Modifying Exposure: Do Going Concern Opinions Reduce the Likelihood of Legal Action Against Auditors in Cases of Fraud?

• In Event: Earnings Management, Modifying Auditor Exposure, Enhancing Skepticism, and Fraud Tales

Abstract

ABSTRACT: This study explores whether modification of the audit opinion with a going concern results in a lower likelihood of enforcement action against independent auditors in cases of fraudulent financial reporting. To examine this issue, we review the audit opinions accompanying allegedly fraudulent financial statements, as identified by Auditing and Accounting Enforcement Releases (AAERs) issued by the SEC. Contrary to research suggesting that opinion modification may actually increase auditor liability in cases of fraudulent financial reporting (Reffett, 2010), we find that going concern modifications decrease the likelihood of audit enforcement action. Additionally, we find that larger audit firms (Big N) and issuing an audit opinion in the post-SOX regulatory environment are factors that decrease the likelihood of audit enforcement action. On the other hand, the length of the fraud and subsequent bankruptcy filings result in an increased likelihood of enforcement action against auditors. This study has implications for auditors in minimizing legal liability, regulators in evaluating the incentives created by enforcement action policies, and academic research which utilizes the propensity to issue going concern opinions as a measure of audit quality.

Authors

• Jared Eutsler, University of Central Florida

• Erin Burrell Nickell, University of Denver

• Sean Robb, University of Central Florida