The Effects of Critical Audit Matter Paragraphs and Accounting Standard Precision on Auditor Liability

Abstract

The Public Company Accounting Oversight Board recently proposed amendments to the standard audit report that would require the disclosure of critical audit matters (CAMs), and the Securities and Exchange Commission continues to evaluate the use of principles-based (imprecise) accounting standards within U.S. generally accepted accounting principles. We assert that jurors perceive precise accounting standards to constrain auditors' control over financial reporting outcomes, resulting in a lower propensity for negligence verdicts when the accounting treatment conforms to the precise standard. However, we hypothesize that the use of either imprecise standards or CAMs reduces the extent to which jurors perceive this constraint to exist, leading to increased auditor liability. We present experimental evidence supporting this argument. Our results highlight the similarities between the effects of imprecise accounting standards and CAMs on negligence assessments. These results provide insight for regulators and the auditing profession about the potential consequences of the proposed regulatory changes.

The Sound of Silence: What Does a Standard Unqualified Audit Opinion Mean Under the New Going Concern Financial Accounting Standard?

“…Finally, our research contributes to the growing body of research related to CAMs. Prior studies suggest that the inclusion of CAMs may improve auditor outcomes in negligence lawsuits under certain circumstances (e.g., Brasel, Doxey, Grenier, and Reffett 2016) and may have the opposite effect under other circumstances (e.g., Gimbar, Hansen, and Ozlanski 2016).…”

Risk Disclosure Preceding Negative Outcomes: The Effects of Reporting Critical Audit Matters on Judgments of Auditor Liability

“…Although these results, coupled with results in contemporaneous studies (Brown, Majors, and Peecher 2015;Kachelmeier, Schmidt, and Valentine 2015) should provide standard setters with a degree of comfort that disclosing CAMs will not increase auditor liability, there undoubtedly are exceptions that future research should examine to further inform policymakers. For example, two contemporary studies report that, in certain situations, disclosing CAMs can increase jurors' judgments of auditor liability such as when misstatements pertain to violations of rules-based/bright line standards (Gimbar, Hansen, and Ozlanski 2016) and/or when the concept of reasonable assurance is not explained to jurors (Backof, Bowlin, and Goodson 2015).…”

Updates and Comparisons Regarding Changes to the Audit Reporting Model in the United States, United Kingdom, and European Union

“…However, when the CAM disclosure also included a description of the audit procedures addressing the CAM and information regarding the concept of "reasonable assurance," the auditors' negligence liability increased. Additionally, results in Gimbar, Hansen, and Ozlanski (2016) suggest that the type of regulatory setting (i.e., rulesversus principles-based settings) influences whether CAM disclosures impact auditors' liability assessments. This study finds that CAM disclosures are associated with increased auditor liability, but only in a rules-based setting, not a principles-based setting.…”

“…Concerning the standards in the United Kingdom and by the IAASB, the NYSSCPA further notes that "the litigation environment in the US is different from these other foreign jurisdictions" (NYSSCPA 2016, p. 1). As the results in Gimbar et al (2016) suggest, the differing regulatory environments between the United Kingdom, EU, and United States can impact how the CAM disclosures are perceived, especially when it comes to auditor liability assessments.…”