What All CPAs Need to Know About Contract Law
Law and accounting are two very different fields, and these different fields tend to attract people with particular strengths and skill sets. Though it has many areas of specialization, law tends to attract people who are verbally adroit and socially savvy. Accounting professionals tend to have above-average mathematical ability and strong analytical reasoning skills. Of course, these generalizations do not apply to every individual case, but they do well to characterize the dominant trend.
It is erroneous to assume, however, that because law and accounting draw very different personality types that this means professionals from these distinct fields are free to ignore each other.
Law professionals need to be equipped with at least a modicum of basic accounting knowledge, and accounting professionals must be conversant with fundamental legal principles. In point of fact, as evidenced by the many accounting scandals of the past several decades, there needs to be much more, rather than less, dialogue between these two professions.
It is simply not possible – or even necessary – for every CPA to acquire a thorough knowledge of the law. But every CPA should make it a priority to become familiar with at least certain critical areas of law. All CPAs, regardless of background or career trajectory, should have a basic understanding of contract law. An understanding of essential contract principles will assist CPAs in various ways:
- They will be able to negotiate with greater confidence.
- They can better understand the implications of their conversations with clients.
- They can more comfortably interact with co-workers and bosses.
In short, a command of contract principles will make CPAs more competent professionals.
Six Elements of a Contract
All CPAs should be acquainted with the process by which a contract is formed. There are five elements that are indispensable to the creation of a valid (that is, enforceable) contract, and there is a sixth element that is necessary in some but not all cases.
The five indispensable elements of a contract are:
The logic of each of these elements is remarkably simple to see. A contract is an agreement (or an exchange of promises) that is recognized by law and capable of being enforced by courts. Hence, in order for an agreement to occur, there must be an offer that reveals totally and clearly what the terms of the agreement will be.
Next, the terms must be fully and unequivocally accepted by all parties.
The terms must have adequate consideration. This means that what is exchanged between the parties must be roughly equal in value. Consideration is perhaps the least intuitive contractual element, but when observed in practice, it becomes easy to understand. If a house has a fair market value of $500,000, the owner cannot contract to sell it for $1 to a relative or friend. The marked imbalance between the fair market value and selling price would indicate a lack of consideration, and consequently, the exchange would be a gift rather than a sale.
There must be legality to the terms of the contract. People cannot contract for goods or services that are forbidden by law. Of course, people do partake in illicit transactions, but such transactions are not valid contracts recognized by the law.
And in addition to legality, the parties of a contract must have the capacity to accept the terms of the agreement. This simply means that they must be of sufficient age and have a sound mental status when the contract is formed. If someone is blind drunk and agrees to something clearly not in his best interest, this would not be an enforceable contract.
The sixth element of a contract is writing. As mentioned prior, it is not always necessary to put the terms of a contract in writing. Writing is only required for certain kinds of transactions or when the contract is for goods that have a value of $500 or greater. If writing is not required, a valid contract has been formed when all five of the elements referenced have been properly satisfied. If an agreement becomes a valid contract, breaching the contract becomes an offense capable of being remedied by a court.
Our body of contract law is actually an exceptionally vast organism with many layers and subtle points. Developing a deep command of contracts requires an amount of time that is unavailable to practically all CPAs. But a working knowledge of how a contract is formed is a tool that every CPA can add to his or her toolkit.
You might also be interested in
John Huddleston, CPA, is the founder and principal of Huddleston Tax CPAs, a firm based in the greater Seattle area that specializes in helping small businesses. In addition to being a CPA, John also holds a JD degree and a master’s degree in tax law from the...