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  • Jennifer M Mueller-Phillips
    Do Going Concern Audit Reports Protect Auditors from...
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Do Going Concern Audit Reports Protect Auditors from Litigation? A Simultaneous Equations Approach.
    Practical Implications:

    The results should be of interest to auditing practitioners. Generally, managers of public companies prefer that the audit report does not contain a going concern paragraph. In this regard, researchers have found that issuing a going concern audit report increases the likelihood of management-initiated auditor switches. These results highlight the expected benefits to auditors from issuing a going concern report to their financially stressed clients. Specifically, better controlling for endogeneity, the evidence indicates that issuing a going concern report lowers the likelihood of investors naming the auditor in a class action lawsuit.

    Citation:

    Kaplan, S. E., and D. D. Williams. 2013. Do Going Concern Audit Reports Protect Auditors from Litigation? A Simultaneous Equations Approach. Accounting Review 88 (1): 199-232.

    Keywords:
    audit reports, auditor litigation, auditor litigation settlements
    Purpose of the Study:

    An important aspect of the auditors’ environment is state and federal laws that allow third parties such as investors to sue auditors in an effort to recover damages. Historically, these litigation-related costs have been substantial. Potentially, auditors may be able to reduce their exposure to litigation when auditing a financially stressed client by issuing a going concern report. Under current auditing standards, a going concern audit report is required when an auditor has substantial doubt about the client’s ability to remain a going concern for a reasonable period of time. Whether a going concern report actually protects auditors against lawsuits is an open question.

    The study applies a simultaneous equations approach to examine the relation between auditor going concern reporting and investors’ decisions to sue auditors. Importantly, this approach takes into account the endogeneity between the auditor’s going concern reporting decision and ex ante litigation risk. The authors explicitly recognize two separate aspects of the relation between going concern reporting and auditor litigation.

    Design/Method/ Approach:

    The sample consisted of 1,211 securities class action lawsuits filed against the auditors between 1986 and 2009. 147 firms comprise the final auditor litigation sample. The authors determined whether a securities class action lawsuit had been filed against the auditors by examining the databases constructed by Palmrose (1999), the Stanford Class Action Securities Clearinghouse, Audit Analytics, LexisNexis, Westlaw, CASEmaker, ISS Securities Class Action Services, and the popular press. 

    Findings:
    • The evidence indicates that for auditors’ going concern reporting decisions as well as for investors’ decisions to sue auditors, the results differ between the two methods.
    • While the relation between the risk of an auditor lawsuit and going concern reporting decisions is consistently positive, the lawsuit coefficient is larger and significant using simultaneous equations but insignificant using probit analysis.
    • The results also show that the relation between going concern reports and investors’ lawsuit decisions is consistently negative.
    • However, and perhaps more importantly, the going concern coefficient is larger and significant when using simultaneous equations but insignificant when using probit analysis. That is, the simultaneous equations results indicate that going concern reports significantly deter investors from suing auditors.
    • The evidence showing that going concern reports deter investors from filing class action lawsuits against auditors is important, in that it suggests that going concern reports are useful to investors.
    • When investors see a going concern report for financially stressed companies, they are less likely to sue the auditor for their investment losses.
    • Issuing a going concern report offers the auditor protection against claims of negligence due to reporting, but not other claims of auditor negligence.
    Category:
    Accountants' Reporting, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Going Concern Decisions, Litigation Risk
  • Jennifer M Mueller-Phillips
    Insider Trading, Litigation Concerns, and Auditor...
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Insider Trading, Litigation Concerns, and Auditor Going-Concern Opinions.
    Practical Implications:

    The study offers two primary contributions. First, it provides insight into the incentive effect of corporate insider trading on auditor behavior. The study helps to fill this gap by providing evidence on the relationship between managers’ incentives and auditors’ opinions. Second, this study adds to the literature on insider trading. The evidence extends this literature by showing that insiders’ incentives to sell and their desire to avoid litigation can influence auditors’ reports.

    Citation:

    Chen, C., X. Martin, and X. Wang. 2013. Insider Trading, Litigation Concerns, and Auditor Going-Concern Opinions. Accounting Review 88 (2): 365-393.

    Keywords:
    going-concern opinion, insider tracking, litigation risk, SOX
    Purpose of the Study:

    The authors investigate whether managers’ litigation concerns about insider selling affect the likelihood of firms receiving going-concern opinions. Prior studies show that managers face the risk of trade-related litigation around news events. To reduce their risk exposure, managers have at least two options. First, they can abstain from trading before notable events.  Alternatively, when managers do choose to trade, they can attempt to alter the information flow in the post-trading period to avoid price swings and escape regulators’ scrutiny. The authors focus on this option with respect to the association between managers’ insider sales and auditors’ going-concern modifications.

    At least two reasons motivate the focus on insider selling. First, the information content of the two types of auditor opinion is asymmetric. First-time going-concern opinions induce significantly negative market reactions, while clean opinions do not generate positive market reactions. Insiders are therefore less concerned about buying and the subsequent receipt of a clean opinion. Second, Roulstone (2008) argues that bad-news disclosures are more likely to trigger investor lawsuits that allege inadequate disclosure by management. Such lawsuits usually use pre-disclosure insider selling to indicate management’s foreknowledge of bad news. Thus, in contrast to insider purchases ahead of good news, insider sales ahead of bad news carry a significant legal risk.

    Design/Method/ Approach:

    The authors obtain insider trading data from Thomson Reuter. They obtain information about audit opinions and audit fees from Audit Analytics for the period 2000 through 2007. They then match the audit opinion data with the Compustat industrial annual file, the Center for Research in Security Prices (CRSP) database, and the Insider Trading database. The final sample retains 12,329 firm years, consisting of 801 observations with first-time going-concern opinions and 11,528 observations with clean opinions.

    Findings:
    • The authors find evidence that a higher level of insider selling is associated with a lower likelihood of receiving a first-time going-concern report.
    • For a one standard deviation increase in insider selling, the probability of receiving going-concern reports decreases by 1.39 percent.
    • The negative relation between insider selling and the probability of receiving a going-concern opinion is stronger for firms that are more economically important to their auditors but weaker for firms whose auditors have greater concerns about litigation exposure and reputation loss and for firms with more independent audit committees.
    • Auditors who issue clean opinions for clients with higher levels of insider selling have a lower frequency of dismissals in the subsequent year.
    • These results are consistent with the notion that management influences auditors’ opinions but are inconsistent with the notion that insiders reduce their selling in anticipation of going-concern reports.
    • The negative relation between insider selling and the likelihood of receiving a going-concern opinion holds for the pre- and post-SOX periods but is significantly weaker in the post-SOX period.
    Category:
    Accountants' Reporting, Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Going Concern Decisions, Going Concern Decisions, Impact of SOX, Litigation Risk
  • Jennifer M Mueller-Phillips
    Are Auditors Professionally Skeptical? Evidence from...
    research summary posted July 22, 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:
    Are Auditors Professionally Skeptical? Evidence from Auditors’ Going-Concern Opinions and Management Earnings Forecasts.
    Practical Implications:

    The decision process concerning a firm’s going-concern status is a crucial component of the overall audit. The authors provide new empirical evidence showing how auditors use potentially biased management forecasts in their going-concern decision process. Auditor professional skepticism is an important concept in audit practice as evidenced by its prominence throughout auditing standards. The authors show that auditors do not significantly overweight management forecasts on average, and even underweight management forecasts they perceive as being suspicious, indicating that auditors exercise professional skepticism when using management earnings forecasts. Thus, this paper is informative to regulators who are mainly concerned about auditors relying too heavily on what their clients tell them and failing to sufficiently test or challenge the forecasts, views, or representations of management.

    Citation:

    Feng, M., & Li, C. 2014. Are Auditors Professionally Skeptical? Evidence from Auditors' Going-Concern Opinions and Management Earnings Forecasts. Journal Of Accounting Research 52 (5): 1061-1085.

    Keywords:
    going-concern, management forecast, professional skepticism
    Purpose of the Study:

    This paper investigates whether auditors exercise professional skepticism about management earnings forecasts when assessing a client firm’s going-concern status. Professional skepticism is “an attitude that includes a questioning mind and a critical assessment of audit evidence”. Regulators have long been concerned that auditors rely too much on what their clients tell them rather than applying professional skepticism. For example, a lack of professional skepticism is one primary cause of SEC actions against audit firms.

    This paper sheds light on auditor professional skepticism due to the joint effect of three important factors.

    • Prospective financial information provided by managers is an important input to auditors when they evaluate the client’s going-concern status. Among this information, management earnings forecasts are particularly important because, if a financially distressed firm is expected to continue generating losses, the losses are likely to drain the firm’s limited cash resources and increase the firm’s likelihood of going bankrupt.
    • Financially distressed firms tend to issue optimistically biased forecasts. Because the firms to which auditors consider issuing a going-concern opinion are generally financially distressed, professional skepticism could be especially important in this setting.
    • Auditors could obtain management earnings forecasts through private communication with managers and/or public earnings forecasts.
    Design/Method/ Approach:

    The authors obtain data from financially distressed firms that have auditor reports available on Audit Analytics and are covered by the Compustat and First Call database for fiscal years 2000 through 2010. This results in final sample of 1,054 firm-year observations with 39 observations receiving going-concern opinions, and 33 filing for bankruptcy in the 12 months subsequent to the auditor opinion issuance date.

    Findings:

    The authors find that, when management earnings forecasts are higher, the firms are less likely to receive going-concern opinions and to subsequently go bankrupt. Moreover, the coefficient on management forecasts in the going-concern model is not significantly different from the coefficient in the bankruptcy model. Hence, there is no significant evidence showing that auditors, on average, overweight management earnings forecasts and thus fail to apply professional skepticism when evaluating the firms’ going-concern status.

    The authors find that auditors’ going concern decisions are not associated with management earnings forecasts with lower perceived credibility, but significantly and negatively associated with the other management earnings forecasts. In contrast, the likelihood of bankruptcy is significantly related to management earnings forecasts, regardless of auditor-perceived credibility. More importantly, the weight that auditors assign to management forecasts with low perceived credibility is significantly lower than the weight implied in the bankruptcy model. In other words, auditors’ underweight management earnings forecasts that are issued by managers who previously missed their own forecasts and management forecasts that predict high earnings increases or high earnings.

    Category:
    Accountants' Reporting, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
  • Jennifer M Mueller-Phillips
    Going Concern Opinion and Cost of Equity
    research summary posted March 9, 2015 by Jennifer M Mueller-Phillips, tagged 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Going Concern Opinion and Cost of Equity
    Practical Implications:

    The evidence in this study illuminates the relevance of going concern opinions and the value of the information embedded in them. We provide evidence that investors perceive companies with going concern opinions to be problematic and thus demand a higher cost of equity. The results of our study are relevant to discussions about the desirability of the new going concern disclosures currently being considered by the FASB and the PCAOB.

    For more information on this study, please contact Jagan Krishnan.

    Citation:

    Amin, Keval, Jagan Krishnan, and Joon S. Yang. 2014. Going concern opinion and cost of equity. Auditing: A Journal of Practice and Theory 33 (4): 1–39.

    Keywords:
    going concern opinion, cost of equity, PCAOB
    Purpose of the Study:

    We examine whether companies that receive a going concern opinion suffer a subsequent increase in cost of obtaining equity capital from investors. 

    Design/Method/ Approach:

    We use data relating to public companies and their auditors for the period 2000-2010. We test the association between the going concern opinion and the cost of equity capital by comparing our test sample of companies with going concern opinions with two control samples with no going concern opinions, the first consisting of financially distressed companies, and the second consisting of companies with similar likelihood as the test firms of receiving going concern opinions.

    Findings:
    • We document that the issuance of the going concern opinion is positively associated with the company’s subsequent cost of equity capital.
    • We also find that the issuance of a first-time going concern opinion is associated with a subsequent increase in the cost of equity capital. The cost of equity is estimated to increase between 3.3 percent and 5.7 percent for companies that receive a first-time going concern opinion.
    • The main findings are robust to sensitivity tests using various subsamples, time periods, and multiple methods for computing the cost of equity capital.
    Category:
    Accountants' Reporting
    Sub-category:
    Going Concern Decisions
  • Jennifer M Mueller-Phillips
    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 in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    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
  • Jennifer M Mueller-Phillips
    The effect of strategic and operating turnaround initiatives...
    research summary posted November 17, 2014 by Jennifer M Mueller-Phillips, tagged 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:

    Taken together, 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.

    For more information on this study, please contact Marleen Willekens.

    Citation:

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

    Keywords:
    audit reporting, business risk auditing, going-concern opinions, company turnaround initiatives, industry specialization
    Purpose of the Study:

    It is well documented in the literature that auditors make going-concern decisions based on reported financial results and compliance with financial obligations. However, research on the effect of turnaround initiatives on audit reporting is scant. This paper examines two issues related to the time horizon and scope of information considered in going-concern decision-making: (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, they examine whether auditor industry specialization amplifies the extent to which auditors rely on strategic or operating turnaround initiatives in this context. 

    Design/Method/ Approach:

    Using regression analysis, the authors estimate the effect of strategic and operating turnaround initiatives on auditors’ propensity to issue a going-concern modified opinion for a sample of distressed US listed companies in the years 1998-2001. Strategic initiatives include the introduction of new products, acquisitions and cooperative arrangements with other firms. The investigated operating initiatives include cost-cutting, asset disposal, product and process upgrading and increasing marketing efforts. 

    Findings:

    The findings show that:

    • Strategic turnaround initiatives that are likely to generate positive cash flow effects in both the short and long run (such as cooperative agreements with other firms) are negatively associated with the likelihood that a going-concern opinion is issued.
    • Strategic initiatives that are likely to generate positive cash flow effects only in the long run (such as mergers and acquisitions) are positively associated with the likelihood that a going-concern opinion is issued.
    • Certain operating turnaround initiatives (such as cost reduction efforts) are perceived by the auditor 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. There is, however, no difference between specialists and non-specialists in their use (and evaluation) of information regarding strategic turnaround initiatives.
    Category:
    Accountants' Reporting
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
  • Jennifer M Mueller-Phillips
    Auditor fees and auditor independence ‒ Evidence from g...
    research summary posted November 12, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Auditor fees and auditor independence ‒ Evidence from going concern reporting decisions in Germany.
    Practical Implications:

    The results of this study show that in general market-based incentives, such as loss of reputation, constitute more important factors with regard to auditor independence than an economic dependence caused by higher non-audit fees. However, those safeguards may not be adequate in all situations given the relatively low litigation risk in Germany. The relatively high importance of consulting services performed in audit engagements by the Big 4 group seems to give Big 4 auditors an incentive to continue the auditor-client relationship, and is therefore to be regarded as an additional economic dependence between auditor and client. The explicit representation of liquidity risks through management appears to influence auditor reporting behavior in relation to going concern risks. This information—even if it is not presented in a separate reporting instrument, such as the Lagebericht—could also determine auditor reporting behavior outside Germany.

    For more information on this study, please contact Nicole Ratzinger-Sakel.

    Citation:

    Ratzinger-Sakel, N. V. S. 2013. Auditor fees and auditor independence ‒ Evidence from going concern reporting decisions in Germany. Auditing: A Journal of Practice and Theory 32 (4): 129-168.

    Keywords:
    Auditor independence, auditor reporting, non-audit fees, audit fees, Germany
    Purpose of the Study:

    On October 13, 2010, the European Commission published a Green Paper entitled “Audit Policy: Lessons from the Crisis”. Against the background of the recent global financial and economic crisis, this Green Paper proposes primarily reforms to improve auditor independence, and therewith audit quality, and to improve the structure of the audit market. One of the main areas of interest in this Green paper is whether the provision of consulting services by statutory auditors endanger the independence of auditors. This paper examines whether this concern can be empirically substantiated by investigating the potential for non-audit services to impair auditor independence using going concern modifications as a proxy for audit quality. While prior research has focused primarily on Anglo-Saxon environments, this study focuses on Germany because of the country’s unique reporting attributes (i.e., Lagebericht, which is a management report, and its associated Risikobericht, which is a risk report) and lower litigation risk when compared to Anglo-Saxon settings.

    Design/Method/ Approach:

    The analysis is based on a sample of financially distressed, capital market-oriented companies from the study period 2005-2009. Companies are defined as financially distressed if they meet one of the following five criteria: (1) negative equity, (2) negative operating cash flow, (3) negative working capital, (4) negative EBIT in the previous year, and (5) net loss in the previous year. These criteria are taken from a survey of German auditors, asking these to estimate the relevance of a number of indicators relating to the going concern assumption. These indicators are very similar to the criteria used in international studies for identifying financially distressed companies. In light of recent research findings on auditor reporting behavior from the United States, which, using strict control samples, report different results compared to previous U.S.-American studies, this study includes a second control sample. In alignment with the U.S.-American literature, this second control sample includes companies showing both a net loss in the previous year and a negative operating cash flow in the previous year. 

    Findings:
    • The results show no evidence of a significant negative relationship between the level of non-audit fees and the likelihood that an auditor issues a going concern opinion (GCO).
    • However, there is some evidence that the potential for non-audit services to impair auditor independence depends on the type of audit firm conducting the audit (Big 4 compared to non-Big 4). If the level of non-audit fees is relatively high, then Big 4 audit firms are less likely to issue a GCO. However, this result holds only for highly financially stressed clients.
    • The results for the examined unique German reporting environment show a positive association between liquidity risks explicitly presented in the Risikobericht and the likelihood that the auditor includes a GCO in the audit report.
    Category:
    Independence & Ethics
    Sub-category:
    Going Concern Decisions, Non-audit Services
  • 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
    Audit Reporting for Going-Concern Uncertainty: A Research...
    research summary posted October 20, 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:
    Audit Reporting for Going-Concern Uncertainty: A Research Synthesis
    Practical Implications:

    This study provides a summary of the literature examining the auditor’s GCO decisions. Determinants of GCOs include client factors (e.g. size, level of financial stress, financial reporting quality, corporate governance), auditor factors (e.g. audit firm size), auditor-client relationships (e.g. auditor switching and the issue of opinion shopping) and environmental factors (e.g. changes in regulations, auditing standards and audit market structure). Important findings are that auditors will change the likelihood of issuing GCOs in response to changes in the environment (whether due to changes in regulation or changes in the economy) and that the majority of companies that receive GCOs do not subsequently file for bankruptcy.

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

    Citation:

    Carson, E., N. L. Fargher, M. A. Geiger, C. S. Lennox, K. Raghunandan, and M. Willekens. 2013. Audit reporting for going-concern uncertainty: A research synthesis. Auditing: A Journal of Practice & Theory 32 (Supp): 353-384.

    Keywords:
    going-concern; audit reporting; bankruptcy
    Purpose of the Study:

    The global financial crisis in 2007 has resulted in an increased incidence of company failures. This led to renewed interest from regulators, standard setters and investors in the auditor’s assessment and reporting on a company’s ability to continue as a going concern. In order to facilitate the understanding of the role and effectiveness of independent audit, this study conducts a comprehensive review to synthesize and discuss the extant academic literature on auditors’ decisions to issue a modified opinion based on going concern uncertainty (hereafter, GCO).

    Design/Method/ Approach:

    This study synthesizes major findings from audit research since the 1970s. Most of the research reviewed is archival; however, a few studies using experimental designs are also cited. A framework is developed to structure the categorization of the extant GCO literature. Three main themes are identified: (1) Determinants of GCOs, (2) Accuracy of GCOs, and (3) Consequences of GCOs. This study also provides a discussion on issues related to research methodology and identifies areas for further research.

    Findings:

    Under the category of “Determinant of GCOs”, the synthesis shows that:

    • Auditors are more likely to issue GCOs after December 2001, which is in response to the accounting and auditing scandals in early 2000s (e.g. collapse of Enron). Also, smaller companies more likely to receive GCOs.
    • In the ten-year period between 2000 and 2010, 60.10% of bankruptcy filings are preceded by GCOs.
    • Determinants of GCOs include: (1) client factors (e.g. size, level of financial stress, financial reporting quality, corporate governance), (2) auditor factors (e.g. audit firm size), (3) auditor-client relationships (e.g. auditor switching and the issue of opinion shopping) and (4) environmental factors (e.g. changes in regulations, auditing standards and audit market structure).

    Under the category of “Accuracy of GCOs”, the synthesis shows that:

    • Since the adoption of SAS No.59, 40-50% of bankruptcy firms did not receive a prior GCO.
    • 80-90% of companies receiving a GCO do not file for bankruptcy in the subsequent year.

    Under the category of “Consequences of GCOs”, the synthesis shows that:

    • Issuance of GCOs is associated with negative excess returns, and the reaction is more negative when problems with obtaining financing are cited.
    • In the U.S., the issuance of GCO can be a “self-fulfilling prophecy” and cause the financial demise of company that would have survived if it had not received a GCO.

    With regards to issues in research methods, this study cautions the use of small samples in analysis and the interpretation of interaction variables in the statistical models. The study also finds general limitations in extant research due to the varying sample selection criteria for identifying financial stressed firms and the exclusion of private companies from samples examined.

    This study suggests further research could (1) examine the relations between auditor independence and GCO decisions, (2) investigate auditor’s GCO decisions and the related issues for financial institutions, non-profit organisations and government entities, (3) replicate research on GCO accuracy in different time periods with different samples, (4) examine the information usefulness of GCOs to a wide set of market participants, and (5) properly distinguish between the roles of management, audit committee and auditor in the disclosure and discussion of going-concern. 

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