Going Concern Principle - Auditor Approach - Coursework Example

Audit and Assurance work - 2009-10 AUDITING THE GOING CONCERN ASSERTION (FOLLOWING THE RECENT CREDIT CRISIS) 2/17 Table of ContentsTable of Contents 2 Introduction 3 Going Concern Principle - Definition (Business Dictionary, 2010) 3 Going Concern Principle - Auditor Approach 3 Auditing and Credit Crunch 4 Going Concern Assertion - Recent Developments 6 Conclusion 8 Recommendations 9 Bibliography 10 Introduction Going Concern Principle - Definition (Business Dictionary, 2010) The "going concern" principle is a basic accounting concept which assumes that any firm will continue to business in the future. The principle gains significance when the value of a going concern business is compared with that of a business being wound up. Any company, while announcing its financial statements, must ensure that they have taken necessary steps with the help of an independent auditor to ensure its future viability. Lenders only lend when they are assured that the firm has a future and that it is not going to be wound up. Going Concern Principle - Auditor Approach The auditor plays a very important role while the financial statements of a firm are made. Not only do they check the accounts but he is responsible to let the stakeholders know of the financial viability of the business. It is their responsibility to see whether the firm has a future, whether it can sustain for a reasonable period of time (Lawson, 2009). This evaluation is done on the auditor's relevant knowledge about the current and past events (Lawson, 2009). This information could be gained through proper analysis of the financial statements (Lawson, 2009). The Audit Council Lays down some guidelines under SAS 59 with respect to do the evaluation to ascertain any substantial doubt about any entity's ability to continue as a going concern: (Lawson, 2009) The auditor must consider all the available information during the course of audit and raise any substantial doubt about the company's going-concern assumption. In order, to clear their doubt they may also take the help of any additional information that might clear the doubt (AICPA, 2010). If the auditor has considerable doubt about the going-concern stipulation for a reasonable period of time, then they may obtain the management's plan to mitigate the risk of such a happening and also evaluate the plans in term of its viability (AICPA, 2010). Once the auditor is certain of the doubts about the firm's ability to perform as a going-concern for a reasonable period then he may disclose the fact in his report along-with an explanation for their decisions (AICPA, 2010). The auditor does not have lay down any procedure or do any prior planning in order to evaluate the going-concern assumption (Roh, 2007). Rather they simply check for any issue that might raise questions on the going-concern ability during the course of audit (Roh, 2007). Such information generally includes the company's ability to meet the current obligations and maturing obligations without having to adopt any strategy such as selling assets, etc (Roh, 2007). These guidelines exempted the auditor of the responsibility of predicting the future conditions and events. The auditor just relied on the previous events and the current information. Auditing and Credit Crunch The world has recently gone through a serious financial turmoil. In 2001, record breaking 257 companies filed for bankruptcy (Venuti, 2009). Out of the 20 largest US companies, 12 filed for bankruptcy (Venuti, 2009). This was the first time in history. Historians and economists, call this recession one of the worst recessions the world has ever seen (Smart Pros Ltd, 2009). But what, astonishes most is the auditors inability to warn the world before it all happened (Roh, 2007). After all they were the ones who knew about the financial positions of any entity; their reports are the one that people refer to before investing. The 12 largest companies had received a clearance from the audit committees about any doubt to their going-concern status, out of the 257 companies that filed for bankruptcy only 48% had a paragraph to explain the doubt about their ability to continue as a going concern (Venuti, 2009). The SAS 59 lays down the guidelines for an auditor to assess the going-concern ability of the firm (AICPA, 2010). Some of the reasons for this are: Fear of the Auditor (Venuti, 2009) - Issuing a statement denying the going-concern ability of the entity itself might prove to be a self-fulfilling prophecy. Issuing such a statement may lower the opinion of the stockholders' and creditors' confidence in the company, the ratings of the company will fall and thus the debt will get downgraded, this will in turn lead to the inability of the company to raise capital to ensure its sustainability. Ethical Dilemma of the Auditor (Venuti, 2009)- If the firm is already in a financial distress, then the auditors' going-concern opinion will further damage it, the loan-officers will get more reluctant to extend a line of credit to that troubled company or else increase the rate of interest charged on that loan and thus making it sure that the company could not evolve out of that situation. Thus this puts the auditor in an ethical dilemma of whether to tell the truth or give the company a chance. Opinion Shopping (Smart Pros Ltd, 2009)- The appointment of the auditors is done by the management. They are the ones who decide the term and remuneration of these auditors. Then if the auditor raise doubts about the going-concern opinion, the management moves on to get the opinion of another auditor. This in turn invokes the fear in auditor in losing the future audit fees. Thus, forcing them to deliver a biased opinion. Cost-Benefit Analysis (Bonham, 2008)- It is difficult for an attorney to bring a successful suit against a company auditor after the Private Securities Litigation Reform Act, 1995. Even if the auditors were proved guilty then also the penalty was proportionately small. The cost of issuing a going-concern is much higher than the cost of not doing so. Thus, the auditor chooses rather not to issue an opinion. Lack of Knowledge (The Auditing Practices Board Limited, 2008)- one of the most important reasons is that the auditors' do not completely understand the concept. They are unable to make the right assumptions. Going Concern Assertion - Recent Developments The credit crunch has sent the going-concern principle for a toss. The reports of the previous year given by the auditors about the financial sustainability of these organizations have failed. A number of companies became bankrupt. Thus, leading to a huge financial loss. This was a major concern for the regulatory bodies all around the world (Financial Reporting Council, 2008). To tackle this situation the laws have been made more stringent with regards to the disclosure of the going-concern opinion. With the view to this situation, the International Auditing and Assurance Standards Board (IAASB) under the International Federation of Accountants (IFC) has released a new practice called the Audit Considerations in Respect of Going Concern in the Current Economic Environment (IAASB, 2009). This guideline encourages the auditor to check the sustainability of the organisation in the event of an economic downturn. It becomes difficult at the time of such an event to assess the going-concern opinion as even the financial sound or companies with easy availability of credit may find it difficult to raise money for their business (IAASB, 2009). If the auditor finds that the entity might not be able to exist in such a situation then he may probe into managements plan to deal with the situation and then evaluate it thoroughly to ensure its viability (IFAC, 2009). Further, the term for which the auditor must make the going-concern assertion has always been vague (Financial Reporting Council, 2008). The auditors have been simply using a period of twelve months to evaluate (Financial Reporting Council, 2008). This guideline also does not clearly states the exact period but it asks the auditor to consider the period which the management uses in its assessment (Accountancy Age, 2009). However, if the period is less than twelve months than the balance sheet date, then the auditor must ask the management to extend its assessment to twelve months from the balance sheet date (IAASB, 2009). The guideline has explicitly mentioned a list of events that might affect the going-concern assumption of an entity like, inability of a firm to meet its debt requirements, indications of creditors to reduce their support, inability to comply with capital and other statutory requirements or losing of a major customer, market, supplier, etc (IAASB, 2009). These conditions do not necessarily mean that the firm will cease to exist in the future but these issues are important for an auditor and the management to consider in order to provide a true picture in terms of sustainability (IFAC, 2009). The guideline also lays down the examples and guidance of auditors wording under different circumstances that may arise: Source: (IAASB, 2009) Conclusion The world has been recovering from a very serious financial problem. The auditors are being blamed for not been able to inform about the same earlier. But the main question which arises is: would it have helped, if they had given these companies, which are now bankrupt, an adverse going-concern opinion Wouldn't the market have fulfilled this prophecy However, the people have now learnt from their mistakes and tightened the policies in this respect. The next step now should be put these new guidelines to a test, to follow them rigorously and hope that the same situation would not arise again. Going-concern, indeed is a very basic assumption, but powerful nevertheless and the proper analysis of this assumption for every entity is required for a healthy economy. The auditors need to let go of their fears and greed and genuinely deal with this issue in each and every organization. Recommendations Most of the issues have been dealt in the new guidelines. However, some of the recommendations which i could come up with to enhance the assertion of going-concern by the auditor are: To issue laws in order to protect the rights of the auditor in terms of their fees. The auditors fear that if they give an adverse going-concern opinion then the management will go for opinion shopping and thus the auditor may lose the future fees. He must be able to get rid of this fear to provide an unbiased report. Provide extensive training to the auditors s that no place is left for misunderstanding in regards to the going-concern assertion. The ethical dilemma of the auditor should be resolved by confirming his report in discussion with other auditors and banks so they could get a clear picture about the company and thus deal accordingly. Bibliography Accountancy Age. (2009, January 21). Audit standard watchdog issues 'going concern' guidance. Retrieved February 17, 2010, from Accountancy Age: http://www.accountancyage.com/accountancyage/news/2234686/going-concern-anxiety-prompts AICPA. (2010). AUditing Standards. Retrieved February 17, 2010, from AICPA: http://www.aicpa.org/Professional+Resources/Accounting+and+Auditing/Authoritative+Standards/auditing_standards.htm Bonham, A. (2008, April 21). Current Audit issues: Going COncern. Technical News Archive . SWAT UK. Business Dictionary. (2010). going-concern principle definition. Retrieved February 17, 2010, from BusinessDictionary.com: http://www.businessdictionary.com/definition/going-concern-principle.html Financial Reporting Council. (2008). Challenges for audit committees arising from current economic conditions. London: Financial Reporting Council. IAASB. (2009). Audit Considerations in Respect of Going Concern in the Current Economic Environment. New York: IAASB. IFAC. (2009). IAASB Practice Alert Helps Auditors and Management Assess Impact of Credit Crisis on Going Concern Assumptions. New York: IFAC. Lawson, V. J. (2009). Auditing in Turbulent Economic Times. The CPA Journal , 34. Roh, T.-G. R.-Y. (2007). The Auditor's Going Concern Opinion Decision. International Journal of Business and Economics , 89-101. Smart Pros Ltd. (2009, January 26). IAASB: Impact of Credit Crisi on Going Concern Assumptions. Retrieved February 17, 2010, from SmartPros: http://accounting.smartpros.com/x64709.xml The Auditing Practices Board Limited. (2008). Audit issues when financial market conditions are difficult and credit facilities may be restricted. The Auditing Practices Board Limited. Venuti, E. K. (2009). The Going-Concern Assumption Revisited: Assessing a Company's Future Viability . The CPA Journal . Read More