Auditor Liability is of great importance in the accounting field because it is such an important and necessary aspect of accounting. Auditors are faced with many difficult decisions in the business world and are always required to disclose what it right and what is wrong. Ever since Sarbanes-Oxley (SOX) was passed in 2002 auditor liability has increased and investors place a lot more emphasis on an auditor's opinion. Although SOX has a positive effect on many aspects of accounting it has also managed to increase law-suits against auditors who do not comply with Generally Accepted Accounting Principles (GAAP) or who disclose financial statements to the public with materially misstated information (Spell 2010). An auditor has a responsibility not only to the client but also to a third party which can include investors or banks. Today our accounting system is based on rules and regulations set by the Public Accounting Oversight Board (PCAOB) while most international countries run on a principle based system. "The standards issued by the Board are overly rule-based and place restrictions on the exercise of professional judgment by an auditor, which in turn leads auditors to adopt a checklist approach rather than using what the Institute called the "thinking mentality" essential to exercising appropriate professional judgment"(Hamilton 2010). A principle based system puts all of its emphasis on professional judgment which in turn can lead to many more law-suits since not everyone's judgment or thought process will be the same. An auditor has such a high liability because it has to attest to all the financial statements they review and disclose all information to the public and SEC so that third parties can build their confidence in the company (Spell 2010). Ruled based accounting has a lower risk for litigation than principle based accounting since complying with rules is safer whereas professional judgment can cross into many different dark areas.
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Auditor Liability in today's society is very high and now definitely more because of the economic condition. Many auditing firms will first asses a firm and find that their level of risk is extremely high causing them to reject to do the audit because of the liability involved and high costs, making it difficult for public companies to enter into a capital market (Laux and Newman 2010). Auditors do not face much litigation from the client because it is not very often that an auditor will break a contract or not do what he or she is supposed to. It is the third-party who will be the most common group to sue an auditor. SOX has also broadened the group that is in a third party which now includes anyone who uses non-financial statements to decide whether or not they even want to look at the audited financial statements and invest in the company (Chung and Farrar and Puri and Thorne 2010). In the past auditors did not have to attest to all the financial statements and disclosures but now they are required to by law causing legal liability towards third parties to be a lot higher ( Chung and Farrar and Puri and Thorne 2010). If a company does not perform like the financial statements say it will or not in accordance with what an investor thinks will happen according to these statements, the third party will most likely file a law-suit. Many of the big four accounting firms have faced immense amounts of law suits in which they have paid millions of dollars. So now as a precaution many of the firms put a cap on legal liability with the client (Spell 2010). This may decrease the liability to the client but it is the shareholders that they have to worry about. According to the Securities and Exchange Commission (SEC) they do not have any plans right now to change auditor's liability to third parties because this kind of liability and punishment shows an auditor the consequences of fraudulent work (Spell 2010). It also allows for third parties to rely more on the financial statements and the auditors work since they know that no auditor will want to deal with the punishments that come with fraudulent behavior (Spell 2010). This liability under a rule-based accounting system is extremely harsh but to avoid fraud it must be done, although third parties should not be able to sue auditors as easily as they do in today's society because the effect of the economy on a company cannot be foreseen by an auditor. In France they use principle based accounting and have many laws that protect them against third parties which means that legal liability for auditors is low, this is the only country that has these protections, he only time they are not protected is if they purposely misstate a financial statement (Chung and Farrar and Puri and Thorne 2010). Most other European countries have the same protection except for that in France if a partner or manager commits the fraud none of the other auditors are liable whereas in other countries the auditors are liable (Chung and Farrar and Puri and Thorne 2010).
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One of the biggest and probably worst punishments for an auditor who materially misstates a financial statement would be imprisonment or paying large sums of money which would be in million dollar amounts. Many auditors could get their licenses revoked and most likely no other accounting firm would hire them as an employee. There have been many proposals to help auditor liability in the USA but none have been formally approved. According to Coffey, "A troubling proposal, being considered by a Treasury Department advisory committee, would place a cap on auditor liability to shareholders in securities class-action cases" (Coffey 2008). This will help the accounting firms because as of right now many firms are losing millions of dollars a year because litigations are constantly being placed amongst them by third parties. So other proposals have been made by many different commissions, one in particular is the "Paulson Committee" which came up with some suggestions such has having someone from a regulatory board come and oversee the firms that have many litigations, trying to clarify the rules so they are easier to follow, and trying to pinpoint the auditors who are making the mistakes as opposed to punishing the whole firm itself (Dickey 2008). Europe also has some changes that are in review that have to deal with caps since it is spoken about so much (Dickey 2008). Some examples include as capping their monetary funds, audit fees, and allocating their liability to auditors based on the amount of responsibility they have (Dickey 2008). The general consensus of accountants today on the issue of reducing auditor liability is to place caps on many of the laws that are enforced. Some of these proposals may fix the liability, but people will always find a way to sue an auditor at the end of the day because they are the ones that are thought of if a company's statements are misrepresented, even if it was not their fault. Having these repercussions for auditors is necessary and helps auditors understand the importance of their job. Imagine there already is all this fraud in today's society and people still commit the fraud knowing the consequences, if they get rid of the liability much more fraud will be committed.
As of right now auditors liability is extremely high but it should remain like that especially now in this economic recession that our country is facing. Although at the same time auditors should not be sent to court for reasons that are not their fault like if a company does not have the funds to pay their shareholders because that is not an auditors fault if they assessed the company in accordance with GAAP. Defensive auditing can be described as an auditor protecting themselves from a lawsuit, there are many ways to avoid this but the most obvious one would be to comply with GAAP and if there are any doubts always ask. (Rittenburg 2008). Some other things that can be done are issuing engagement letters, making sure you know everything about the client you are auditing, having proper liability insurance, disclosing all your information with great quality documentation, and making sure that the firm can actually handle the audit (Rittenburg 2008). These are the standard precautions that a firm should take to avoid lawsuits and if these steps are followed an audit should go in the right directions
All in all it should be concluded that the current system the USA has for auditor liability is a good system to follow by. Of course it has negative aspects but what system does not. If auditors do what they are supposed to do and follow the correct regulations, and disclose the necessary information their liability should not be as high.