Uncertainty about litigation losses and auditors' modified audit reports

Most research investigating the usefulness of auditors' reports modified because of material uncertainties has concentrated on either (1) financial statement users' reactions to such qualifications or (2) the ability of auditors to predict bankruptcy given a going concern qualification. This study presents evidence about whether audit reports modified for litigation uncertainty convey information about the probability and/or amount of litigation losses. This research indicates that firms whose audit reports are modified because of litigation uncertainty are not more likely to lose a lawsuit than firms with an unqualified opinion and footnote disclosure of litigation; however, many losses are reported as immaterial. An analysis of firms with material litigation losses shows that significantly more of them received qualified opinions than received unqualified opinions. The results also indicate that the expected amount of the loss is greater for a firm receiving a modified report than one only having footnoted disclosure. The conclusion reached is that qualified opinions are useful to financial statement users in predicting material litigation losses. Data used in this study are available from the authors.