The Impact of Audit Evidence Documentation on Jurors' Negligence Verdicts and Damage Awards

Abstract

Audit workpapers play a key role in auditor negligence trials, yet little is known about how workpaper documentation affects jurors' decision making. I investigate how auditors' documentation of their consideration of the alternative accounting treatments and their risk-based audit approach influence jurors' negligence verdicts and damage awards. I find that documentation of their consideration of the accounting alternatives increases the likelihood that auditors are found negligent because it increases jurors' perceptions of the foreseeability of the misstatement. However, when combined with documentation that explicitly links the audit risks to the work performed to address each risk, jurors award lower damage awards because they perceive auditors' actions prior to the negligent act as more compliant with the auditing standards. My results highlight the consequences of more complete documentation on jurors' evaluations of auditors and suggest the need for documentation policies that more effectively communicate the appropriateness of auditors' professional judgments.

The Effects of the Internal Control Opinion and Use of Audit Data Analytics on Perceptions of Audit Quality, Assurance, and Auditor Negligence

“…had prior investment experience. Participants in our sample are comparable with those in recent studies eliciting juror negligence judgments in auditor litigation cases (e.g., Lowe, Reckers, and Whitecotton 2002;Backof 2015;Gimbar et al 2016). Our participants were appropriate given our research goals (Libby et al 2002;Elliott et al 2007).…”

What matters in disclosures of key audit matters: Evidence from Europe

“…() extend these studies by including not only nonprofessional investors but also investment professionals. Like Backof (), they find that KAMs have no communicative value for nonprofessional investors, but for professional investors, a negative KAM (small changes in key assumptions could eventually lead to goodwill impairment) leads to a better assessment of a firm's economic situation than a positive KAM (large changes in key assumptions could eventually lead to goodwill impairment).…”

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

“…As is well documented, auditors operate in highly litigious environments that continue to impose increasing costs on public accounting firms (see Donelson 2013). Further, Reffett (2010) and Backof (2015) find that identifying and documenting areas of concern (e.g., fraud risks or possible alternative accounting methods) in the audit work papers increases jurors' auditor liability judgments when auditors fail to detect misstatements related to the areas of concern, suggesting that disclosing CAMs could lead to increased litigation against audit firms. Nevertheless, at the time concerns over the Proposal were expressed, there was little to no direct evidence to indicate whether such concerns were warranted.…”

“…Most notably, there is an important distinction between CAMs and the contexts examined in prior research. Specifically, unlike prior studies' contexts (i.e., work paper documentation [Reffett 2010;Backof 2015]), auditors will publicly disclose CAMs prior to the revelation of financial statement misstatements, effectively alerting users to the potential for misstatements within related areas of the financial statements. As such, we contend that jurors will view previously disclosed CAMs as having effectively ''forewarned'' financial statement users of a heightened risk of undetected misstatements.…”