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.
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.
The results of this study are important for firms to consider given the recent and historical problem of rising litigation costs. Firms are likely to be targets of lawsuits following the revelation of fraud within a client’s financial statements regardless of whether the firm was complicit in the fraud. Even lawsuits that are settled quickly result in high litigation costs, and the reputational costs to the firm can be just as problematic as the monetary costs. Very few audits are “perfect,” particularly when examined in hindsight. This study suggests that there are benefits to a firm being honest and apologetic about any deficiencies in an audit when the deficiencies do not relate to the fraud itself.
For more information on this study, please contact Jason Rasso.
Rasso, J. T. 2014. Apology accepted: The benefits of an apology for a deficient audit following an audit failure. Auditing: A Journal of Practice & Theory 33 (1): 161-176.
The results of this study have implications for regulatory agencies and standard-setting bodies. As regulators contemplate whether to mandate IFRS and standard setters determine the level of implementation guidance for new standards, the litigation consequences of standard precision are an important consideration. Further, these results highlight the importance of regulators developing ways for jurors to evaluate audit judgments under imprecise standards, especially in industries and areas without precise industry reporting norms. Prior discussion on this issue has focused on how professional judgment frameworks are necessary to protect auditors and their clients from second guessing. This study suggests that judgments frameworks, if effective, may help protect auditors who make conservative judgments and also help hold auditors accountable for overly aggressive judgments.
Kadous, K., and M. Mercer. 2016. Are Juries More Likely to Second-Guess Auditors Under Imprecise Accounting Standards? Auditing: A Journal of Practice and Theory 35 (2): 101-117.
This study provides an important implication for audit firms in maintaining their worldwide brand name reputation. The results suggest that, for global audit firms, the damage to auditor reputation in one country may spill over and cause concern among investors about the quality of their services in other countries. Further, the damage to reputation is greater where the demand for auditing and assurance is higher.
Cahan, S. F., D. Emanuel, and J. Sun. 2009. Are the Reputations of the Large Accounting Firms Really International? Evidence from the Andersen-Enron Affair. Auditing: A Journal of Practice and Theory 28 (2): 199-226.
The uncertainties surrounding material weaknesses, the difficulty of auditing around some types of weaknesses, and the fact that the auditor must explain why it issued a clean report on the financial statements when it had issued a MWO, may cause the auditor to become conservative in its GCO decision, which is fairly ambiguous to start with. The study has particular relevance for policy makers and a need for a broader evaluation of the effects of SOX 404.
Goh, B. W., Krishnan, J., & Li, D. 2013. Auditor Reporting under Section 404: The Association between the Internal Control and Going Concern Audit Opinions. Contemporary Accounting Research 30 (3): 970-995.
This study sheds light on why auditors choose to resign from auditing particular clients. The authors find that public information about audit risk, business risk, and litigation risk as well as private information about audit risk and business risk all play a role in the auditor’s resignation decision. This is useful for audit firms and regulators to consider.
Ghosh, A. and C.Y. Tang. 2015. Auditor Resignation and Risk Factors. Accounting Horizons 29 (3): 529-549.
The results of this study suggest that the current negligence system of auditor liability could, in certain circumstances, penalize auditors for investigating specific fraud risks. As such, results of this study suggest that the current system of liability for auditors could provide disincentives for auditors to expand the scope of their fraud detection audit procedures. That said, it is important to note that this study does not indicate that auditors should restrict fraud detection procedures. Specifically, at least two factors drive the expected litigation cost of an audit: (1) the probability of being sued; and (2) the expected loss if sued. This study only examines the expected loss if sued for negligence and thus does not examine the overall litigation cost.[1]
For additional information on this study, please contact Andrew Reffett at reffeta@miamioh.edu.
[1] The purpose of this study and the practical implications of this study are based on, and discussed in more detail in a practitioner summary of Reffett (2010). The citation for that summary is as follows: Reffett A. 2011. No Good Deed Goes Unpunished? Recent Evidence on the Effects of Identifying and Investigating Fraud Risks on Auditors’ Litigation Exposure. Current Issues in Auditing Vol. 5 (2): 1-8.
Reffett, A.B. 2010. Can identifying and investigating fraud risks increase auditors’ liability? The Accounting Review 85 (6): 2145-2167.
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.
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.
While the results of this study are not conclusive, both expert panels of auditors and lay jurists rely on different, legally irrelevant inputs when making assessments of auditor liability. Auditor evaluators rely more on their emotional connections to other auditors while lay evaluators focus more on plaintiff losses as evidence of negligence. This study is only a first step in determining whether expert panels of auditors would improve the judicial process.
Reffett, A., B. E. Brewster, and B. Ballou. 2012. Comparing Auditor versus Non-Auditor Assessments of Auditor Liability: An Experimental Investigation of Experts' versus Lay Evaluators' Judgments. AUDITING: A Journal of Practice & Theory 31 (3): 125-148.
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.
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.