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Judgments and Ethical Decisions
Breach of contract
Failure to perform a contractual duty that has not been excused; for
audit firms, the parties to a contract normally include clients and
designated third-party beneficiaries.
Class action lawsuits
Lawsuits that are brought on behalf of a large group of plaintiffs to
consolidate suits and to encourage consistent judgments and minimize
litigation costs; plaintiff shareholders may bring suit for themselves
and all others in a similar situation, that is, all other shareholders of
record at a specific date.
Common law
Liability concepts are developed through court decisions based on
negligence, gross negligence, or fraud.
Confidential information
Information obtained during the conduct of an audit related to the
clients business or business plans; the auditor is prohibited from
communicating confidential information except in very specific
instances defined by the Code or with the clients specific
authorization.
Contingent fee
A fee established for the performance of any service in which a fee will
not be collected unless a specified finding or result is attained, or in
which the amount of the fee depends on the finding or results of such
services.
Contingent-fee cases
Lawsuits brought by plaintiffs with compensation for their attorneys
being contingent on the outcome of the litigation.
Contract law
Liability occurs where there is a breach of contract. The contract is
usually between the external auditor and the client for the
performance of the financial statement audit.
Covered member
An individual on the audit engagement team, an individual in a position
to influence the audit engagement, or a partner in the office in which
the lead audit engagement partner primarily practices in connection
with the audit engagement.
Deep-pocket theory
The practice of suing another party not based on the level of their true
fault in a legal action, but based instead on the perceived ability of that
party to pay damages.
Direct financial interest

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A financial interest owned directly by, or under the control of, an
individual or entity or beneficially owned through an investment
vehicle, estate, or trust when the beneficiary controls the intermediary
or has the authority to supervise or participate in the intermediarys
investment decisions.
Ethical dilemma
A situation in which moral duties or obligations conflict; an ethically
correct action may conflict with an individuals immediate selfinterest.
Expectations gap
A misunderstanding whereby shareholders mistakenly believe that
they are entitled to recover losses on investments for which the auditor
provided an unqualified opinion on the financial statements.
Foreseeable user
Those not known specifically by the auditor to be using the financial
statements, but recognized by general knowledge as current and
potential creditors and investors who will use them.
Foreseen user
Individually unknown third parties who are members of a known or
intended class of third-party users who the auditor, through knowledge
gained from interactions with the client, can foresee will use the
statements.
Fraud
Intentional concealment or misrepresentation of a material fact with
the intent to deceive another person, causing damage to the deceived
person.
Gross negligence
Failure to use even minimal care or evidence of activities that show a
recklessness or careless disregard for the truth; evidence may not be
present, but may be inferred by a judge or jury because of the
carelessness of the defendants conduct.
Identified user
Third-party beneficiaries and other users when the auditor has specific
knowledge that known users will be utilizing the financial statements in
making specific economic decisions.
Indirect financial interest
A financial interest in which the beneficiary neither controls the
intermediary nor has the authority to supervise or participate in the
intermediarys investment decisions.
Joint and several liability
A type of liability that apportions losses among all defendants who
have an ability to pay for the damages, regardless of the level of fault.

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Negligence
Failure to exercise reasonable care, thereby causing harm to another or
to property.
Objectivity
An impartial, unbiased mental attitude that auditors should maintain.

Privileged communication
Information about a client that cannot be subpoenaed by a court of law
to be used against a client; it allows no exceptions to confidentiality.
Principles of professional conduct
Broad principles that articulate auditors responsibilities and their
requirements to act in the public interest, to act with integrity and
objectivity, to be independent, to exercise due care, and to perform an
appropriate scope of services.
Professional judgment
The application of relevant professional knowledge and experience to
the facts and circumstances in order to reach a conclusion or make a
decision.
Proportionate liability
Payment by an individual defendant based on the degree of fault of the
individual.
Prospectus
The first part of a registration statement filed with the SEC, issued as
part of a public offering of debt or equity and used to solicit
prospective investors in a new security issue containing, among other
items, audited financial statements. The Securities Act of 1933
imposes liability for misstatements in a prospectus.
Rights theory
An ethical theory that identifies a hierarchy of rights that should be
considered in solving ethical dilemmas.
Rules of conduct
Detailed guidance to assist the auditor in applying the broad principles
contained in the AICPAs Code of Professional Conduct; the rules have
evolved over time as members of the profession have encountered
specific ethical dilemmas in complying with the principles of the Code.
Scienter
Knowledge on the part of the person making the representations, at
the time they are made, that they are false; intent.
Stakeholders

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Those parties who have a vested interest in, or are affected by, the
decision resulting from an ethical dilemma.
Statutory law
Laws developed through legislation, such as the Securities Act of 1933
and the Securities Exchange Act of 1934.
Third-party beneficiary
A person who was not a party to a contract but is named in the
contract as one to whom the contracting parties intended that benefits
be given.
Tort
A civil wrong, other than breach of contract, based on negligence,
constructive fraud, or fraud.
Utilitarian theory
An ethical theory that systematically considers all the potential
stakeholders who may be affected by an ethical decision and seeks to
measure the effects of the decision on each party; it seeks to facilitate
decisions resulting in the greatest amount of good for the greatest
number of people.