The Effects of Critical Audit Matter Paragraphs and Accounting Standard Precision on Auditor Liability
Posted: 4 Sep 2014 Last revised: 7 Jan 2016
Date Written: August 1, 2015
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 precise accounting standards are perceived by jurors 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 removes this constraint, leading to increased auditor liability. We present experimental evidence, including a mediation analysis, supporting this argument. Our results highlight the similarities between the effects of imprecise accounting standards and CAMs on negligence assessments. The results provide insight for regulators and the profession about the potential interactive consequences of the proposed regulatory changes.
Keywords: critical audit matters, key audit matters, auditor negligence, audit litigation, audit risk
JEL Classification: M40, M41, K20, K22
Suggested Citation: Suggested Citation