Accounting Irregularity, Improper Revenue Recognition and Auditor Litigation

• In Event: Public Interests

Abstract

We examine the likelihood that an auditor will be sued in a class action initiated by shareholders against the audit client. We examine the accounting misstatement characteristics that triggered the class action lawsuit and we use litigation data from the Stanford Securities Class Action Clearinghouse database for the period 1996 to 2005. Using logistic regressions, we find that external auditors are more likely to be sued when audit clients improperly recognize revenues and the accounting misstatement is due to an accounting irregularity. We also find that external auditors are more likely to be sued by shareholders when the Securities and Exchange Commission (SEC) initiates an enforcement action through a court filing or an administrative proceeding. Our results suggest that revenue misstatement, accounting irregularity and SEC enforcement actions appear to be indicators of audit failure. The results should be of interest to regulators and other stakeholders who are concerned with improving audit quality.

Authors

• Nana Yamfo Amoah, Rollins College

• Isaac Bonaparte, Towson University

• Muniratu Kelly, Morgan State University

• Bilal Makkawi, Morgan State University