Focus on KPMG (Klynveld Peat Marwick Goerdeler) firm.
How can auditors avoid litigation without compromising on the quality of the audit?
(Consider the business risks and threats to the auditors if they were made liable for accounting misstatements that might prevent them from providing the assurance that is needed). Your arguments must be supported by research evidence.
The Correct Answer and Explanation is:
To avoid litigation without compromising audit quality, auditors like those at KPMG must adopt a robust risk management approach, uphold professional skepticism, and maintain independence and ethical integrity, while documenting audit procedures rigorously. These strategies not only shield auditors from legal risks but also sustain the credibility and utility of their assurance services.
Explanation
Auditors face increasing litigation risks, especially when stakeholders suffer losses from financial misstatements. According to Palmrose (1988), litigation often stems not only from actual audit failures but from the expectation gap—when users expect auditors to detect all frauds, which exceeds the profession’s intended scope. To reduce this risk, KPMG and similar firms must manage expectations by clearly defining the scope and limitations of audit engagements through engagement letters and client communications.
Furthermore, auditors should adhere strictly to auditing standards such as the International Standards on Auditing (ISA) or PCAOB standards, which emphasize professional skepticism, sufficient appropriate evidence, and clear documentation. Research by Knechel et al. (2013) shows that higher audit quality correlates with lower litigation risk. KPMG, for instance, has been increasing investment in digital audit tools, which enhance evidence gathering and reduce errors or omissions.
Maintaining independence is also crucial. The Enron–Arthur Andersen scandal demonstrated that compromised independence leads to catastrophic reputational and legal consequences. KPMG mitigates this through strict internal policies on auditor rotation and prohibiting certain non-audit services.
Auditors must also identify and manage client-related business risks. For example, audits of high-risk clients in volatile industries or with aggressive earnings management practices require additional scrutiny. Failure to do so exposes auditors to lawsuits, as seen in KPMG’s past involvement in the Wirecard scandal, where lapses in skepticism and oversight were criticized.
In conclusion, by combining rigorous audit methodology, technological tools, strong ethical standards, and transparent client communication, auditors can minimize legal exposure without compromising audit quality. This approach also aligns with public interest, preserving the profession’s integrity and the capital market’s trust.
References:
- Palmrose, Z. (1988). An analysis of auditor litigation and audit service quality. The Accounting Review.
- Knechel, W.R., Vanstraelen, A., & Zerni, M. (2013). Does the identity of engagement partners matter? An analysis of audit partner reporting decisions. Contemporary Accounting Research.
