appointment procedures and fourthly that the monitoring regime should extend it the management of economically significant clients
7.12 Fourth Investigative Aim: The Audit Expectations Gap In countries like Italy and Germany where users of
to the US and the UK),462 the expectations gap in these jurisdictions can be ascertained through the characteristics of the users of financial information.
US,463 this would tend to reduce the expectations gap which exists in the US when compared to the EU and jurisdictions within the EU.
mainly of core, insider shareholders464 hence the expectations gap is more likely to be reduced than the case of the UK and the US where there are many outside shareholders.
In addition, the type of legal system (be it common law based or codified) is likely to have an impact on the expectations gap as the law can be said to be more well defined in codified systems in comparison to common law systems. These differences between credit/insiders (Germany and Italy) and equity/outsiders ( the UK and the US) shareholders and the legal systems may be determining factors in the expectations gap within these jurisdiction. The situation however, is not so clear cut.
R Parker, Comparative International Accounting p 22 46
460 ibid
461 ibid
462 C Nobes and
463 See ibid p
464 Ibid p 24
Institutional and private investors now have an increasing importance in Germany465 and as mentioned in the second chapter, the Italian and German governments have realised the growing
two contexts since it requires audits of public companies not only to include procedures that will ensure the detection of fraud
importance of audits and requiring public or listed companies to publish detailed, audited financial statements.
Litigation and legal exposure risks created by the expectations gap has led to great concerns for the international auditing community.466 Such are those concerns that the implementation of
“expectations gap” auditing standards has taken place in the US.467 In addition, legislation relating to proportionate legal liability for auditors, the Private Securities Litigation Reform Act, was passed by the US Congress in 1995.468 Management fraud and bankruptcy are two important audit contexts which not only present considerable legal exposure to the audit profession but have also been directly addressed in both international and US auditing standards.469 The Private Securities Litigation Reform Act470 does not emphasise the significance of these
having a direct and material effect on the financial statements, but also an assessment of an entity’s ability to continue as a going concern, hence avoiding bankruptcy.471
Litigation concerns have increased following the demise of Arthur Andersen, as a result of the Enron scandal. According to a European Commission policy paper due for publication in January 2007, the big four audit firms needed legal protection against potentially damaging legal actions.472 Four ways whereby Brussels could enhance protection for auditors as suggested by the Commission paper are as follows:473 Firstly, through the imposition of a fixed monetary cap for auditor liability at European level via EU legislation; secondly, by introducing a cap based on the market capitalisation of the audited company; thirdly, the proposal of a cap based on a multiple of the audit
465 Ibid p 23
466 B Anderson, M Maletta and A Wright, 'Perceptions of Auditor Responsibility: Views of the Judiciary and the Profession' (1998) 2(3)International Journal of Auditing 215
467 Ibid p 216
468 Ibid; The Act establishes conditions for auditor liability dependent on proportionate responsibility as opposed to joint and several liability which was stipulated by previous US law.
469 Ibid p 217; See ISA No 240 ( International Federation of Accountants 1996a), ISA No 570 (International Federation of Accountants 1996d), SAS No 59 (American Institute of Certified Public Accountants, 1988d) SAS No 82 (American Institute of Certified Public Accountants 1997); ibid.
470 Title III
471 B Anderson, M Maletta and A Wright, 'Perceptions of Auditor Responsibility: Views of the Judiciary and the Profession' (1998) 2 (3)International Journal of Auditing 217
472 T Buck 'Brussels Suggests Legal Shield for Big Audit Firms' Financial Times January 18 2007
473 ibid
fees charged by the auditor to his client; and fourthly, through the principle of “proportionate liability” which can only be implemented by national governments. Under the principle of proportionate liability, auditors would only be liable for damages resulting from their own mistakes
Expectations gap contribute to litigation risk because differences in perceptions between the judicial
he audit profession attaches great importance to materiality issues in addressing audit responsibility in a fraud case,
parties.479 Unique factors which exist in Germany include the close relationship of all professional
and not their clients’. At present, a liability cap exists in just five EU member states namely Germany, Austria, Belgium, Greece and Slovenia.474 Britain, in the meantime, is implementing the concept of “proportionate liability”.475
and audit profession, particularly with regards to the issue of materiality, are likely to result to a higher level of litigation risk – since judges’ lack of consideration of materiality levels are likely to subject less culpable auditors to less favourable judicial decision making.
As well as evidence shows that certain external factors from the audit environment, held to be highly important by auditors are considered by the judiciary in deciding responsibility assessments and mitigate the effects of judges’ unfavourable attitudes towards the auditing profession, it has also been shown that whilst reliability and materiality greatly influenced auditors’ attributions, they did not play a part in the attributions of the judges.476 Findings show that whilst t
judges do not appear to take into consideration whether a fraud is above or below the auditor’s materiality level.477 If factors such as materiality play such a role in the audit standards, then judges should also consider these factors during responsibility assessments of auditors.
In Germany, auditor legal liability is capped at a maximum amount and whilst there are pressures in other jurisdictions (such as the UK)478 to pass limited liability legislation, German auditors sought to increase the cap on audit liability in order to avoid broader unlimited responsibilities to third
, M Maletta and A Wright, 'Perceptions of Auditor Responsibility: Views of the Judiciary and the essio ' (1998
ever this has changed with the Companies Act 2006, which has removed the previously existing its on
Judiciary and the
474 ibid
475 ibid
476 B Anderson
Prof n ) 2 (3) International Journal of Auditing 218
477 Ibid p 227
478 How
lim auditor liability and compelled an agreement between the company and the auditor. See Sections 534 – 536 Companies Act 2006
479 B Anderson, M Maletta and A Wright, 'Perceptions of Auditor Responsibility: Views of the Profession' (1998) 2(3) International Journal of Auditing 229
groups within the state, the strong influence of banks and conservative accounting.480 These factors are said to have accounted for the acceptance of capped audit liability arrangement over the past 60 years and for the initiative by auditors in seeking to increase the cap in order to avoid broader, unlimited responsibilities to third parties.481 In April 1998, through amendments made to the German Commercial Code, audit reforms made effective for fiscal years ending after December 31 1998, became law.482 As well as changing the objective of the audit, the audit reforms refined audit reporting requirements, and increased the legal liability of auditors.483 The legislation resulting
ility limits of audit failures from 250,000 Euros to 4 million