Using Financial and Market Information to Identify Pre-Engagement Factors Associated with Lawsuits Against Auditors.

Abstract The article identifies several client and auditor characteristics as being associated with lawsuits against auditors. The accounting profession is witnessing an increase in both the number of lawsuits against auditors and the settlements associated with those suits. An additional cost to firms associated with this litigation is reflected in the rise of malpractice insurance rates. During 1984 the AICPA's professional liability insurance plan doubled its insurance premiums while at the same time increasing deductibles and decreasing coverage. Auditing firms also suffer indirect costs as a result of increasing litigation. An increasing frequency of litigation against an auditing firm is viewed as a negative signal about the quality of auditing services provided by the firm, thereby impairing its reputation. Two conditions are likely to exist in order for a lawsuit to be filled against an auditor: an allegation of audit failure, and legal action provides a cost-effective alternative for potential plaintiffs.