MODULE 21 PROFESSIONAL RESPONSIBILITIES
decisions, (3) contract with the client, (4) GAAS and GAAP,
and (5) customs of the profession. Therefore, failure to fol-
low GAAS constitutes, a breach of a CPA's duty of due care.
Answer (a) is incorrect because issuance of an oral rather
than written report does not necessarily constitute a failure
to exercise due care. Answers (b) and (c) are incorrect be-
cause the standard of due care requires the CP A to exercise
the skill and judgment of an ordinary, prudent accountant.
An honest error of judgment or failure to provide money
saving tax advice would not breach the duty of due care if
the CP A acted in a reasonable manner.
32. (a) A CPA's liability for constructive fraud is estab-
lished by the following elements: (1) misrepresentation of a
material fact, (2) reckless disregard for the truth, (3) rea-
sonable reliance by the injured party, and (4) actual dam-
ages. Gross negligence constitutes it reckless disregard for
the truth. Answer (b) is incorrect because ordinary negli- I
gence is not sufficient to support a finding of constructive
fraud. Answer (c) is incorrect because the liability for con-
structive fraud does not depend upon the identification of
third-party users. Answer (d) is incorrect because the pres-
ence of the intent to deceive is needed to satisfy the scienter
requirement for fraud. However, even in the absence of the
intent to deceive, the CPA can be liable for constructive
fraud based on reckless disregard of the truth.
B.2. Common Law Liability to Third Parties (Noncli-
ents)
33. (b) A foreseeable third party is someone not identi-
fied to the CP A, but who may be expected to receive the
accountant's audit report and rely upon it. Even though this
party is unknown to the CP A, the CP A is liable for gross
negligence or fraud.
34. (a) Lack of privity can be a viable defense against
third parties in a common law case of negligence or breach
of contract. A client's creditor is not in privity of contract
with the accountant. Answers (b) and (d) are incorrect be-
cause plaintiffs who are suing for fraud, constructive fraud,
or gross negligence, which involves a reckless disregard for
the truth, need not show privity of contract. Answer (c) is
incorrect because the accountant's client is in privity of
contract with the accountant due to their contractual agree-
ment.
35. (c) Since Sanco was a foreseeable third party in- '
stead of an actually foreseen third party by the CP A, Sanco
in most states cannot recover. Answer (a) is incorrect be-
cause most states do not extend liability to mere foreseeable
third parties for simple negligence. Answer (b) is incorrect
because the Ultramares decision limited liability to parties in
privity of contract with the CPA. Answer (d) is incorrect
because the client can recover for damages caused to it
when negligence is established.
36. (b) Under the Ultramares rule, the accountant is held
liable only to parties whose primary benefit the financial
statements are intended. This generally means only the cli-
ent or third-party beneficiaries who are in privity of contract
with the accountant. Many courts have more recently de-
parted from the Ultramares decision to allow foreseen third
parties to recover from the accountant. However, those
courts that adhere to the Ultramares rule do not expand li-
ability to foreseen parties.
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,37. (a) In order to establish common law liability
against an accountant based upon negligence, it must be
proven that (1) the accountant had the duty to exercise due
care, (2) the accountant breached the duty of due care,
(3) damage or loss resulted, and (4) a causal relationship
exists between the 'fault of the accountant and the resulting
damages. The accountant may escape liability if due care
can be established. The standard for due care is guided by
state and federal statute, court decisions, contract with client,
GAAS and GAAP, and customs of the profession. Although
following GAAS does not automatically preclude negli-:
gence, it is strong evidence for the presence of-due care.
Answer (b) is incorrect because although the client may be
aware of the misstatement, the auditor has the responsibility
to detect the material misstatement ifit is such that an aver-
age, reasonable accountant should have detected it. An-
swer (c) is incorrect because the client and Larson intended
for the opinion and the financial statements to be used by
purchasers. Therefore, a purchaser is considered a third-
party beneficiary and is in privity of contract. Answer (d) is
incorrect because the accountant need not know the specific
identity of a third-party beneficiary to be held liable for neg-
ligence.
38. (a) To establish a CPA's liability for common law
fraud, the following elements must be present: (1) mis-
representation of a material fact or the accountant's expert
opinion, (2) scienter, shown by either an intent to mislead or
reckless disregard for the truth, (3) reasonable or justifiable
reliance by injured party, and (4) actual damages resulted. 'If
Larson did not have actual or constructive knowledge of the
misstatements, the scienter element would not be present
and thus Larson would not be liable. Answers (b) and (d)
are incorrect because neither contributory negligence of the
client nor lack of pri vity of contract are defenses available to
the accountant in cases of fraud. Answer (c) is incorrect
because an accountant is generally liable to all parties
defrauded. Therefore, the accountant need not have actual
knowledge that the purchaser was an intended beneficiary.
B.3. Statutory Liability to Third Parties-Securities Act
of 1933
39. (b) The Securities Act of 1933 requires that a plain-
tiff need only prove that damages were incurred and that
there was a material misstatement or omission in order to
establish a prima facie case against a CP A. The Act does
not require that the plaintiff prove that s/he relied on the
financial information or that there was negligence or fraud
present. The Securities Act of 1933 eliminates the necessity
for privity of contract.
40. (c) Mac is a third party that the accountant knew
would rely on the financial statements. Queen's financial
statements contained material misstatements. Mac can re-
'cover by showing that the accountant was negligent in the
audit. Mac also needs to establish that it did rely on the
financial statements in order to recover from the accountant
for the losses on Queen.
41. (c) .Under the Securities Act of 1933, a CPA is li-
able to any third-party purchaser of registered securities for
losses resulting from misstatements in the financial state-
ments included in the registration statement. The plaintiff
(purchaser) must establish that damages were incurred, and
that the misstatements were material misstatements of facts.