Question

explain the relationship between acceptable audit risk and the legal liability of the auditor??

Answer 1

Acceptable audit risk is the only part of the audit risk model that is completely out of the hands of the company. The level of acceptable audit risk is the amount of risk that the auditor is willing to accept that the financial statements might contain any amount of material misstatement. Auditors may have lower levels of acceptable audit risk for small businesses that operate in litigious environments and higher levels of acceptable audit risk for companies that do not. Publicly traded companies are usually deemed to be riskier for an auditor.

Source of Legal Liability

Example of Potential Claim

Liability to client: Client sues auditor for not discovering a material fraud during the audit

Liability to third parties under common law: Bank sues auditor for not discovering that a borrower’s financial statement is materially misstated

Civil liability under statutory laws: Combined group of shareholders sues auditors for false information in prospectus

Criminal liability: Federal government prosecutes auditor for knowingly issuing incorrect audit report

Based on the above definitions, if the auditor lowers the acceptable audit risk and the auditor is not able to perform his duties, the auditor will be legally liable as per above.