Topics: Auditor's report, Audit, Auditing Pages: 45 (13592 words) Published: August 26, 2013
Part I: Understanding Auditor Responsibilities
Chapter 4
Professional Liability

Learning Objectives:

By studying this chapter, students should be able to:

1. Discuss the liability environment in which auditors operate, the factors that have led to litigation against auditors, increasingly including shareholder class actions, and the effects of lawsuits on audit firms.

2. Describe the causes of legal action against auditors and identify parties that may sue auditors.

3. Explain the impact of key court cases on the public accounting profession.

4. Describe auditor liability, discuss auditor responsibilities, identify possible auditor defences, and discuss possible remedies and sanctions available under both common law and statutory law.

5. Identify professional requirements that help assure audit quality and minimise auditor exposure to liability suits.

6. Describe defensive actions that audit firms can take to limit the effects of litigation on audit firms and individual auditors.

7. Apply the decision analysis and ethical decision-making frameworks to issues that could result in litigation.

Teaching Suggestions

Even though most audits are properly performed, a significant percentage of the gross revenue of public accounting firms is spent on professional liability insurance and litigation costs. Litigation costs and settlements caused Andersen, once the world’s largest public accounting firm, to declare bankruptcy. In today’s litigious environment, it is extremely important that auditors use due professional care to minimise such costs. Even when due professional care is exercised, the government, investors, and clients may still sue auditors. This chapter discusses the legal environment and concepts related to audits, and approaches to minimising exposure to liability. It also looks at several key court cases and their impact on the profession.

The challenge when teaching this material is to impart to students a genuine understanding of the legal environment in which auditors operate without overwhelming them with material to memorise that they are unlikely to remember. This challenge is heightened by the need to stress the importance of ‘liability avoidance’ without leaving the impression that it is the major focus of the audit process.

Begin by reviewing pertinent legal terminology. Then discuss the litigious climate for auditors and how that climate has changed over the past few decades. Reasons for the increase in litigation, often settled out of court include greed on the part of unscrupulous financial report users and preparers, ignorance and neglect on the part of auditors, and a volatile business climate characterised by numerous business failures. Public distrust adds to the problem. Stress the impact of litigation on the profession: (1) considerable resources expended to litigate, (2) some distrust and loss of credibility in the public accounting profession which is heightened by negative media coverage, (3) proliferation of new auditing standards, and (4) pressure from stock exchanges which has resulted in the establishment of audit committees and ‘comfort letters’ to underwriters.

It is helpful to go over the concept of due care found in tort law. Ask students how they view their liability if, as new employees, they are asked to complete a task that they do not feel qualified to do. Explain the imprecision of the ‘reasonable man’ concept and the problems that arise when ‘ordinary citizens’ sit on juries involving technical matters with which they are unfamiliar.

The text outline can be followed when discussing the specific legal concepts that affect the auditing profession including the auditors’ liability to clients and third parties. Stress that carefully following Auditing Standards and maintaining a healthy sense of professional scepticism with regard to client assertions can reduce legal problems. Emphasise that defensive auditing also...
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