An empirical examination of the influence of the “new” US audit report and fraud red‐flags on perceptions of auditor culpability

Abstract

In 1988, the US standard form audit report experienced its first major modification in 39 years. Among the objectives of the “new” report were better auditor/user communications leading to, among other things, an abridgement of auditor liability. Nearly a decade later, this issue has yet to be addressed empirically and with rigour. The empirical research reported examines the ability of the “new” audit report to reduce perceptions of auditor responsibility/liability across two instances of alleged audit failure. It is argued that a jurist’s advantage of “perfect hindsight” may mitigate the effectiveness of revised communications contained in the audit report, in instances where audit risk at the time of the audit appears high. Accordingly, consideration of environments of both high and low perceived risk were provided in a behavioural experiment conducted with 81 investors serving as subjects. Findings reveal that the revised audit report language may provide relief for auditor liability, but the presence of red‐flags, or red‐flag related environmental conditions, may exacerbate negative perceptions.