Auditor liability: A comparison of judge and juror verdicts

This research examines differences between judges and jurors in rendering liability judgments in auditor litigation cases. While any number of case contexts would allow us to contrast and compare judges and jurors, we chose one that we believed would also address a second timely issue, auditor reliance or non-reliance upon the work of others. Within the general context of litigation of an alleged audit failure, we manipulated, between-participants, external auditor reliance on the work of others (relied on outsourced work, relied on in-house internal auditors’ work or did not rely). Our results show differences in the liability assessments of judges and jurors. Judges assign more liability to auditors that rely on the work of in-house internal auditors, less liability to auditors that rely on outsourced internal auditors and the least liability to auditors that choose not to rely on the work of internal auditors (but re-perform the work themselves) while jurors assess higher liability regardless of the work done by the auditors. Mediation analyses suggests the differences found in the overall liability assessments of jurors and judges are partially driven by their divergent attitudes towards the public accounting profession with jurors’ unfavorable attitudes leading to them assign liability regardless of the work performed. Further analysis suggests juror insensitivity to our reliance manipulations may reflect a strict liability perspective (consistent with prior work by Charron and Lowe (2008)); while judges consider other factors when making liability assessments.     

Effect of audit report disclosure on auditor litigation risk

Internationally, the escalating number of cases levelled against auditors and the costs of defending such actions has led to the auditing profession calling for measures to reduce their liability burden. Relatively few measures have been taken by the auditing profession by way of adapting the disclosure contained in the audit report to mitigate their litigation risk. This study examines whether the issuance of an audit opinion with a going concern related ‘emphasis of matter’ paragraph or work practices disclosure has any effect on potential litigants' likelihood of pursuing litigation against the auditor. An analysis of 69 responses from advanced law students and 18 practitioners working in corporate liquidation demonstrate that a modified (but not qualified) audit report effectively acts as a ‘red flag’ and reduces potential litigants' propensity to initiate litigation. However, work practices disclosure did not significantly alter potential litigants' inclination to recommend litigation. Despite this finding, respondents (particularly liquidators) indicated that work practices disclosure was an important factor in their litigation decision. These results suggest that further investigation into how to effectively disclose the work done on audit and assurance engagements is needed. This has implications for standard setters and the auditing profession, especially considering recent changes in the disclosure contained in audit and assurance reports.     

Drivers of juror's malpractice assessments in auditor litigation involving offshoring and overtime: Generation and a management Mindset

The Center for Audit Quality (CAQ) estimated audit firms' lawsuit costs roughly equaled 15% of their 2008 annual revenues, and auditors still remain frequent targets of shareholder litigation today. However, settlements have declined following two critical Supreme Court rulings. Higher standards of liability in Janus v. First Derivatives have changed the landscape; audit firms are much more willing to litigate, sensing a greater likelihood to prevail. In this environment, the importance of juror perceptions of audit quality is critical. Simultaneously, juror perceptions of audit firm motives are equally important, as standards related to scienter remain ambiguous (Tellabs v. Makor). Our research manipulates variables directly germane to both perceptions of audit quality and scienter. Our research is also important because the accounting profession still provides no clear standards of audit quality. Without standardized measures, we expect jurors to seek easily understood information when tasked to assess audit quality and inferring scienter. We examine how jurors use their prior experiences to assess overtime and offshoring practices in rendering verdicts in instances of alleged “audit failures”. Specifically, we hypothesize (and find) more youthful jurors (who face more pressure to work more hours than did prior generations) interpret excessive overtime practices more negatively; and jurors with more managerial experience (who reflect a more high-level construal mindset focused on goals) interpret offshoring practices more favorably.     

Including audit regulation in the accounting curriculum

Audits and auditors are regulated to uphold audit quality, thus regulation is important to the public interest and clearly impacts firms and CPAs. Moreover, the reach of audit regulation has expanded greatly in the last decade with the establishment of the Public Company Accounting Oversight Board (PCAOB). Recent research and calls from the profession point to enhancing the coverage of audit regulation in the accounting curriculum so that students understand the consequences of failing to adhere to professional standards. In this paper, we propose regulatory content for inclusion in the curriculum, we survey and catalog existing auditing textbooks and other educational materials for regulatory content, and we suggest flexible alternatives for incorporating this topic into the curriculum. It is our hope that, with these resources, faculty can more effectively include audit regulation in the classroom and achieve a high level of student comprehension and learning on the topic.     

The CLERP 9 Audit Reforms: Benefits and Costs Through the Eyes of Regulators,Standard Setters and Audit Service Suppliers

Over the past decade or more Australia amongst other jurisdictions has experienced substantial reforms to auditing regulation in an effort to boost public confidence in the auditing profession. This paper aims to examine whether these changes in the Australian regulatory environment for audits have (a) provided enhanced confidence in reported financial data, (b) impacted audit costs and (c) not limited competition in the market for audit services. Using qualitative interview data, this study reports on the perceptions of auditors, auditing standard setters and regulators in relation to the CLERP 9 reforms to the Australian auditing regime in the later part of the 2000s. A theoretical framework is developed to evaluate whether these reforms are substantive enough in nature to effect public confidence in reported financial data and market competition in audits.     

An examination of contextual factors and individual characteristics affecting technology implementation decisions in auditing

While computer-assisted audit techniques (CAATs) have the potential to increase efficiency and effectiveness of audit engagements, research in this area suggests that such techniques are under-utilized in public accounting. We propose that this condition is due to performance evaluation pressure and the use of budgets for multiple purposes, which result in the misalignment of firm and individual employee goals. We apply technology acceptance and budgeting theories to test this contention as well as potential organizational strategies for reducing the impediments to technology acceptance in the audit profession.Results from an experiment with experienced auditors suggest that firms have the ability to influence the implementation of new technology by using longer-term budget and evaluation periods and by communicating the approval of remote superiors regarding the software. In the absence of such firm interventions, the individual characteristics of the auditor (risk-aversion and perceptions of budgetary pressure) determine implementation decisions. Specifically, risk-seeking individuals are more likely to implement technology regardless of budget pressure perception, but for risk-averse individuals the decision to implement is positively related to perceived budget pressure.     

The effect of small audit firms’ failure to remediate the PCAOB’s quality control criticisms on audit market segmentation

This paper examines the role of the Public Company Accounting Oversight Board (PCAOB) quality control inspection program on market segmentation of small firms’ audit services. Specifically, we investigate how non-remediation of quality control criticisms (QCCs) affects the supply and demand of low-quality audits. We find that remediation of QCCs improves audit quality for small accounting firms. However, some small accounting firms do not remediate QCCs (NR firms) and continue to provide low audit quality. We investigate how NR clients react to the disclosure of non-remediation of QCCs. We find that NR clients with low agency costs are more likely to retain NR firms after the disclosure of non-remediation. This finding is consistent with our expectation that voluntary QCC remediation creates a low-quality audit market segment for NR firms. Our findings suggest that the public disclosure of QCCs is not sufficient to remove low-quality auditors. Instead, NR clients use the disclosure of non-remediation of QCCs as a signal to sort themselves into segments based on their demand for audit quality. We are the first to study and find that PCAOB inspections, and specifically the voluntary nature of remediation and public disclosure of lack of remediation, create market segmentation.     

Quis Auditoret Ipsos Auditores? Can Auditors Be Trusted?

This article explores the extent to which the audit profession and its practices promote public trust in audits. Differences between auditors and non‐auditors as to beliefs about the role of a financial report audit have long been discussed under the term ‘expectations gap’. However, this prior debate has tended to focus on non‐auditors’ alleged misunderstanding of audit processes without a corresponding understanding on the part of the profession as to why the public might place its trust in auditors. The study explores the nature of trust in an auditing context and notes that like any profession, auditing faces practical limitations but the inability to directly observe the conduct of audits combined with professional status create an ‘over trust’ expectation in the public. Changes in audit practices and culture have also exposed the profession to criticism. The article seeks to offer one approach by which the auditing profession can restore public confidence; namely, evidence‐based practice, which has proven effective in improving the quality of practice in medicine. Adoption of a reflective evidence‐based approach to audit practice offers the promise of greater audit quality and an improvement in the profession's accountability and public confidence.     

Could Accounting Have Saved Itself from the Antitrust Laws?Revisiting the Antitrust Investigations into the US Accounting Profession 1966–1990

While the role of lobbying in the US public accounting profession has been the subject of several studies, what has not been addressed is the profession's historic reluctance to lobby and the impact this may have had on the profession. This paper provides a case study of public accounting's interaction with government and the need for the profession to articulate the impact of government policies on the practice of accounting. It reviews and assesses the antitrust investigations by the US Justice Department and Federal Trade Commission that led to the repeal of the profession's anticompetitive ethics rules, rules that had governed American public accounting for most of the 20th century. These investigations are often blamed for an increased competitive atmosphere in public accounting that prioritized growth and profitability over quality in attest services. Using records obtained from Freedom of Information Act requests and archival sources, I attempt to reconstruct the US Government's motivations and the efforts of the American Institute of CPAs. I find a troubling lack of understanding of the audit profession by executive branch regulators and Congress and a reticence by the American Institute of Certified Public Accountants to advocate for the profession that led to what many observers see as a profound misapplication of the antitrust laws. While this study deals only with the US, similar regulatory changes took place in Canada, the UK, Australia, and New Zealand.     

Internal control audits: Judges' perceptions of the credibility of the financial reporting process and likely auditor liability

This paper reports the results of a study in which fifty-seven sitting United States judges participated in a behavioral experiment to assess the perceived credibility of the financial reporting process and the legal risk auditors bear under conditions where they provide an internal control audit report (vs. no report) under two corporate governance environments. We find that participating judges believe internal control audits provide enhanced assurance that intentional misstatements do not exist and also serve to provide elevated protection to the public, but only under conditions of a strong corporate governance environment beyond current regulatory requirements. We also find that, after being informed of an undetected material fraud, judges who currently have high expectations of the auditing profession find auditors more liable when an internal control audit report has been issued (as compared to when no such report has been issued).     

Do auditors’ early-life socioeconomic opportunities improve audit quality? Evidence from China

Prior research documents significant variation in audit outcomes based on individual auditors' demographic features, working experience, educational background, and social connections. This study examines whether individual auditors' early-life socioeconomic opportunities also affect audit practices. We expect that auditors from big cities have more access to socioeconomic opportunities and accumulate more human capital in early life, thus are more capable of providing high-quality audits after they start careers. Consistent with this hypothesis, we find that auditors from big cities make more audit adjustments to earnings compared with auditors from small towns. Additional tests suggest that this early-life effect on audit quality is moderated when auditors receive higher education or gain more auditing experience and is more pronounced in downward adjustments than in upward adjustments. We also find a fee premium for auditors from big cities. Overall, this paper provides evidence that auditors’ early-life socioeconomic opportunities have a far-reaching influence on audit quality.     

Auditor health and audit outcomes before COVID-19

This study examines whether influenza-like illnesses (ILIs), a potential threat to the conduct of public company audits, are associated with audit outcomes. Because the peak months of flu season overlap with audit busy season, audit offices most at risk of ILIs may be adversely affected. The demanding nature of audit busy season and the culture of audit firms may compel employees to go to work sick, a phenomenon known as presenteeism. When auditors go to work with flu-like symptoms, cognitive functioning is impaired, resulting in brain fog. This impairment may influence auditors’ ability to exercise judgment and professional skepticism, leading to adverse outcomes. Using data collected from the Centers for Disease Control and Prevention (CDC) we find that the filing of audit reports is delayed and audit quality suffers in audit offices most at risk of influenza-like-illnesses. The observed effects of health impairments on company outputs have broad implications for both the audit profession and workplaces as a whole.     

The association between characteristics of audit committee accounting experts,audit committee chairs,and financial reporting timeliness

We investigate the association between audit committee (AC) members' financial expertise and financial reporting timeliness, and extend the discussion by investigating how the source of accounting expertise (e.g., public accounting or CFO) differentially influences financial reporting timeliness. We predict and find that AC accounting financial expertise is associated with timelier accounting information. Further, we find that accounting expertise gained from public accounting experience is associated with timelier financial reporting; however, accounting expertise gained from CFO experience is not. We also find that AC chairs (ACCs) with accounting expertise from public accounting experience are significantly associated with timelier financial reporting while ACCs with CFO-sourced accounting expertise are not. Our results are important for two reasons. First, our results suggest that AC accounting financial expertise contributes to AC effectiveness by improving the timeliness of financial information. Second, our findings highlight how personal characteristics of accounting financial experts influence contributions toward AC effectiveness.     

Measuring audit quality of local governments in England and Wales

The purpose of this paper is to model and test the audit quality provided to local governments in England and Wales. A key question is: are there major differences in audit quality provided? The Audit Commission, a national public body under Parliament, regulates the audits. It sets audit standards, appoints the auditors, and (although each auditor and client local government set the specific audit fee for that client) it establishes a formula to determine standard audit fees. The Audit Commission also conducts an annual review of the audit quality provided by the selected auditors, as well as a survey of client satisfaction. The majority of audits are conducted by District Auditors (public sector employees of the Audit Commission). About a quarter of local governments are audited by one of six private sector auditors (including three of the Big 4). Actual results indicate that audit quality differences are associated with the number of governmental audit clients and local government type. Generally, there were modest quality differences by auditor category.     

Sampling Practices of Internal Auditors at Corporations on the Standard & Poor's Toronto Stock Exchange Composite Index*

The purpose of this study is to find out how often statistical and nonstatistical audit sampling practices are used by internal auditors in companies listed on the Standard and Poor's (S&P) Toronto Stock Exchange (TSX) Composite Index and how such practices are related to the training and background of the respondents. We adapted the questionnaire used by Hall, Hunton, and Pierce (2002) in their survey of U.S. auditors in public accounting, industry, and government. Although 20 percent of companies responding do not have an internal audit department, the other 80 percent use statistical methods to plan sample sizes 15 percent (+5 percent) of the time, random sample selection methods 23 percent (+5 percent) of the time, but statistical evaluation methods only 10% (+4%) of the time. Despite the low percentage use, almost half of the respondents reported substantial training in statistical sampling and evaluation methods. Moreover, we found statistically significantly higher proportions of respondents with substantial training in audit sampling methods among companies cross‐listed on U.S. exchanges compared with companies listed only on the TSX. Finally, respondents with a chartered accountant designation tend to have a negative impact on the use of statistical methods in audit sampling, and companies cross‐listed on U.S. exchanges tend to have larger internal audit departments than companies listed only on the TSX.     

财务报表重述公司审计质量研究

以财务报表重述公司为研究对象,考察财务报表重述公司年报审计质量。结果表明:财务报表重述的幅度对非标审计意见的出具有显著的影响力;初始差错年和报表重述年,注册会计师都能在一定程度上识别上市公司的盈余管理动机,并在审计意见中有所反映;审计师任期和对财务报表重述公司出具非标审计意见之间没有显著的相关性;事务所规模和非标审计意见的相关性并不显著,结论没有支持大事务所更有可能对重述公司出具非标审计意见。     

AUDITOR PREFERENCES FOR LIABILITY LIMITATION

Debate over statutorily limiting auditor civil liability has implicitly assumed auditors are homogeneous in their preferences for capping liability. This study examines the preferences of auditors for limiting auditor liability and investigates reasons for the preferences. The study uses an Australian setting in which there has been a persistent debate for a decade or more over regulatory intervention in this area. The study provides a background to the debate over this issue and addresses the effects of two factors suggested by the extant literature, namely auditor size and the business risk of an auditor's client portfolio. These factors are argued to affect the expected costs of litigation facing auditors and therefore their preferences on capping liability. Using the submissions by audit firms on an Australian Companies and Securities Law Review Committee Discussion Paper on limiting auditor liability, the study finds larger audit firms that have greater capacities to lobby and greater expected costs of litigation from unlimited liability than smaller firms, dominate the respondents on the Paper and tend to be more supportive of liability limitation than smaller audit firms. Within the array of possible methods of capping liability canvassed by the Discussion Paper, the study documents evidence of diversity in preferences among audit firms. Larger audit firm size is associated with a preference for a group of methods that provides such firms with opportunities to benefit from the capping at the expense of the smaller audit firms. The method most preferred by the larger audit firms is the multiple of fee with a prescribed minimum. Perhaps not surprisingly, this is also the preferred method of the professional accounting bodies in Australia. As to the effect of the riskiness of the client portfolio on preferences for methods of limiting liability, the study finds that higher business risk in an auditor's portfolio is associated with a preference for methods that give greater control over their liability exposure. The study has implications for the impact of regulation of capping liability on competition in the audit services market.     

Corporate employment,red flags,and audit effort

U.S. regulatory agencies and congressional oversight committees have expressed concerns that auditors often neglect red flags embedded in the operating characteristics of firms that misstate their financial reports. This study examines whether labor employment decisions, a major part of a firm’s operations, help predict accounting improprieties and consequently play a role in audit planning and pricing. We find that negative abnormal employment changes are associated with a higher likelihood of subsequent financial restatements, accounting irregularities, and lawsuits related to accounting fraud, and generally require greater effort from auditors as manifested by higher audit fees and longer audit report lags. Positive abnormal employment changes are associated with subsequent restatements and longer audit report lags, but not associated with fraud or audit fees. Taken together, the results are consistent with auditors recognizing the individual misstatement risks pertaining to companies’ employment decisions. These results suggest that standard setters, regulators, and practitioners should devote more attention to operational statistics to identify potential red flags.     

An empirical study of audit expectation-performance gap: The case of Libya

The purpose of this research is to empirically examine the causes of the audit expectation gap in Libya. The study builds on the frameworks developed by Porter (1993) and Porter & Gowthorpe (2004) to investigate the influence of the audit expectation gap to the auditing profession in the case of Libya. The data was collected through a questionnaire survey randomly selected members of four broad interest groups including auditors, auditees and audit beneficiaries both inside and outside the financial community were followed by in-depth interviews. A total of 988 questionnaires were distributed from which 431 questionnaires with usable responses were received from four groups. The overall usable response rate was 44%, ranging from 47% for the financial community audit beneficiaries to 41% for the auditors group. The findings of the study revealed that there exists audit expectation-performance gap and that the gap is as result of the following factors in different levels of percentages. Deficiency standards and deficient performance gaps constitute 49% and 15%, respectively, of the audit expectation-performance gap. The audit expectation-performance gap derives from society having unreasonable expectations of auditor’s significant proportion 36% of the gap. As result of the following interviews demonstrated that the objectives of auditing are not as clear to the financial statement users as they are to the auditors and the financial statement preparers in Libyan business environment. Further, we observe that reducing the expectations gap is to improve knowledge responsibilities between the auditors and user groups and understanding of the auditor’s role and responsibilities through the provision of auditing illegal acts.     

Disclosure of fair value measurement in goodwill impairment test and audit fees

Recent increases in the occurrence and magnitude of goodwill impairment charges highlight the increasing importance of the role of the auditor in goodwill accounting. This study examines the association between disclosures about the fair value measurement of goodwill and audit fees. We find that goodwill-related disclosures are positively related to audit fees, consistent with the idea that auditors increase their audit efforts to mitigate potential reputational and litigation losses (“audit risk effect”). Additionally, our results indicate that the information asymmetry and investor scrutiny moderate the association between goodwill-related disclosures and audit fees. One possible explanation is that auditors take goodwill-related disclosures as a signal of truthful goodwill accounting and this “signaling effect” partially offsets the “audit risk effect” of goodwill-related disclosures when information asymmetry or investor scrutiny is perceived as high.