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    An Examination of the Legal Liability Associated with...
    research summary posted November 10, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 11.0 Audit Quality and Quality Control, 11.01 Supervision and Review – Effectiveness 
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    Title:
    An Examination of the Legal Liability Associated with Outsourcing and Offshoring Audit Procedures
    Practical Implications:

    This study is important to audit practice as it provides an initial view into the effects of outsourcing and offshoring on juror perceptions of the due care exhibited in supervising audit work performance as embodied in assessed damage awards, while also providing perceptions on the expected quality and risk associated with these relationships. The results may be of particular interest to the profession given that this study examines audit work outsourced and/or offshored to India, the country cited as conducting the most outsourced audit work for North American CPA firms. Interestingly, the professional bodies (i.e., NASBA) have chosen not to grant reciprocity of practice for Indian charted accountants (i.e., Mutual Recognition Agreements). India has been denied multiple times while reciprocity has been granted to CPAs/CAs in Australia, Canada, Hong Kong, Ireland, Mexico, and New Zealand (NASBA 2012). The juror perceptions of quality and risk of audit work outsourced offshore, as shown in this study, parallel the concerns expressed by professional bodies.

     

    For more information on this study, please contact Alex Lyubimov.

    Citation:

    Lyubimov, A., V. Arnold, and S.G. Sutton. 2013. An Examination of the Legal Liability Associated with Outsourcing and Offshoring Audit Procedures. Auditing: A Journal of Practice and Theory 32 (2): 97-118.

    Keywords:
    outsourcing; offshoring; audit quality; litigation risk; juror decision-making; auditor liability; counterfactual reasoning.
    Purpose of the Study:

    Accounting firms have steadily increased the use of outsourcing and offshoring of professional services including independent audit procedures. While firms suggest that the work is of higher quality and similar litigation risk, questions remain as to whether public perceptions may be more negative. The purpose of this study is to examine the effect of outsourcing and offshoring of audit work on juror’s perceptions of auditor legal liability when an audit failure occurs.  More specifically, this paper examines liability associated with an audit failure when work is performed by another office of the same firm or outsourced to a separate firm, and whether the work is performed domestically or in another country.  Theory suggests that outsourcing and offshoring of those outsourced audit procedures has the potential to erode the perceived professionalism of auditors’ work as embodied through decreases in perceptions of work quality, increases in perceptions of associated risk, and ultimately more severe damages assessed against auditors during litigation.

    Design/Method/ Approach:

    An experiment was conducted using a 2 (insource vs. outsource) X 2 (onshore vs. offshore) design. The experiment was delivered through an internet application to facilitate the use of a diverse national sample of jury eligible participants. Participants, representing a broad demographic base, were individuals who were over the age of 18, jury-eligible in the US, had no legal or auditing experience, and not CPA’s. Data were collected over a four-day period in December, 2010.

    Findings:

    Results indicate that choosing to outsource audit work to another audit firm is associated with higher compensatory damages in case of an audit failure.  Furthermore, when this third party audit firm is located in a different country (offshoring), outsourcing leads to significantly higher punitive damages.  Surprisingly, jurors assess higher than expected litigation awards for a failure by another domestic office of the firm for punitive damages. This result suggests that the close proximity in terms of both geography and organizational distance of the domestic office of the firm leads jurors to find the audit failure less understandable. Post hoc analyses indicate that potential jurors perceive that work completed by another domestic office of the firm has the highest expected quality and lowest risk, while work that is outsourced offshore is expected to be lowest quality and highest risk—consistent with proximity theory.

    Category:
    Audit Quality & Quality Control, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Litigation Risk, Supervision & Review – Effectiveness