Auditor Liability Essay Research Paper Throughout the

Auditor Liability Essay, Research Paper

Throughout the Eighties and into the Nineties the

question of liability has become more prevalent in the practice of public

accounting. Recently, the AICPA has been lobbying for liability reform in

cases 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 a

few. (Bolinger p. 53) The key to success for the AICPA, according to Gary

M. Bolinger is creating

an image as a, “profession performing high-quality services but faced

with excessive liability burdens that harm the public interest.” (Bolinger

p.56)

One should not be concerned, however, in the pending political

outcome, but in weighing the evidence argued by both sides and developing

a sound reasonable basis. Therefore, the remainder of this document shall

concern itself with comparing the prevalen t arguments of both sides

against one another and drawing a conclusion based on the evidence.

Opponents of liability reform rely heavily on an idealistic

constitutional argument as well as an economic argument to foster their

point. The main components of their argument are as follows: Limiting

recovery of loss has a detrimental effect on those

which are harmed by alleged negligence. The cost of liability is

reasonable when compared to total revenues, and in light of a CPA’s public

responsibility. Indemnity insurance spreads risk in the aggregate

therefore removing the element of risk at the f irm level. The threat of

litigation provides public accountants with a deterrent against negligent

work. Finally, the results of lawsuits cause the profession itself to

implement new standards. (Bolinger p.54)

The AICPA and its supporters have developed their argument based

on continued liability’s likely effect on the profession as well as an

economic argument. The arguments in favor of liability reform include the

effect of continued liability on the availab ility of CPA services. The

likelihood of fee increases resulting from liability risk. The threat of

the inability of public accounting to obtain and retain qualified

individuals. (Bolinger p.56) Finally, the complexities involved in the

audit engagemen t and the subjective decision making process versus the

ability of a given jury to understand and levy a fair decision in such

cases. After examining the arguments of both sides one will see that

litigation in its current form is a hindrance to the accou nting

profession as well as society, and the benefits provided by litigation are

attainable through enforcement of professional standards.

The first of the opponents arguments finds it’s basis from

idealistic Constitutional principal. The notion that those which have

been wronged, either directly or indirectly, deserve compensation for

their estimated loss is one which first found favor in

the case of Thomas v. Winchester in 1942. (Minnis p.4) In this case, for

the first time a third party received compensation. (Minnis p.4) The

precedent set by this case is the notion of duty owed to a third party–

if it ascertains that a duty is owed t hen a third party has a right to

seek compensation. The case which most directly affected auditors is a

case 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 a

ban k passed to its client a certificate of credit-worthiness on a

potential client. The business which was deemed credit-worthy ultimately

failed, and claim resulted by the third party against the bank issuing the

certificate.!

(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 is

embraced by the legal community– and rightfully so, after all a drastic

reduction in the number of claims filed would r esult otherwise. The

argument made in its favor is that all those harmed by negligent activity

deserve compensation. Idealistically this is true, and theoretically

anyone who makes a decision based entirely on the results of an auditor’s

report, and suf fers a loss due to negligence in preparation by the

auditor, deserves compensation. Realistically, however, this is not

usually the case. With the exception of banks, whom are approached by

businesses for the possibility of tendering a loan, and therefo re do not

initiate contact; all other investors would only take the time to review

the financial statements of a given company if another mitigating force

attracted them. Therefore, it is reasonably asserted, that significa!

nt third parties, such as banks a

A second argument against liability reform is that the cost of

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