According to academic research: “The potential for increased audit firm litigation exposure remains a controversial aspect of the ongoing transition to imprecise accounting standards. Kadous and Mercer (2012) find that imprecise standards can increase audit firm litigation exposure when client accounting is inconsistent with industry norms, suggesting that audit firms would be motivated to herd to industry norms as a new form of rules and a safe harbor.”
A recent research paper by Grenier, Pomeroy and Stern uses a series of experiments to examine how audit firms can defend professional judgments in light of severe consequences associated with an alleged material misstatement and client accounting that is inconsistent with industry norms. It predicts and finds that, mock juror assessments of audit firm negligence can increase under imprecise relative to precise standards, but this increase is mitigated when audit firms make efforts to signal that their auditors made high quality judgments.
Importantly, audit firms can signal judgment quality in several ways: staffing engagements with recognized technical experts; utilizing professional judgment frameworks and highly reliable decision aids; and demonstrating adherence to professional standards. The results suggest that audit firms can make relatively cost effective efforts to cope with the potential for increased litigation exposure under imprecise standards. Thus, a transition to imprecise standards will not necessarily result in herding to industry norms.
To learn more, read the March 2012 SSRN research
paper, The
Effects of Accounting Standard Precision, Auditor Task Expertise, and Judgment
Frameworks on Audit Firm Litigation Exposure (posted online October 27,
2010 and last revised April 4, 2012). The paper was prepared by: Jonathan H. Grenier, Ph.D, Miami University -
Department of Accountancy; BradleyPomeroy, Ph.D, University of Illinois at Urbana-Champaign - Department of
Accountancy; and Matthew Stern, Ph.D student, University
of Illinois at Urbana-Champaign.
