Auditor Failures: Insolvency Risk and Earnings Manipulations

Auditors are often blamed, and not infrequently sued, by clients and third parties alleging a range of failures in the conduct of annual financial-statement examinations. Despite auditors’ decades of efforts to educate clients, investors, regulators and others about the practical limitations of audits, users of financial reports continue to treat “clean opinions” as guarantees of company viability and management probity.

Auditors cannot be expected to foretell the normal vicissitudes of business cycles and the effects they may have on any given enterprise, let alone the possible impacts of wholly exogenous factors like global financial crises. In many instances, these lawsuits against auditors are near-automatic reactions to stock price dips or revelations about ill-conceived business acquisitions.

In at least two respects, however, auditors have often failed to make use of generally available analytical tools that could significantly improve the quality of their work. One of these is the failure to perceive early warnings of impending insolvency or collapse of entities under audit.

The other most common auditing failure is the lack of appropriate focus on financial reporting fraud, which is endemic, costly and itself a leading indicator of corporate bankruptcy.

Read more in Dr. Barry Jay Epstein’s recent article titled, “Common Auditor Failures: Overlooking Insolvency Risk and Earnings Manipulations,” published in Westlaw Journal Professional Liability, Volume 25, Issue 1, July 2015.

About the Author

Barry Jay Epstein, Ph.D., CPA, CFF, is a principal with Epstein + Nach LLC in Chicago. Dr. Epstein has, through 2013, served as the author or co-author of over sixty editions of three standard reference works on U.S. GAAP and IFRS, and on auditing.

Dr. Epstein has also authored or co-authored over fifty articles published in leading legal and professional accounting journals, and has lectured widely in the U.S., the Far East, and the Middle East. His practice centers on technical consultations on accounting, auditing, financial reporting, financial analysis, and governance matters; the conduct of forensic examinations; and expert testimony arising from professional liability and contractual dispute matters. Contact him at BEpstein@EpsteinNach.com or at 312-464-3520.