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    Auditors’ Organizational Form, Legal Liability, and R...
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 09.0 Auditor Judgment 
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    Title:
    Auditors’ Organizational Form, Legal Liability, and Reporting Conservatism: Evidence from China
    Practical Implications:

    The results of this study show the organizational form of a CPA firm affects its reporting due to the threat of liability exposure.  Currently, there are debates in the U.S. about limiting the liability auditors are faced with in civil lawsuits.  Audit firms argue for caps to limit their exposure. Investors, however, believe the caps will have an adverse effect on audit quality.  This study shows that the type and amount of liability exposure auditors’ face affects their reporting styles, which could affect the quality of the audit.  

    For more information on this study, please contact Michael Firth.
     

    Citation:

    Firth, M., P.L.L. Mo, and R.M.K. Wong. 2012. Auditors’ organizational form, legal liability, and reporting conservatism: evidence from China. Contemporary Accounting Research -29 (1): 57-93.

    Keywords:
    audit firm organizational form; legal liability; reporting conservatism.
    Purpose of the Study:

    This study examines the association between the organizational form of CPA firms and auditors’ reporting conservatism in China.  China presented a unique setting, since in 1998-99 all former state-owned CPA firms were required to become either unlimited liability partnerships or limited liability firms.  Unlike their U.S. counterparts, Chinese limited liability firms limit the liability of both negligent and non-negligent partners. In contrast, partners in a partnership are jointly and severally liable for the liabilities of all partners and the firm.  Therefore, this paper is able to examine the effect unlimited and limited liability organizations have on auditor’s reporting conservatism.  Due to the higher risk and liability exposure, the authors predict auditors in unlimited liability partnership firms are more conservative in their audit reporting.

    Design/Method/ Approach:

    The study covers audit reports for Chinese listed companies from 2000-2004. Reporting conservatism is defined as the propensity to issue a modified audit opinion. 

    Findings:
    • Auditors in partnership CPA firms are more likely to issue modified audit reports than auditors in limited liability CPA firms.
    • A client that is audited after a CPA firm is incorporated as a limited liability organization is less likely to receive a modified audit report than before the incorporation.
       
    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk