Describe about the Liability Facing Auditors due to Global Financial Crisis.
The contemporary worldwide financial crises have escalated lasting debate relating to professional accounting as well as financial press regarding the reasonable nature of the liability of the auditor as well as the possible risk which fruitful lawsuits against auditors of a failed financial services organization and banks might serve to reduce a known audit companies (Anderson 2008, p. 56). The principle of privity of contract has been dominance in the legal arena. Under such a policy, auditors appeared vulnerable as they were liable to contractual entities like the user Corporation or main beneficiary outlined in the agreement of the audit.
The literature on auditor liability has previously emphasized individual issues isolation. The paper has integrated the key issues while considering, cost as well as implication of the audit liability regime. It has also overviewed the contemporary calculus utilized in the assessment of damages as well as reform suggestion to limit liability. The results show that the current audit liability regime applicable to auditors is severe as it inequitably imposes enormous costs on auditors (Baker and Prentice 2008, p.34). It can be argued rightly that a better intervention would seem to be the introduction of a professional liability regime coupled with a mandatory need which directors hold professional liability insurance alongside reformation of the calculus utilized in the assessment of damages.
The array of operators to whom inspectors owed duties of care extended progressively and consequently hit the degree where liabilities claim might be affected by practically any participant sensibly regarded to depend on opinion of audit (Quick 2013). The scope extension emerged as an appropriate mechanism to encourage the professional conduct of auditors as well as a reaction to the rising civic requests to reasonable ‘innocent’ third party service. Liability of auditors during the financial crisis is a critical issue that face auditors as they audit the financial statements of corporations. Like any other expert advisers, auditors frequently be indebted duties of care to their auditing clients (Rajacic, Rajapakse and Webb 2000, p. 48). The liability entails a responsibility in law that requires auditors to undertake their works with the skills as well as competence which society as well as end-users need to be entitled to anticipate. In the case of the existence of this duty of care, and an auditor fails to undertake the auditing work out of the standard required, the end-users have the right to sue such an auditor for compensation for the loss caused by an auditor’s negligence.
Liability of audit is tied to the manner it needs, adjustments and corrections for making financial statements. The auditors must make corresponding changes to the financial declarations of the opinion of auditors to cancel the reservations. It, therefore, trails that an existence of direct link to liability as well as obedience with reporting of the accounts regardless of whether it is a sole management’s responsibility of the inspected company (Kachelmeier, Schmidt and Valentine 2015, p.59). The management responsibility of the auditees is critical than that of auditor responsible for the grounding of financial statements for adherence to the financial reportage structure accounting for the manner he planned as well as operative internal control system, the statement of line which provides the assessor.
Accordingly, it remains essential to pronouncement of conformism as it settles that managing supply the auditor with the required material. During the volatile market crises period particularly the market of real estate succeeding the fair value estimates is regularly fairly hard and more problematic hence the examiner lacks indexes on the estimates dependability made by the company (Hodge, Martin and Pratt 2005, p.63). Auditors’ reports need always to consist of a section on parts of accountability of the auditor alongside management, explicated the kind of audit as well as statements affirming the reasonability of the opinion to assurance rather than outright assurance that the financial statements remain safe of any substantial misstatement.
Exposing auditors to such a liability is always viewed a good thing as it concentrates the advisers’ minds thereby driving quality and customer care. The auditors might cause severe dangers to corporations where they are not motivated by the prospect of the retribution for the substandard work. This is because it will give most advisers a gap thereby failing to exercise the right level of care and skills. No one is, therefore, advocating for freeing auditors for this reason from liability for the mistake auditor commit and which lead to poor quality audited reports (Pitts and Wale 2008, p.40).
The responsibility is hence leadership and pronounces all associated parties as well as transactions between the parties. The auditors needs to take this declaration seriously in his work. Surprisingly, the auditor cannot verify very the accuracy of these operations and hence constrained when reporting in different audit report paragraphs (Gaver, Paterson and Pacini 2012, p.53). The auditor is responsible for the formulation of an opinion on the financial statement affirming their correct and fair reflection in all factual facets as well as dealings of trading period to which it denotes (Free 2009, p. 54). The auditor, in some conditions, may not express any opinion, particularly when the mission’s scope is restricted or where the auditor lacks the capacity to consider all the needed standards to provide a view.
The auditor also has a responsibility for making sure that there is quality control of work as well as audit work by having an effective teamwork. The rationale of cooperation as a display of quality control is that working in teams; one will be able to check works done by another giving collaboration a kind of quality control auditing of the expert services. The quality control is a critical aspect in auditing since individual audit firm or Cabinet has to make sure that whatever is undertaken is done effectively.
Controlling quality is primarily prearranged since they exist adequately comprehensive printed processes that are appropriate as well as reliable to decrease or even get rid of the risk of error during the audit mission. The financial review ensures quality by completing as well as signing all the sections relevant to the program of the audit (Davies 2011, p.171). It is also achieved by financial audit signing as well as dating all the working document of the entity who has made as well through the analysis as well as synthesis to prove individual element of balance as well as by analyzing all the significant amount of loss or profits.
The financial auditor has a responsibility evaluating as well as using the control system and they are required to account for its position in the audit work. In case the internal control system is inexistence or improperly established, the auditor might fail to recognize much risk of error and fraud which are the two critical misleading information in auditing work (Burton, Wilks and Zimbelman 2013, p.65).). It is typical that the target users of any financial statement do recognize error and fraud, however, it is the responsibility of the auditor to consider fraud in an audit of the financial statements.
The financial auditor will, however, not held responsible for the prevention of error and fraud, but bears the sole responsibility for planning as well as performing the audit thereby obtaining reasonable assurance that the financial statements are meaningfully accurate on both fault and fraud (Brown, Majors and Peecher 2014, p. 40). It is, however, a challenging task if the auditor is required to uncover all the fraud and errors to establish threshold of errors. This is, indeed the relative significance of the financial auditor which find their view articulated.
Joint and various Liability
Debates exist pointing out that in some cases, rules regarding liability of auditors can be unreasonable and culminate into undesirable consequences. The reference here is based on joint and various liability which exist in the United Kingdom and several common law-oriented jurisdictions globally. Under such a system, an individual who has been owed a duty of care, and who subsequently claims to have a damage, enjoys a right to take a legal action against any or all auditors alleged to have triggered the loss (Pitts and Wale 2008, p.47). The critical matter is that in case an individual party is regarded to be able, and thus more probably to be in a situation essentially to compensate the compensations demanded, the plaintiff has an option of choosing to sue just that party while the rest let off effectively.
The ‘deep-pocket syndrome’ further makes the auditors the most vulnerable group since they have professional indemnity insurance hence perceived as the best targets. The situation is likely to collapse in two undesirable outcomes (Persellin 2013, p.65). In case auditors are so confined by the threats of being sued, the auditors will choose to remain reluctant to participate in any innovative work which might actually generate real benefits to stakeholders.
Auditors have, therefore, been ‘admission tickets’ for both creditors and investors. Many have contended that creditors and stockholders tend to view collapse or failures of businesses as failures of auditors. They, therefore, frequently look to the auditors whenever they search for a flush party from whom losses can be compensated. Even though auditors may be comforted by the latest decisions linked to liability to third parties, the potential liability scope to entities as well as liquidators remain vast (Asay 2014, p. 43). This is because when an auditor accepts a contract to advise the client who employs her, she owes a duty to exercise that standard of skills as well as care relevant to such a professional status. Accordingly, the auditor will be liable both in tort and contract for all the losses suffered by the Client because of any breach of such a duty.
The auditor needs to be careful when expressing his opinion since in case of an adverse auditor’s opinion unfairly and incorrectly confirming the correct reflecting of reality, the responsibility of the auditor will derive from his perception. The liability of the auditor in this case will increase as a result of the potential occurrence of event following the date of the balance sheet (Elliott, Rennekamp and White 2015, p. 65). The management of the audited entity will regard the materiality of the facts before making a decision on whether it is essential to modify the financial statements. Here, it remains hard for the auditor to control whether following such alterations, the items’ value included in the financial statements are properly created.
Auditors are also subject to various heads of potential liability as they discharge their statutory roles. This responsibility stretches to liabilities as reflected in subsection fifty-two and seventy-four of the Trade Practices Act of 1974 alongside many state Fair Trading Acts (Auditor’s Legal Liability to Third Parties. 2013, p.145).
Auditing standards, however, makes no difference as to the statutory auditors’ liability in the detection of errors from the financial burden of the auditors in discovering fraud (Beever 2012; Zisa 2013, p.45). Financial auditor is needed to acquire as well as deliver reasonable assurance that the financial statements lacks erroneous information for both fraud and error. It is, however, a common knowledge that it is challenging to acknowledge fraud than detection of the unintentional errors being concealed by the managers and employees who have committed a fraud. Nevertheless, the responsibility of the auditor for successful financial audit management remains unchanged even in the face of this difficulty.
The auditing profession has been criticized and accused quite often over the years of being too conservative and of couching reports in defensive and legalistic basis to escape litigation. The resulting problem is that auditors are currently needed to expand the scope of their work, but this is restricted unless the threat of litigation is eliminated to avoid auditors’ destruction (Pál, 2010, p.30). Threats of litigation has various undesirable consequences to both auditors and their clients:
The restriction thus means that regulatory bodies and stakeholders functions such as provision of assurance by auditors on new areas such as company’s risk management effectiveness is impaired as no auditors will be willing to take up such expanded tasks.
The other unfortunate consequences of auditors’ reluctance which is linked directly to matters of completions are the possible disincentive to smaller companies to acquire services of an audit of large corporations due to the threat of being sued (Messier, Quick and Vandervelde 2014, p.59). A small firm might be compelled to refrain from seeking the assistance of a large audit firm even if it regards to have the competence, resources, skills and experience to tender an engagement if the financial risk linked to audit failure would be adequate to collapse the company.
Auditors and firms should embrace a school of thought that emerged after Anderson collapse. The failure followed the Enron scandal ruining its name that reputational risk is equivalent financial risk as an inducement to provide the finest guidance.
Academics and practitioners alike should lobby for separation of responsibilities between management and auditors regarding identification of fraud and errors to reduce liabilities since audit responsibility has been a matter of escalating concern.
Audit firms and institutes in Australia, Europe as well as North America should lobby for alterations in the law emphasized on the concept of joint as well as several liabilities. This will address the significant claims alongside skyrocketed cost of indemnity insurance cover.
There is a need for refocus on matters pertaining corporate governance as well as general viewpoints requiring directors to embrace a proactive undertaking in the corporate management thereby elevating the issues circumventing the limitation of auditors’ liability.
The theoretical problem of an auditor liability must be one which designs an optimal measure to provide incentive to an auditor rather than shirking without culminating to extreme burden.
References
Anderson, A.P., 2008. Accountants’ Liability to Third Parties for an Audit. Marquette Law Review, 52(1), p.158.
Asay, H.S., 2014. Horizon-induced optimism as a gateway to earnings management. Available at SSRN 2274180.
Auditor’s Legal Liability to Third Parties, The. W. Res. L. Rev., 7, p.145.
Backof, A.G., Bamber, E.M. and Carpenter, T.D., 2016. Do auditor judgment frameworks help in constraining aggressive reporting? Evidence under more precise and less precise accounting standards. Accounting, Organizations and Society, 51, pp.1-11.
Baker, C.R. and Prentice, D., 2008. The origins of auditor liability to third parties under United States common law. Accounting History, 13(2), pp.163-182.
Beever, J.R., 2012 Zisa, J.W., 2013. Guarding the Guardians: Expanding Auditor Negligence Liability to Third-Party Users of Financial Information. Campbell L. Rev., 11, p.123.
Brown, T., Majors, T.M. and Peecher, M.E., 2014. The impact of a judgment rule and critical audit matters on assessments of auditor legal liability–the moderating role of legal knowledge. Available at SSRN 2483221.
Burton, F. G., Wilks, T. J., & Zimbelman, M. F. (2013). How Auditor Legal Liability Influences the Detection and Frequency of Fraudulent Financial Reporting. Current Issues in Auditing, 7(2), P9-P15.
Davies, M., 1991. Liability of Auditors to Third Parties in Negligence, The. UNSWLJ, 14, p.171.
Elliott, W.B., Rennekamp, K.M. and White, B.J., 2015. Does concrete language in disclosures increase willingness to invest?. Review of Accounting Studies, 20(2), pp.839-865.
Free, C., 1999. Limiting auditors’ liability. Bond L. Rev., 11, p.i.
Gaver, J.J., Paterson, J.S. and Pacini, C.J., 2012. The influence of auditor state-level legal liability on conservative financial reporting in the property-casualty insurance industry. Auditing: A Journal of Practice & Theory, 31(3), pp.95-124.
Hodge, F.D., Martin, R.D. and Pratt, J.H., 2005. Audit qualifications of income-decreasing accounting choices. Available at SSRN 574222.
Kachelmeier, S.J., Schmidt, J.J. and Valentine, K., 2015. The disclaimer effect of disclosing critical audit matters in the auditor’s report. Available at SSRN 2481284.
Messier, W.F., Quick, L.A. and Vandervelde, S.D., 2014. The influence of process accountability and accounting standard type on auditor usage of a status quo heuristic. Accounting, Organizations and Society, 39(1), pp.59-74.
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Persellin, J.S., 2013. The influence of PCAOB inspections on audit committee members’ judgments. Behavioral Research in Accounting, 25(2), pp.97-114.
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