Accountant's liability definition
/What is Accountant’s Liability?
An accountant's liability is the potential legal risk that an auditor bears for not spotting misstatements in a client's financial statements. If the auditor does not spot these misstatements and the financials are then sent out to users with a clean audit opinion, the auditor is liable for losses suffered by the users. These losses could be substantial, since a lender might lend funds based on the clean opinion, and investors may buy a company's stock for the same reason - and then lose their money when the company fails. The presence of this liability forces auditors to be unusually thorough in examining the books of their clients.
Example of Accountant’s Liability
An example of accountant’s liability involves Waste Management, Inc. and Arthur Andersen LLP, which served as its auditor. In 1998, Waste Management was found to have fraudulently overstated earnings by $1.7 billion over a six-year period. The company engaged in various accounting manipulations, including inflating asset values and failing to record depreciation properly.
Arthur Andersen had audited Waste Management’s financial statements and issued unqualified audit opinions during those years, despite being aware of the aggressive accounting practices. Internal documents later revealed that Andersen partners had privately referred to the accounting irregularities as “improper” but failed to require Waste Management to restate its financials.
When the fraud was eventually exposed, Waste Management’s stock plummeted, resulting in significant losses for shareholders. The U.S. Securities and Exchange Commission charged Arthur Andersen with violating auditing standards, and the firm ultimately settled the case by paying $7 million, which at the time was the largest civil penalty ever paid by an accounting firm.
Related AccountingTools Courses
Guide to Auditor Legal Liability
How to Conduct an Audit Engagement
Accountant Professional Liability Insurance
Auditors pay for professional liability insurance coverage to protect themselves from lawsuits relating to their work. This coverage pays for legal defense costs, as well as some or all of any eventual payout made to the plaintiffs.
The cost of this insurance can be significant, so the added cost can drive up the fees that auditors must charge to their clients.