“In 54 percent of the 673 largest bankruptcies of public corporations since 1996, auditors provided no warnings in the months prior to bankruptcy.” (David Dietz, Pittsburgh Post-Gazette, 4/26/02)
After showing the above quotation on the screen, I ask my students why auditors might be “timid” about expressing doubt about a client’s ability to continue as going concern. Students hypothesize that auditors might be afraid the client will retaliate by firing them or that the modified report might become a “self-fulfilling prophecy.” That is, the modified report might worsen the client’s situation by scaring away customers and creditors. The Geiger et al. Advances in Accounting study presents evidence suggesting that both fears are warranted.
The Heilig-Meyers case has always generated good class discussion for me because the choice is not obvious. There are enough facts to build a case for modifying the report or for issuing a standard opinion.
“Living with a Scarlet Audit Letter,” Sarah Johnson, CFO.com (October 21, 2009). A going concern modified audit report may make the client’s situation worse and become a self-fulfilling prophecy.
“Regulators Eye ‘Going Concern’ Concerns,” Sarah Johnson, CFO.com (April 6, 2009). PCAOB reconsidering standard for auditors evaluating going concern. Judgment is difficult and “extremely subjective” in an unstable economy. 23 percent of audit reports in early 2009 contained a going concern modification.
“Auditors are Timid: They Failed to Warn in Most Big Firm Bankruptcies Since 1996,” David Dietz, Pittsburgh Post-Gazette (April 26, 2002): C8. Of 673 bankruptcies since 1996, only 46 percent received modified audit opinions. Small firms are more likely than large firms to receive a modified opinion.
“Auditors Often Victims of ‘Kill the Messenger’ Mentality,” Bill Deener, Dallas Morning News (March 7, 2002): A1. Auditors who issue going concern modified audit reports are three times more likely to be fired than auditors of financially-distressed clients who do not issue a modified opinion.
“SAS 59: How to Evaluate Going Concern,” John Ellingson, Kurt Pany & Peg Fagan, Journal of Accountancy (January 1989): 51-57. This article provides a concise summary of SAS No. 59 and includes a checklist of conditions and events that may indicate a going concern problem.
“The Rise and Fall of Heilig-Meyers,” Paul Clikeman, Journal of Accounting Education (December 2005): 215-231. Students must decide whether to issue a modified auditor’s report on Heilig-Meyers’ fiscal 2000 financial statements.
“Investor Reaction to Going Concern Audit Reports,” K. Menon & David D. Williams, Accounting Review (November 2010): 2075-2105. Companies suffer negative excess stock returns when they receive a going-concern modified audit report. The stock price reaction is more negative when the auditor discloses that the client is having trouble obtaining financing. Institutional investors tend to divest their shares after a company receives a going-concern modified audit report.
“Costs Associated With Going-Concern Modified Audit Opinions,” Marshal Geiger, K. Raghunandan & D.V. Rama, Advances in Accounting (1998): 117-139. Financially-stressed companies who receive a going-concern modified audit report are more likely than financially-stressed companies who do not receive a modified audit report to: (1) switch auditors, and (2) declare bankruptcy.
“What Is Substantial Doubt?” Lawrence Ponemon & K. Raghunandan, Accounting Horizons (June 1994): 44-54. Judges and financial statement users have different perceptions of “substantial doubt.” Bankers and financial analysts believe a modified auditor’s report indicates a high probability of bankruptcy while judges think auditors should issue a modified report even when the probability of bankruptcy is relatively low.
“Going-Concern Evaluations: Factors Affecting Decisions,” Vicky Arnold & Donald Edwards, CPA Journal (October 1993): 58-60. In deciding whether to express substantial doubt about a client’s ability to continue as a going concern, auditors are most influenced by the client’s: operating income or loss, availability of trade credit, potential liability from litigation, possibility of losing a major customer, and current ratio in relation to loan covenants.