Accountant's Liability: What it Means, How it Works

What Is Accountant's Liability?

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.

Key Takeaways

  • Accountant's liability refers to the legal liability assumed by an individual when conducting professional accounting work.
  • Accountants are liable for any misstatements that occurred while auditing and preparing financial documents for a client.
  • Because accountants are held responsible for any inaccuracies and as a result can face legal charges or monetary losses, they often take out professional liability insurance.
  • The type of professional liability insurance is often known as errors and omissions insurance.
  • Under the generally accepted accounting principles (GAAP), an accountant will usually not be held liable for any misstatements if they acted in good faith.

Understanding Accountant's Liability

The standard of care applicable to the conduct of audits by public accountants is no different than that of doctors, lawyers, architects, engineers, and others providing skilled services for compensation, and that standard requires reasonable care and competence therein.

Accountant's liability adds an element of pressure to an accountant's performance of duties. An accountant's actual participation in fraud can be hard to prove because management could be the ones committing the fraud, which the accountant can fail to notice. This makes the accountant legally liable for being negligent of fraud or misstatements, even if they had no direct hand in committing them.

The Impact of Inaccurate Statements

If a bank decides to lend money to a company based on the positive review of a company's financial statements audited by an accountant and then down the line the company cannot pay back its debt, resulting in a loss for the bank, the accountant could be held responsible. Similarly, if investors purchase a company's stock based on the financial statements and the company performs poorly and the stock goes down, the accountant can be held responsible for the losses. Of course, in these scenarios, the injured party would have to prove that their decision was based on reviewing the company's financial statements.

Auditors typically purchase professional liability insurance to protect themselves from any monetary damage arising from such situations. This is often referred to as errors and omissions insurance. This additional cost for the accountant can often raise the cost of the audit.

For ordinary negligence, an auditor owes a duty only to their client. An auditor’s liability for general negligence in the conduct of an audit of its client's financial statements is confined to the client. That being the person or business entity who contracts for or engages the audit services. Other persons may not recover on a pure negligence theory.

Accountant's Liability and Securities Law

Many accountants believe that they cannot be liable under federal securities laws because their practice does not involve securities. However, the comprehensive definition of securities indicated in the statutes and the pertinent case law has left many accountants subject to unanticipated liability lawsuits.

It is not uncommon for accountants and auditors to carry professional liability insurance to cover such areas as:

  • Network and information security offense coverage
  • Security breach remediation and notification expenses
  • Investment advisor coverage
  • Personal fiduciary coverage
  • Crisis event coverage
  • Pre-claim assistance

Accountant's Liability and GAAP

The generally accepted accounting principles (GAAP), issued by the Financial Accounting Standards Board (FASB), which all public U.S. companies must comply with, reflect the "skills and care" that an accountant would have to abide by in performing their duties.

Typically, if an accountant shows good faith in their preparation of financial documents, they will usually not be held liable for any incorrect conclusions or for relying on faulty information provided to them.

Article Sources
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  2. Gruenbaum, Samuel H., and Marc I. Steinberg. "Accountants' Liability and Responsibility: Securities, Criminal and Commmon Law." Loyola Law Review, vol. 13, 1979, p. 247.

  3. Hagen, Willis W. "Certified Public Accountants' Liability for Malpractice: Effect of Compliance with GAAP and GAAS." Journal of Contemporary Law, vol. 13, 1987, p. 65.