Accounting and Law

AuthorVern Krishna
Chapter : Accounting and Law
Accountants and auditors can be liable to users of nancial statements.
Liability may be in contract, tort, securities, or tax law. e scope and
extent of their liability depends upon the branch of law, the particular
users of the nancial statements, the nature of the claims, statutory
structures, and public policy considerations.
Although public accountants perform a wide variety of services
for their clients, their primary function, and the one that most fre-
quently gets them into legal trouble, is auditing nancial statements.
Accountants are the traditional target in business lawsuits. is is
because most business failures, whether of public or private compan-
ies, involve some aspect of their nancials. e plainti might com-
plain that the statements were prepared without adequate care in the
audit process or that the auditors misapplied GAAP or IFRS. e
plainti may allege that the statements are misleading, whether inno-
cently or fraudulently, and caused the plainti (or class of plaintis)
nancial harm.
However, there is another more practical reason why accountants
are often in the crosshairs of plaintis’ lawyers. Accounting rms do
not like to be dragged into court, where litigation can extend for years
and attract attention in the business press. In many cases, it is the insur-
ance coverage that attracts plaintis’ lawyers, like bees to honey. us,
334 Financial Skills for Professionals
accountants and accounting rms are amenable to settlement, if the
settlement is within their professional insurance limits, and their legal
fees are insured. In the nal analysis, it is the insurance company that
loses. However, it makes up its losses through increased premiums and
tax write-os. Ultimately, taxpayers bear the settlement costs.
For example, in the s, the “Big Five” (originally the “Big Eight”
and now reduced to the “Big Four”) faced more than USD$billion
in legal actions against them. Laventhol & Horwarth, the seventh lar-
gest accounting rm at the time, declared bankruptcy in  because
it could not meet its liability claims. In four years, the “Big Six” (as
they then became) paid out USD$. billion in securities fraud cases.
e current debacle of nancial statement manipulation is merely
a variation on old themes. Accounting and auditing standards induce
behavioural responses from the users of nancial statements. e
essential question is whether the standards are ahead of the creativity
of enterprising manipulators and nancial regulators.
Although accounting fraud is sometimes a problem in the secur-
ities markets, the more signicant risk of nancial misstatement is
auditor bias. is risk arises when the auditor of a company also
advises on consulting matters, which puts pressure on the auditor to
accommodate the client on its nancial statements or risk losing the
lucrative consulting or tax work. is creates a conict between the
self-interest of the audit rm and the public interest of investors.
Ultimately, the integrity of the nancial markets depends upon
the unbiased authentication of public nancial information and fair
audit opinions. is requires regulatory and judicial rules that dis-
courage, and penalize, inappropriate nancial reporting.
e Enron scandal represented the most serious consequences ever
visited upon an accounting rm and its ultimate demise. e scandal,
which destroyed a reputable accounting rm, illustrates the magni-
tude of nancial problems in the capital markets, and the human and
nancial tragedy that results from inadequate auditing and nancial

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