Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

research summary

    Do Going Concern Audit Reports Protect Auditors from...
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions 
    242 Views
    Title:
    Do Going Concern Audit Reports Protect Auditors from Litigation? A Simultaneous Equations Approach.
    Practical Implications:

    The results should be of interest to auditing practitioners. Generally, managers of public companies prefer that the audit report does not contain a going concern paragraph. In this regard, researchers have found that issuing a going concern audit report increases the likelihood of management-initiated auditor switches. These results highlight the expected benefits to auditors from issuing a going concern report to their financially stressed clients. Specifically, better controlling for endogeneity, the evidence indicates that issuing a going concern report lowers the likelihood of investors naming the auditor in a class action lawsuit.

    Citation:

    Kaplan, S. E., and D. D. Williams. 2013. Do Going Concern Audit Reports Protect Auditors from Litigation? A Simultaneous Equations Approach. Accounting Review 88 (1): 199-232.

    Keywords:
    audit reports, auditor litigation, auditor litigation settlements
    Purpose of the Study:

    An important aspect of the auditors’ environment is state and federal laws that allow third parties such as investors to sue auditors in an effort to recover damages. Historically, these litigation-related costs have been substantial. Potentially, auditors may be able to reduce their exposure to litigation when auditing a financially stressed client by issuing a going concern report. Under current auditing standards, a going concern audit report is required when an auditor has substantial doubt about the client’s ability to remain a going concern for a reasonable period of time. Whether a going concern report actually protects auditors against lawsuits is an open question.

    The study applies a simultaneous equations approach to examine the relation between auditor going concern reporting and investors’ decisions to sue auditors. Importantly, this approach takes into account the endogeneity between the auditor’s going concern reporting decision and ex ante litigation risk. The authors explicitly recognize two separate aspects of the relation between going concern reporting and auditor litigation.

    Design/Method/ Approach:

    The sample consisted of 1,211 securities class action lawsuits filed against the auditors between 1986 and 2009. 147 firms comprise the final auditor litigation sample. The authors determined whether a securities class action lawsuit had been filed against the auditors by examining the databases constructed by Palmrose (1999), the Stanford Class Action Securities Clearinghouse, Audit Analytics, LexisNexis, Westlaw, CASEmaker, ISS Securities Class Action Services, and the popular press. 

    Findings:
    • The evidence indicates that for auditors’ going concern reporting decisions as well as for investors’ decisions to sue auditors, the results differ between the two methods.
    • While the relation between the risk of an auditor lawsuit and going concern reporting decisions is consistently positive, the lawsuit coefficient is larger and significant using simultaneous equations but insignificant using probit analysis.
    • The results also show that the relation between going concern reports and investors’ lawsuit decisions is consistently negative.
    • However, and perhaps more importantly, the going concern coefficient is larger and significant when using simultaneous equations but insignificant when using probit analysis. That is, the simultaneous equations results indicate that going concern reports significantly deter investors from suing auditors.
    • The evidence showing that going concern reports deter investors from filing class action lawsuits against auditors is important, in that it suggests that going concern reports are useful to investors.
    • When investors see a going concern report for financially stressed companies, they are less likely to sue the auditor for their investment losses.
    • Issuing a going concern report offers the auditor protection against claims of negligence due to reporting, but not other claims of auditor negligence.
    Category:
    Accountants' Reporting, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Going Concern Decisions, Litigation Risk