. This standard requires the
auditors to carry out every step of the audit engagement in an alert and diligent manner.

4. Adequate planning and supervision: - It is one of the standards of fieldwork related to

accumulating and evaluating evidence sufficient for the auditors to express an opinion of the
financial statements and adequate planning is essential to a satisfactory audit. The
appropriate number of audits staff of varies level of skill and the time required of each need
to be determined in advance of field work.
5. Sufficient understanding of Internal Control: - An effective internal control structure
provides strong assurance that the client’s records are dependable and that its asset are
protected when auditors find this types of strong internal control. The quantity of other
evidence required is much less than if controls are weak. Thus the auditor’s assessment of
internal control has great impact on the length and nature of the audit procures.
6. Sufficient competent evidential matters: - The third standard of field work regards that the
auditors gather sufficient competent evidence to have a basis for expressing an opinion on the
financial statements. The term competent refers to the quality of the evidence.
7. Standards of reporting (7 to 10): - The four reporting standards establish some specific
directives for preparation of the auditor’s report. The report must specifically state whether
the financial statements are in conformity with generally accepted accounting principles. The
report must contain an opinion on the financial statement as a whole, or must disclaim an
opinion.
2.2 Professional Ethics and legal liability of auditors
Professional Ethics
All recognized professions have developed code of professional ethics. The fundamental
purpose of such codes is to provide members with gaudiness for maintaining a professional
attitude and conducting themselves in a manner that will enhance the professional statues of their
disciplines. Our purpose in this topic is to discuss the need for professional ethics in auditing
profession.
Need for professional Ethics
To understand the importance of a code of ethics to public accountants and others professions,
one must understand the nature of a profession as opposed to other vocations. There is no

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universally accepted definition of a profession but certain types of activities have been
recognized as a profession such as medicine, law, engineering, architecture, and theology. Public
accounting is a relative new comer to the ranks of the professions, but it has achieved widespread
recognition in the recent decades.
All of the recognized professions have several common characteristics. The most important of
these characteristics are-
1. A responsibility to serve the public
2. A complex body of knowledge
3. Standard of admission to the profession
4. A need for public confidence
Let us briefly discuss these characteristics as they are applied to public accounting
Responsibility to serve a public: - The certified public accountant is the representative of the
public such as creditors, stockholders, consumers, employees, and others in the financial
reporting process. The role of the independent auditors are to ensure that financial statements are
fair to all parities and not biased to benefit one group at the expense of others. This responsibility
to serve the public interest must be a basic motivation for the professionals. in addition, public
accountants must maintain a high degree of independence from their clients (businesses those are
under Audit) In order to serve the larger community.
Complex body of knowledge:- Any practitioner or student of accounting has only to look at the
abundance of authoritative pronouncements governing financial reports to realize that accounting
is a complex body of knowledge. One reason why such pronouncements continue to grow is that
accounting must reflect what is taking place in an increasingly complex environment. The
continual growth in the common body of knowledge “for practicing accountants” has led the
AICPA to enact continuing education requirements for CPA’s.
Standard of Admission in the Profession: - a license to practice as a certified public accountant
requires an individual to meet minimum standards for education and experience. The individual
must also pass the uniform CPA examination showing mastery of the body of knowledge
described above. Once licensed, certified public accountants must adhere to the ethics of the
profession.
Need for Public confidence: Lawyers, physicians, certified public accountants, and all other
professionals must have the confidence of the public to be successful. To the CPA, however,

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public confidence is of special significance and the CPA product is credibility. With out public
confidence in the auditing practice, the attest engagement will serve no useful purpose.
Professional ethics in public accounting
Professional ethics in public accounting as in other professions have developed gradually and are
still in a process of change as the practice of public accounting itself changes. This code of
professional conduct for public accounting is developed by American institute of certified public
accountant (AICPA). this code provides practical guidance to the individual members in
maintaining a professional attitude. In addition, this code gives assurance to clients and to the
public that the profession intends to maintain high standards and to enforce compliance by
individual members in maintaining a professional attitude. In addition, this code gives assurance
to clients and to the public that the profession intends to maintain high standards and to enforce
compliance by individual members. These standards of conduct set forth the Basic
responsibilities of CPAs to the public, clients. The AICPA code of professional conduct is
designed to provide a framework for expanding professional services and responding to other
changes in the profession, such as the increasingly competitive environment.
The AICPA code of professional conduct consists of two sections: - The first section, the
principle, is goal oriented, positively stated discussion of the professions responsibility to the
public, clients, and fellow practitioners. The principles provide the framework for the rules,
which is the second section of the code. The rules are comfortable application of the principles.
They define accountable behavior and identify source of authority for performance standards.
To provide guidelines for the scope and application of the rules, The AICPA issues
interpretations. In addition, the AICPA issue Ethical rulings, which explain the application of the
rules and interpretations to specific factual circumstance involving professional Ethics. A
portion of the principle section of the code of professional conduct and rules are explained in
detail as follows.
Section 1 principles
This principle of the code of professional conducts of the AICPA expresses the professionals’
recognition of its responsibilities to the public and to the clients. Generally the principles
includes six articles
Article 1-Responsibilities

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In caring out their responsibilities as professionals, members should exercise sensitive
professional and moral judgments in all of their activates.

Article 2- the public interest

Members should accept the obligation to act in a way that will serve the public interest, honor the
public trust and demonstrate commitment to professionalism
Article 3- Integrity
To maintain and broaden public confidence, members should perform all professional
responsibilities with the highest sense of integrity.
Article 4- objectively and independence
A member should maintain objectivity and be free of conflict of interest in discharging
professional responsibilities. A member in public practice should be independent when providing
auditing and other attestation services.
Article5- Due care
A member should observe the profession’s technical and ethical standards, strive continually to
improve competence and the quality of services, and discharge professional responsibility to the
best of the members’ ability.
Dear learners, members of CPAs in determining whether to provide specific service for clients
should consider each of the above principles.
There are six Principles of Professional Ethics

I. Responsibilities: In carrying out their services as professional, members should exercise

sensitive professional and moral judgments in all their activities. Auditors play significant role in
the society by rendering different types of services that are essential to make various decisions,
which involves usage of scarce resources. Therefore, all members have responsibilities to those
who use their professional services. Besides, auditor has responsibility to corporate which each
other to:

 Improve their profession

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 Maintain the public confidence ,and

 Carryout the profession‘s self-governance responsibilities

Application of this principle increases the quality of professional services rendered by auditors
and thereby boosts the status of the profession.

II.The public interest: Members should accept the obligation to act in a way that will serve the
public trust and demonstrate commitment to professionalism. The public interest of an auditor is
the collective wellbeing of the community of people and institutions that use its services. These
include clients, creditors, governments, employers, investors, and the public at large, who rely on
the objectivity and integrity of auditors. This reliance imposes high reliance of responsibility on
the auditors. In discharging their responsibilities, members of the profession may encounter
conflicting pressures between information providers and users. This conflict would be resolved
when auditors carryout their responsibilities with integrity. Auditors should show their
commitment to honor the public trusts to those who rely on their services: i.e. they expected to
provide quality services within integrity, objectivity, and due professional care.

III. Integrity: To maintain and broaden public confidence members should perform all
professional services with the highest form of integrity. In order to maintain the public trust and
confidence members should act in an honest manner.
Integrity is measured by what is right and just in the circumstances. Integrity means in this case,
acting according to the code of professional conduct (ethical standards).

IV. Objectivity and independence: A member should maintain objectivity and be free of conflicts
of interest in discharging professional responsibility. A member in public practice should
beindependent in fact and appearance when providing auditing and other attestation services.
This principle requires auditors to avoid circumstances that involve conflicts of interest.
Independence in fact refers that the auditor should maintain an objective and impartial mental
attitude throughout the engagement. Independence in appearance refers to the relationship
between the CPA and the client must appear to be independent to third parties. The auditors‘

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opinion will get credibility if the users perceive that the auditor as objective and impartial.

V. Due Care: A member should observe the profession technical and ethical standards, strive
continually to improve competence and quality of service; and discharge professional
responsibility to the best of the member‘s ability. Due professional care applies to the exercise of
professional judgment in the conduct of the work performed. Due professional care implies that
the professional approaches matter requiring professional judgment with proper diligence.

VI. Scope and nature of service: A member in public practice should observe the principles of
the code of professional conduct in determining the scope and nature of services to be
provided.The auditor should consider the above principles in deciding to provide the specific
services in specific situations. In addition, members should:

 Practice only in firms that have adequate internal control procedures

 Determine whether the scope and nature of other services requested by an audit client

would create a conflict of interest in providing auditing.

 Assess whether the requested service is consistent with his role as a professional

Section II Rules
The following figure shows the complete list of rules that are presented and analyzed in detail
below.
Rule Title
101 Independence
102 Integrity and objectivity
201 General standards
202 Compliance with standards
203 Accounting principles
301 Confidential client information

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302 contingent fees
501 Acts Discreditable
502 Advertising and other form of solicitation
503 Commission and referral fees
504 (deleted)
505 Form of organization and name
Rule 101 - Independence

Rules: Rule is an accepted principle or instruction that states the way things are or should
be done, and tells you what you are allowed or are not allowed to do:
Rule 101 Independence
A member in public practice shall be independent in the performance of professional
services as required by council. A member should be independent in financial statement
audit, review, and examination of prospective financial statements for his/her is attesting
information to third party. But he/she does not have to be independent in rendering
accounting, tax, or management advisory services.
The AICPA has also adopted the following interpretation of the rule. Independence shall
be considered to be impaired if, for example, a member has any of the following
transactions, interests, or relationships.
A. During the period of professional engagement or at the time of expressing an opinion, a
member or a member‘s firm:
1. Has/or was committed to acquire any direct or indirect financial interest in the
enterprise.
2. Was a trustee of any trust or executor or administrator of any estate if such trust or state
has or was committed to acquire any direct or material indirect financial interest in the
enterprises?
3. Had any joint, closely held business investment with the enterprises or with any officer,
director, or principal stockholders thereof that of material in relation to the member‘s net
worth or to the net worth of the member‘s firm.
4. Had any loan to or from the enterprise or any officer, director, or principal stockholder
of the enterprise. This prescription does not apply to the following loans from a financial

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institution when made under normal lending procedures, and requirements:-Loans
obtained by a member or a member‘s firm that are not material in relation to the net
worth of such borrower Home mortgages and Other secured loans
B. During the period covered by the financial statements, during the period of the
professional engagement, or at the time of expressing an opinion, member or a member‘s
firm:
1. Was connected with the enterprise as a promoter, underwriter or voting trustee, as a
director or officer, or in any capacity equivalent to that of member of management or of
any employee.
2. Was a trustee of any pension or profit sharing trustee of the enterprise? The above
examples are not intended to be all-inclusive. To have a clear understanding of the
rules, in what follows we will see the application of independence rule in relation to
professional services, individuals, and time period. Professional services; independence
rules applies to auditing and other attestation services such as review of financial
statements, examination of financial forecasts. The independence rule applies to:
 All parents or shareholders of the audit firm
 All managerial employees assigned to an office that significantly participates in the
engagement
 All professional staff personally participating in the engagement Therefore, it is not
required that all employees of the firm be independent if the client, i.e. independence of the
employee is impaired does not necessarily mean that independence of the firm is also
impaired. If independence of an employee having no managerial responsibility is impaired,
independence of the audit firm will be maintained by assigning the employee to other
engagements. If independent of a managerial staff is affected, he/she has to be transferred
to an office of the firm that is not significantly participating in the audit engagement.
Period: an auditor is required to be independent of the client during the following time
period
 During the period of examination(auditing) process
 During the period covered by the financial statements
 At the time of expressing the auditor‘s opinion(the date of the report)
During these time period holding of financial interest, or a commitment to acquire a

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financial interest, establishing business relationships may adversely affect the auditor
independence.
Financial interest: According to the interpretation of rule 101:
 A member or a member‘s firm client cannot have any direct financial interest in the
client. Direct financial interest indicates any involvement in the client. Direct financial
interest comprises independence. Hence firm‘s entire partners and all other professional
staff that would participate in that specific engagement should not have any direct financial
interest. Indirect financial interest exists when a member or a member‘s firm owns stock in
a mutual fund, and/or when a member‘s non-dependent close relative has a financial
interest in the client.

 A member should not have joint closely held business investment with a client company.
Or officers, directors, or a principal stockholder of such enterprise that is material to either
of the member‘s or the audit firm‘s net worth.
 A member is not permitted to have any loan to or from a client, or its officers, directors
or principal stockholders, which is not made under normal lending, procedures, terms and
requirements. This prevents any favoritism that affects or (appear to have affected) the
auditor‘s independence.
The following may considered as ways of maintaining independence:
 Training: members should be adequately trained to help them understand the technical
standards relevant to various types of professional engagement. Advice should also be
given to members for specific situations.
 There should be a controlling body that sanctions the public accounting firm and or
auditors for misconduct.
 Public accounting firms should give much emphasis to independence as it is the vital
means of gaining reputation, and therefore there should be internal pressure that forces
members to act in professional manner. Before accepting a new client public accounting
firms should evaluate as the existence of threats of independence.

A member in public practice shall be independent in the performance of professional service as

required by standards promulgated by bodies designed by council.

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 Rule 102 – Integrity and objectivity
In the performance of professional service, a member shall maintain objectivity and integrity,
shall be free of conflicting interest, and shall not knowingly misrepresent facts or subordinate
disorder judgment to others.
Rule 201 - General standards
Member shall comply with the following standards;
 professional competence
 Due professional care
 Planning and super
 sufficient relevant data
Rule 202 – Compliance with standards
A member who performs auditing, review, compilation, management consulting, tax or other
professional service shall comply with standards.
Rule 203 – accounting principles
A member shall not (1) express an opinion or state affirmatively that the financial statement or
other financial data of any entity are presented in conformity with generally accepted accounting
principles, or (2) sate that he or she is not aware of any material modifications that should be
made to such statement or data in order for them to be in conformity with generally accepted
accounting principles, if such statement or data contain any departure from an accounting
principle.
Rule 301- Confidential client information
A member in public practice shal1 not discloses any confidential client information with out the
specific consent of the client.
Rule 302 – Contingent fees
A member in public practices shall not;
1. Perform for a contingent fee any professional service, or receive such a fee from a client
for whom the members firm performs an audit or review of financial statements.

2. Prepare an original or amendment tax return or claim for a tax refund for a contingent fee
for any client.
Rule 501 Acts Discreditable

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A member shall not commit an act discreditable to the profession.
Rule 502 advertising and other form of solicitation
A member in public practice shall not seek to obtain clients by advertising or other form of
solicitation a manner that is false, misleading, or unreliable.
Rule 503- commission and referral fees
Prohibited commissions- A member in public practice shall not for a commission recommend or
refer to a client any product or service, , when the member or the member’s firm performs an
audit, review or examination of financial statements.
Disclosure of permitted commission- a member in public practice who is not prohibited by this
rules from performing services for or receiving a commission and who is paid or expects to be
paid a commission shall disclose the fact to any persons a product or service to which the
commission relates.
Referral fees- any member who accept a referral fee for recommending or referring any service
of a CPA to any person or entity who pays a referral fee to obtain a client shall disclose such
acceptance or payment to the client.
Rule 505 form of organization and name.
A member may practice public accounting in a form of organizations permitted by state low or
regulations. However, any member shall not practice public accounting on the name of the firm.
2.3 Legal liability of auditors
In the previous sub topics we have seen professional standards and ethics regarding auditing
profession. We believe also that you clearly understand such standards, ethical rules and
principles those guide the auditing profession. Consequently, now let us see the auditors’ liability
against their clients and third parties beneficiaries when they fail to obey and implement the
above standards, ethical principles and rules.
Basic terminologies
Discussion of auditors’ liability is best preferable by first understanding basic terminologies of
business law.
Negligence- it is also referred to as ordinary or simple negligence. For the CPA, negligence is
failure to perform a duty in accordance with applicable standards. For practical purpose,
negligence may be viewed as “failure to exercise due professional care”.

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Gross negligence is lack of even slight care in caring professional service. It is substantial
failure on the part of an auditor to comply with generally accepted auditing standards.
Fraud is defined as misrepresentation by a person of a material fact, known by that person to be
untrue, with the intention of misleading the other party and with the result that the other party is
injured.
Constrictive fraud it differs from fraud because it does not involves a misrepresentation with
intent to deceive. Gross negligence from the side of auditor can be interpreted by the court as
constrictive fraud.
Privities are the relationship between parties to a contract. A CPA firm is in privities with the
client it is serving, and with any third party beneficiaries.
Third party beneficiary is a person- not the promisor or promise- who is named in a contract to
have definite right and benefit under the contract. For example ABC and company, CPAs, is
engaged to examine the financial statement of XYZ company and to send a copy of its audit
report to Development Bank as support for a loan, the bank is a third party beneficially under the
contract of ABC and co. and XYZ Company.
An engagement letter:- is the written contract summarizing the contractual relationship
between auditor and clients.
Breach of contract:- is frailer of one or both parties to a contract to perform in accordance with
contract provision
The plaintiff: - is the party claiming damages and bringing suit against the defendant.
Contributory negligence: - is negligence on the part of the plaintiff that has contributed to his or
her having incurred a loss.
Comparative negligence:- is a concept used by certain courts to allocate damages between
negligent parts based on the degree to which each party is at fault.
Common law: - is unwritten law that has developed through court decision; it represent judicial
interpretation of a society’s concept of fairness for example, the right to sue a person for fraud is
a common law right.
Statutory low: - is law that has been adopted by a governmental unit, such as the federal
government.
Auditors’ liability for their clients under common law

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Audition must design their audit to provide reasonable assurance of detecting errors and
irregularities that are material to the financial statements. In doing so, they must exercise due
care and professional skepticism in planning, performing, and evaluating the results of audit
procedures. Auditors liability to their clients most often arises form a failure to uncover an
embezzlement or defalcation (misappropriation of asset) against the clients by client employees.
When CPAs take on any type of audit engagement, they are obliged to render due professional
care. The obligation occurs whether or not it is specifically set it the written contract with the
client. Thus, CPA’s are liable to their clients under common law for any losses caused by CPA’s
failure to render due professional care. In short, ordinary negligence is a sufficient degree of
misconduct to make CPA’s liable for damages caused to their clients. However, when the CPAs’
firm’s audit has been made in accordance with generally accepted auditing standards, the firm
should not hold liable for failure to detect the existence of errors or irregularities.
To obtain a judgment against its auditors, an injured client must provide that it sustained a loss as
a result of the auditors’ negligence. As defendants, the auditors can disprove this claim by
showing that either.
1. They were not negligent in the performance of their duties, or

2. Their negligence was not the direct cause of the client loss.

Demonstrating contributory negligence by the client is one means of showing that the auditors
negligence was not the cause (or sole cause) of the client’s loss. In some jurisdictions, a defense
of contributory negligence will eliminate the auditors’ liability to their clients. In addition, the
concept of contributory negligence is used to allocate damages between the clients and the
auditors based on the extent to which each is at fault.
Auditors’ liability to third parties under common law
What do you think about auditors liability to third parties those rely up on audited financial
statements? How these parties recover their losses from auditors’ those performed an improper
audit?
Auditors could be liable to third party beneficiaries under common law. The degree of
negligence required to establish the auditors’ liability to third parties under common law varies
from one case to another. Dear colloquies, three general approaches may be used to summarize
auditor’s liability to third parties under common law. There are:

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 1. Ultramar Approach
2. Restatement of torts Approach
3. Rosenblum Approach
Ultramar Approach
In this case, auditors are liable for ordinary negligence and for third parties if the users of audited
financial statement are specifically identified, and they are liable for grass negligence even for
unidentified third parties.
Example:
The defendant CPA has issued an audit opinion on the balance sheet of the company engaged in
the importation and sale of rubber. On the bases of CPA’s opinion, Ultramar’s (the third party),
made several loan to the company. Shortly there after, the company was declared bankrupt and
ultra mares sued the CPA’s for ordinary negligence. Finally, the court decided that the CPA
should be held liable for ordinary negligence only to their client and only third party beneficiary
that are specifically identified as a user of the CPA’s repot. In addition, the court indicates that
the auditors should be held liable to unidentified third party users of the audit report if there is
Gross negligence or fraud.
Therefore, in order to cover a loss from CPA’s ultra mares should verify;
1. Whether the audit report is prepared for the consumption of the client and specifically
identified third party.

2. The CPAs were grossly negligent in performing their audit.

Restatement of torts Approach

It is also referred to as the foreseen third –party approach. In this case CPA’s are liable for
ordinary negligence to a limited class of fore seen third parties of known or intended user of the
audited financial statements.
Example:
Girum and Company, CPA, perform the audit of Lyman Corporation. The CPA was aware that
Lyman intended to use the audit report to obtain a bank loan. However, no specific bank was
identified to the CPA-firm. After the report was issued, Lyman obtained loan from the Dashen
bank and Awash bank. In addition, ABC manufacturing Company relied on Girum opinion in
providing trade credit to Lyman. If the court applied the principles contained in the restatement

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Approach, Girum could be liable to Dashen and Awash bank if there is ordinary negligence in
the performance of his audit. On the other hand, ABC manufacturing company would have to
prove gross negligence on the part of Girum to recover its losses.
Rosenblum Approach
This Approach expand liability of auditors to third parties whether or not users of the audit report
are specifically identified from the point of view of that audit report should avail correctly to all
3rd parties.
Example: Girum, CPA, issued an audit report on the financial statement of Giant Stores
Corporation that showed the corporation to be profitable. In reliance up on these statements,
ABC sold a catalog show room business to Giant in exchange for share of Giant stock. Shortly
afterward, Giant filed for bankrupt and the stock become worthless. ABC suet Girum and the
court decided that Girum, CPA firm, is liable for ordinary negligence even for unidentified third
parties from the point of view of that audit report should be reliable for all types of users.
(Rosenblum Approach)

Auditor’s liability to third party under statutory law

Statutory law is written law, created by state or federal legislative bodies-most countries have
commercial law that regulate the trade and commercial activity of the country. Dear learners,
auditors will be liable under statutory law when the injured third party could justify the
relationship between the loss and the information provided with audit report.
Auditors’ liability for accounting and review service
Up to this point, we have emphasized the liability of CAP firms when they are associated with
audited financial statements. In addition, CPAs are subject to legal liability when they perform
accounting service such as write-up work and compilation of un audited financial statements.
These services differ from audit engagement because the CPAs neither perform investigative
procedures that involved in an audit engagement nor do they issue an auditors opinion as to the
fairness of the financial information.
The term compilation refers to the preparation of financial statements based up on information
provided to the CPA by the client. A compilation is not intended to lend any assurance to any
party that the CPA has determined the information to be reliable. A review consists of limited

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investigative procedures, substantially less in scope than an audit, designed to provide uses of
unedited financial statement with a limited degree of assurance as to the statements reliability.
Do CPAs associated with unaudited financial statements have any potential legal liability? The
answer is yes. The CPAs, acting as accountants rather than as auditors, still have a liability to
their client to exercise due professional care. In addition, they still may be liable under common
law for losses to third parties attributable to the accountants’ ordinary and gross negligence.

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