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    The effect of strategic and operating turnaround initiatives...
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions 
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    Title:
    The effect of strategic and operating turnaround initiatives on audit reporting for distressed companies.
    Practical Implications:

    The results on the relations between management turnaround initiatives and going-concern decisions suggest that auditors consider strategic information when making going-concern decisions, and that there is a relationship between auditors’ strategic risk assessment (typically done in a business risk auditing context) and the outcome of the audit (i.e., the opinion). The results further indicate that auditors do not limit their evaluation of mitigating strategic actions to the management plans explicitly suggested in the audit standards. Furthermore, the evidence suggests that auditors are already adopting a long-term view when assessing client viability, which again suggests that the current discussion on expanding the time horizon for going-concern assessment would not affect current practice substantially.

    Citation:

    Bruynseels, L., and M. Willekens. 2012. The effect of strategic and operating turnaround initiatives on audit reporting for distressed companies. Accounting, Organizations & Society 37 (4): 223-241.

    Keywords:
    corporate turnarounds, strategic planning, auditors’ report, going-concern decision
    Purpose of the Study:

    Audit reporting of distressed companies is more relevant than ever as management and auditors face the consequences of the global financial crisis and economic downturn. In the midst of this economic turmoil, standard setters are considering revisions to the auditing standard on the auditor’s evaluation of a company’s ability to continue as a going concern.

    This paper examines two issues related to the current debate about the time horizon and scope of information considered in going-concern decision-making: In particular, the authors ask: (1) do auditors take into account management plans and strategic actions to overcome financial difficulties, and (2) do auditors only assess short-term viability, or do they adopt a long-term view when making a going-concern decision. To that purpose the authors investigate whether and how a broad array of strategic and operating turnaround initiatives taken by management of financially distressed firms affect the auditor’s going-concern decision. In addition, the authors examine whether auditor industry specialization amplifies the extent to which auditors rely on strategic or operating turnaround initiatives in this context. The authors argue that their knowledge of industry best practices will allow specialist auditors to evaluate the adequacy and appropriateness of proposed management turnaround initiatives better, which in turn leads to an increased use of this type of information in going-concern decision-making.

    Design/Method/ Approach:

    The authors select a sample adopting a matched pair design. The authors select a sample of companies that received a first-time going-concern opinion and then a match sample of distressed companies that did not receive a going-concern opinion. They identify manufacturing companies from the Compustat database that received a qualified opinion or unqualified opinion with an explanatory paragraph. This results in a final sample of 389 manufacturing companies that received a non-clean audit opinion in fiscal years 1998 2001. To test the going-concern model, they match the going-concern opinion (GCO) sample with a sample of distressed companies that did not receive a going-concern report. The final sample consists of 174 distressed firm observations. 

    Findings:
    • The presence of strategic turnaround initiatives that are likely to generate positive cash flow effects in both the short run and the long run is negatively associated with the likelihood that a going-concern opinion is issued.
    • Cooperative agreements provide positive signals about the going-concern status of the firm and therefore can be interpreted as a distress-mitigating factor.
    • In contrast, the authors find that strategic initiatives that are likely to generate positive cash flow effects only in the long run are positively associated with the likelihood that a going-concern opinion is issued.
    • The evidence suggests that new mergers and acquisitions are not perceived as mitigating factors but rather as going-concern risk factors.
    • Only particular operating turnaround initiatives are associated with a higher likelihood that a going-concern opinion is issued.
    • More detailed analysis shows that cost reduction initiatives are perceived as additional going-concern risk factors, increasing the likelihood of a going-concern opinion.
    • City-level industry specialists perceive the implementation of short-term operating initiatives as a going-concern risk factor, whereas non-specialists do not.
    • Together with the finding that there is no difference between specialists and non-specialists in their use (and evaluation) of information regarding strategic turnaround initiatives, the authors find only partial confirmation for the expectation that industry specialists rely more on turnaround initiatives in their going-concern decision.
    Category:
    Accountants' Reporting, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions