Audit Going Research Articles

Corporate Governance Factors and Auditor Going Concern Assessments

When making going concern assessments, Statement on Auditing Standards No. 59 (Auditing Standards Board 1988) directs auditors to consider the nature of management's plans and ability to mitigate periods of financial distress successfully. Corporate governance factors reflect attributes of control, oversight, and/or support of management's plans and actions intended to overcome financial distress. Correspondingly, this study investigates the impact of certain corporate governance factors on the likelihood of a going concern modification. Using survival analysis techniques, we examine a sample of 161 financially distressed firms for the time period 1988–1996. We find that auditors are twice as likely to issue a going concern modification when the CEO is replaced. We also find that going concern modifications are inversely associated with blockholder ownership. We also confirm Carcello and Neal's (2000) findings with respect to the association between an independent audit committee and an increased likelihood of modification. In a repeated events setting, we find that insider ownership and board independence are inversely associated with repeated going concern modifications. Our study concludes by proposing implications for the current financial reporting environment (including the Sarbanes‐Oxley Act of 2002) and future research avenues.

Going concern guidance for New Zealand auditors: transitions in communicative acts

In this evaluation of New Zealand audit going concern standards, we ask what underlying messages can be found in these professionally-designed standards. To do so, we apply a linguistic taxonomy of communicative acts to the three sets of going concern standards, and 469 speech acts, that have over time been produced. This taxonomy developed by Bach and Harnish (1979) is based on Austin's well-known linguistic principle of the illocutionary act, which is concerned with the force of a text. Our analysis is further informed by our evaluation of the New Zealand socio-political–economic context and from the results of an interview with one of the standard setters. We conclude that among other possible rationales, a lack of courtroom guidance, a defensive posture and a marketing exercise in standard expansion may explain the force of the text that we found. Our results also reveal a profession which, in this text at least, situates itself ‘above public debate’, conveying a sense of ‘expertise’ in devised ‘truths’ about the obligations of the auditor and others.

Long‐term effects of the going concern opinion

Studies have suggested that the auditor's fear of self‐fulfilling prophecy may alter an auditor's behavior concerning the issuance of a going concern opinion. This study investigates a sample of firms that received auditor going concern opinions and ultimately resolved these opinions successfully, as evidenced by subsequent unqualified opinions. The study finds that over 70 percent of these firms provide value to shareholders when monitored over a 12 to 18 year time period. Additionally, the study finds that this result is consistent with a matching sample of firms that had not received going concern opinions. The study further suggests that shareholders do best when the firm is acquired rather than when it continues in business. Larger firms are more likely subjects of acquisition while the smallest firms simply go out of existence over time. Considering the similarity in outcomes between the resolved going concern sample and the matching sample, it appears that there is no long‐term stigma attached to having received a going concern opinion.

Ethical Behaviour in the U.K. Audit Profession: The Case of the Self-Fulfilling Prophecy Under Going-Concern Uncertainties

External auditors owe a professional duty to the company's stockholders and to society in general. However their remuneration is determined by management. The resulting conflicts of interest are particularly acute in distressed companies where the auditors are required to disclose uncertainties regarding future survival. We focus on the consequentialist self-fulfilling prophecy argument whereby auditors may fail to disclose such uncertainties due to the belief that the disclosure itself would precipitate the company's bankruptcy. We find no empirical support for such beliefs for a sample of distressed U.K. companies with audit reports published between 1986 and 1993. Companies whose auditors disclose going concern uncertainties are no more likely to fail than those without such disclosures; indeed three out of four reports containing going concern uncertaintiesare not followed by failure before publication of a subsequent set of accounts. Instead we find that it is the degree of financial distress that drives both bankruptcy and the auditor's going concern disclosure rather than that the disclosure itself causes failure. Belief in the self-fulfilling prophecy effect nevertheless persists, and this despite the profession's clear ethical guidelines that audit opinions should provide an objectively true and fair view, paying no regard to possible consequences. It may be that the continued attractiveness of the self-fulfilling prophecy belief is due to its providing a means of resolving intense auditor/management conflict in what is a particularly complex decision situation. We argue that, if the profession's clear ethical guidelines are to play a greater role in this area, issues such as enforcement will need to be addressed.

An Analysis of Fuzzy Clustering and a Hybrid Model for the Auditor's Going Concern Assessment*

ABSTRACTThis study provides a description and testing of fuzzy clustering and a hybrid model that can support the decision an auditor makes when completing the going concern evaluation. Fuzzy clustering is based on fuzzy logic, and the hybrid system is designed to address the going concern decision through the combined use of a statistical model and an expert system. These models have the capability of identifying categories of firms with particular characteristics that may indicate whether or not the audit report of the firms requires a going concern modification. A prediction of whether or not a firm may go bankrupt is included as one of the components of the going concern decision. As a result, if a firm is placed in a particular bankrupt category by a decision model, it may help in the determination of the auditor's opinion regarding the continuity of the business.

The auditor's going concern opinion decision: a pilot study

This research attempts to find empirical evidence of ex ante factors relating to the economic trade-offs that an auditor faces when deciding whether or not to disclose going concern uncertainties in an audit report in a non-litigious continental European setting, Belgium. The research methodology consists of univariate and logistic regression analysis. The results of the study confirm the belief that the auditor's going concern opinion decision is not only a question of competence but also of independence. A significant moderating factor appears to be recent client loss on the part of the auditor. The legal obligation for Belgian auditors to refer to the report of the Board of Directors in their own audit report seems to significantly influence their reporting behaviour. The disclosure by the Board of Directors of ‘bad news’ regarding the state of affairs of a company diminishes any conflict of interest that may exist between the Board and the auditor. However, no evidence was found to justify the fear for a ‘self-fulfilling prophecy’ effect.

The Auditor's Going Concern Opinion Decision: A Pilot Study

This research attempts to find empirical evidence of ex ante factors relating to the economic trade‐offs that an auditor faces when deciding whether or not to disclose going concern uncertainties in an audit report in a non‐litigious continental European setting, Belgium. The research methodology consists of univariate and logistic regression analysis. The results of the study confirm the belief that the auditor's going concern opinion decision is not only a question of competence but also of independence. A significant moderating factor appears to be recent client loss on the part of the auditor. The legal obligation for Belgian auditors to refer to the report of the Board of Directors in their own audit report seems to significantly influence their reporting behaviour. The disclosure by the Board of Directors of ‘bad news’ regarding the state of affairs of a company diminishes any conflict of interest that may exist between the Board and the auditor. However, no evidence was found to justify the fear for a ‘self‐fulfilling prophecy’ effect.

Discussion: “An Analysis of the Usefulness of Debt Defaults and Going Concern Opinions in Bankruptcy Risk Assessment”

“Much Ado About Nothing?” Not quite, but one wonders where the real contribution is in this paper; indeed, in the several articles that have been written on the paper's central premise. The central premise is that the occurrence of a loan default or loan accommodation adds significantly to the ability of a model to accurately explain and predict bankruptcy. A minor theme involves the examination of whether an auditor's going concern qualification, with or without the already observed loan default/accommodation, adds to our ability to predict bankruptcy.

The information content of the auditor's going concern evaluation

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. My study assesses the information content of the independent auditor's going concern evaluation by examining the abnormal stock returns surrounding the release of the auditor's report. A sample of 68 audit reports which disclose going concern uncertainties and a sample of 86 unqualified audit reports received by financially-distressed firms were obtained. Abnormal returns were measured as market model residuals. Portfolio tests indicated that the mean abnormal return surrounding the release of the auditor's report was negative for firms which received going concern opinions and positive for distressed firms which received clean opinions. Ordinary least squares (OLS) regression tests indicated that mean abnormal returns surrounding the release of the auditor's report were lower for going concern opinions than for clean opinions and that the magnitude of the abnormal returns depended on the extent to which the opinion type was unexpected. A proxy for investor's expectations was generated from a logistic regression model which used publicly available data to estimate the probability that a firm would receive a going concern opinion. The regression tests included variables to control for unexpected default and earnings information.

An Investigation of Framing and Firm Size on the Auditor's Going Concern Decision

Abstract This study investigated the effects of framed information and firm size on the auditor's going concern report modification decision. Framing has been shown to affect individual decision-making in a variety of contexts. Investigations of framing effects in an audit context have reported mixed results. The findings of this study indicate that auditors are susceptible to the effect of framed information. Previous research has reported that auditors from small firms may be less conservative in audit disclosure recommendations than auditors associated with larger firms. This study evaluated the going concern decisions of auditors from three firm sizes: local/regional, a large non-Big Six firm, and a Big Six audit firm. Results indicate that differences in the report issued do exist across firm size. Possible explanations for the reported results are discussed.

The Application of Neural Networks and a Qualitative Response Model to the Auditor's Going Concern Uncertainty Decision*

An auditor gives a going concern uncertainty opinion when the client company is at risk of failure or exhibits other signs of distress that threaten its ability to continue as a going concern. The decision to issue a going concern opinion is an unstructured task that requires the use of the auditor's judgment. In cases where judgment is required, the auditor may benefit from the use of statistical analysis or other forms of decision models to support the final decision. This study uses the generalized reduced gradient (GRG2) optimizer for neural network learning, a backpropagation neural network, and a logit model to predict which firms would receive audit reports reflecting a going concern uncertainty modification. The GRG2 optimizer has previously been used as a more efficient optimizer for solving business problems. The neural network model formulated using GRG2 has the highest prediction accuracy of 95 percent. It performs best when tested with a small number of variables on a group of data sets, each containing 70 observations. While the logit procedure fails to converge when using our eight variable model, the GRG2 based neural network analysis provides consistent results using either eight or four variable models. The GRG2 based neural network is proposed as a robust alternative model for auditors to support their assessment of going concern uncertainty affecting the client company.

Debt covenant violation and manipulation of accruals

This paper examines the abnormal accruals of a sample of 94 firms that reported debt covenant violations in annual reports. We expect debt covenant restrictions to influence accounting choices in the year preceding and the year of violation. Time-series and cross-sectional models are used to estimate ‘normal’ accruals. In the year prior to violation, both models indicate that ‘abnormal’ total and working capital accruals are significantly positive. In the year of violation, there is evidence of positive abnormal working capital accruals after controlling for management changes and auditor going concern qualifications.