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    Turnaround Initiatives and Auditors’ Going-Concern J...
    research summary posted November 17, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions 
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    Title:
    Turnaround Initiatives and Auditors’ Going-Concern Judgment: Memory for Audit Evidence
    Practical Implications:

    The results on the relations between management turnaround initiatives and going-concern decision-making show that auditors consider client turnaround initiatives when making going-concern decisions. Specifically, client operating turnaround initiatives (such as cost cutting) have a negative indirect effect on auditors’ going-concern judgment through a decrease in attention to subsequent positive client financial information. This suggest that short-term operating management turnaround initiatives may serve as an “early warning signal” of client distress for auditors which causes them to focus less on positive financial client information in subsequent analysis. 

    For more information on this study, please contact Liesbeth Bruynseels.

    Citation:

    Bruynseels, L., W. R. Knechel and M. Willekens. 2013 Turnaround Initiatives and Auditors' Going-Concern Judgment: Memory for Audit Evidence. Auditing: A Journal of Practice & Theory 32(3): 105-121

    Keywords:
    management turnaround initiatives, audit reports, going-concern uncertainties.
    Purpose of the Study:

    This study extends prior archival research that examines the relationship between operating and strategic management plans and the auditor’s going-concern decision. Recent studies on this topic indicate that actions taken by management, such as cost-cutting and strategic initiatives with a short-term impact, are associated with the likelihood that a distressed client receives a going-concern report. This research contributes to this line of research by investigating how auditors’ awareness of turnaround initiatives taken by a distressed client influences their evaluation of subsequent financial information in a going-concern decision context.

    Specifically, the authors expect that auditors’ going-concern judgment will be influenced both directly and indirectly when information is available early in the audit engagement that a client suffers from financial distress and is undertaking efforts to mitigate its financial problems.

    • A direct effect is expected because once auditors are sensitized to a client’s financial distress, they are required to take into account the mitigating or aggravating impact of client initiatives when making a going-concern decision.
    • The presence of company turnaround initiatives is also likely to have an indirect effect on auditors’ perception of client viability by changing the focus of the evaluation of financial information that is considered later in the audit.
    Design/Method/ Approach:

    The research evidence is collected in late 2005. An experiment was conducted in which audit managers and partners assessed going-concern risk for a distressed client who was planning on implementing either operating (i.e., cost cutting), strategic (i.e., forming strategic alliances), or no turnaround initiatives.

    Findings:

    The results indicate that auditors’ knowledge of client turnaround initiatives early in the audit process influences their attention for subsequent financial evidence. In particular, the results show that:

    • auditors who received information that their client implemented short-term operating initiatives (i.e., cost cutting) recalled proportionally less positive client financial information, compared to auditors whose clients did not undertake any turnaround initiatives.
    • for auditors whose clients implemented strategic initiatives (i.e., forming strategic alliances), there was no effect on  auditors’ attention for subsequent financial evidence.

    Further analysis shows that attention for financial evidence is significantly associated with the going-concern opinion, suggesting that client operating turnaround initiatives have a negative indirect effect on auditors’ going-concern judgment through a decreased recall of positive financial information. The results showed no evidence of a direct link between client operating or strategic initiatives and auditors’ going-concern judgment. 

    Category:
    Accountants' Reporting, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions