The Importance of Clarification of Auditors' Responsibilities Under the New Audit Reporting Standards*

TLDR

Uncertainty over auditors’ responsibilities prompted standard setters to consider clarifying terms such as reasonable assurance, yet the PCAOB ultimately omitted such language while other bodies mandated it. This study examines how clarifying reasonable assurance affects perceptions of auditor negligence. The results show that without clarification, jurors view auditors as more negligent when a critical audit matters disclosure is present, but clarifying reasonable assurance reduces this perception, suggesting the PCAOB’s omission may have unintentionally increased auditors’ litigation exposure.

Abstract

ABSTRACT Given the uncertainty regarding auditors' responsibilities, standard setters considered the need for clarification of technical terms such as reasonable assurance in the new audit reporting models. The PCAOB ultimately decided to exclude clarifying language from its final standard, while the Auditing Standards Board and IAASB made such language mandatory. Given the difference in reporting models, this study investigates the role clarification of reasonable assurance plays in auditor negligence. We predict and find that, absent clarification, jurors judge auditors to be more negligent when the audit report includes a related critical audit matters disclosure than when it does not. However, consistent with our prediction, clarifying what is meant by reasonable assurance mitigates this increase in auditors' liability exposure by reducing jurors' perceptions of auditors' personal control over the misstatement at the time of the audit. Thus, our evidence suggests that the PCAOB's decision to not include such language in the new audit reporting model may have been shortsighted given the potential for clarification to mitigate a potential negative unintended consequence to auditors' litigation exposure under the new audit reporting model.