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    Can Reporting Norms Create a Safe Harbor? Jury Verdicts...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, last edited September 19, 2013, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 15.0 International Matters, 15.02 IFRS Changes – Impacts 
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    Title:
    Can Reporting Norms Create a Safe Harbor? Jury Verdicts against Auditors under Precise and Imprecise Accounting Standards
    Practical Implications:

    The results of this study are important for audit firms to prepare for the adoption of IFRS and/or less precise standards under U.S. GAAP. The results indicate that a move to less precise standards will not necessarily result in more verdicts against auditors. There is only one condition in which an imprecise standard leads juries to return more verdicts against the auditor: when the client’s reporting complies with the precise standard and is inconsistent with the industry reporting norm. The results suggest that auditors can reduce this liability by ensuring that their client’s reporting is consistent with industry reporting norm.

    For more information on this study, please contact Kathryn Kadous.
     

    Citation:

    Kadous, K., and M. Mercer. 2012. Can Reporting Norms Create a Safe Harbor? Jury Verdicts against Auditors under Precise and Imprecise Accounting Standards. The Accounting Review 87 (2):565-587.

    Keywords:
    Audit litigation, principles versus rules, jury decision making, IFRS
    Purpose of the Study:

    The transition from U.S. GAAP to International Financial Reporting Standards (IFRS) has been a topic of debate among regulatory bodies, standard-setters, firms, and their auditors. IFRS tend to provide less precise guidance than current U.S. accounting standards, so their application requires more professional judgment. Auditors have expressed concern that the adoption of IFRS will result in increased legal liability. This paper addresses this concern by investigating how the level of precision in accounting standards affects jury verdicts in auditor negligence lawsuits. Based on legal studies and the psychology literature, this paper studies how the effect of accounting standard precision on jury verdicts depends on two factors:

    • The aggressiveness of the audit client’s reporting choice
    • Whether the audit client’s reporting choice is consistent with the industry reporting norm
       
    Design/Method/ Approach:

    The authors collected their evidence prior to September 2010.  They use a group of undergraduate students to act as jurors in a simulated auditor negligence case. The participants deliberate in juries of six persons. Each jury is asked to assess the auditor’s conduct and to provide a verdict.  

    Findings:
    • The authors find that effect of accounting standard precision on jury verdicts depends on both the aggressiveness of the client’s reporting choice and on the industry reporting norm. Jurors use a hierarchy of decision rules. When the accounting standard does not provide a clear decision criterion, jurors seek other decision rules such as whether the client’s accounting is consistent with the industry reporting norm. 
    • The authors find that when the client’s accounting is more aggressive and violates the precise standard, a majority of juries return verdicts against the auditor, regardless of whether the industry reporting norm is met. When the client’s reporting is less aggressive and does not violate the precise standard, juries rarely return verdicts against the auditor, regardless of whether the reporting is consistent with the industry reporting norm. 
    • The authors find that when the accounting standard is imprecise, compliance with the industry reporting norm is a stronger predictor of jury verdicts. In particular, under the imprecise standard, no juries find against the auditor for allowing the more aggressive client reporting when the reporting is consistent with the industry reporting norm; when the reporting norm is violated, about half of the juries find the auditor negligent.
       
    Category:
    International Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    IFRS Changes – Impacts, Litigation Risk