Limiting Accountants' Liability for Prospective Financial Information

By Reed, Allen P.; Macia, Alberto A. | The CPA Journal, March 1994 | Go to article overview

Limiting Accountants' Liability for Prospective Financial Information


Reed, Allen P., Macia, Alberto A., The CPA Journal


In the course of their professional practice, some accountants prepare and present financial information about the future. This prospective financial information generally is a forecast or projection of an entity's financial position, results of operations, and cash flows. A forecast is based on the responsible party's assumptions reflecting conditions it expects to exist and the course of action it expects to take. A projection is similar to a forecast except it is based not on expected conditions and courses of action, but rather on hypothetical assumptions. A projection responds to the question: What would happen if...?

Your client requests that you prepare a forecast or projection for a real estate partnership he or she is forming. A favorable forecast or projection placed in an attractive prospectus will aid in the sale of partnership units to investors. Or, your client is a corporation in need of a forecast or projection to help secure a bank loan. Either scenario, given the inherently unreliable nature of forecasts and projections, should be cause for concern. If the forecast or projection does not materialize, and your client or investors or lenders consequently sustain financial loss, you may find yourself in court. There has been an increasing number of lawsuits filed by persons claiming financial loss as a result of investment or business decisions made in reliance on a forecast or projection reported on by an independent accountant.

Presently there are various standards courts use to define the scope of an accountant's liability for providing inaccurate information. The most common are:

1. An accountant is liable to persons with whom he or she is in privity, i.e., the client who engaged him or her;

2. An accountant is liable to persons with whom he or she is in privity or whose relationship with the accountant sufficiently approaches privity;

3. An accountant is liable to persons with whom he or she is in privity and to persons or members of a limited group of persons for whose benefit and guidance the accountant intends to supply the information or knows that the recipient of the information intends to supply it; and

4. An account is liable to persons with whom he or she is in privity and to persons who reasonably can be foreseen to rely on the information.

Depending on the jurisdiction in which you practice, one of these standards likely defines the group of persons to whom you may be held liable for providing a report on an inaccurate forecast or projection. The problem is determining how to protect yourself from unnecessary or unreasonable liability to those persons.

THE AICPA'S GUIDE

The AICPA's Guide for Prospective Financial Information (1993) (AICPA Guide) notes that "the disclosure of significant assumptions is essential to the reader's understanding of the financial forecast. Thus "the responsible party should disclose those assumptions deemed to be significant to the statements." The assumptions disclosed should include:

a. Assumptions about which there is a reasonable possibility of the occurrence of a variation that may significantly affect the prospective results;

b. Assumptions about anticipated conditions that are expected to be significantly different from current conditions, which are not otherwise reasonably apparent; and

c. Other matters deemed important to the prospective information or its interpretation.

A projection should also disclose the above assumptions. In addition, a projection should disclose "which assumptions in the projection are hypothetical," and "if the hypothetical assumptions are improbable, the disclosure should indicate that."

The AICPA Guide also states that the introduction to a forecast "should include a caveat that the prospective results may not be attained." The introduction should be similar to the following:

This financial forecast presents, to the best of management's knowledge and belief, the company's expected financial position, results of operations, and cash flows for the forecast period. …

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