Abstract
When there is significant doubt about a firm's ability to continue as a going concern, professional standards require independent auditors to disclose the uncertainty in their report. This study assesses the influence of the independent auditor's going-concern evaluation by examining default following the release of the auditor's report. We use a proprietary sample maintained by the Portuguese Central Bank on 12,199 audit reports relating to approximately 2000 firms that are liable by law to have their accounts audited on an annual basis. Empirical estimation of a logit model controlling for accounting cash- flow-related and nonaccounting variables shows that the likelihood of default for firms that received going concern opinion is 2.792 times that of firms that received a clean opinion. Likelihood ratio tests for omitted variable also confirm the incremental predictive ability of going-concern opinion over and above accounting and nonaccounting variables for the estimation and hold-out samples. In the nondefaulting group, the average default rate is 6.05%, in the defaulting group it is 17.78%. The default rate for firms in the nondefaulting group that received a going-concern opinion is 9.92% and for firms that received a clean opinion it is 5.96%. In the defaulting group, the rate for firms that received a going-concern opinion is 35.49% and for firms that received a clean opinion it is 16.96%. Checks for robustness across different asset classes, age, industries, and regions indicate that firms that receive a going-concern opinion on average default more than those that receive a clean opinion.
Highlights
Independent auditors that have a substantial doubt about the ability of a company to continue to meet its obligations are required to disclose this uncertainty in their opinion.1 there has been apparent public support for the requirement to disclose going concern uncertainties in the independent audit report, there is some opposition to this on the contention that the auditor's evaluation of uncertainties is not superior to evaluations which statement users could make (Brown, 1989)
When there is substantial doubt about an entity's ability to continue as a going concern, professional auditing standards require the independent auditor to disclose the uncertainty in the auditor's opinion
Empirical estimation of a logit model controlling for accounting cash flow related and non-accounting variables shows that the likelihood of default for firms that received going concern opinion is 2.792 times that of firms that received a clean opinion
Summary
Independent auditors that have a substantial doubt about the ability of a company to continue to meet its obligations are required to disclose this uncertainty in their opinion. there has been apparent public support for the requirement to disclose going concern uncertainties in the independent audit report, there is some opposition to this on the contention that the auditor's evaluation of uncertainties is not superior to evaluations which statement users could make (Brown, 1989). Loudder et al (1992) find that the market reaction to subject-to qualifications depended on the probability that the independent auditor would issue a qualified opinion They provide separate statistics for clean and going concern opinions. Jones (1996) provides evidence on the incremental value of the going concern disclosures in the audit report to investors in financially distressed firms. According to the rules of the chamber of ROC, independent auditors are required to proactively assess the going concern status of a client and issue a GCO opinion.
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