Auditor Liability (2004 words) Essay Example For Students

Auditor Liability (2004 words) Essay Auditor LiabilityannonThroughout the Eighties and into the Nineties thequestion of liability has become more prevalent in the practice of publicaccounting. Recently, the AICPA has been lobbying for liability reform incases involving negligence or malpractice by public acco untants. Opposition to this lobbying has come from consumer advocacy organizations,trial lawyers associations, and state public interest groups to name afew. (Bolinger p. 53) The key to success for the AICPA, according to GaryM. Bolinger is creatingan image as a, profession performing high-quality services but facedwith excessive liability burdens that harm the public interest. (Bolingerp.56)One should not be concerned, however, in the pending politicaloutcome, but in weighing the evidence argued by both sides and developinga sound reasonable basis. Therefore, the remainder of this document shallconcern itself with comparing the prevalen t arguments of both sidesagainst one another and drawing a conclusion based on the evidence. Opponents of liability reform rely heavily on an idealisticconstitutional argument as well as an economic argument to foster theirpoint. The main components of their argument are as follows: Limitingrecovery of loss has a detrimental effect on thosewhich are harmed by alleged negligence. The cost of liability isreasonable when compared to total revenues, and in light of a CPAs publicresponsibility. Indemnity insurance spreads risk in the aggregatetherefore removing the element of risk at the f irm level. The threat oflitigation provides public accountants with a deterrent against negligentwork. Finally, the results of lawsuits cause the profession itself toimplement new standards. (Bolinger p.54)The AICPA and its supporters have developed their argument basedon continued liabilitys likely effect on the profession as well as aneconomic argument. The arguments in favor of liability reform include theeffect of continued liability on the availab ility of CPA services. Thelikelihood of fe e increases resulting from liability risk. The threat ofthe inability of public accounting to obtain and retain qualifiedindividuals. (Bolinger p.56) Finally, the complexities involved in theaudit engagemen t and the subjective decision making process versus theability of a given jury to understand and levy a fair decision in suchcases. After examining the arguments of both sides one will see thatlitigation in its current form is a hindrance to the accou ntingprofession as well as society, and the benefits provided by litigation areattainable through enforcement of professional standards. The first of the opponents arguments finds its basis fromidealistic Constitutional principal. The notion that those which havebeen wronged, either directly or indirectly, deserve compensation fortheir estimated loss is one which first found favor inthe case of Thomas v. Winchester in 1942. (Minnis p.4) In this case, forthe first time a third party received compensation. (Minnis p.4) Theprecedent set by this case is the notion of duty owed to a third partyif it ascertains that a duty is owed t hen a third party has a right toseek compensation. The case which most directly affected auditors is acase filed in the UK, Hedley Byrne and Co Ltd v Heller and Partners Ltd(1964). (Minnis p.9) This case ultimately developed a situation where aban k passed to its client a certificate of credit-worthiness on apotential client. The business which was deemed credit-worthy ultimatelyfailed, and claim resulted by the third party against the bank issuing thecertificate.!(Minnis p.9) The finding in the The notion that all parties remotely affected by a given action(or lack thereof) deserve compensation for their loss is one which isembraced by the legal community and rightfully so, after all a drasticreduction in the number of claims filed would r esult otherwise. Theargument made in its favor is that all those harmed by negligent activitydeserve compensation. Idealistically this is true, and theoreticallyanyone who makes a decision based entirely on the results of an auditorsreport, and suf fers a loss due to negligence in preparation by theauditor, deserves compensation. Realistically, however, this is notusually the case. With the exception of banks, whom are approached bybusinesses for the possibility of tendering a loan, and therefo re do notinitiate contact; all other investors would only take the time to reviewthe financial statements of a given company if another mitigating forceattracted them. Therefore, it is reasonably asserted, that significa!nt third parties, such as banks aA second argument against liability reform is that the cost ofmalpractice suits are reasonable in comparison with the revenues and levelof public responsibility delegated to CPA firms. An argument against thisis made twofold. First, the total numberof claims is not reasonable, but rather, astronomical. According to arecent industry estimate, the accounting profession as a whole is facing4,000 lawsuits and $30 billion in potential claims pending against it.(Clolery p.42) Recent trends indicat e the total value of claims arecontinually increasing, one has to ask at what point will the value ofclaims become unreasonable? As claims continue to increase the demand forindemnity insurance, which is cyclical in nature, will increase alsocausing insurance expense to continually rise. The French and Indian War EssayThis brings up another key point in the liability reform issue,which is the likelihood of fee increases. Fee increases as a result ofmalpractice are incurred in three areas: the increase resulting frominsurance expense, the increase resulting from t he costs of performingthe engagement, and increases resulting from litigation expense. Thefirst two issues are covered previously. The area of insurance expense isdiscussed in the section covering indemnity insurance, while the cost ofthe engagementis illustrated in the most recent section. Additionally, the cost oflitigation services are also absorbed in engagement fees. A third area used in the AICPAs argument is that of obtaining andretaining quality professionals. The basis for this argument is that welleducated intelligent persons, ones which public accounting seeks toattract into the profession, are less likel y to pursue a career in publicaccounting if high levels of liability risk exist. Furthermore, those whodo enter public accounting are more likely to leave the profession due toliability risk. This argument has merit inasmuch as pointing out theprofe ssions dedication to employ only qualified individuals; however theeffect it will have on those choosing to enter the profession is difficultto prove. One may ascertain the rationale behind leaving a professionwhere the pressures of liability exist, b ut public accounting will neverhave difficulty recruiting young professionals. Finally, an area not addressed by the AICPA but which deservesconsideration nevertheless, is that of the complexities and subjectivenessof auditing versus the ability of jurors to issue an educated decision. The justice system relies on the services o f jurors to levy decisions;however, in highly technical areas the ability of jurors is suspect. Inmalpractice cases the verdict often hinges on compliance with GAAS. (Buckless p.164)A study was conducted concerning juror decisions based on a firmscompliance with GAAS by Frank A. Buckless and Robert L. Peace of the NorthCarolina State University. They conducted a factorial experiment using22 format. The four possibilities are as follows: instructionsindicating compliance with GAAS and such compliance is the onlyconsiderable factor, compliance with GAAS and all factors are considered,compliance with government standards and only compliance is considerable,and compliance wit h government standards with all factors beingconsidered. (Buckless p.169) The study concluded, that jurors attachedgreater credibility to auditing standards established by the federalgovernment than to those established by the auditing profession. (Buckless p.173) In a subsequent article the point is raised that whendiscussing the issue of government versus professional standards, one areaincluded a government witness while the other a witness from theprofession, b!ut not a cros s sample of both; thIn regression analysis of the same sample, education is foundsignificant with those more educated being more likely to find in favor ofthe auditor. (Buckless p.172) This creates significant implicationsregarding a jurys ability to reach a fair verdi ct in cases as technicaland subjective as accounting malpractice cases. The above argument shows major points used by both sides in theongoing fight involving liability reform in public accounting. Additionally it suggests that the profession itself need bear the burdenof deterrence, enforcement, and investigation whereb y eliminating theexisting systems only strength. If the AICPA in cooperation with stateboards becomes more willing to accept the role as investigator andpunisher, then the economics of the argument suggest that liability reformis in order.