The role of the ISA 570 “Adverse key financial ratios” in going concern assessment in Italy

Melchior Gromis Di Trana,Simona Alfiero

doi:10.22495/cocv16i4art1

Abstract

This study aims to identify if financial ratios may be useful tools to assess whether an entity may incur in going concern matters and, as a consequence, in a Going Concern Opinion. Starting from an IAASB suggestion reported in the ISA 570 and our previous investigation establishing which financial ratios are most widely used in professional practice by auditors for this type of evaluation, our research is focused on verifying their effectiveness. In particular, an empirical analysis, based on a logit model and than a discriminant analysis, performed on a sample of Italian listed companies confirms the importance of the relations between the net financial position and the cash flow from operations, as well as the relevance of the equity on debts ratio. The results would help auditors and directors to focus on the synthetic indicators that are the most relevant in the financial sustainability evaluation, but they may also be considered by the Italian Legislator that is implementing the new Italian Insolvency Law Reform to fix the synthetic indicators which are able to warn stakeholders regarding the risk of insolvency.

Highlights

The Going Concern (GC) assumption is a highly topical issue, as it is relevant in periods of economic crisis for the proliferation of corporate failures
Many studies aim to identify the main determinants on GC assessment and many of them are focused on financial indicators based on financial statement items
We have investigated whether, in the Italian context, financial ratios based on financial statements data are useful tools in order to assess the presence of the GC assumption

Summary

Introduction

The Going Concern (GC) assumption is a highly topical issue, as it is relevant in periods of economic crisis for the proliferation of corporate failures. IAS 1 defines GC as the capability of a company to continue to operate in the foreseeable future. This means that management is periodically obliged to make this type of evaluation in order to prepare financial statements on a GC basis. From 2008 onwards, this issue has acquired more relevance due to the significant increase in the number of publicly traded Italian companies that have received a modified opinion (GCO) from their auditors because of multiple material doubts regarding their ability to continue as a going concern (15 qualified GCOs were issued in the period between 2004-2007, against 43 in 2008-2011) (Bava et al 2018). In Italy, during the Sovereign Debt Crisis, “the financial system suffered for a strong speculative attack that caused a dramatic widening of the spread on Government Bonds” (Pampurini & Quaranta, 2018)

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