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The litigator’s lens: A new perspective on audit risk management

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Audit engagement risk is something all auditors think about and incorporate into their decisions, but recent research suggests that they might not be thinking about it as broadly as they should. 

To better understand audit litigation risks, we joined our colleagues in interviewing 39 very experienced audit litigators, including attorneys, trial consultants, and expert witnesses. These experts averaged 31 years of experience in audit litigation and provided us with a comprehensive perspective on trial preparation. Our study, published in “The Accounting Review,” was inspired by earlier work with litigators suggesting that auditors systematically underestimate audit litigation risk because they don’t adequately understand all the factors that can affect it.

Even when auditors follow all the standards and perform a high-quality audit, they can still be sued if a client or third parties believe they made a mistake. This includes honest errors, fraud that they didn’t catch, or misperception about what an audit actually covers. Even a squeaky-clean audit won’t immunize you from litigation, and there are several other factors that can affect the outcome of a case, many of which come into focus during trial preparation. 

So, it’s not enough to focus on audit quality — it’s also critical to focus on what would happen if your work were ever to go before a judge and jury.

Think like a litigator

Based on our research, the first thing you need to do is start thinking like a litigator and learn to think about your audits through a legal lens. The “Elaboration Likelihood Model” from psychology research provides a helpful way to think about this. 

ELM explains how people — including judges and juries — are persuaded, and it depends on how deeply they think about the information they’re given. “High elaboration” means jurors are thinking critically about the evidence and the facts of the case, while “low elaboration” means they’re going more with their gut feeling and emotions.

Here’s what our research found:

  • Plaintiff attorneys prefer to keep things simple and emotional, encouraging low elaboration by jurors. They know that auditing standards are complex, and most jurors don’t have the background to understand them. They’ll often use arguments like, “This company lost millions of dollars. The auditor should have caught it.” This kind of argument preys on the misconception that many jurors have — that an audit is a guarantee of accuracy or future business success.
  • Defense attorneys, in contrast, want jurors to use high elaboration. To achieve that, they need to spend a lot of time educating jurors about the technical details of auditing, the relevant standards, and what an auditor’s work actually showed. They essentially have to teach a crash course in auditing, which is difficult and time-consuming, and there’s no guarantee that it will work.

The venue and jury matter

The venue of the trial and the potential jury pool are also really important and are things that auditors can consider in advance. Our research found that:

  • Federal courts tend to be more favorable to auditors than state courts because federal judges are usually more sophisticated and knowledgeable about business matters.
  • Jurors with high levels of education and business experience are more likely to understand the technicalities of an audit and won’t be as swayed by emotional arguments. This means that if your client is headquartered in a city with a lot of college graduates and white-collar jobs, you’re less likely to face a runaway jury.
  • Jurors with a strong hometown bias are unlikely objective, and are more likely to side with a local company over an outside audit firm. This hometown bias can be a real problem, especially for smaller firms.

What can auditors do?

So, what can auditors do about all of this? The good news is that our research suggests there are several steps you can take.

During client acceptance, firms should:

  • Consider the potential trial venue and jury pool. It’s a little morbid to think about, but ask yourself, “If I were to be sued over this audit, where would the trial be held? What are the demographics and sophistication of the jury pool in that jurisdiction?” Auditors should incorporate these factors into their risk assessment and management processes. 

And during the audit, you should:

  • Go beyond merely complying with auditing standards to minimize the possibility of errors or misstatements that could lead to litigation. This means taking a proactive approach to risk assessment and considering factors that might increase the likelihood of a lawsuit when planning an audit engagement, even if they aren’t explicitly required by the standards.
  • Be clear about the scope of the audit and your responsibilities in your engagement letter and throughout the engagement. Make sure the client understands what you are doing, what you are not doing, and the limitations of an audit. Document all communications with the client and make sure your workpapers clearly reflect the work that was done.
  • Write audit workpapers with potential litigation in mind. Use clear and concise language that a layperson could understand, and explain how your work meets the relevant auditing standards.

Beyond our findings, it’s also important to:

  • Consider engaging with trial consultants to help you assess your litigation risk in different jurisdictions and develop strategies for dealing with different types of juries.
  • Educate the public about auditing to dispel the common misconceptions about your role and responsibilities. The more people understand about what auditors do (and don’t do), the less likely they are to make unreasonable demands and file frivolous lawsuits.

By being aware of the legal context and planning ahead, you can better manage your litigation risk. This doesn’t mean you should drop clients with higher business risk, but it does mean you need to be aware of all the factors that can contribute to audit litigation risk and assess your ability to mitigate those risks. In doing so, you can continue to provide valuable services to your clients and protect the integrity of the financial reporting system.

The insights from our research make one thing abundantly clear: Focusing on compliance with auditing standards is not enough. To truly protect yourselves, your firms, and the investing public, auditors need to broaden their perspectives and develop a sophisticated understanding of the legal and social context in which they operate. 

This requires auditors to be more proactive, more communicative, and more willing to challenge the status quo. Ultimately, the future of the profession may depend on your ability to adapt to the changing legal landscape and embrace a more holistic view of audit risk.

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Accounting

AICPA survey: Americans delaying spending over financial worries

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Some Americans are changing their financial behaviors and delaying purchases based on their feelings about their financial situation, according to a new survey by the American Institute of CPAs. 

Thirty-seven percent of adults have felt cautious and 36% have felt uncertain about their financial situation in the past 12 months. As a result, 28% reported they have been charging less to their credit cards, and 27% said they have started saving or increased their savings rate.

AICPA building in Durham, N.C.

Over a quarter (27%) said they delayed a major purchase — like a car or home — in the past 12 months, and over half (57%) of those who delayed something said it was because of the cost of goods and services. 

“Money is one of the biggest stressors in many Americans’ lives, at times causing anxiety and tension with a spouse, partner or other family members,” Dan Snyder, director of personal financial planning for the AICPA, said in a statement. “Taking control of your financial situation and finding comfort with what you can and can’t control is a good starting point to help alleviate financial uncertainty.”

Looking forward, respondents were divided on how the next 12 months will compare to the previous 12 months. Thirty-three percent believe it will be better, 37% expect it will be the same and 30% anticipate it will be worse.

The survey was conducted by The Harris Poll on behalf of the AICPA to kick off National Financial Literacy Month. It collected responses from over 2,000 U.S. adults from April 1-3.

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Accounting

AI, PE and future career opportunities in public accounting

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How will artificial intelligence and private equity shape the work of young accountants like me? As someone who has worked in this profession, I wonder about the increasing commercialization of accounting to the extent that firms will prioritize profitability over professional integrity and change the personal growth and involvement of the staff. 

The combination of PE investments and AI offers both tremendous opportunities and difficulties for public accountants. While PE investments are changing the structural dynamics of accounting businesses, AI has the potential to completely transform auditing procedures, increasing accuracy and efficiency while reducing data entry on the detailed analysis. 

My question is whether AI diminishes the role of accountants, or will it require us to develop entirely new skill sets? Will PE funding compromise audit independence and long-term growth in pursuit of short-term profits? These are the questions that make me apprehensive about the direction of the profession.

Artificial intelligence in public accounting

The integration of AI and other advanced technology into public accounting is transforming traditional audit methodologies. Firms are adopting AI-powered tools to analyze extensive financial data, identify potential risks, process vast amounts of financial information, enhance the detection of misstatements and irregularities, uncover trends and predict future courses of action. 

AI-driven audit technologies enable auditors to examine entire data sets rather than relying on sampling, which requires time-consuming staff involvement and audit oversight, including time to process the sampling results. AI-powered comprehensive analyses improve the reliability of audit findings and streamline the auditing process. They will also enable the auditing of a larger population of transactions, increase the reliability of the results and reduce the reliance on materiality limits for certain auditing steps.

While this innovation is exciting, it also raises concerns about the changing role of accountants. AI will replace traditional audit techniques and responsibilities, somewhat reducing human judgment. The shift from manual reviews to AI-driven analysis will also favor tech-savvy professionals over traditional accountants. This will create pressure to continually improve and adapt, which is both an opportunity and a challenge. 

PE investments in accounting firms

The public accounting industry is undergoing tremendous change as a result of the entrance of PE investments and technological improvements. PE investors are purchasing shares in a number of American accounting firms, providing funding for hiring new employees, improving technology, adding advisory services, growing infrastructure, allowing marketing outside of CPA firms’ traditional client base and buying out retiring partners.

Public accounting is built on trust, and the increasing influence of profit-driven investors makes me question whether firms will be pressured to prioritize financial returns over audit integrity. If accounting firms start operating with a private equity mindset, it might cause ethical considerations to take a backseat for revenue targets. However, while accounting is a professional service, the firm is a business organization, and the juggling of ethical issues has always been a concern, as is the need for profitability and growth. This concern will surely increase. 

Auditors may face conflicts of interest when dealing with clients connected to their PE investors. However, accounting firms have similar issues with audit clients when performing advisory services. Of further concern, various accounting oversight boards may heighten their scrutiny of accounting firms with PE investments. However, PE investments alleviate personal wealth concerns caused by the current buy-out arrangements for retiring partners, and the risks associated with the practice of borrowing to finance growth.

Navigating the future

Adopting AI can enhance productivity and enable more insightful assessments in public accounting, but AI must be balanced with professional judgment and skepticism. AI will enable us to focus more quickly and be more targeted in areas where work should be performed that will yield better results. Private equity is the latest iteration of the growth of the accounting industry, bringing new capital and opening new opportunities. 

The intersection of AI and PE in public accounting presents both opportunities and concerns. By staying adaptable and committed to upholding the integrity of accounting, accounting firms can position their staff for a successful fulfilling career in an evolving landscape. The best approach is to stay continuously alert, adaptable, flexible and informed about regulatory developments and actively engaged in discussions of ethical accounting practices.

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Harvard intensifies funding fight with Trump administration

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Harvard University sued several U.S. agencies and top officials for freezing billions of dollars in federal funding, significantly ratcheting up a high-stakes showdown with the Trump administration.

The government unlawfully suspended Harvard’s funding after it refused to comply with “unconstitutional demands” to overhaul governance, discipline and hiring policies, as well as diversity programs, lawyers for the university argued in a lawsuit filed Monday in federal court in Massachusetts. The Trump administration has accused the nation’s oldest and richest university of failing to combat antisemitism on campus.

“Over the course of the past week, the federal government has taken several actions following Harvard’s refusal to comply with its illegal demands,” the university’s president Alan Garber said. “We filed a lawsuit to halt the funding freeze because it is unlawful and beyond the government’s authority.”

In a statement on the university’s website, Garber cited the government’s pause in federal funding, threats to block an additional $1.1 billion in grants, a crackdown on foreign students, and the possible revocation of Harvard’s tax-exempt status. 

The White House is pushing for sweeping changes at the most elite U.S. universities, and has frozen or is reviewing federal funding to Princeton, Cornell, Northwestern and Columbia universities. At Harvard, the government halted $2.2 billion of multiyear grants on April 14, claiming the school failed to enforce civil rights laws to protect Jewish students.

Harvard’s lawsuit claims that the funding freeze violates its First Amendment guarantee of free speech and the Administrative Procedures Act. It asks a judge to bar the U.S. from freezing the funding and declare the government’s actions unconstitutional. 

“The government has not — and cannot — identify any rational connection between antisemitism concerns and the medical, scientific, technological, and other research it has frozen that aims to save American lives, foster American success, preserve American security, and maintain America’s position as a global leader in innovation,” the lawsuit claims.

The White House and the Education Department didn’t immediately respond to a request for comment.

Education Secretary Linda McMahon on Tuesday morning emphasized that the government’s actions were designed to protect students’ civil rights rather than infringe on universities’ free speech. She said she hopes Harvard comes back to the table, signaling there may be a path to deescalating the situation.

“We remain open to talking to Harvard, but they responded by filing a lawsuit,” McMahon said in an interview on CNBC. 

Trump escalated his fight with Harvard after the school refused to bow to his administration’s demands. Since threatening its funding, Trump suggested the Internal Revenue Service should tax the university as a “political entity,” a move that would significantly hit the school’s finances and make it harder to raise money from wealthy donors.

Government demands

The showdown began last month when the government threatened about $9 billion in federal funding to Harvard. Days later, the administration demanded that Harvard remake its governance, transform admissions and faculty hiring, stop admitting international students hostile to US values and enforce viewpoint diversity. 

The government also called for scrapping any hiring preferences based on race or national origin, adopting a broad ban on masks and adding oversight for “biased programs that fuel antisemitism.” 

Harvard rejected those demands on April 14, saying it “will not surrender its independence or relinquish its constitutional rights” and that a private university “cannot allow itself to be taken over” by the U.S. government. 

McMahon said on CNBC that the demand letter to Harvard was a “point of negotiation” and that she had hoped the university would “come back to the table.”   

As part of its legal team, Harvard has hired two conservative lawyers with connections to the Trump administration — William Burck and Robert Hur. Harvard also tapped a lobbying firm, Ballard Partners, where Trump’s chief of staff used to be a partner. The school also named John Manning, a conservative lawyer, as its permanent provost, the second-most powerful leadership role at the university.  

“The government has only ratcheted up cuts to funding, investigations and threats that will hurt students from every state in the country and around the world, as well as research that improves the lives of millions of Americans,” the complaint claims.

The school has a $53 billion endowment but that money is restricted in how it can be spent, meaning the university relies on federal funding. Without that support, the school said in its complaint, it will be forced to either reduce or halt ongoing research projects and terminate employment contracts with researchers, staff and administrators, or make other cuts to departments or programs.

Campuses across the U.S. were roiled by protests after Hamas, which the U.S. considers a terrorist organization, murdered 1,200 Israelis and took more than 200 hostages in October 2023. Israel’s retaliation against Hamas in Gaza has killed more than 48,000 Palestinians, according to the Hamas-run health ministry.

Other university leaders, including Princeton’s, have expressed support for Harvard’s stance, but they also face pressure from the White House. The administration has already canceled $400 million in federal money to Columbia University and frozen dozens of research contracts at Princeton, Cornell and Northwestern universities. 

“All told, the tradeoff put to Harvard and other universities is clear: allow the government to micromanage your academic institution or jeopardize the institution’s ability to pursue medical breakthroughs, scientific discoveries and innovative solutions,” Harvard argued in its lawsuit.

Presidents of some of the most prestigious universities and small colleges signed a joint letter opposing “undue government intrusion in the lives of those who learn, live, and work on our campuses,” according to a statement from the American Association of Colleges and Universities, a trade group. 

“As leaders of America’s colleges, universities and scholarly societies, we speak with one voice against the unprecedented government overreach and political interference now endangering American higher education,” according to the letter, signed by leaders of schools including Princeton, Amherst College and the Massachusetts Institute of Technology.

Harvard named several cabinet secretaries as defendants in the lawsuit, including Robert F. Kennedy Jr., whose agency, Health and Human Services, funds the most research, as well as other agencies including the Department of Defense and the National Aeronautics and Space Administration.

The case is President and Fellows of Harvard College v. U.S. Department of Health and Human Services et al, 25-cv-11048, U.S. District Court, District of Massachusetts (Boston).

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