Despite the increasing concern on the auditors to reveal the going concern ability of the client, it would be apparent from the literature reviewed that in many cases corporate failure was not perceived by a going-concern modified opinion in the independent auditor’s report.
Hasnah el al (2009) argued that an audit opinion on the financial statements of a company became an important issue, attracting much public attention. Further, they insisted that collapses of these companies may have been avoided if appropriate reports were issued. Waymond et al in 2008 stated that several financial scandals have implicated auditors’ lack of independence (WorldCom, Tyco, Enron, Global Crossing, Parmalat, etc.).
The fact that the auditor qualifies the opinion on the grounds of invalidation of going concern assumption, it should not merely be an indication to get away from its responsibilities. Many instances public and legislatives have bemoaned company failures without a prior warning from the auditor in the form of a going-concern modified audit report.
According to Daniel et al (2005), the going concern opinion should be disclosed sufficiently early to allow the interested groups to alter their decisions. Further, they argued if the going concern opinion does not give sufficient time for the stakeholders to change their decisions, the opinion would be nothing more than a eulogy.
Previous empirical studies have proved that the inability of the auditors to express an opinion on the going concern of client had widened the expectation gap. Parker (1994) argued that accounting profession requires adherence by its members to a clear code of ethical behaviour, both to serve the public interest and to safeguard the long-term private interests of its members.
The auditors have a moral duty to signal the interest groups of the financial distressed companies. Recent financial scandals have reopened the continuing debate regarding the credibility of the auditing profession. As a result, audit reputation and, in particular, the usefulness of auditors’ warning signals remains hotly disputed (Waymond et al 2008).
Further, early warning signals of the corporate were not forthcoming merely through the perusal of financial statements and concluding only on the consideration in absolute terms of negative profits and equity. Hence, the auditors must draw the attention to qualitative aspects as well when drawing the conclusion not merely relying on financial data.
Many hold auditors responsible for not detecting the potentials for bankruptcy during the most recent audits (Michael et al 2003). According to Wendy (1995), Judging whether a going-concern qualification is required is a difficult and unstructured task which presents the auditor with a dilemma, and may actually hasten a corporate collapse. Moreover, issuance of a going concern opinion is a ‘self-fulfilling prophecy’ in that the going concern opinion itself triggers a bankruptcy.
On the other hand, if a financially distressed company is not qualified on the going-concern basis and afterward fails, the auditor could be perceived as inattentive. Therefore, the auditor must be skeptical on the evidence they receive during their course of audit in order to protect themselves being charged for the noncompliance with relevant auditing standards.
Previous literature had perceived going concern status in three alternative approaches. i.e. firms’ current status, firms’ future status and individual judgment. With regard to first and second phenomena, the financial distressed company’s ability to continue for a foreseeable future could be determined merely by the financial indicators. Yet, the third concerns on the human ability to predict the future viability of a firm. Which means that, some has argued the going concern status continues an objective reality, independent from individuals’ actions, therefore, they developed statistical model to predict the bankruptcy. On the other hand, the researchers those who believed that the going concern is a matter of human judgment, and not analogues to a natural phenomena, adopted a behavioural approach (Sylvia, 2002).
Wendy (1995) examined the incidence of going-concern audit qualifications and corporate failure for Australian publicly listed companies within the decade of 1980 to 90. The examination included a review of annual reports for companies that had going concern qualifications but did not subsequently fail and corporate failed without receiving an qualification prior to its collapse.
Finally, she identified potential indicators of survival. The study identified the differences between the corporate that collapsed subsequent to receiving an unmodified opinion and corporate survived even with a qualified opinion on going concern. Using descriptive statistics the research was carried out in order to build relationship among going concern qualification and corporate failure. This empirical study divulges 223 instances of going concern qualifications.
The study revealed that annual 83.3% of the going-concern- qualified companies that subsequently did not fail changed their company structure and operations. This may have helped the companies to survive. The most common factor leading to failure for qualified companies was found to be incurring losses, while for non-qualified companies it was change in operations.
In determining the future status and individual judgment many researchers adopted the prediction of going concern through models. In this regard, predictions of going concern could be identified in two folds: corporate failure through financial indicators and; through behavioural studies. Various predictive models have been developed to test the consistency of going concern qualification, including Altman (1968), Dugan and Zavgren (1989), Ponemon and Schick (1991), Koh and Oliga (1990), Koh (2004) and Mc Kee (2003).
Among other behavioural models recency effect considered as one of the popular models. Many researchers have followed the recency effect (Andre´s and Francisco in 2006). With respect to evaluation of auditors’ judgment on going concern, many has adopted the recency effect model of Hogarth and Einhorn (1992), who proposed a descriptive model of belief revision that takes recency into account. Recency requires that when people evaluate a sequence of contradictory evidence items their judgments will be manipulated by evidence received later in the sequence.
Some argues that recency effect is biased (J. Behav. Dec. Making 2002).Robert and Kennedy (2002) criticised recency effect model stating that, the basic assertion is simply that judgments and choices should be based on substantive evidence features and not on features such as where the evidence happens to fall in a sequence of inputs.
According to the research done by Andre´s and Francisco (2006), study looked at Spanish auditors’ sensitivity towards financial evidence and the implications of the so-called “recency effect”. This is again a behavioural study. The study was designed to be a lab experiment to examine how presentation order affects the going concern judgments and the audit decisions of auditors, and the level of skepticism showed by auditors towards the signs of evidence. The study was primarily focused on the model of recency effect which predicts the auditor’s decision patterns when he receives short series of mixed evidence.
Andre’s and Francisco (2006) designed a simulated case to test how the presentation order affects the auditors going concern judgment and their sensitivity towards the evidence. The sample was selected to comprise 81 Spanish auditors and 104 auditing postgraduate students. For the evaluation of human decision process Hogarth and Einhorn’s (1992) mathematical model, was used.
The dependant variable in this regard is the likelihood of issuing unqualified audit reports and the independent variables and the findings were as follows; In order to evaluate whether auditors are susceptible to the recency effect the first dependent variable was identified as order in which the auditor receive mitigating factors. The study found that auditors who were exposed to mitigating evidence at the end of the series not only gave more relevance to the hypothesis of the company’s ability to continue in existence but they also issued less severe audit reports. A second attempt is to reduce the recency effects through framing (slight changes in wording or presentation of a task can alter an individual’s predisposition) hypothesis and the audit experience. Here, the independent variables were framing hypothesis and experience. Yet, experimental results found that recency effect for going concern evaluation was in existence. Finally, the attitudes of the auditor or the skepticism were recognized as the fourth independent variable which affect to the issuance of a qualified going concern opinion.
The findings of this study was similar to the that of Ashton and Ashton in 1988 for the recency effect, framing and the attitude test results were not contradicting with the study of Brenner and Moir, in 2004, Asare (1992) and Butt and Campbell’s (1989) and McEnroe and Martens in 2001. With respect to experience the study presented a different evidence than Kennedy (1993), Messier and Tubbs (1994) and Trotman and Wright (1996) due to the fact that the study was manipulated as the experience of auditors was compared with postgraduates rather than considering audit expertise.
In a critique on the quality of audit firms depend on the size, Marshall and Rama (2006) were of the view that Big 4 audit firms exhibit higher quality audit reporting decisions. There are two types of reporting errors related to going-concern modified audit. Those are: The subsequent failure rate after receiving a first-time going-concern modified audit opinion will be higher for Big 4 audit firms than non-Big 4 audit firms (i.e., fewer type I errors for Big 4 firms): and The proportion of client bankruptcies with a prior going-concern modified opinion will be higher for Big 4 audit firms than non-Big 4 audit firms (i.e., fewer type II errors for Big 4 firms). The study revealed that Big 4 firms exhibit significantly fewer both type I and type II reporting errors than non-Big 4 firms. However, the results were inconsistent with the argument that Big 4 firms would protect their ‘‘wealth at risk’’ by simply adopting a conservative reporting attitude and issuing going-concern modified reports more often than necessary.
According to Sylvia (2002), the study was carried out through collecting data through survey questionnaire by examining the three dimensions namely indicator of going concern uncertainties, action triggers and group interactions. Aforementioned three variables were selected as predictor variables in logit model through the review of previous literature and through consultation of practitioners. The dependant variable is considered as the individuals perceived going concern status of financially distressed firms.
In the construction of hypothesis, Sylvia raised three fundamental questions in her questionnaire. i.e., what is the importance of financial and nonfinancial indicators of going concern uncertainties; actions triggers leading to audit qualifications; potential group interaction; in determining the going concern status of financial distressed firms?, How are these influencing the judgment of auditors?, why these factors important? Based on the aforementioned research questions the following hypotheses were developed. Null hypothesis was the company is a going concern: and the alternative hypothesis were; Indicators of going concern uncertainties are significantly influencing the going concern opinion decision: Action trigger leading to an audit qualification are significantly influencing the judgment of the opinion:
Action triggers leading to receivership are judgment of going concern opinion decision: Group interactions are significantly influencing the judgment of the going concern opinion decision.
The sampling frame of the population was based on the directory of practicing auditors issued by ICAEW and ACCA. Then probability sampling was applied to select 300 out of the sample frame. Questionnaires were set using a five-point Likert type scale as the survey dealt with measuring attitudes. Further ANOVA procedures were used while using a logistic regression model to construct the validity of the study.
With respect to H1, the results indicated that only financial variables were influenced individuals decisions whereas non-financial indicators were not important. The latter justified a further research as non-financial indicators are important but not decisive in this context. Regarding events leading to audit qualification, the important variable is the appointment of a liquidator. The events leading to receivership, breach of dividend contracts and loan default were confirmed as indicators. Therefore the evidence supported H1, H2 and H3. Yet, group interaction and their impact on going concern decision could not be examined as the evidence was not supportive for H4. Finally through this study the so-called self fulfilling prophesy argument holds true. A self-fulfilling prophecy is a prediction that directly or indirectly causes itself to become true, by the very terms of the prophecy itself, due to positive feedback between belief and behaviour or it could be identified as statement that alters actions and therefore comes true.
Hasnah el al (2009) gave a greater insight in to relationships between financial indicators and non-financial indicators for predicting bankruptcy of corporate. The research studied three factors simultaneously for the company listed on the Jakarta Stock Exchange, namely, (a) the influence of the company's financial strength on the auditor's going concern opinion; (b) the influence of the type of evidence disclosed on the auditors' going concern opinion; (c) the influence of management effort disclosed on the auditor's going concern opinion; and (d) whether there is consensus among the auditors on their going concern opinions. In this context the consensus means the audits giving similar opinion when they face with the same scenario. Therefore, if the level of consensus among auditors is low, the decisions of the auditors are less accurate.
The independent variables in this study were the financial strength of the company, the types of evidence, and disclosure and the dependant variable is the issuance of going concern opinion. Accordingly, the study was carried out testing the following hypothesis; A company's strong financial condition (as opposed to poor or moderate) will have the greatest influence on the issuance of a going concern opinion: Positive evidence (as opposed to negative) will lead to a lesser probability of the issuance of a going concern opinion: Disclosure of information (as opposed to nondisclosure) has a lower likelihood of issuance of a going concern opinion: Two- and three-way interactions between financial strength, evidence and disclosure will have a greater effect on the probability of issuance of a going concern opinion (compared to the main effect): There is consensus among auditors on the issuance of a going concern opinion among auditors.
Hasnah el al (2009) discovered that the financial strength of a company, disclosure and the type of evidence had a significant effect on an auditor's judgment regarding the issuance of a going concern opinion. All interactions among aforementioned variables had a significant effect on auditor's decision to issue a going concern opinion. These results show that auditors examined the factors simultaneously. Thus, H1, H2, H3 and H4 were accepted. With respect to H5, it was observed that, the correlation of answers by the auditors for each case is quite high. The correlation is above 0.90 for all the cases and is significant. This demonstrates that there is consensus among auditors. Furthermore, all the findings were considered as in line with the previous research findings.
This study contained several limitations. Even though it controlled for experience and professional membership, other factors discussed in previous researchers, such as the personality of the auditor, the type of work performed and pressure from superiors, were not considered.
David and Richard (2001) examined the issue of auditors’ independence in dealing with failing companies concentrating on the treatment adopting an independent stand in reporting going concern uncertainties. This thesis was fundamentally based on the auditor’s adherence to the code of professional ethics, when the question arises whether to qualify a financially distressed firm on the grounds of going concern assumption. They selected null hypothesis H1, which expected to be rejected. Then tested the validity of the significant list belief held by auditors that adverse reactions to a going concern qualification in their client’s accounts will lead to its bankruptcy. H1: Financially weak companies with going concern qualification in their last accounts are no more likely to go bankrupt than similar firms without going concern qualifications.
The results related to all independent non-financial companies listed on the London Stock Exchange, or traded on the Unlisted Securities Market. The first part focuses on those companies with going concern qualifications published between 1986 and 1993 and a matched sample of non-qualified enterprises, and the second the complete population of firms failing between 1987 and 1994.
The study thus unable to find any empirical evidence in support of the important list self fulfilling prophecy argument. Not only that, but the finding, that more than twice as many qualified companies undergo major restructuring as fail, is consistent with the reverse hypothesis, viz. that a going concern qualification may, in fact, have a positive effect on company survival and promote timely rescue activity. David and Richard (2001) suggested that many companies with going concern qualifications are able to raise new finance. Which is controversial to the other research findings. Therefore, going concern opinion would have a positive impact as well.
Holding a similar conviction Daniel et al in 2005 suggested that, management attempt to switch auditors, considered to be a way of suppressing the negative information of the firm among others which could otherwise lead to its own survival. This study mainly focused on the development of test model and establishment of hypotheses on bankruptcy emergence (indicative of going concern opinions being an effective warning of financial distress), auditor switching and income-increasing accounting methods influence on auditors going concern opinion. The results show that firstly, the going-concern opinions are positively associated with bankruptcy emergence. This is an indicative of going concern opinions being an effective warning of financial distress. Secondly, the association between going concern opinions and bankruptcy emergence is significantly stronger for small firms than for large firms. In contrast, the study reveals that the negative association between auditor switching and the use of income-increasing accounting methods is stronger for large firms than small firms. But Lili holds a different argument which is illustrated at the latter part. These findings imply that manager’s actions at large firms may be more successful in delaying a going concern opinion. Therefore the warning is not sufficiently early for the stakeholders to intervene and reverse the financial distress. Daniel et al further suggest that as the management discretion to delay or avoid the issuance of going concern opinion could result in delay in implementing actions to turnaround the business, as such that the remaining assets are insufficient to reverse the pending financial collapse.
References
|
Andre´s, G. and Francisco, E., 2006. Are Spanish auditors skeptical in going concern evaluations?. Managerial Auditing Journal, 21( 6 ), pp.598-620.
|
Antony, Y. and Yi, W., 2008. Multi-risk level examination of going concern modifications. Managerial Auditing Journal, 25, pp.756-791.
|
David, B. and Richard, J., 2001. Ethical behaviour in the U.K. audit profession: the case of the self-fulfilling prophecy under going-concern uncertainties. Journal of Business Ethics, 29, pp.353–363.
|
Hasnah, H., Bambang, H., Mahfooz, A. and Ishak I., 2009. Factors influencing auditors' going concern opinion. Asian Academy of Management Journal, 14, pp.1–19,
|
Marshall, A. G. and Rama, D. V., 2006. Audit firm size and going-concern reporting accuracy. Accounting Horizons, 20(1), pp.1–17.
|
Michael, A., Meredith, A. M. and Don Giacomino, 2003. Going-concern opinions: broadening the expectations gap. The CPA Journal, 73 (10).
|
Parker, L., 1994. Professional Accounting Body Ethics: In Search of the Private Interest. Accounting, Organizations and Society, 19, pp.507–525.
|
Robert, H. A. and Kennedy, J., 2002. Eliminating recency with self-review: the case of auditors’ ‘going concern’ judgments. Journal of Behavioral Decision Making, 15, pp.221–231.
|
Sylvia, C., 2002. Auditors’, bankers’ and insolvency practitioners’ going concern opinion logit model. Managerial Auditing Journal,17, pp.487-501.
|
Waymond, R., Andre´s, G. and Jose´, A. G., 2008. Different pathways that suggest whether auditors’ going concern opinions are ethically based. Journal of Business Ethics, 86, pp.347–361.
|
Wendy, G., 1995. Addressing the issues relating to going concern audit qualifications and corporate failure. Australian Accounting Review, pp. 26-43.
|
Eidleman, G. J.,1995, Z scores - a guide to failure prediction. (business failure) (Auditing) [online], The New York State Society of CPAs, The CPA Journal, Available at: http://www.nysscpa.org/cpajournal/old/16641866.htm, [Accessed 20th November 2010]
|
No comments:
Post a Comment