Does a Manager Respond to a Going-Concern Audit Opinion with an Asymmetry in Gain and Loss?

Taewoo Kim

doi:10.3390/su13084425

Abstract

In this paper, I investigate the relationship between previous going-concern audit opinions and subsequent asymmetric timeliness in accounting. Using the time-series and price-based models and conservatism proxy, I find that firms with going-concern audit opinions subsequently report losses in a more timely manner than firms that did not receive going-concern audit opinions. Furthermore, I also find that firms exiting going-concern audit opinions are more likely to report losses rather than gains in a timely manner, compared to firms non-exiting from going-concern opinions. This study extends the prior research by exploring the association between going-concern opinions and accounting conservatism from the perspective of client firms—that is, how firms behave strategically and conservatively to bypass going-concern opinions, once the firms had received previous going-concern opinions.

Highlights

SAS No 59 states that an auditor is required to assess a client’s ability to continue as a going-concern and has the responsibility to modify the audit opinion if the auditor’s assessment of the client’s going-concern status leads to substantial doubt [1]
GCOs are more likely to report losses rather than gains in a timely manner, compared to firms non-exiting from GCOs
While prior literature still shows that accounting conservatism hampers earnings quality [19,20,21], this study extends the work of DeFond et al [15] by confirming that accounting conservatism contributes to risk reduction, such as litigation risk and engagement risk, rather than poses an impediment to financial reporting quality

Summary

Introduction

SAS No 59 states that an auditor is required to assess a client’s ability to continue as a going-concern and has the responsibility to modify the audit opinion if the auditor’s assessment of the client’s going-concern status leads to substantial doubt [1]. If firms receiving GCOs in earlier fiscal periods subsequently choose to recognize losses rather than gains in a more timely manner to exit from GCOs, auditors’ assessments on management’s going-concern evaluations may change as auditors value accounting conservatism. This is consistent with the view that management has incentives of conservative accounting for earnings and net assets [18]. This study is consistent with the findings of DeFond et al [15] in that conditional conservatism in accounting alleviates information uncertainty by associating a firm’s reporting behavior in accounting with an auditor’s discretionary decision on the firm’s ability to continue as a going-concern.

Issuance of GCOs

Benefits of Accounting Conservatism

Hypothesis Development

Time-Series Test of Timeliness in Loss Recognition

Price-Based Regression of Accounting Conservatism

Sample Selection

Descriptive Statistics and Correlations

Past Going-Concern Opinions and Subsequent Accounting Conservatism

Exit from Going-Concern Opinions and Accounting Conservatism

Conclusions