Financial Statement Reporting of Pending Litigation: Attorneys, Auditors, and Differences of Opinions

Summary


Pending litigation can be a significant source of potential liability for public companies. The lack of adequate disclosure of this potential liability has caused confusion for investors, lenders, and other financial statement users. Auditors are required to assess the appropriateness of financial statement disclosures regarding pending litigation. However, the auditor's ability to do so depends upon receiving information from the company's attorneys. As independent auditors, Certified Public Accountants express their opinion regarding the reliability and integrity of a publicly traded company's financial statements based upon their examination and testing of the company's books and records. The authors' recommendation is that the auditor should consider limiting the scope of the audit to recognize the inherent limitation of the information available to the auditor concerning legal matters. While this approach does not resolve the communication conflict between the auditor and the attorney, it does signal to investors, lenders and others relying on the company's financial statements that the auditor is unable to render an opinion on these matters.

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Extract


Financial Statement Reporting of Pending Litigation: Attorneys, Auditors, and Differences of Opinions

What we've got here is a failure to communicate.1

I. INTRODUCTION

Pending litigation can be a significant source of potential liability for public companies. The lack of adequate disclosure of this potential liability has caused confusion for investors, lenders, and other financial statement users. Auditors are required to assess the appropriateness of financial statement disclosures regarding pending litigation. However, the auditor's ability to do so depends upon receiving information from the company's attorneys. Obtaining this information, however, is problematic because the accounting and auditing standards that guide auditors and the professional standards that guide attorneys have been at odds for the past thirty years. Recent scandals2 have resulted in legislation3 and increased scrutiny of the disclosure of contingent liabilities from pending litigation, thus magnifying this conflict between auditors and attorneys.

Parts II and III of this Article discuss the U.S. accounting standards and auditing standards applicable to pending litigation. Part IV identifies the issues raised by communications between attorneys and auditors, including the attorney-client privilege, the work product doctrine, and the American Bar Association guidelines4 on communications with a client's auditor. Part V describes three possible solutions offered by previous commentators to the conflict between attorneys and auditors and an assessment of the viability of these solutions. Finally, Part VI provides our conclusions and a recommendation for addressing this confl...

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