Mario Christodoulou, Accountancy Age, Thursday 10 June 2010 at 00:30:00

Firms may struggle over how to disclose legal liabilities in the wake of the appeal ruling over Ernst & Young's audit of Equitable Life

The lasting legacy of Ernst & Young's audit of Equitable Life may be increased fees and lengthier audits as firms come to grips with when and how to disclose legal liabilities.

The final chapter of the Equitable saga ended last week when an appeal ruling was published on disciplinary charges brought against E&Y over the Equitable audit. Costs and fines amounted to more than 9m in the original ruling.

he appeal reduced that to just under 3m and reversed a ruling that the firm and auditor Kevin McNamara had sacrificed their objectivity and independence during the audit.

The firm stumbled on a key accounting principle which governs how liabilities arising from court cases are disclosed to shareholders.

In Equitable?s case, E&Y agreed it was very unlikely a key court case ? the Hyman case ? would be lost and therefore no liability was recorded in the Equitable accounts.

The case rested on E&Y accepting legal advice obtained by Equitable instead of seeking further advice.

Under current accounting rules companies record a liability if the chances of losing a court case, or having to pay out funds, is greater than 50%. The value recorded in
</br> the financial statements represents the company?s ?best estimate? of this liability.

Following last week?s verdict, industry figures close to the case believe auditors may now second guess legal advice provided by their clients ? a common practice according to auditors and lawyers.

Seeking professional legal advice can be among the costliest exercises during an audit. Seeking a second or third legal opinion from a reputable firm, some feel, may considerably add to the cost of an audit.

One legal expert told Accountancy Age that such secondary advice would be unnecessary in most cases.

There remains divergent approaches among corporations about how much information to disclose about legal liabilities. Lawyers say while some firms will disclose all information in the public domain, including information in court documents and in the press, others will opt for a minimal approach.

A liability figure is only disclosed if there is a chance a company may have to pay out at the end of a litigation. The amount is based on how much a reasonable entity might pay to be rid of the liability.

Auditors agree on this figure in consultation with their client and sometimes their client?s lawyers. A close observer of the Equitable tribunal said the decision may add to the pressure in these circumstances to make the ?right? decision, despite the uncertainty and speculation which often surrounds major court cases.

E&Y?s appeal was centred on the claim that the firm and its auditor lacked objectivity and independence.

The appeal tribunal concluded: ?In order to amount to a breach of the fundamental principles of objectivity and independence something sigificantly more serious is required than mere incompetence or inadvertence on the part of the auditor in relation to specific audit issues.?

E&Y issued a statement which said: ?We extend our sympathies to the policy holders of Equitable Life, who have been impacted by the near collapse of the society, following events which lay outside of our control and the remit of our role as auditor.?

Further reading:

Equitable ruling leaves audit guessing over legal liabilities