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  • Jennifer M Mueller-Phillips
    Investor Reaction to Going Concern Audit Reports
    research summary posted March 9, 2015 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Investor Reaction to Going Concern Audit Reports
    Practical Implications:

    The evidence suggests that institutional investors drive the reaction to the GCAR, since there is no detectable reaction at low levels of institutional ownership. The market reaction gets more negative as the level of institutional ownership increases, and there is a decline in institutional ownership after the GCAR is issued. These results are due to sophisticated investors’ awareness of the firm’s financing needs and the covenants carried by the firm’s debt.

    The literature contributes primarily to the line of auditing research on GCARs. First, this study provides relatively unambiguous evidence that going concern audit reports provide useful information. Second, it provides insight into the reasons that investors find the GCAR to be useful by showing that GCARs that cite financing problems result in a more negative reaction than do other GCARs. Third, while there is evidence of the importance of restrictive debt covenants in other areas of accounting research, there is little or no evidence in auditing. Finally, this study adds to the literature by showing that institutional investors use the information in audit reports.

    For more information on this study, please contact Krishnagopal Menon.

    Citation:

    Menon, K. and D. D. Williams. 2010. Investor Reaction to Going Concern Audit Reports. The Accounting Review 85 (6): 2075-2105. 

    Keywords:
    audit reports; going concern; debt covenants; institutional ownership
    Purpose of the Study:

    There is a long-standing debate on the usefulness of the going concern audit report (GCAR). Auditors have expertise in assurance audits, not in judging the going concern status of a firm, and their assessment may not add to what investors already know. On the other hand, auditors have access to information unavailable to investors and can reveal this information through the GCAR.

    One way of judging the usefulness of the GCAR is to see whether investors react to GCAR announcements. If the auditor’s unfavorable assessment provides new information on the firm, then the price of the firm’s securities should decline.

    This study provides evidence on this issue, using a substantially larger sample than those used in previous studies, and provides mixed evidence on whether investors find audit reports modified for going concern reasons to be useful. 

    Design/Method/ Approach:

    Using a substantially larger sample than previous studies, the authors observe negative excess returns when the GCAR is disclosed. The sample for the study consists of firms that receive an initial GCAR in the period 1995 to 2006. We identify firms receiving an initial GCAR by searching the Compact Disclosure database, the Audit Analytics database, Compustat, and the business media, and then confirming the existence of a first-time GCAR by reading audit reports in current and previous 10-K filings. All American Depositary Receipts (ADRs) are excluded. The research includes only the first GCAR received by the firm in the sample, even if the firm obtains a GCAR, or several consecutive GCARs, is then issued an unmodified opinion, and later receives a GCAR once more. 

    Findings:

    The study finds that investors react more adversely to GCARs that cite financing problems. Further, since many firms carry debt with a covenant that requires the firm to present GCAR-free financial statements, the GCAR can a trigger covenant violation that results in stricter loan terms. It is shown by the study that the reaction to the GCAR is worse for firms that violate a covenant when they receive a GCAR.

    The study also finds that the price reaction to the GCAR varies inversely with the level of institutional ownership. In addition, the negative market reaction for firms with GCARs citing financing problems or for firms violating a debt covenant by receiving a GCAR is observed only at higher levels of institutional ownership. The differences are attributed to institutional investors likely having greater knowledge of the terms of the firm’s debt contracts.

    Category:
    Auditor Judgment
    Sub-category:
    Going Concern Decisions
  • The Auditing Section
    Recent Changes in the Association between Bankruptcies and...
    research summary posted April 13, 2012 by The Auditing Section, tagged 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Recent Changes in the Association between Bankruptcies and Prior Audit Opinions
    Practical Implications:

    The evidence from this study can beused to support the perspective that the auditing profession is essentially self-correcting in that it seeks to maintain a positive image and control litigation costs.  This has practical implications for regulators and legislators in that these groups should evaluate the extent of the auditing profession’s changed behavior in the post-December 2001 period before promulgating further detailed, prescriptive regulations.  Specifically, this study implies that there are multiple ways to influence auditor behavior in addition to the traditional means of changing laws and auditing standards, such as litigation, harsh media and congressional pressure.  Another source of pressure on auditor behavior, not included in the article, would be the threat of sanctions on firms and individual partners (which arguably becomes more visible in recent years with the presence of PCAOB). Further, this study has implications for regulators and legislators in that it provides evidence that auditors’ increased conservatism did not result in longer audit delays.

    Citation:

    Geiger, M. A., K.
    Raghunandan, and D. V. Rama.  2005.  Recent Changes in the Association between Bankruptcies and Prior Audit Opinions.  Auditing:
    A Journal of Practice and Theory
    24 (1): 21-35.

    Keywords:
    Bankruptcy, going concern reports.
    Purpose of the Study:

    The purpose of this study is to examine if and how the events of 2001 impacted auditors’ reporting decisions with respect to going concern opinion modifications.  

    The authors note that media and congressional attention on auditors in the wake of high-profile alleged audit failures in Fall 2001 was almost entirely unfavorable.  Further, high-profile corporate failures during this time amplified this negative attention on auditors.  Given these factors, the authors investigate whether auditors’ behavior was impacted by the events of 2001.  This study examines whether auditors became more “conservative” in their opinion decisions after these events.  Specifically, this study examines the change in the rate of the issuance of going-concern modified audit opinions for firms entering bankruptcy from before the Enron scandal to after the scandal to determine: 

    •  whether bankrupt companies were more likely to have received a prior going-concern modified audit opinion after December 2001 than in the immediately preceding period, and 
    •  whether an increase in the likelihood that bankrupt companies received a prior going-concern modified audit opinion after 2001, if any, was caused by changes in auditor reporting strategies, and not only by changes in economic conditions or client characteristics.   
    Design/Method/ Approach:

    The authors use data on publicly-traded companies that filed for bankruptcy during the years 2000 to 2003. The list of bankrupt companies is obtained from New Generation Research Inc. who publishes the annual Bankruptcy Almanac

    The authors compare the likelihood of firms receiving going-concern modified audit opinions in the period before December 2001 to the period after December 2001. To rule out an alternative explanation on change in economic conditions, the authors compare auditor reporting strategies in their sample period to those during an earlier recessionary period in 1991-1992. To ascertain that change in going-concern rates after 2001 was not caused only by changes in client characteristics, the authors break down the identified change into two parts: (1) changes due to client characteristics and (2) changes in auditor reporting strategies. 

    Findings:
    • Auditors are more likely to issue going-concern modified audit opinions for firms entering bankruptcy in the period after December 2001. 
    • Auditors were more likely to issue prior going-concern modified opinions for firms entering bankruptcy in 2002-2003 than in the previous recession recovery period (1991-1992). 
    • The increase in going-concern modification rates for bankrupt companies after December 2001 is due to changes in auditor reporting decisions, and not solely due to changes in client characteristics between the time periods studied.  
    • The authors argue their results suggest that there was a significant shift in auditors’ decisions in the post-December 2001 period, in that auditors became more conservative in this period.  
    • The increase in the issuance of going-concern modified opinions did not result in increased audit delays.
    Category:
    Accountants' Reporting
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
    Home:
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  • Jennifer M Mueller-Phillips
    State Liability Regimes within the United States and Auditor...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 09.0 Auditor Judgment, 09.04 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    State Liability Regimes within the United States and Auditor Reporting
    Practical Implications:

    These results imply that auditors are more likely to render modified GC opinions for clients subject to regimes that hold auditors liable to a larger class of third parties and impose joint-and-several liability for third-party damages, both of which reflect greater liability exposure. The higher incidence of GC opinions accompanying stronger state-level litigation threats could reflect higher audit quality, but it could also stem from excessively conservative auditors protecting their interests by avoiding costly civil lawsuits, which could undermine audit quality in some circumstances. 

    Citation:

    Anantharaman, D., J. A. Pittman, and N. Wans. 2016. State Liability Regimes within the United States and Auditor Reporting. The Accounting Review 91 (6): 1545 – 1575.

    Keywords:
    auditor litigation risk, state common law, and going-concern opinions
    Purpose of the Study:

    The authors of this study analyze the relation between state regimes governing auditor liability and auditors’ propensity to modify their opinion to express uncertainty on financially distressed clients’ ability to continue as a going concern.  Extant research implies that auditors have strong incentives to conduct high-quality audits in order to reduce the litigation examining consequences stemming from an alleged audit failure; however, the bulk of this research focuses on auditor liability arising under federal statutory laws, not state laws. This study delves into the issue of state laws, including if and to what extent litigation exposure under state common law affects auditors’ reporting decisions. 

    Design/Method/ Approach:

    A previous study developed a state-level score that captures third-party liability standards, which the authors of this study rely on to measure auditor litigation exposure stemming from third-party liability standards. To evaluate variation in liability-sharing standards across states, the authors closely read the relevant law to construct a state-level index that identifies whether each state follows a joint-and-several approach or a proportional approach to liability sharing. The authors assign to each client firm the highest of the liability indices dependent on the states in which the firm does business, and they measure audit outcomes with the propensity to issue going-concern (GC) opinions to financially distressed clients. 

    Findings:
    • The authors find that auditors are significantly more likely to issue a GC opinion to clients from states applying:
      • A more expansive third-party liability standard, or
      • The joint-and-several liability (JSL) rule for apportioning damages among defendants.
    • The authors find that liability regimes primarily affect auditor reporting for clients that are inherently more likely to be sued, reinforcing the conclusion that state-level liability regimes matter more when litigation exposure is higher.
    • The authors find some suggestive evidence that the higher expected legal costs arising from state-level liability regimes have a stronger impact on Big 4 auditors that are more sensitive to litigation threats. 
    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Going Concern Decisions, Litigation Risk
  • Jennifer M Mueller-Phillips
    The Auditor’s Going- Concern Opinion as a Communication of R...
    research summary posted October 10, 2013 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 in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Auditor’s Going- Concern Opinion as a Communication of Risk
    Practical Implications:

    The results of this study have very important implications to auditors of publicly traded firms whose audit reports are available to the general public. Auditors should always keep in mind that their opinion has great importance to the market’s perception of their client. The effects that issuing a going-concern modified audit opinion can have on the market perception of a firm’s value, as evidenced by the different market perceptions for similarly financially distressed firms when one had a going-concern modified report and one did not, are grave enough to warrant significant consideration by auditor’s deciding whether or not the going-concern modified opinion is necessary.

    For more information on this study, please contact Allen D. Blay.
     

    Citation:

    Blay, A.D., M.A. Geiger, and D.S. North. 2011. The auditor’s going- concern opinion as a communication of risk. Auditing: A Journal of Practice and Theory 30 (2): 77-102.

    Keywords:
    auditor’s opinion; going- concern; value-relevance; financial distress.
    Purpose of the Study:

    The auditor’s report is the only lawful way for auditors to communicate with the general public concerning business matters of a particular client. The information conveyed in the audit report is usually limited to an opinion of the accuracy and completeness of the client’s financial information and the related disclosures. However, SAS 59 requires the auditor to add modified language to the standard audit report when it is deemed necessary. An occurrence that makes modified wording necessary is the auditor’s belief that substantial doubt exists that the client will continue to be viable over the next reporting year. This situation illustrates the only way that an auditor can indicate his or her perceived risk regarding the continuity of a client’s business. This study provides evidence regarding the effects of an auditor’s communication of business risk through the issuance of a going- concern modified audit report for the first time for a particular client on the valuation mechanisms used by the securities market to adjust share price. The authors studied how a going- concern modified audit report affected the market’s perception of financially distressed firms in order to assess the relevance of specific nonfinancial information communicated by the external auditors in the audit report.

    Design/Method/ Approach:

    The data for this study was collected from Compustat and 10-K filings in the SEC EDGAR database for the period 1989-2006. The authors chose to study durable manufacturing firms that met one of four distress criteria: operating loss, bottom line loss, negative working capital, or negative retained earnings in the last three years. For comparison, these firms were then matched to similar firms that had not received a modified audit report and financial and market data was gathered for both types of firms.

    Findings:
    • The issuance of a going-concern modified audit report in the U.S. conveys substantial value relevant information about the abandonment risk of a firm.
    • Market valuation is significantly altered from the traditional measures of a focus on both the income statement and balance sheet to a focus on solely the balance sheet in the year that a firm receives a going-concern modified opinion for the first time.
    • The market increases the value of assets and liabilities that are directly related to abandonment value such as, cash, receivables, and long-term assets and liabilities, while it devalues assets that would generally possess more value if the firm continued in existence and were not liquidated such as inventory.
    • The book value of equity has a greater valuation weight for firms receiving a first-time going-concern modified audit report compared to their earlier years and to similarly financially distressed firms that did not receive a modified audit report for going-concern.
    • These results hold even after controlling for several other measures of financial distress, expanding the control sample of distressed firms, and examining individual sub-periods within the 18 year examination period.
    • The market interprets the going-concern modified audit opinion as an important communication of risk that results in a substantial shift in the structure of the market valuation for distressed firms. The market perceives the auditor’s opinion as incrementally value-relevant even when paired with other financial distress measures that exist in the financial statements.
       
    Category:
    Accountants' Reporting, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
  • Jennifer M Mueller-Phillips
    The changing relationship between audit firm size and going...
    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 in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The changing relationship between audit firm size and going concern reporting.
    Practical Implications:

    The results raise an interesting policy issue related to the ability of financially stressed clients to hire an audit firm. While the results of the study indicate that financially stressed clients are still able to hire an audit firm, their options appear to be decreasing over time. To the extent that their audit firm options continue to shrink over time, some financially stressed public companies may be unable to hire an audit firm in the future. Evaluating the implications and potential consequences to these firms represents an important area for further research. 

    Citation:

    Kaplan, S. E., and D. D. Williams. 2012. The changing relationship between audit firm size and going concern reporting. Accounting, Organizations & Society 37 (5): 322-341.

    Keywords:
    decentralization in management, financial stress, going concern report
    Purpose of the Study:

    Under Generally Accepted Auditing Standards (GAAS), audit firms have the responsibility to evaluate the going concern status of each of their clients and to include explanatory language in their report when they conclude that there is “substantial doubt” about a client’s ability to continue as a going concern (GC) over the next year. This responsibility has been controversial, as well as consequential. Generally, managers of public companies prefer not to receive a GC report, in part because equity markets react negatively when a GC report is issued. However, issuing a GC report presumably lessens the litigation risks audit firms face from investors seeking to recover their losses.

    The purpose of the current study is to provide longitudinal evidence on the changing relationship between audit firm size and auditor going concern reporting. The study focuses on three classes of audit firms (e.g., Big N, national, and regional) across four different ERAs. Over time, the authors expect that financially stressed public companies will increasingly be audited by regional audit firms, who in turn will increasingly report more conservatively as demonstrated by a higher propensity to issue a GC audit report.

    Design/Method/ Approach:

    The authors collected data for public companies over a 22-year period between 1989 and 2010, primarily derived from COMPUSTAT and supplemented by Compact Disclosure, CRSP, AuditAnalytics, and SEC filings. The authors refer to the 199,921 firm-year observations as the All Firms sample. Two other samples were also identified.

    Findings:

    The authors document that across the ERAs, financially stressed public companies are increasingly audited by regional audit firms. Specifically, the evidence indicates that regional firms only audited approximately 16% of financially stressed public companies in the first two ERAs, but over 30% in the last two ERAs. While a variety of factors are involved, this change reflects, in part, a decreasing willingness by larger audit firms to audit financially stressed public companies.

    The authors also document that for their financially stressed public companies, regional audit firms were more likely to issue a GC report in the latter ERAs, whereas Big N and national audit firms were increasingly less likely to issue a GC report. In the case of regional firms, the authors believe this change reflects, in part, increases in regional firms’ exposure to catastrophic litigation. They also believe the change among Big N firms reflects, in part, increases in Big N firm reliance on client screening as a mechanism to control their firm’s exposure to litigation risks.

    Category:
    Accountants' Reporting, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
  • Jennifer M Mueller-Phillips
    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 in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    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
  • The Auditing Section
    The Effects of Experience on Complex Problem Representation...
    research summary posted May 9, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Effects of Experience on Complex Problem Representation and Judgment in Auditing: An Experimental Investigation
    Practical Implications:

    The results of this study have implications for training future professionals.  In the classroom problem-solving techniques that more closely resemble the experienced group can be incorporated to advance professionals to the expert level faster.  Further, a stage approach may be more efficient.  This idea incorporates having two “expert systems”, one to move novices to the intermediate level of knowledge more quickly and another to move intermediates up to the level of experts faster. 

    Citation:

    Lehmann, C.M., and C.S. Norman. 2006. The effects of experience on complex problem representation and judgment in auditing: an experimental investigation. Behavioral Research in Accounting 18 (1): 65-83.

    Keywords:
    expertise; problem representation; going concern; expert-novice paradigm
    Purpose of the Study:

    The purpose of this study is to evaluate how an accounting professional’s level of experience affects their ability to describe a problem (problem representation) and their judgment regarding a going-concern task.  The authors argue that as auditors become more experienced, they become more concise in their problem representations, capturing only the information most relevant to the judgment at hand.  Thus recent graduates and staff level auditors are the least concise and include more superficial analysis; senior associates are more concise and able to focus on relevant information better than novices, while partners/managers are able to provide the most condensed summaries.  

    This study also examines whether the different types of concepts noted in the problem representations are related to differences in judgment regarding a company’s ability to continue as a going-concern and which audit report is recommended. 

    Design/Method/ Approach:

    The experiment was performed with both graduate students and audit professionals.  Participants were split into three groups based on experience level: novice (graduate students and less than 1 year experience), intermediate (1-6 years’ experience), and experienced (more than 6 years’ experience).   

    Participants were provided industry background and financial information that included evidence of going-concern issues and were asked to summarize the financial condition, assess going-concern and recommend a type of audit report.  The authors based their conclusions on these responses. 

    Findings:
    • Experienced individuals are more concise in their problem representations (i.e. mentioned fewer concepts, relationships, and summaries) than intermediates or novices.
    • Intermediates noted fewer relationships than novices. 
    • The novices provided significantly more causation links than the experience group and the intermediate groups. The novice group provided significantly more summaries than the experienced group, but not the intermediate group.
    • The authors examined the effect of including certain concepts in an individual’s problem representation on their going-concern judgments and find that line of credit issues are related to lower assessment of survival and cash flow issues are associated with modifying the audit opinion.  However, the inclusion of regulatory issues or the industry in the summary is associated with higher assessment of survival.  These results did not differ by experience level, indicating judgments were not impacted by experience level. 
    Category:
    Auditor Judgment, Accountants' Reporting
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
    Home:
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  • Jennifer M Mueller-Phillips
    The Global Financial Crisis: U.S. Bankruptcies and...
    research summary posted October 22, 2014 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 in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Global Financial Crisis: U.S. Bankruptcies and Going-Concern Audit Opinions
    Practical Implications:

    As the PCAOB, SEC and other regulators assess auditors’ reporting decisions in the wake of the GFC, the results of our study provide evidence that the propensity to issue a GCO to a financially stressed and subsequently bankrupt client increased during the GFC. Our results suggest that critics of the auditors’ role during the GFC may have overstated a perceived problem based on relatively few bankruptcies without a prior GCO. At the same time, our results indicate that this increased scrutiny was similar for Big 4 and non-Big 4 auditors, but that it was largely restricted to smaller clients. Auditor going-concern modification decisions remain a complex process that is not fully understood or easily captured.

     

    For more information on this study, please contact Marshall Geiger via email at mgeiger@richmond.edu.

    Citation:

    Geiger, M.A., K. Raghunandan, and W. Riccardi. (2014). The global financial crisis: U.S. bankruptcies and going-concern audit opinions. Accounting Horizons 28 (1): 59-75.

    Keywords:
    going concern; bankruptcy; audit opinion; financial crisis
    Purpose of the Study:

    The reporting responsibility of auditors with respect to financially troubled clients received renewed attention from standard setters and regulators in light of the “Global Financial Crisis” (GFC). Both auditing regulators and the business press had complained that auditors did not provide adequate warning in their reports prior to many companies’ bankruptcy filings during the GFC. Accordingly, the purpose of this study is to examine whether auditors’ propensity to issue going-concern audit opinions (GCO) decreased after the onset of the global financial crisis. We also examine whether the observed effects differ for the largest audit firms (i.e., the “Big 4”). In additional analyses, we further examine whether our detected results differ with client size.

    Design/Method/ Approach:

    The study is based on a sample of financially stressed U.S. companies that entered into bankruptcy between 2004 and 2010. Sample firms’ bankruptcies are coded as being during the GFC if the associated audit opinion is dated after September 1, 2008. 

    Findings:

    Our empirical findings are summarized as follows:

    • Overall, we find that the auditors’ propensity to issue going-concern modified opinions increased after the onset of the GFC. This suggests that, collectively, auditors in the U.S. were more likely to provide a signal of clients’ impending bankruptcy during the GFC.
    • We find no difference in this effect for auditors of different size (i.e., Big 4 versus non-Big 4). That is, both Big 4 and non-Big 4 auditors significantly increased the probability of issuing a going-concern modified audit opinion to subsequently bankrupt clients after the start of the GFC.
    • Of particular interest, we find that for both Big 4 and non-Big 4 auditors, the observed increase in the likelihood of issuing a going-concern modified audit opinion is restricted to smaller clients.
    • There does not appear to be any change in auditors’ weighting of our financial stress variables between the pre- and post-GFC periods. 
    Category:
    Accountants' Reporting, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
  • Jennifer M Mueller-Phillips
    Threats to Auditor Independence: The Impact of Relationship...
    research summary posted December 3, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 09.0 Auditor Judgment, 09.04 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Threats to Auditor Independence: The Impact of Relationship and Economic Bonds
    Practical Implications:

    The results of the study suggest that establishing close auditor-client relationships can reward audit firms with higher NAS revenues from clients. In particular, longer audit firm tenure and audit firm alumni directors benefit the audit firms with higher NAS provision. This indicates that a successful strategy for audit firms may be to develop long-term associations with clients at the firm level (rather than at the partner level) and to establish active alumni networks. At the same time audit firms should ensure that adequate procedures are in place to ensure that appropriate audit reports are issued, most particularly when strong auditor-client relationships are present.

    For more information on this study, please contact Elizabeth Carson.

    Citation:

    Ye, P., E. Carson, and R. Simnett. 2011. Threats to auditor independence: The impact of relationship and economic bonds. Auditing: A Journal of Practice & Theory 30 (1): 121-148.

    Keywords:
    Independence and ethics; non-audit services; going concern decisions; alumni
    Purpose of the Study:

    Auditor independence is the foundation of high quality audit services and a crucial component in the statutory corporate reporting process. The cases of high-profile corporate failure associated with auditing scandals in early 2000s have cast doubts over auditor independence and the value of auditing. Most regulatory concerns regarding auditor independence have centered on three alleged independence threats:

    • Auditor’s economic dependence on the client due to the provision of non-audit services (NAS)
    • Auditor’s familiarity with the client due to lengthy audit tenure
    • The personal relationships between the audit engagement partner and client’s directors

    Relevant regulatory reforms have taken place in both the U.S. (SOX, 2002) and Australia (CLERP 9, 2004) to mitigate such concerns. However, empirical evidence only provides limited support to the regulations, and two fundamental questions underlying the independence issue remain unanswered:

    • What factors influence a company’s decision to purchase NAS from its incumbent auditor?
    • How do the economic and social bonds between auditors and clients affect auditor independence?

    This paper addresses the questions to inform regulation by examining:

    • Whether client’s NAS purchase from the incumbent auditor is affected by four identified auditor-client relationships: (1) audit firm tenure, (2) audit partner tenure, (3) relationship tenure (ongoing personal interactions between audit engagement partner and client’s director), and (4) client’s director being an alumnus of the audit firm. 
    • Whether auditor’s propensity to issue a going-concern opinion (as the manifestation of auditor independence) is affected by the provision of NAS and the four identified auditor-client relationships.
    Design/Method/ Approach:

    The study uses 2002 Australian data on publicly-traded companies. 2002 is chosen as a period when the audit environment was still relatively unregulated. Data was hand-collected from companies’ annual reports. The impacts of various factors on auditor independence are examined using statistical analysis.

    Findings:

    The study finds:

    • Some evidence that increased audit firm tenure and the presence of directors with alumni connections to the incumbent audit firm is associated with an increased likelihood of clients’ NAS purchase from the incumbent audit firm. Such impact is stronger in companies with lower leverage and higher ownership concentration.
    • No evidence that audit partner tenure or relationship tenure (between audit partner and client director) impacts client’s NAS purchasing decisions.
    • Evidence that higher levels of NAS provision and longer audit partner tenure are associated with a lower propensity in auditor’s issuance of going-concern opinions.
    • No evidence that audit firm tenure, relationship tenure or the presence of client director’s alumnus status impacts on auditor’s propensity to issue going-concern opinions.
    • Evidence that auditors are less likely to issue a going-concern opinion when there is a high-level NAS provision to the client and the client has an incumbent audit firm alumni director.
    Category:
    Auditor Judgment, Independence & Ethics
    Sub-category:
    Going Concern Decisions, Non-audit Services
  • Jennifer M Mueller-Phillips
    To What Extent are Auditors’ Attitudes toward the Evidence I...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    To What Extent are Auditors’ Attitudes toward the Evidence Influenced by the Self-Fulfilling Prophecy?
    Practical Implications:

    This study is important to regulators, standard setters, users of financial information and the auditing professions as it relates to the going concern evaluation and biases in auditor judgment.  If auditors are motivated to achieve a desired result to ensure that a client continues, then the negative perception of the going concern opinion and the public’s expectation gap of what a going concern means will remain.  As such, the profession needs to evaluate whether the self-fulfilling prophecy exists and ways to address the lack of knowledge surrounding the going concern opinion.


    For more information on this study, please contact Andres Guiril.
     

    Citation:

    Guiral, A., Ruiz, E. and W. Rodgers. 2011. To What Extent are Auditors’ Attitudes toward the Evidence Influenced by the Self-Fulfilling Prophecy? Auditing:  A Journal of Practice and Theory 30 (1): 173-190.

    Keywords:
    Going concern evaluation, self-fulfilling prophecy, attitude toward the evidence, motivated reasoning, framing
    Purpose of the Study:

    This study seeks to evaluate the self-fulfilling prophecy effect and the impact that is has on biasing auditor judgments in a going concern setting.  The authors use the self-fulfilling prophecy effect in their experiment by creating instruments that may influence an auditor’s decision to arrive at a specific conclusion given how the information is framed and presented.  A motivated reasoning theory is used to understand how asymmetrical evidence is evaluated by auditors and how it influences the decision-making process.  Furthermore, there is also a notion that auditors that are motivated to arrive at a specific conclusion may evaluate audit evidence in a way that causes them to arrive at this desired outcome.  More weight may be assigned to the evidence that supports the preferred outcome. 

    In the going-concern context, an auditor may believe that issuing a going-concern opinion implies that the client will inevitably go bankrupt.  A client’s bankruptcy will then ultimately result in the auditor’s loss of audit fees.  Given this, the auditor’s self-fulfilling prophecy may create a strong desire for the client to continue, which, in turn, may bias the auditor’s judgment of audit evidence.  As a result, the auditors may weigh the audit evidence that supports the viability of the client’s business and may please less weight on evidence that is to the contrary in order to forego the potential issuance of a going concern opinion.  The authors of the study hypothesize that authors are influenced by the stigma that a going concern opinion may decrease the client’s ability to continue.  Issuing an unqualified opinion provides the appearance that client is viable and results in the auditor retaining the client’s fees. 
     

    Design/Method/ Approach:

    The authors perform an experiment using 88 partners and senior managers from an international accounting firm.  The research design was a 2x2 between-subjects design.  The participants were asked to assess the going concern status of a client with different groups of participants receiving confirming or disconfirming evidence.  The framing condition was in the context of whether the company’s operations were deemed to viable.  Specifically, the auditors were asked to evaluate whether the client had the “ability to continue to exist” versus whether there was a “possibility that a client will fail.”  The participants are also presented with mitigating factors (i.e. plans to cut production costs, receive a grant from the government, etc.) and contrary evidence (i.e. potential employee strikes, a credit line will not be renewed with a bank and the use of another bank will raise interest costs).

    Findings:

    The results of the study indicating that auditor’s expectation of a desired outcome tends to influence their evaluation of audit evidence so that they can achieve that desired outcome (i.e. not issue a going concern opinion). The auditors had a greater sensitivity to mitigating factors and had a lower tendency to favor contrary evidence.

    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Evaluation of Evidence, Going Concern Decisions, Going Concern Decisions