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    Liability of Accounting Firms

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    With the recent prevalence of corporate scandals in the United States recently, there have been many efforts made towards reform.

    You have been asked to evaluate the following proposal and debate it with other experts (your classmates) in the field:

    Accounting firms should be liable to pay stockholders if they give a company a clean audit and it goes bankrupt within a year.

    © BrainMass Inc. brainmass.com June 3, 2020, 8:55 pm ad1c9bdddf

    Solution Preview

    Although this idea may sound appealing at first glance, there are many issues with such a strict standard of auditor liability. It ignores the fact that companies can go bankrupt for a variety of reasons, most of which are not under the purview of the auditor. Business conditions can change very rapidly, and especially if poor management decisions are made, a previously unforeseen crisis can rapidly arise. In these cases, which account for a sizable percentage of bankruptcies, it would be inappropriate to hold the auditor liable for investors' losses because the auditor was not responsible and could not have detected the cause of the bankruptcy through its audit.

    Also, such a strict standard of liability will create a moral hazard as well. If accounting firms are liable for bankruptcies under any circumstances, investors have less interest in performing their own research because the accounting firms are effectively ensuring their investments. This could lead to more reckless investment, resulting in less efficient allocation of capital in the economy as a whole. Riskier ...

    Solution Summary

    This posting evaluates in detail the proposal to make Accounting firms liable to pay their stockholders if they give a company a clean audit and it then goes bankrupt within a year.